The Year in Money

Yves here. I hate to differ with someone as astute as Perry Merhling, but I am wary of declarations like “Financial globalization is here to stay.” As Carmen Reinhart and Ken Rogoff ascertained, high levels of international capital flows are strongly correlated with more frequent and severe financial crises. And the backstop for financial systems remains, as Merhling acknowledges, nation states.

By Perry G. Mehrling, professor of economics at Barnard College. Originally published at his website

A 2017-end post with this title might be thought to focus on bitcoin, and I will indeed have something to say about that, but in my view the bitcoin bubble is mostly a symptom of deeper trends that need to be uncovered first.

Today money is global, so we can start pulling the string anywhere and eventually get the full picture, just by following the trail from any particular balance sheet, with its own assets and liabilities, to the counterparty balance sheets on both sides, and the counterparties of those counterparties, and so forth.  Notwithstanding the reality of financial globalization, politically the globe is still divided into separate nations, as we are reminded by this year’s rise of various nationalisms, all of them at least in part reacting to the reality of global money, so let’s start there.

Yu Yongding, in a remarkable essay for INET, draws our attention to “Imbalances in China’s International Payment System”.  Basically China has been borrowing private (FDI) and lending public (US Treasuries), both sides of its consolidated national balance sheet denominated largely in dollars, which is to say in global money.   There is nothing new in this per se, as it has been going on for a decade at least.  What is new is a recent shift in the lending side from official assets (held by the central bank) to nonofficial assets (held by private citizens or businesses), and subsequently some shift of those nonofficial assets out of China.  “To a large extent, [this development] reflects an unwinding of carry trades and capital flight.”

Yu does not say so explicitly, but we might concretely picture what is happening as China shifting from US Treasuries held by the central bank to US real estate held by private citizens.   The problem is that, whereas official holdings of US Treasuries can be used to pay off dollar denominated foreign debt, non-official holdings of US real estate cannot.  And whereas official holdings of US Treasuries could potentially be used to acquire higher yielding foreign assets as preparation for the demographic challenge facing China as a whole, non-official holdings of US real estate cannot.  “Capital account deficits caused by such activities cannot lead to increases in foreign assets and decrease in foreign liabilities.”

Meanwhile, as Zoltan Pozsar points out in a remarkable book of data he calls “Dollar Funding after the Storm”, global money markets have been through a transformation.  One dimension of that transformation is a shift from unsecured funding to secured funding; formerly the central rate for global dollar funding was LIBOR in the Eurodollar market, but now increasingly is the tri-party RP rate.  Another dimension of that transformation is a shift in the location of market-making from the balance sheets of global banks to the balance sheets of asset managers and broker-dealers of various sorts.   Arbitrage profits in the cross-currency basis swap, especially the dollar/yen swap, were the key incentives driving that institutional change at the global level.

Pozsar does not say so explicitly, but we might concretely picture what is happening as a shift of matched book market-making operations out of the banking system entirely, largely onto central clearing counterparties, coupled with a significant reduction in the balance sheet capacity for speculative book market-making operations.  The driving force for all this transformation has been the desire to “protect the taxpayer”, by raising the cost of market-making within the banking system.  The desire to avoid public loss exposure has focused attention on solvency more than liquidity, and on the national more than the global footprint of the system.  I conclude that the transformation of the system remains a work in progress, probably incomplete.  It remains to be seen to what extent we have yet succeeded in reconstructing a private market-making system that is able to absorb periodic shocks without collapsing onto the public dealer-of-last resort backstop.

The important point to hold onto, when reading both Yu and Pozsar, is that the capital market-based credit system that has arisen as the natural form of banking for a financially globalized world is here to stay.  Absent a global depression or world war, we are not going back to the national autarky of immediate post-WWII, any more than we are going back to the bank loan-based credit system that proved to be the natural form of banking for that world.  Financial globalization is here to stay.

Even more, the massive expansion of credit since the crisis, almost all of it in the emerging market economies and substantially denominated in dollars, suggests that financial globalization is now spreading on the extensive margin into every corner of the world.  It’s not just China, it’s everywhere.  Private firms are tapping global dollar funding markets, and central banks are accumulating global dollar reserves.  The visible face of financial regulation has focused on solvency, while leaving potential liquidity problems to national central banks, and their loose global system of liquidity support through regional reserve pooling and bi-lateral central bank swaps.

Against this background of reality, the bitcoin bubble points our attention to the central challenge of making financial globalization work, which is a political economic challenge more than a technical one.  The bitcoin bubble is a symptom of that challenge, insofar as it arises from deep distrust of both states and banks.  The crypto dream is of a world without governments or financial intermediaries, a radically decentralized and non-hierarchical world in which each individual interacts with each individual directly, those interactions being facilitated by computers and code.  Put simply, trust in bitcoin is a measure of distrust in traditional authority, both public and private.

Can bitcoin replace the dollar?  I have already weighed in negatively on that score, and I have not changed my mind.  My opinion on that point was almost entirely based on my understanding of how monetary systems work, which is to say the economics of payment systems and the economics market-making.  In both, credit is completely central, a feature not a bug, and hence impossible to eliminate.  The inherent instability of credit is therefore also a feature, of the market-based credit system just as much as the loan-based credit system.  What is needed is not bitcoin but rather management, both private and public management, and that’s where the problem lies because a prerequisite of management is legitimate authority.

Let us stipulate that we have succeeded in putting in place the foundations of a new global monetary system.  The problem of re-establishing the legitimacy of authority remains.

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  1. cojo

    I am wary of declarations like “Financial globalization is here to stay.”

    I think this belief is predicated on one’s definition of global. Through out human history, “global” was defined by multi-polar powers/empires interlinked by geography and trade routes. Numerous times through history one power/empire (Babylonian, Roman, Persian, Mongol, Arab, Ottoman, British, American) may have had a disproportionate influence on global trade, but I think overall, we as a race have acted “globally” for as long as civilizations have existed through the trade/exchange of goods and ideas.

    1. Thuto

      “Global/ized” these days is a proxy catchall moniker for any trend applicable to industrialized economies, some asian tigers/asean member countries, brics countries and some warsaw pact countries. In a world of 195 countries, a trend only has to envelop the aforementioned countries and regions before pundits start using the word “global” to describe it. Malawi, Peru, Nepal et al don’t factor into it…

  2. Wukchumni

    Too much typing has been wasted on the subject of Bitcoin, but a bit of overkill never hurt anybody…

    In a way, Bitcoin and others of it’s ilk are messianic, in that they are god-like money that one has to take on faith, as there is strictly no there there, despite every article i’ve read in regards to, that always has an image of a metallic coin displayed symbolizing it, funny that.

    The claim is, that 95% of the gold resources in California is still in the ground, is there any way to monetize it’s value w/o going through the dirty work of finding and extracting it?

    1. Jfree

      From an economic perspective, the value of money was that it was actual surplus. That’s when Say’s Law works – an existing thing is demanded for consumption or it is demanded for savings. Monetizing something before it exists/known just introduces the same risks as credit – that the future cannot possibly be as known as the present – and when that disconnect gets significant you get a financial crisis or a business cycle

  3. Jim Haygood

    ‘Can bitcoin replace the dollar? I have already weighed in negatively on that score, and I have not changed my mind.’

    Gresham’s law asserts that bad money (fiat dollars) drives out good (bitcoin). The two will soldier on in parallel, with depreciating dollars treated as hot potatoes to be unloaded onto hapless workers and vendors, while non-inflationary bitcoin will be hoarded like gold as a hedge against the increasingly desperate and insane behavior of the authorities.

    US sanctions against bête noire nations and individuals are the most effective tool ever invented to destroy dollar hegemony — another desperate and insane action of an empire in its dotage, ripe for replacement.

    1. david lamy

      Gresham’s law asserts that bad money (fiat dollars) drives out good (bitcoin)

      Umm, so utility companies should take bitcoin in lieu of dollars or yuan?

    2. Wukchumni

      Seeing as it costs 9 cents to mint a nickel and 16 cents to print a $100.00 banknote, which physical money is bad and which one is good, if Gresham were around to render his judgement?

  4. Perry Mehrling

    To prevent misunderstanding, let me assert that when I say “financial globalization is here to stay”, I am imagining that somehow we will avoid global economic collapse (as Great Depression) or global war (as WWI and WWII). Which is to say that I am imagining we will find a way to make financial globalization work, since I think of Depression and World War as a essentially consequences of previous failure to make financial globalization work. Can we do it? Dunno, but I hope so. That’s the challenge in front of us, anyway.


    1. lyman alpha blob

      If financial globalization is here to stay, then when to we get one global currency?

      If we don’t, then I don’t believe financial globalization will be with us in the long term.

      This financial globalization is exploitative. It only works for the finance sector if they can turn a profit and that only happens when they are able to exploit some sort of assymetry between nation states, for example differently valued currencies or different labor costs.

      People are catching on which would be my guess as to why the trust in governments and banks is tanking. They know they are being taken for a ride by the neoliberal priests preaching the inevitability of globalization.

      If globalization in general is here to stay (and I’m not so sanguine- climate change may have something to say about that), and we are truly one connected world, then the exploitation has to stop. We simply cannot have a globalized world constructed merely so the elites can prey on more people than just those in their own nation-states.

      For all the scifi fans out there, I’ll recommend this book which contains a lot of political and economic discussion: The author is a Renaissance historian and not an economist, but that probably just makes her ideas better ;)
      It posits a truly globalized world with a new economic system after nation states have been rendered obsolete by the future equivalent of Uber (not sure I buy that particular bit, but Palmer has a lot of interesting ideas). Rather than being born into a system, people are free to chose which larger group they’d like to join when reaching adulthood.

      1. cojo

        You don’t need a one world currency (a bad idea if you ask any southern European tied to the Euro) but you do need central bank cooperation and collaboration, especially in times of crisis. I think the main concerns about a globalized “New World Order” are really, more political than they are monetary. This concern goes back to a previous time as mentioned by Perry Mehrling, when we had a breakdown in the globalization of the past during the interwar period leading up to World War II. This was apparently a topic of debate between H.G. Wells and George Orwell at the time.

    2. jsn

      Thanks for clarifying!

      Behind “legitimacy of authority” stand always those with guns. The credit relationship works because some “legitimate” authority somewhere enforces contracts.

      The market utopians who imagine the global capital structure having some kind of staying power ignore that force cannot be legitimate originating in an organization that can fire people. A society includes its cultural capital and all the humans engaged with it, a market entity requires the backing of society to exist at all: people created markets, not the other way around. Those market entities that can fire non-performing people will never have the legitimacy to enforce contracts, they best they can hope for is to be a sturdy mafia.

      Some authority that can command allegiance independent of income, that is an authority that sees its remit as society as a whole rather than the market and making money, will always be necessary in order for markets to exist. The great struggle of the market utopians at present is to try to engineer their way out of this bind, which they can’t without forming above themselves some legitimate authority.

    3. hemeantwell

      Perhaps I’m not understanding equivalent terms, but can someone address how this shift impacts on the question of committed vs. speculative, “hot flow” investment? It seems like what is being described is a twist on the development Yves discussed in Econned. In the book, banks have less and less skin in the game and are only interested in profiting from deal-making and other kinds of highly liquid machinations that have little to nothing to do with producing exchange value linked to useful objects, however broadly understood. If, as the article contends, asset managers are taking over from banks, how would this affect the tendency for M –> M1 to reign supreme. Would their preferences favor “real” value generation? Would their efforts to get governments to back them up bring gov’t in closer proximity to “real” investment decisions? Could this be leveraged to social democratic ends, i.e. what Obama didn’t do? Or would it just be another form of the “state capitalism” we have now, as in capitalism free to profit with the state blank-checking it?

    4. rd

      Before WW II occurred, WW I was know as the “War to End All Wars” since they couldn’t imagine in the 1920s and early ’30s that governments would double-down on the colossal stupidity of WW I. But they did more than double-down and ended up with something even more horrific. So I am always cautious about thinking that experience will make us wiser.

      Brexit, Trump, and Macron are harbingers of the destabilization and tribalism that large scale inequality can cause while the 2008 financial crisis was an indicator that massive destabilizing greed is an inherent human property. Surprisingly, the outcome of 2008 was not a Pecora Commission and Glass-Steagal Act, but a Rube-Goldberg set of rules constructed that has quickly devolved into a de-regulatory desire to return to a pre-1933 financial system.

      So a sane person looks at nuclear weapons and financial weapons of mass destruction can can’t imagine them ever being used, but it is not clear that it is the sane people actually running the asylum. We came close to global financial meltdown in 2008, a little too close for my comfort in believing that the people running the show are actually running the show.

      1. Peter Phillips

        RD, to your point that “it is not clear that it is the sane people actually running the asylum”, we have the manchild in the White House today asserting in the Twittersphere that “My Nuclear Holocaust is bigger than yours!”, in reply to the other manchild, Kim Jong-un asserting that he always has his big red button within arms reach.

        With that degree of irrationality on clear display from our “world leaders”, maybe the next “global meltdown” wont play out around “hot money” and poor Barron will never get to play outside daddy’s nuclear bunker.

        I hope for humanity’s sake I’m way off the mark.

  5. Chauncey Gardiner

    With money, Perception is Reality. The dominant perception globally, a continuing legacy of the financial collapse in 2008-09 and the damage done to ordinary people in nations around the world, is that supranational institutions like the ECB and IMF; central banks; those who control national governments; and large privately owned transnational banks, cannot be trusted to implement policies that optimize the public welfare in a debt-based global monetary system. The proceeds of looting nations and the general public, whether through targeted predation or speculation, without fear of imprisonment, are simply too great. Once lost, trust is very difficult to re-establish.

    Accordingly, we are seeing the emergence of alternatives like bitcoin, the re-emergence and growth of collateral-based short-term funding mechanisms, an effort by nations like China and Russia to reinstitute a place in the system for gold-backed sovereign money and to enable the Chinese yuan to be used in payment for crude oil purchases, and capital flight into what are perceived to be stores of value such as real estate.

    As Perry Mehrling alludes, and the old Chinese curse goes, “May you live in interesting times.”

  6. csissoko

    I discuss the problems with this “new global monetary system” in this paper: (Ungated version:

    I write: “It is after all far from clear that financial stability is a reasonable goal in a world where the banks originating and trading assets are not incentivized to originate and trade high-quality assets and where it is common for money market instruments to be backed by capital market assets.” The latter is a reference to the bubble-bust price dynamic observed when capital market assets are financed by repos, e.g. by Adrian and Shin:

  7. Steven

    Notwithstanding the reality of financial globalization, politically the globe is still divided into separate nations, as we are reminded by this year’s rise of various nationalisms, all of them at least in part reacting to the reality of global money, so let’s start there.

    This sounds like propaganda for the US dollar-based international monetary system – the system that is going to allow Trump and his 0.001% buddies to add $1.5 trillion to the existing $20 trillion US government debt over the next ten years, the system that the US has been abusing to punish recalcitrant nations which don’t want to be a part of the U.S. Empire of Debt, the system with the “exorbitant privilege” of creating money out of thin air and using it to buy up the world’s real wealth or bomb nations whose leadership won’t go along with the plan back to the stone age.

    And the US does this because it can; because “it’s our money but your problem”. Isn’t financial globalization wonderful! Look at how much peace and prosperity it has brought to the world.

  8. VietnamVet

    The nation state evolved as a reaction to free market capitalism. The state provides the order that markets need to operate. The nation is human society. Although Bill Clinton’s said, “The era of big government is over”; in fact, the USA is a corporate led hegemon with a mercenary army with one aim; making more money for the global connected.

    At the same time the media is silent on the fracturing of the human bedrock that makes the nation state. The biggest winners in Donald Trump’s tax overhaul is the liquor industry which will see sales increase with the cut in alcohol excise taxes. This will accelerate intoxication, illness and death. Americans are already under siege with offshoring, the opioid crisis and the defunding of the public health system. The incompetence is astonishing. The establishment just doesn’t get it. If the coming war with Iran, North Korea, Russia or China doesn’t get them, the drunken masses crashing into their gated communities will.

    1. JBird

      The nation state evolved as a reaction to free market capitalism. The state provides the order that markets need to operate. The nation is human society.

      Capitalism started at almost the same time with (I think the Dutch first, the English second, then everyone else) the legal framework of the nation-state established with the Treaty of Westphalia ending the Thirty Years War. Said war being worse for the then Germanies than both world wars combined. For example ½ of the male German population died. Which is why the nation-state rather than empire became the new regime and also why wars of religion stopped in the West, or at least using them as an excuse to start a war.

      Now the business interests of the capitalist system did pushed the Western powers to create empires and colonize much of the planet. This modern consuming of the economies of whole states and later some empires has been happening since the Dutch Republic was created.

  9. JBird

    I use to work in International shipping and there it was pointed out to me that international shipping collapsed in 1914 and did get back to pre 1914 levels until sometime around 2000. So, at best, eighty years before recovery, and I bet that the economic damage was both the caused of the intervening years of fun and caused by the fun it. A feedback loop.

    So when I hear of this or that system is here to stay, I get a flashback to those stories printed just before August of 1914, especially when they refer to how we depend on each other too much and that the Powers That Be will keep it going.

    It’s like they have not read any history.

    1. Andrew Dodds

      Indeed, the UK and Germany were each other’s largest trading partners in 1914. The modern analogy being the US and China..

      Luckily it’s not like China is building a fleet to challenge US naval dominance.. or has multiple territorial squabbles with neighbors.. or a need to use external threats to stifle internal dissent..

  10. ebbflows

    Gresham was alluding to the human tool user problem [psychology – sociology] acerbated by corruption and not quantity.

    Mister Haygood forgets his history or clouds it with preference e.g. the QTM under the bimetallism standard did nothing to stop the GD. Currency is just a means of exchange, contracts on the other hand need to be properly collateralized and underwritten.

    Furthermore at this moment one could reasonably argue that were entering another free banking period, shades of the 1800s. Most of the credit issuance is not occurring in the traditional banking sector, the shadow sector is manifold it, then you have all and sundry lenders all over the web, not to mention investor driven sub prime and 5K level app loans.

    Then we get to crypto, an Ideology wrapped in code and tech. Many proponents of crypto have deep feelings about RE price inflation, and unearned income, though curiously are quite adamant about earning the inflation on a non asset or non yielding bit of notional price, that is quite susceptible to big players moves in increasing or decreasing the notional value e.g. it has zero fundamentals to it. More importantly – has squat to do with socially productive enterprise.

    Having noted all that one might ask after decades of wage stagnation or deflation, falling worker rights [in some cases actual theft of wages (2B last look)], w/ increased outlays [pay as you go] and attendant crapification of goods and services, one has to question the money crankery view considering wages set the floor under all of it.

    Last I remember the QTM camp is the same that forwarded the wage inflation hysteria along with taxes are theft memes, but yeah fiat did it, banks did it, et al. Something about self fulfilling prophecy, only that the proponents have cornucopia of demons to pin reoccurring failure on.

  11. Sound of the Suburbs

    The West set its heart on a financialised globalisation and its fate was sealed.

    No one understood the basics of the monetary system, where money comes from or how banks work.

    2008 – “How did that happen?”

    They didn’t realise that the monetary system relied on prudent lending and loans being paid back. They allowed securitisation where bad loans could enter the system and be bundled up into securities, e.g. NINJA mortgages and sub-prime auto loans.

    They didn’t realise that the money supply is effectively generated from bank loans.

    The money supply ≈ public debt + private debt

    They allowed financial liberalisation and national economies went haywire as the money supply grew unsustainably through debt fuelled real estate booms.

    M3 is going exponential, an unsustainable credit bubble is underway (debt ≈ money)

    They didn’t realise that banks created money and it is very important where that freshly created money is directed.

    The three types of lending:

    1) Into business and industry – gives a good return in GDP and doesn’t lead to inflation
    2) To consumers – leads to consumer price inflation
    3) Into real estate and financial speculation – leads to asset price inflation and gives a poor return in GDP and shows up in the graph of debt-to-GDP

    Richard Werner explains in 15 mins:


    1929 and 2008 stick out like sore thumbs.


    This real estate and financial speculation fuelled economy always was on a one way trip to a financial

    Before releasing the power of finance, get a good grip on the basics of how the system works.

    Oh well, it’s too late now.

    1. Sound of the Suburbs

      The West’s “new normal” of “secular stagnation” is Japan’s “old normal” of “secular stagnation”

      Richard Koo knew what would happen in 2008.

      It wasn’t hard.

      2008 – “How did that happen?” the chocolate teapots, aka mainstream, neoclassical economists.

      The West went through its Minsky Moment in 2008 as Japan had done at the end of the 1980s.

      The West’s “new normal” of secular stagnation” is Japan’s “old normal” of “secular stagnation”.

      Richard Koo has had twenty years to study it ……

      The neoliberal revolution bought spending power forward from the future to bring prosperity into today. We are now in the future we took that spending power and prosperity from, its repayment time.

      The problems leading to 2008 were caused by the build up of private debt in the economy.
      The problems since have been caused by the repayments on that private debt.

      Just like Japan.

      Our mainstream, neoclassical economists don’t even consider private debt and are going to be about as much use as a chocolate teapot.

      Adair Turner has looked at Japan’s very slow recovery and seen the massive public debt that built up solving the private debt problem.

      He has moved on to come up with a better and faster solution.

  12. Scott

    Marx is right that you want Industrial Service Banking.
    Michael Hudson is right about all of it now.
    Grotius was right in 425 BC, you are more likely to go to war with those you do business with, than those you don’t.

    That is why the Cold War worked as much a MAD.
    Globalization meaning business with everybody all the
    Time, implies more of Econ Wars by parasitical pirates
    independent of nation state wars, and constant terror.

    If Bitcoin is so great, gold is better.

    What system would prevent war?
    Goals matter and now the goal of the
    Banks is to take control of territory & Assets,
    as is the Great Greece lesson.

    Why hasn’t Putin offered to pay for Territory he

    A US Treasury whose power is denied
    The States is the Set up for Finance to
    Treat states as Greece & Puerto Rico
    Are Treated.

    US Governors need to lead legislators to tax properly
    Instead of Bonding themselves to death.

    Everybody here has written some great comments.
    What is the International System that would prevent
    War? I hazard a guess thinking some world leaders
    Need to speak to the bankers about their priorities
    & Goals. The System existing only to take territory.

    What happened to the SetlCoin?

    If the Banks & the Bankers are more
    about tricking & trapping nation states
    Than building up nations &
    all the cash is carried to secret accounts
    In Jets to do nothing for anyone but
    Make the rich able to simply buy up
    all the land everywhere and jack up the
    rent so 25 percent are always refugees,
    it is a Dystopia the bankers want, right?
    Basically it is about Goals isn’t it?
    If the goal is Dystopia you can have that,
    & if the goal is Utopia, you can have that.

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