Saturday, March 17, 2012

Money as a liability

Nick Rowe has posts here and here that explain why money is not a liability. This is related to his point that  money is not a store-of-value.

I have several comments on each thread.

In short, I disagree with him. If you do the security analysis, central bank issued notes and deposits are unsecured senior perpetual liabilities with a limited floating conversion feature attached to them. Most people don't perceive them as such because in the normal course of life they only experience these liabilities as pure means-of-exchange. Only those individual's with a banker or investor's mentality treat central bank issued notes and deposits. Either way works - what is interesting is how these two mentalities weave together to create an integrated store-of-value and medium-of-exchange approach to understanding money.

Nick also tries to re-conceptualize central bank issued money as put options. This money can be "putted" for CPI. I like this idea. Because I see central bank issued notes and deposits as liabilities, I prefer the analogy to convertible bonds. Convertibility is really just an option feature added on to a liability like a bond, deposit, or note. How does this convertibility work?  The Bank of Canada, for instance, will conduct sale and repurchase operations (SRAs) - selling bonds for cash - should the overnight fall below its target. Banks have the option in this case to convert their deposits into the underlying. This is a floating rate because over time the Bank will change the note-to-bond conversion price.


  1. JP, what is your opinion of US coins. Here's what I understand: they are minted by the US Mint (part of Tsy) and sold to the Fed at face value (the Mint loses money on pennies and nickles, BTW.. so a negative seigniorage on those two?).

    Now technically I understand that even though they have their face value from the day they are minted, they are not actually considered money until they are on their way to the Fed.

    But, my real question is are coins thus an asset to all parties? Mint, Fed, banks, non-banks, Tsy, etc?

    I searched for an answer, but did not find it. Now there is another item of currency that I thought would be accounted in a similar manner: namely US notes. US notes are paper money that was issued directly by Tsy (from what I understand). They were last put in circulation in 1971, but they are still considered to be legal tender and a form of currency. They have been supplanted, of course, completely by paper reserve notes, which are purchased by the Fed from the BEP (also part of Tsy) for production cost, but then sold to the banks at face value and entered onto the Fed's balance sheet as liabilities once they go out the door to the banks.

    OK, but back to US notes: They are counted as a liability on the Tsy's balance sheet, but a liability in a special category which does NOT contribute to the debt ceiling. I thought I'd find in this same document something about coins, but I didn't. Well, actually, I was arguing that coins are NOT a liability to Tsy in the usual sense (nor are US notes apparently). But I still don't know how coins are accounted for. Do you know?

    Cullen thinks they have to be some kind of liability to the Tsy. I think it's possible they could just be an asset to everyone. JKH at propsed that they were really a "contingent liability" of the Tsy, which he described in a satisfying way: it sounds like an off-balance sheet liability in that the Tsy is obligated to accept them as payment and to exchange them for undamaged coins, but they don't appear on a balance sheet and thus are not liabilities in the usual sense. I liked this concept, but I could not find any reference for the phrase "contingent liability" anywhere except in comments or articles by JKH.

    Any light you could shed on this would be much appreciated. Thanks!

    1. I believe that a coin is an asset to whomever happens to be holding it. As far as I can tell there is no record of an offsetting "coin liability" on any balance sheet, at least not up here in Canada. Perhaps a coin should be recognized like a toy is recognized -- once a toy is produced and sold by a toy company, it moves off of the company's balance sheet forever and onto the asset side of the balance sheet of the purchasing family. I suppose that both coins and toys could bear a remaining unrecognized liability in the form of potential compensation of consumers for bad product, although if we go this route then almost every object in the world is a contingent liability.

      US notes are an explicit liability of the Treasury.

    2. Great! That's what I thought. Any ideas about how I'd go about making sure this was the case? I've searched through a lot of documents, and like you say I can't find that it shows up as a liability anywhere, or that coins are described as such anywhre (except in this "contingent" sense by JKH), but I'd think some gov doc would spell this out more explicitly.

      JP, thanks very much for you answer! I really appreciate it. I made a post on this some time back that I'm thinking of cleaning up a bit, and I wanted to try and make sure I understood the coin thing first.

      Keep in mind, I'm an amateur attempting to help explain things to other amateurs... so I know there's a lot more to money than I present there. I'm trying to keep it fairly simple. I should probably take some time and really look over your site because I have the impression that's one of your specialties... I always enjoy when you pop in on Cullen, Glasner, or Sumner and offer you $0.02. ;^)