Today’s Izabella Kaminska post on FT’s Alphaville is interesting, important and rightly pointing deep questions about modern monetary systems and the economic theories underpinning it. It starts by referring Martin Wolf’s article about the way modern money is created, with the excellent FT’s commentator and columnist defense of endogenous theory of money.
But Izabella displays nicely her criticism of that defense. I found quite interesting the notion that money is a kind of credit today of which the backing isn’t necessarily today’s collateral but future returns on investment, and that is what makes possible that deposits in the Banking system act as part of the money supply and is simultaneously a liability and a form of Equity to banks’ Balance Sheet.
Here the main part:
”If Wolf is right, then financial instability is very likely a product of the system’s tendency to take the private money issuance power of banks for granted. In reality, this power is thrust upon banks by system participants and can be easily compromised if these institutions prove unreliable at matching trusted liabilities with projected assets which don’t exist yet.
A great deal of the instability is so related to public misunderstanding about what bank money really is, namely imitation electronic cash which does a good job of mimicking state cash, the only safe source of purchasing power in a developed economy with a competent central bank. As FT Alphaville has stated before, that means unproven private liabilities get entangled with sovereign liabilities, making them impossible to differentiate or to value on individual terms, a fact which ultimately leaves the state on the hook for guaranteeing them even though it was not the state which was responsible for creating them.
The problem for financial stability comes about if, when the private issuance power of banks fails, there isn’t a more trusted authority that can step in to guarantee those liabilities directly — and equally so, if there is such an authority but they are unwilling to take on those private liabilities due to price stability fears. ”
All of this is after justified and put in the perspective that Central Banks are at the same time today with huge power in the System, for theirs is main job of guaranteeing stability, but also to assure that the main functions of Money are well established, like for example as a medium of exchange in a world of Fiat Money, but also with huge responsibility of getting the proper understanding the fundamentals of the Economy right, if they are to accomplish their mandates and goals. For the sake of us all and the credibility of the system.
We then expect further on this, for all the good reasons and not least for forming our own mature position as regards the ”who’s in the right” challenge posed by Kaminska, along the way witnessing her doubts and double Mind on Wolf’s pessimistic stance being definitely cleared…:
” In Wolf’s opinion towards the argument for eliminating of private money outright:
Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.
This, as it happens, is where we respectfully agree but disagree at the same time with our esteemed colleague. But we’ll expand more on why that is in our next post.”