Towards a Theory of Shadow Money

By Daniela Gabor, associate professor in economics at the University of the West of England, Bristol, and Jakob Vestergaard, senior researcher at the Danish Institute for International Studies. Originally published at the Institute for New Economic Thinking website

Struggles over shadow money today echo 19th century struggles over bank deposits.

Money, James Buchan once noted, “is diabolically hard to write about.” It has been described as a promise to pay, a social relation, frozen desire, memory, and fiction. Less daunted, Hyman Minsky was interested by promises of unknown and changing properties. “Shadow” promises would have fascinated him. Indeed, Perry Mehrling, Zoltan Pozsar, and others argue that in shadow banking, money begins where bank deposits end. Their insights are the starting point for the first paper of our Institute for New Economic Thinking project on shadow money. The footprint of shadow money, we argue,* extends well beyond opaque shadow banking, reaching into government bond markets and regulated banks. It radically changes central banking and the state’s relationship to money-issuing institutions.

Minsky famously quipped that everyone can create new money; the problem is to get it accepted as such by others. General acceptability relies on the strength of promises to exchange for proper money, money that settles debts. Banks’ special role in money creation, Victoria Chick reminds us, was sealed by states’ commitment that bank deposits would convert into state money (cash) at par. This social contract of convertibility materialized in bank regulation, lender of last resort, and deposit guarantees. But even money-proper is not the same for everyone. Central banks create the money in which banks pay each other, while private banks create money for households and firms. Money is hierarchical, and moneyness is a question of immediate convertibility without loss of value (at par exchange, on demand).

Using a money hierarchy lens, we define shadow money as repurchase agreements (repos), promises to pay backed by tradable collateral. It is the presence of collateral that confers shadow money its distinctiveness. Our approach advances the debate in several ways.

First, it allows us to establish a clear picture of modern money hierarchies. Repos are nearest to money-proper, stronger in their moneyness claims than other short-term shadow liabilities. Repos rose in money hierarchies as finance sidestepped the state, developing its own convertibility rules over the past 20 years. To convert shadow money into settlement money in case of default, repo lenders sell collateral. An intricate collateral valuation regime, consisting of haircuts, mark-to-market, and margin calls, maintains collateral’s exchange rate into (central) bank money.

Second, we put banks at the center of shadow-money creation. The growing shadow-money literature, however original in its insights, downplays banks’ activities in the shadows because its empirical terrain is U.S. shadow banking with its institutional peculiarities. There, hedge funds issue shadow money to institutional cash pools via the balance sheet of securities dealers. In Europe or China, it’s also banks issuing shadow money to other banks to fund capital market activities. LCH Clearnet SA, a pure shadow bank, offers a glimpse into this world. Like a bank, it backs money issuance with central bank (Banque de France) money. Unlike a bank, LCH Clearnet only issues shadow money.

Third, we explore the critical role of the state beyond simple guarantor of convertibility. Like bank money, shadow money relies on sovereign structures of authority and credit worthiness. Shadow money is mostly issued against government bond collateral, because liquid securities make repo convertibility easier and cheaper. The legal right to re-use (re-hypothecate) collateral allows various (shadow) banks to issue shadow money against the same government bond, which becomes akin to a base asset with “velocity.” Limits to velocity place demands on the state to issue debt, not because it needs cash but because shadow money issuers need collateral.

With finance ministries unresponsive to such demands, we note two points in the historical development of shadow money in the early 2000s. In the United States, persuasive lobbying exploited concerns that U.S. Treasury debt would fall to dangerously low levels to relax regulation on repos collateralized with asset and mortgage-backed securities. In Europe, the ECB used the mechanics of monetary policy implementation to the same end. When it lent reserves to banks via repos, the ECB used its collateral valuation practices to generate base-asset privileges for “periphery” government bonds, treating these as perfect substitutes for German government bonds, with the explicit intention of powering market liquidity.

Fourth, we introduce fundamental uncertainty in modern money creation. What makes repos money – at par exchange between “cash” and collateral – is what makes finance more fragile in a Minskyan sense. Knightian uncertainty bites harder and faster because convertibility depends on collateral-market liquidity.

The collateral valuation regime that makes repos increasingly acceptable ties securities-market liquidity into appetite for leverage. Here, Keynes’ concerns with the social benefits of private liquidity become relevant. Keynes voiced strong doubts about the idea of “the more liquidity the better” in stock markets (concerns now routinely voiced by central banks for securities markets). Liquid markets become more fragile, he argued, by giving investors the “illusion” that they can exit before prices turn against them. This is a crucial insight for crises of shadow money.

A promise backed by tradable collateral remains acceptable as long as lenders trust that collateral can be converted into settlement money at the agreed exchange rate. The need for liquidity may become systemic once collateral falls in market value, as repo issuers must provide additional collateral or cash to maintain at par. If forced to sell assets, collateral prices sink lower, creating a liquidity spiral. Converting shadow money is akin to climbing a ladder that is gradually sinking: The faster one climbs, the more it sinks.

Note that sovereign collateral does not always stop the sinking, outside the liquid world of U.S. Treasuries. Rather, states can be dragged down with their shadow-money issuing institutions. As Bank of England showed, when LCH Clearnet tightened the terms on which it would hold shadow money backed with Irish and Portuguese sovereign collateral, it made the sovereign debt crisis worse. Europe had its crisis of shadow money, less visible than the Lehman Brothers demise, but no less painful. “Whatever it takes” was a promise to save the “shadow” euro with a credible commitment to support sovereign collateral values.

Shadow money also constrains the macroeconomic policy options available to the state. That’s because what makes shadow liabilities money also greatly complicates its stabilization: it requires a radical re-think of many powerful ideas about money and central banking. The first point, persuasively made by Perry Mehrling, and more recently by Bank of England, is that central banks need a (well-designed) framework to backstop markets, not only institutions. Collateralized debt relationships can withstand a systemic need for liquidity if holders of shadow money are confident that collateral values will not drop sharply, forcing margin calls and fire sales. Yet such overt interventions raise serious moral hazard issues.

Less well understood is that central banks need to rethink lender of last resort. Their collateral framework can perversely destabilize shadow money. Central banks cannot mitigate convertibility risk for shadow money when they use the same fragile convertibility practices. Rather, central banks should lend unsecured or without seeking to preserve collateral parity.

We suggest that the state, as base-asset issuer, becomes a de facto shadow central bank. Its fiscal policy stance and debt management matter for the pace of (shadow) credit expansion and for financial stability. Yet, unlike the central bank, the state has no means to stabilize shadow money or protect itself from its fragility. It has to rely on its central bank, caught in turn between independence and shadow money (in)stability, which may require direct interventions in government bond markets.

The bigger task that follows from our analysis, is to define the social contract between the three key institutions involved in shadow money: the state as base collateral issuer, the central bank, and private finance. In the new FSB or Basel III provisions, we are witnessing a struggle over shadow money with many echoes from the long struggle over bank money. The more radical options, such as disentangling sovereign collateral from shadow money, were never contemplated in regulatory circles. Even a partial disentanglement has proven difficult because states depend on repo markets to support liquidity in government bond markets. Our next step, then, will be to map how the crisis has altered the contours of the state’s relation to the shadow money supply, comparing the cases of the U.S., the Eurozone, and China.

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  1. cnchal

    Financial anarchy is my interpretation of shadow banking.

    . . . The legal right to re-use (re-hypothecate) collateral allows various (shadow) banks to issue shadow money against the same government bond, which becomes akin to a base asset with “velocity.” Limits to velocity place demands on the state to issue debt, not because it needs cash but because shadow money issuers need collateral.
    The bigger task that follows from our analysis, is to define the social contract between the three key institutions involved in shadow money: the state as base collateral issuer, the central bank, and private finance.

    Who does shadow banking serve? It is so far from capitalism, it should be illegal.

    Bernie Sanders: The business of Wall Street is fraud and greed.

    1. Robert Coutinho

      Well…yes and no. There is real “need” for some shadow banking services. However, the idea of having Central Banks (issuers of money, or whatever) loaning based on … nothing?

      Less well understood is that central banks need to rethink lender of last resort. Their collateral framework can perversely destabilize shadow money. Central banks cannot mitigate convertibility risk for shadow money when they use the same fragile convertibility practices. Rather, central banks should lend unsecured or without seeking to preserve collateral parity.

      “Europe had its crisis of shadow money, less visible than the Lehman Brothers demise, but no less painful. “Whatever it takes” was a promise to save the “shadow” euro with a credible commitment to support sovereign collateral values.”

      Yes, but Lehman was not a taxing authority (although to be fair, Ireland were not money-issuing sources).

      I am having a hard time understanding all of this–but as far as I can tell, the authors are basically suggesting that sovereign governments should be backing up the shadow banking system. However, I have not seen them suggest any reason for it except that the entire house of cards could come falling down. Boo hoo for the banksters–tell them to do things out of the “shadows”.

  2. Jujeb

    Why is there a need for ‘shadow money’ in the first place?
    Afaik, banks create money when they loan and central banks(especially the Fed) issues the most secure assets, their securities, which are used as collateral.

  3. abynormal

    Thanks Yves for sharing Gabor…what a Mess! towards the end of 2012 the US shadow banking was said to be around 67 Trillion…did something get baked-in? 2014 the IMF has a much smaller ‘account’…(Japan being the worst laughing stock). the gaps are no small detail:

    The IMF’s latest Global Financial Stability Report analyzes the growth in shadow banking in recent years in both advanced and emerging market economies and the risks involved.

    According to the report, shadow banking amounts to between 15 and 25 trillion dollars in the United States, between 13.5 and 22.5 trillion in the euro area, and between 2.5 and 6 trillion in Japan—depending on the measure— and around 7 trillion in emerging markets. In emerging markets, its growth is outpacing that of the traditional banking system.

    1. Stephen Verchinski

      That sure seems a Rx for destabilizing the world currencies to precipitate a collapse. Track and publicize the visits of Congressmen and Senators to the BIS and COL to start. Why are they making these visits under cover? Who are they meeting with? Are they being prepared as to what to expect a deliberate world currency crash? . Our political elite are so beholden to the bankers to allow for the theft of the wealth of nations for unattainable expanding growth and skimming of millions. Is it possible in regard the corporate banks to have the strings attached on the use of shadow money at time of chartering or in the case of the do over at time of bankruptcy?. How is this done? I’d also like to know a good proposal for the private investment boutique banks. Have any bills at state and federal levels been proposed and if not, why not? What would the main sections of such a bill look like. Thanks.

  4. ke

    A derivative promise made by a Wall Street prostitute, ultimately contingent upon the ability to liquidate the very users of the instrument, with currency debasement, and war to restock.

    Paying people to buy stuff from others being paid to buy stuff, with the full faith and credit of dependent seniors in a collapsing actuarial ponzi, with nothing more than made for TV mercenaries, isn’t likely to end well.

    Craps, the bank moves to the next suckers, with nothing more than the promise of an exotic vacation, billed to someone else.

  5. Steve H.

    – Limits to velocity place demands on the state to issue debt, not because it needs cash but because shadow money issuers need collateral.

    There’s a dirty linchpin. Even if the diabolical multiplier from cnchal’s quote were removed, and the dollar was hard-pinned to a pound of silver to pay the sheriff with, infinite debt issuance can step in to the feed the hungry beast.

    Promises to pay kept mercenaries in line during the city-states. If you didn’t win you didn’t get paid. Unless you turned around and took your employers gold instead. Which is a bit like capturing the central banks.

    Still, debt can be put to good uses. Infrastructure, maybe. Basic necessities and health. ‘When the people are strong, the nation is strong.’ Instead, the gearing seem like the machine in Princess Bride, sucking time from peoples lives.

  6. Watt4Bob

    With regard to velocity;

    Ask any highway patrolman, the faster the speed limit, the worse the accidents.

    On the famed autobahns of Europe, the no speed limit means that when an accident occurs, the results are likely to be catastrophic.

    And I really love the observation that central banks need a mechanism to backstop the market.

    Reminds me of the main problem with the famous Vincent Black Shadow motorcycle, it could attain speeds close to 200 mph, but brake designs at the time didn’t work at those speeds, so as Hunter S. Thompson remarked;

    “If you rode the Black Shadow at top speed for any length of time, you would almost certainly die.”

    Wall $treet wants to go fast, the faster the better, but they haven’t got any brakes, and worse than that, we’re all along for the ride whether we like it or not.

    1. Jim Haygood

      Richard Thompson got it too:

      Oh, says Red Molly to James, “That’s a fine motorbike
      A girl could feel special on any such like”
      Says James to Red Molly, “My hat’s off to you
      It’s a Vincent Black Lightning, 1952”

      [James gets shot in a robbery]

      When she came to the hospital, there wasn’t much left
      He was running out of road, he was running out of breath
      But he smiled to see her cry
      And said I’ll give you my Vincent to ride

      Oh, he reached for her hand then he slipped her the keys
      He said, “I’ve got no further use for these
      I see angels on Ariels, in leather and chrome
      Swooping down from heaven to carry me home”

      And he gave her one last kiss and died
      And he gave her his Vincent to ride

      It was sorta like that when Bernanke handed J-Yel the keys to his QE penny farthing bike.

      1. Watt4Bob

        I’d flesh out that analogy a bit;

        The Bernanke and J-Yel witnessed the header that Greenspan took on that bike, and decided to leave it standing against the wall.

        When you consider the fact that neither of them could reach the pedals, let alone mount the thing and ride, that was probably a good idea.

  7. Chauncey Gardiner

    When did the central banks’ framework to backstop markets morph into an organized effort to push the value of repo collateral relentlessly upward forever?…

    What about increasing the relentless decline in the Velocity of Money by gradually increasing interest rates? Yes, that might be a catalyst to trigger a “liquidity spiral”. So what? We now have moral hazard in spades and at some point will have to cross the Rubicon, whether willingly or not.

    1. cnchal

      i am reading one of the links from the post titled “Regulating money creation after the crisis”, and it’s even worse than government approved fraud. I am only part way through it, but here is a gem.

      On page 10

      . . . Instead, OLA was designed to preserve the value of the assets of failed financial firms until they are liquidated, a worthy aim, but a very different one. At the same time, the Dodd-Frank Act has imposed significant new limitations on the government’s freestanding panic-fighting tools. These limitations, absent future congressional action, would render next to impossible the kind of aggressive government rescue operation that was staged during the recent crisis.

      Criminality and corruption is embedded at the top of the financial food chain, by law.

  8. Keith

    Before we complicate the issue, it is fairly obvious no one understands conventional money and it is one of the best kept secrets on the planet.

    Learn how normal money works and how its mismanagement has led to many of today’s problems.

    Banks create money out of nothing to allow you to buy things with loans and mortgages (fractional reserve banking).

    After years of lobbying the reserve required is often as good as nothing. Mortgages can be obtained with the reserve contained in the fee.

    After the financial crisis there were found to be £1.25 in reserves for every £100 issued on credit in the UK.

    Having no reserve shouldn’t be a problem with prudent lending.

    Creating money out of nothing is the service they really provide to let you spend your own future income now.

    They charge interest to cover their costs, for the risk involved and the service they provide.
    Your repayments in the future, pay back the money they created out of nothing.

    The asset bought covers them if you default, they will repossess it and sell it to recover the rest of the debt unpaid.

    At the end all is back to square one.

    The bank has received the interest for its service.

    You have paid for the asset you have bought plus the interest to the bank for its service of letting you use your own money from the future.

    Today’s massive debt load is all money borrowed from the future for things already bought.

    It can also go wrong another way, when banks lend into asset bubbles that collapse very quickly. The repossessed asset doesn’t cover the outstanding debt and money gets destroyed on the banks balance sheets.

    When banks lend in large amounts, on margin, into stock markets, the bust shreds their balance sheets (1929).

    When banks lend in large amounts on mortgages into housing markets, the bust shreds their balance sheets (2008).

    If banks don’t lend prudently you are in trouble.

    Then they developed securitisation …… oh dear (no need to lend prudently now).

    Housing booms and busts around the world …… oh dear.

    All that money borrowed from the future and already spent …… oh dear.

  9. susan the other

    This is so interesting. It seems to be approaching the subject that Wray speculated about a while back – that we should give central banks fiscal responsibility. Because otherwise a sovereign state has no control over its sovereign money? It seems to me that money itself becomes a rehypothecated asset by virtue of being invested over and over again – if it is well allocated and under good fiscal control all is well. If not we get the Great Recession. So let the state become the defacto shadow central bank so it had direct control of its own money. Instead of hanging on to the old gold standard mindset of top down management, why not think of people, not collateral, as the root of the system – the grass roots. How much money does a system – a sovereign country – need per person. And then establish a sovereign central bank to deal directly, bringing the shadows into the sunlight of fiscal control.

  10. JTHcPhee

    …and does anyone remember the triumph of the desk slaves of the Crimson Permanent Assurance? Monty Python understood something abou political economies and how one might achieve more fairness in outcomes…

  11. Paul Tioxon

    Moneyness, like doggitas, you just can’t scratch behind its ears. If shadow money is distinguished by its relationship to collateral, as opposed to money issued by the state, with the entire human enterprise of civilization as its basis, it still seems to me that at the top of the money hierarchy is fiat money, the real money by the real social order empowered by the social forms of power that sustain human life in all of its aspects, not just the financial conveniences. Shadow money sounds to me like fictional capital by another name. And contractual based deposits sounds like counterfeiting. With the distinction that the man with counterfeit printing press robs the train, while the man who runs the Wall St Investment bank repo trading desk robs the whole railroad. Am I right or Am I right. What a bunch of Losers!!!

    And if there is any doubt about the fictional quality of $Trillions and $ Trillions of dollars, physicists can not find anything naturally occurring in the universe beyond billions and billions. Money, simply a numbered record, a counting or cardinal number, transforms into money in name only, MINO, when it refers to fictional amount that can only appear contractually as words, and do not count how much economic activity or output has been produced.

    Therefore,Money becomes a victim of the ontological argument for God by St Anselm. If God does not exist, an all powerful, all knowing, all present infinitely great in all categories of Supreme Being could not be written or spoken about, lacking the quality of existence. The fact that we CAN speak about an Omnipotent Supreme Deity means that one in fact exists, due to existence is part and parcel of Omnipotence. But of course, because we can talk or write about something, does not make it real.

    It can become socially acceptable as in the case of shadow money, but it is fictional capital, a shadow of the real thing. Time to get out of the cave of finance with its shadows dancing from the light of the fires and walk eyes wide open in the bright light of sunshine!

  12. craazyman

    I don’t know about this one. It seems to me to be some pretty queasy thinking. It kind of wanders around in circles of confusion. “my existence led by confusion boats, mutiny from stern to bow”.

    That’s pretty funny somebody would say that money is diabolically hard to write about. That’s pretty funny.

    Money is actually the easiest thing to write about, because it’s formless energy. It’s not that the phenomenon is shadow money, it’s shadow assets.

    You have to be able to separate in your mind the ideas of 1) Quantity and 2) Form. That’s why economics is a mental disorder, because it doesn’t separate quantity and form. If you can’t or don’t, then yes, it’s diabolically hard to write about because you’re writing about two different things simultaneously without realizing it. Money is a quantity that is infinite and continuous, but form is an idea that is discontinuous and finite. People do what the forms tell them to do. The money is just like electricity that powers the animation of the forms. Repo is a form it’s not money. It’s existence results in a certain ordering of social relations, that’s also a form. But money is just the energy that makes the forms potent.

    The primary challenge is to come up with an ordered way of thinking about the forms themselves. That’s frankly not easy. The ideal would be to understand them in the manner in which Euclid understood geometrical ideas. If you can get the vision, then you can see all the possibilities for structure and ordered relationships. there’s really no triangle in reality and there’s no point and there’s no line and there’s no plane. They just made them up to approximate physical reality. Then they thought to themsevels “Holy shit! These ideas interrelated in an astounding range of symmetries and causations.” Then they became a lens or a framework through which physical reality was interpreted. But they didn’t confuse the idea of “number” with the idea of “triangle” or “circle”.

    Certainly in math the algebraic interpretation doesn’t rely completely on the geometrical interpretation. But if there is no geometrical interpretation and it’s only algebra, then so much is missing, so much is lost. I guess that’s why they used to call it “political economy” before the mental disorder fully usurped the power of perception and reasoning.

    1. Watt4Bob

      Certainly in math the algebraic interpretation doesn’t rely completely on the geometrical interpretation. But if there is no geometrical interpretation and it’s only algebra, then so much is missing, so much is lost.

      With that firmly in mind, I think it’s necessary to mention the fact that the “study” of “economics” relies on calculus, wherein we are introduced to the notion of change over time, volume, motion, acceleration, rates of change, vectors, etc.

      Algebra and geometry are, as you point out, obvious abstractions, but once you add volume motion, and rates of change, the models become very seductive, and it’s easy to see how one can be convinced that they are approaching an understanding of ‘reality’.

      The trouble is of course, that the egg-heads busy trying to describe economic “reality” with calculus, are, for the most part in the employ of savages who will forever cling to a simple arithmetic where their only interest is in “having it all”.

      Genius employed to make excuses for demented indifference.

  13. Jim Haygood

    ‘Central banks should lend unsecured … we suggest that the state, as base-asset issuer, becomes a de facto shadow central bank.’ — Daniela “Zsa Zsa” Gabor

    This statement desperately needs Walter Bagehot’s qualifications: “to solvent institutions” and “at a penalty rate.”

    Otherwise, we’re just talking about another squalid round of “TARP for Jamie,” as we peasants reach for our pitchforks.

    1. cnchal

      Bagehot, eh.

      It should however be pointed out that the idea of shadow banking is not remotely new. The concept was presaged well over a century ago by Walter Bagehot, the legendary English banker, essayist, and theorist. In 1873, Bagehot wrote Lombard Street: A Description of the Money Market, his canonical work on the money market and central banking. In it, he observed that the great London banks were accompanied by a parallel set of financial firms, known as “bill brokers,” which in many ways resembled modern-day securities dealers. Like today’s dealers, these bill-brokers financed themselves with borrowings that, Bagehot informs us, were “repayable at demand, or at very short notice.”

      Formally speaking these firms were not banks but to Bagehot they might as well be. “The London bill brokers,” he observes, “do much the same [as banks]. Indeed, they are only a special sort of bankers who allow daily interest on deposits, and who for most of their money give security [i.e., collateral]. But we have no concern now with these differences of detail.” At times, Bagehot is careful to note that the short-term obligations of bill-brokers were not technically deposits; he observes that the maturing of these liabilities “is not indeed a direct withdrawal of money on deposit,” although “its principal effect is identical.”

      Other times, however, Bagehot dispenses even with this distinction: “It was also most natural that the bill-brokers should become, more or less, bankers too, and should receive money on deposit without giving any security for it.” Here we have an unambiguous identification of the shadow banking phenomenon about 140 years ago.

  14. Bas

    it’s all been reduced to gambling with no meaningful value in “The House” to back it up. Money will disappear, like in Star Trek.

  15. fresno dan

    I would posit that there are two types of money
    A – money of the 0.001% – if they walk into a casino, real estate transaction, or any asset for that matter they can NOMINALLY lose money – in fact the 0.001% NEVER lose any of THEIR money, they just lose your money. All winnings, of anybody doing anything anywhere, belong to them.
    B – money of everybody else – this money nominally is yours to do with as you see fit, but it ALL belongs to the 0.001%. The collateral that backs it up is everything you earn and own and when necessary your, and your family’s, internal organs…

  16. Russell

    When a child first works they are told to save their money. That is about it. They eat candy because they are hungry. Their parents pay for the house the car, the school is just there.
    Count your money like this. The man counting bills pulls them towards himself.
    Don’t invest in stocks with money you can’t afford to lose.
    It is real money. Coins. Your brother steals it. You didn’t know you had to lock it up, or count it more than once a week. You go out of business. Go to work for the Boy Scouts.
    There are some songs about money and business. They are hard to find. You can dance to one of them.
    Oh, Money is one thing? Oh Currency is another? Look at the money they got for the Pet Rock. Think about Pet Rocks. Sell records? Yeah.
    Finally, get an accountant. Get a Lawyer. Give them money. They fill out forms and go and sit in court.
    Repo? The house is falling down, the roof is rotted off. It is in ruins. The currency out there competing with other currencies made shingles cheap, but labor was high.
    Just tear down the house.
    Move into a loft. Get used to sweating cinderblocks.
    Strike it rich on a Transformational wave before it is a fad. Get money from robots. Lobby for better robot treatment. Saturate the market with a robot that sings about money a tune everyone wants to dance to.
    Get out before everyone else makes a robot that dances and sings about money and will sleep with you.
    Compound interest. Money works. Yeah, Finance.
    Shadows? Oh, you went bankrupt. We understand. We’ll give you money. You understand. Pay more.
    Things go up. Things go down.
    No. You need it now.
    Go to the shadow lender and buy a house that is easy to move. That is your first house. When you move, take the house and sell the lot. Give the shadow a check.
    Accountant and Lawyer. 10 cents on the dollar for the lot. What house?
    Private money & Public Currency.
    In my hands or your hands it is just money. The people that make it live in another world.
    Look at the key that even David Bowie learned to turn. Bonds. Anybody can Make money now.

  17. Jamie

    “The nation [England] was not a penny poorer by the bursting of these soap bubbles of nominal money capital. All these securities actually represent nothing but accumulated claims, legal titles to future production. Their money or capital value either does not represent capital at all … or is determined independently of the real capital value they represent.”

    – Marx
    Banking Capital’s Component Parts
    Capital: Volume Three

    1. James Levy

      Marx is failing to acknowledge that supposedly hard-headed Capitalism is actually all about living beyond your means and mortgaging the future. It was designed from the Fuggars’ and the Medici’s to be about debt and fractional reserves and interest. A system based on a finite supply of money is going to grow not much faster, at best, than the money available allows. Capitalism allows explosive growth by supplying explosive amounts of credit. All this shadow banking activity is designed to get around reserve requirements; nothing else I can see calls all this complexity into existence. The banks always need more, because lending is how they make their money, so they want an infinite amount to lend in order to drive their profits towards the infinite.

  18. Sy Krass

    A sovereign can create its own currency, but theoretically couldn’t it create any currency? Couldn’t Greece for example click a few key boards put some ones and zeros in and say, “oh our account with $1,000,000 US is actually $10,000,000,000 US?


  19. financial matters

    This article I think defines shadow money alright as starting where bank deposits leave off but as the above comments suggest seems to miss some key points.

    I think a major problem with the article is seeing central banks as separate from the state rather than seeing the central bank along with the Treasury as the state itself.

    The article gets Treasury debt wrong by seeing it as the central bank funding the state rather than as actually coming from the state.

    This leads to wrong policy choices such as this state money being used to bail out useless financial transactions and asset appreciation rather than the public purpose.

    I think crazyman has it right. We left behind the power of perception and reasoning by not realizing the importance of political economy.

  20. ewmayer

    Some issues with the piece and questions for the authors (and fellow NCers):

    o I really wish such analyses would use the more-precise term “credit-money” in reference to money creation by banks, to distinguish it from government money creation, which similarly may have repayment requirements attached (bonds), but need not be so. The “need not be so” may occur via outright fiat emission, but more commonly appears in form of a public debt stock which continually increases with time, at least in nominal terms.

    o The legal right to re-use (re-hypothecate) collateral allows various (shadow) banks to issue shadow money against the same government bond, which becomes akin to a base asset with “velocity.”

    Fine, but what about that other crucial element of modern bank credit-money creation, leverage? Are there any practical limits on shadow banks’ issuance of multiple units of shadow money against the same government-bond money unit? If so, how are they enforced (if at all)? Note also the key concept of “implied leverage” inherent in such schemes, where the leverage ratio may fluctuate drastically with the mark-to-market valuation of the collateral. Banks play endless games with “fictional reserves”; it would be naive to imagine that non-bank shadow lenders don’t do similarly with their alleged collateral.

    o The first point, persuasively made by Perry Mehrling, and more recently by Bank of England, is that central banks need a (well-designed) framework to backstop markets, not only institutions.

    Erm, markets are the *only* thing the government should be committed to ensuring functioning of — we have overwhelming evidences from multiple boom-bust-crisis episodes over the last 3 decades of the toxic results of governments backstopping hyperleveraged fraud-riddled institutions and the crooks running same.

  21. RBHoughton

    The article says repos are money because their at par exchange between “cash” and collateral. And the authors note it makes finance more fragile.

    In the Repo world of snakes and ladders, we have arrived at the realisation of the position we have always been in – if governments are unable to maintain the value of their paper, there’s a long ladder.

    There seems to be no way of limiting the risks, indeed the moneymen move forward faster than the central bank / treasury, so we all keep dancing til the music stops.

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