This Credit Suisse graph posted by Cardiff Garcia on December 5 has been getting some serious attention in wonkier sections of the econoblogosphere:
2007-2011 in charts: moving down in quality
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.