A Surfeit of Dearth? Tight "Money" and the Decline of AAAs
This Credit Suisse graph posted by Cardiff Garcia on December 5 has been getting some serious attention in wonkier sections of the econoblogosphere:
And Angry Bear‘s own Rebecca Wilder gave us this on December 21:
2007-2011 in charts: moving down in quality
Brad DeLong discussed this on December 21, riffing off David Wessel’s piece where he jumps on the bandwagon with a tarted-up version of the Credit Suisse chart.
David Beckworth has the best commentary I’ve found on the subject so far:
…many of these safe assets serve as transaction assets and thus either back or act as a medium of exchange. AAA-rated MBS or sovereigns have served as collateral for repurchase agreements, which Gary Gorton has shown were the equivalent of a deposit account for the shadow banking system. The disappearance of safe assets therefore means the disappearance of money for the shadow banking system.
This prompts me to suggest a radical idea that I’ve been hesitant to broach for fear of revealing myself to be the internet econocrank that I am: that all financial assets are, in some very real or at least useful definitional sense, “money” — even though you can’t necessarily use them to buy a pack of gum at the corner store (you have to trade them for something currency-like first). I’ll get back to that in a future post.
Izabella Kaminska made a similar point back in November:
…quality collateral has become the most sought over security in town. So much so, in fact, that some quality collateral is hardly circulating.
…the best indicator of collateral crunch intensity is instead the repo rate. The lower the rate, the greater the crunch.
The wider the spread between Libor and the secured (repo) rate, the greater the general distress in the market. The following chart reveals just how good an indicator of general market stress it is:
“Some quality collateral is hardly circulating.” That starts to sound decidedly like a “velocity of money” argument.
And indeed, Cardiff Garcia frames it just this way:
Now, if you’ve read your Manmohan Singh (or your Izzy Kaminska or your Tracy Alloway), you’ll know that this availability is the first of two parts of the collateral shortfall effect. The other part is the shortening of “re-pledging chains”, otherwise known as a reduction in the velocity of collateral and which Singh explains thusly:
Intuitively, this means that collateral from a primary source takes ‘fewer steps’ to reach the ultimate client. This results from reduced supply of collateral from the primary source clients due to counterparty risk of the dealers, and the demand for higher quality collateral by the ultimate clients.
And why does it matter? Singh again, emphasis ours:
The “velocity of collateral”—analogous to the concept of the “velocity of money”—indicates the liquidity impact of collateral. A security that is owned by an economic agent and can be pledged as re-usable collateral leads to chains. Thus, a shortage of acceptable collateral would have a negative cascading impact on lending similar to the impact on the money supply of a reduction in the monetary base.
Brad DeLong gives us some theory that will sound familiar to readers of my recent posts:
And when an economy is short of AAA assets, it can fall into a recession — but not a monetarist or a Wicksellian recession, rather an Minskyite recession–because in the absence of long-enough collateral chains the web of banking intermediation would have to run on trust that isn’t there.
Again, emphasis mine.
The upshot: the global economy needs more babysitting scrip. Since money issuers continue to labor under the gold-standard fallacy that they can’t just create money, issue more scrip like the babysitting co-op did — that they have to “borrow” it (and this stricture is inscribed in law) — the only way to create that scrip is for governments to issue more bonds. So banks can issue money using those bonds as collateral, allowing shadow banks to keep their collateralized towers from teetering.
It’s a stunningly byzantine and dysfunctional approach to managing the supply of money to the real economy that produces human-consumable goods and services (though it works out very nicely for the bankers, personally). But it’s what we’re stuck with.
If this doesn’t make sense to you, try here.
Cross-posted at Asymptosis.
So that financial/shadow economy is starting to feel the effects of neglect of the labor/consumer economy that it is all based on.
Gee, I wonder where the big boys and grils are going to put the money for safe keeping? A matress? Yeah, that will really increase the velocity.
Of course, there is always the bail out tool. Only this time they better fix the basement as fixing the roof and stopping the water washing the foundation did not actually fix the foundation.
just so you dont miss this new post from david beckworth, tying together more loose ends:
More on the Shortage of Safe Assets – As a follow up to my earlier piece on the shortage of safe assets, I direct you to Rebecca Wilder’s post where she documents the broad decline of investment grade sovereign debt. As I mentioned before, this increasing shortage of safe assets matters because because many of these assets serve not just as a store of value but as transaction assets that either back or act as a medium of exchange. In other words, this problem matters because it adversely affects the demand for money and therefore nominal spending. One solution is for producers of truly safe assets, primarily the U.S. Treasury, to create more safe assets. Brad DeLong takes this view. This approach, however, worsen the Triffin dilemma for the world’s go-to safe asset, U.S. Treasury debt. Another solution is for the Fed and the ECB to restore nominal incomes to pre-crisis trends. Doing so would spur a sharp recovery that would that would lower the demand for safe assets and increase the stock of safe assets. Both of these developments would reduce the excess money demand problem and avoid worsening the Triffin dilemma for U.S. treasury debt. See my previous post for more.