By way of David Andolfatto's comment on my earlier post on safe assets, I stumbled onto a talk by John Moore and Nobuhiro Kiyotaki called Evil is the Root of All Money, which in turn invokes a 1978 paper by Antoin Murphy called Money in an Economy Without Banks: The Case of Ireland (pdf link). For anyone interested in the conjunction of history of economic thought and economic history, Murphy is a great resource. I definitely suggest his The Genesis of Macroeconomics.
Murphy's paper describes an interesting episode in Irish financial history. From May 1 to November 17, 1970, all banks in Ireland went on strike. This meant that Irish bank deposits were indefinitely frozen. Despite being deprived of a large chunk of their safe and liquid assets, the Irish populace managed to soldier on with little economic difficulty—according to Murphy, retail sales were barely affected by the bank closures.
Ireland filled the void vacated by frozen deposits by using uncleared cheques as a circulating medium. Cheques are normally accepted with the intention of quickly cashing or depositing them. During the strike, an Irish family could now sign and spend a cheque at the grocer for food, and the grocer in turn could pass off that family's cheque to the local pub for a beer, who in turn was free to spend it onwards. Thus cheques boomeranged around the economy, even though they could not be cleared and no one knew when the banking system would reopen.
The genius of this system is that it resorted to an unused asset to create the new circulating medium: personal credit. Says Murphy:
In a normal banking system cheques are readily acceptable because it is believed that they are drawn against known accounts and will be cleared quickly. During the bank disputes they were drawn, not against known credit accounts or allowed overdraft limits, but against the value of other uncleared cheques and/or the transactor’s view as to his creditworthiness.The tight-knit nature of Irish society allowed for an informal credit-rating network which, according to Murphy, was underpinned by Irish public houses. At the time, there was one pub for every 190 adults. The information that various retail outlets had about their customers allowed them to verify the ability of individuals to stand by their credit. This system had a degree of sophistication, since cheques were not universally accepted but rather were graded by risk.
This illustrates one of the ideas that I was (perhaps ineptly) trying to explain in my previous post. Just as the Irish quickly fabricated safe and liquid assets when their existing ones disappeared, wouldn't a modern shortage of safe assets be remedied in a few weeks, maybe months? What is blocking the same set of powerful market forces that quickly resupplied the Ireland with safe assets from operating today? Won't a rise in existing safe asset prices provide the economy with the desired level of safety? An excess demand for safe assets just doesn't sound like it can be a chronic problem to me.
In any case, give the Murphy paper a read. It has some gems in it.
Why can't more safe assets be created? I expressed a similar view on David Beckworths blog (on a post on which you also commented) here: http://macromarketmusings.blogspot.com/2013/01/resolving-safe-asset-shortage-problem.html?showComment=1358180148614#c6390727789866873241
ReplyDeleteOn thinking about it, I came to the conclusion that risk is now so widespread and returns are so low that it simply is not viable to produce safe assets (eg by repo or tranching) that can return more than money (ie a zero nomimal return).
In other words, never-ending easing is underpinning the liquidity trap; we need more liquidation.
I saw that and actually linked to your comment in my previous post.
DeleteEven if returns are low and risk widespread, we've got record corporate bond issuance. We've got to distinguish between a change in tastes for assets (which has surely occurred) and the idea that this change cannot - or hasn't already - been accommodated by the market.
I can't believe I missed that post! Thanks for the mention. I guess I must be a dummy too.
DeleteI was interested to note that Diego Espinosa made a comment consistent with my liquidation point above: http://jpkoning.blogspot.com/2013/01/i-must-be-dummy-for-not-understanding.html?showComment=1358784243503#c5701329798537216397
The reason it worked in Ireland is exactly because it is "a tight-knit society". If people know and trust each other you actually do not need safety assets. In fact, you do not even need money, which,incidentally, is what the paper "Evil is the root of all money" says. The other reason you may not need safety assets is when you do not need to save and that can happen when you do not need to store resources because things are free. That may actually happen in our generation future if technology continues to progress at this pace.
ReplyDeleteAnton, thanks for your comment. I suppose that when people know and trust each other, the asset they are transferring is their word, not an actual formal paper or electronic title. But it's still a safe asset.
DeleteIf you're interested, we had an good debate on the "Evil is the root of all money" idea once before. See here and here.
jp - since there was no quantity of money, it couldnt have had any impact on the price level, output, employment etc, no?
ReplyDeleteThere were still circulating Bank of England notes and coin.
DeleteIf the Irish hadn't found liquid substitutes for deposits, then notes and coin would have had to do far more "work". What would have likely happened in that scenario is a rise in the value of notes & coin... ie. a fall in prices, combined with a slowdown in output/employment. Using uncleared cheques prevented notes and coin from taking the brunt of people's demand for liquidity.
JP,
ReplyDeleteNo one denies that the private sector creates money as it is needed. In fact, the private sector goes to great lengths in manufacturing "safe" (informationally insensitive) financial instruments that help facilitate intertemporal trade.
The AAA rated tranches of MBS up until recently are an example of this (the manner in which they were used as collateral in repo arrangements). It all worked pretty well...for a while. But that's really not the point now, is it?
David,
DeleteOne reason I found the Ireland story interesting is because the market spontaneously switched to using unsecured credit, which is commonly supposed to be inferior to secured credit. Market's seem to provide the necessary assets very quickly.
Maybe modern markets take time to make the switch to unsecured credit. So in the meantime they turn to treasuries. But where's the problem? One thing about t-bonds is that we don't need to fabricate more of them to meet our demands for safety... we just need a higher real value on the stock of existing t-bonds. This can be entirely met by shifts in prices. Thus, the demand for safety is satisfied. Maybe we experience problems if we hit the zero lower bound, but this doesn't seem to be a part of your story.