Teaching the social outcomes of trading money

As Bagehot (1873) clearly said:  banks trade money. In the current banking scenario, the interconnections between credit and capital markets foster the growth of banks’ assets and profits. The other side of the “coin” shows higher corporate leverage and household debt. As a result, all society has been subordinated to trading private money.  Accordingly J.M.Keynes, money, as the institution that founds the exchange system, is a link between the present and the future. Money trade by banks fosters the capital accumulation process that develops through time and involves credit contracts.  In a context of uncertainty and speculation, the tensions between money as a public and as a private good overwhelms central banks’ actions, as we are seeing in the current bail-outs. The 2008 financial crisis has shown sources of worldwide financial fragility: the financial innovations regarding bank’s asset, liability and capital management, the movement toward securitized finance, the growing importance of institutional investors, besides the random investors´ behavior in a context of capital account openness.    Indeed, the evolution of banking practices can be apprehended in a changing historical context where tensions between the regulation of capitalist finance and the strategies of innovative profit-seeking banks arise.  In fact, since banks play a crucial role in determining the pace of growth, any new banking practices and products  turn out to affect the overall stability of the economy. From H. Minsky we learned that financial innovations are not just techniques or product phenomena, but involve institutional changes. Banking practices have increasingly included risk management, such as liquidity, credit, interest rate and currency risk. Banks have increasingly adopted an integrated approach called asset & liability management and enhanced further banking innovations. The target of this process is to expand the endogenous money creation by banking institutions since the new loans are considered profitable. Accordingly H. Minsky, the growth of financial innovations did not mainly occur because of competitive market forces. Under his opinion, the role of both banking regulation and monetary policy has been outstanding to explain new management practices and innovations.  In the context of the “New Deal” segmented system of financial regulation, commercial banks began to actively manage liabilities, in order to raise additional funds. In the 1960s, as a result of banks’ innovations, the development of the fed funds market in the US turned out to reduce the Fed’s ability to use legally required reserves to constrain bank lending. In other words, financial innovations turned out to subvert constraints imposed by financial regulation and monetary policy.  More recently, the 2008 financial global crisis revealed that the evolution of  banking practices deeply depends on the arbitrage/speculation made by global players in the financial markets. In the aftermath of the crisis, banks continue trading money, but the distinction between private and public debt has become blurred.  To fund banks’ assets, central banks have been expanding loans to commercial banks at both short and longer-term maturities.  In addition to low interest-bearing deposit facility, central banks’ actions have also included the acquisition of government bonds issued by Treasuries to face the debt crisis.     In this scenario, many nation- states – that used to defend the expansion of financial liberalization – have taken a stake of more than 50% in banks’ capital and implemented austerity programs that fostered unemployment and the lost  of social rights. Indeed, the social costs of the banking sector bail-outs have undermined the idea of efficiency of the self-regulated financial markets and the trust in the social dimension of public policies. Considering this background, two relevant questions arise: Which is the room for maneuver of nation-states to shape a financial  agenda towards sustainable economic and social growth? Could banking regulation induce more control over banks’ management practices in the future?.

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2 comments
  1. Thanks for pointing out these issues, which are indeed central to understanding economic issues facing the world today. I found the most insightful writings on this topic to be Ellen Brown: The Web of Debt and also the The Public Bank Solution. Both of these books provide considerable insight into current system of private money creation and its harms — the second book also points out a solution to the problem which has been used with success in many places. My own attempts to understand the relevant issues and summarize them, especially in the context of Islamic laws regarding interest and money creation, have been summarized in On the Nature of Modern Money, available from SSRN:
    http://ssrn.com/abstract=2535697

  2. Maria Alejandra Madi said:

    Asad, Many thanks for the reading suggestions.

    Maria

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