What is Money and how does it come to be?

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JCD
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Joined: Sat Jul 20, 2019 9:12 am

What is Money and how does it come to be?

Post by JCD »

My exploration of the topic

I've been trying to wrap my head around the topic of currency and/or money recently. This is my 3 corners, hoping someone will give me the 4th.  Unless relevant, I want to set aside the distinction of 'gold is money and fiat is currency' as I'm not trying to say what a good system is or trying to do historic analysis.  If I say money or currency, I mean the same thing, fiat based numbers that people perceive as being valuable.  

I've been reading Richard Werner's work on the creation of currency and been thinking a lot about inflation.  One of the claims is that the Federal Reserve has created some large % of all money that has ever existed and I'm starting to wonder about that story.  Let's set that aside for a minute and go back to Werner's 3 types of banking systems, at least as I understand them:

- Banks can only loan out deposits.  There is no created money via banks.  Money is created elsewhere.
- Banks can't create money, but the banking system can.  This is caused by the fact that one man's assets are another man's liabilities.  The fact that each bank can lend out x% of their savings creates money because each time someone lends the money the money comes back as savings from another individual, allowing the bank to re-lend the money, not knowing it was previously lent out.
- Banks create credit.  As I understand it, this would be sort of like super-fiat in that it isn't even dollars but rather numbers on a ledger, handed from one bank to another.  From our point of view, it looks like money, but it isn't or is it?

Werner claims in his study he found that the 3rd option is what he observed in a bank transaction under the hood.

So my first question as a reaction to this is, what actually is money?  How is money created?  Who can create money and during what circumstances?

Before anyone answers, I want to put some thoughts on some techniques that might either be money or ways to create money.  These are the concepts of derivatives, rehypothecation and subway tokens...er... bank reserves

Regarding money creation, some point to the federal reserve, using the open market to buy treasuries off of other entities, which puts new, previously non-existent money into the system.  Then there is the US Treasury which creates bonds in the first place and sells them into the market.  I recall watching Warren Mosler, father of MMT insist that the government must spend first then tax or else money could not exist.  One form of this was Mosler describing the currency as subway tokens, which the issuer creates the tokens and "spends" them by selling rides first before collecting them for fairs.  I don't know the mechanism he assumes the gov't creates the money from.

As I understand it, hypothecation is where some entity provides something of value or asset for cash.  The asset is known as "collateral" in the jargon. The most obvious sort of example is a bank loan used to buy a house where the house is used as collateral.  Rehypothecation is where the collateral is traded hands multiple times, each time the entity handing off the collateral getting cash.  One problem is that an intermediary who once held the collateral might go bust and creditors might go after that asset.  Why?  Because you can do this off balance sheet, meaning the asset shows up on multiple balance sheets.  That in a sense also appears to be creating money, which can in effect create money for even the hardest of assets.

In other versions of this, you might take out Eurodollar loans by buying a future's contract and using that as collateral to prove you have dollars. or at least that is how I think it would work.  The Eurodollar system was somewhere in the range of 13 Trillion in size as of 2016, but is really unmeasured.  If a contract that might cost 1K in USD creates 1 M in assets, is that money creation?  Jeff Snider seems to say banks do create money and implies that the Eurodollar system is bank controlled.  Throw in Werner's "banks create money" and it doubly sounds like money creation.

Then we have derivatives, basically a bet on an underlying asset.  The thing is, these bets create liabilities that may be unlimited.  For example, in 2018 more than 5 trillion in SP500 'shares' were handled by derivatives (See https://www.sec.gov/files/Analysis_of_P ... Pilots.pdf Search for "Table 1").  Based upon my brief analysis, this likely doesn't include future markets nor derivatives around ETFs based upon SP500.  The end of 2018 Market cap for the SP500 was 22 T, making derativies 1/4th the size of the market.  I have heard some say it is as big as the market at this point.  I captured that data to run a thought experiment.   What if I took 1 Trillion and put it into an ATM call option of a stock valued at 10 dollars, which for each call, I paid 2 dollars.  The stock doubles in value at my call's expiration.  One of a few things might happen:

- I make 20-12=8*1 Trillion or 8 T in cash if cash settled.
- I gain 8 T worth of shares.
- There are not enough shares (say the stock only had a market cap of .5 T after the pop) or cash and my counterparty blows up.

In effect, I used leverage to make money.  My question is, where did the cash from the other side of the trade come from if the market maker chose to take on the trade themselves?  Yes, I know they buy shares as a hedge to be delta neutral, but how are they getting the cash to buy the shares?  Are they doing it via rehypothecation?  If so, where are those entities getting the cash?  

I feel like I have a sense of different bits of the elephant, but no idea that it is an elephant.  Finally, returning back to the federal reserve at the start, even if what they are doing is money printing, does it matter if they are just one of many mechanisms that is ill defined, ill regulated and ill measured?  It seems that the system isn't legible or even understandable.  It seems absurd that Werner had to do so many crazy steps just to determine where money comes from, and even now I'm suspicious it is only one of a multitude of ways and it may vary by country.  So let me repeat my questions and clarify them.

What I'm trying to learn

What actually is money?  How is money created?  Who can create money and during what circumstances? In asking these, I'm not really looking for subway tokens and gold style answers, I'm trying to understand what ultimately has direct relationship to our financialized system and largely what money looks like from those in high finance not the plebs on the street. In some sense, I'm trying to understand where does leverage come from? What allows leverage to be created and where does the cash that is put into the loans to generate the leverage get conjured from? In other words, if you are levered 30 to 1, who is the sucker who gave you that multiple of your cash and where did they get that cash from? If the creditor of that leverage got it from loans, where did they get the cash from? And so on. Any pointers, theories, videos or books are welcome on the subject.

Solvent
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Re: What is Money and how does it come to be?

Post by Solvent »

Yes, banks create money. Another source

Your examples are pretty convoluted, and I'm not sure how to pick out exactly what you're asking from those... But I think the answer you're looking for, essentially, is that yes, commercial banks create money. Perhaps when looking at your complicated examples it pays to keep in mind that in many of those transactions (as far as I can tell) when one party's account is credited with money (or an asset), another party's loses it. And certain assets appearing on a party's balance sheet != Money (like the house as collateral for a loan, I think).

If you are levered 30 to 1, who gave you that cash? The bank. Where did they get it from? They made it after they decided it would positively affect their profitability.

Optimal_Solution
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Re: What is Money and how does it come to be?

Post by Optimal_Solution »

"Money" is an imprecise term. There are more precise definitions: M0 , M1, etc. I find it easier to grok money when the concept is decomposed into its various types.
https://en.m.wikipedia.org/wiki/Money_supply#M0

xmj
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Re: What is Money and how does it come to be?

Post by xmj »

Money is that which can function as unit of account, store of value and medium of exchange.

JCD
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Re: What is Money and how does it come to be?

Post by JCD »

My biggest issue with the credit creation story is it isn't clear what the main forces on banks are.  Things like runs on the bank would seem unlikely, but I imagine the response is "regulation."  In looking at Northern Rock's case I wonder why they couldn't print themselves more money to survive the crisis given that the UK gov't seemed keen to keep them alive.  Even so, the more "regulation" is the answer, it doesn't then explain the particular limits of money creation banks have nor why banks bother with buying treasuries to match "liabilities" of savings accounts.  It would seem like they would just buy as many treasuries as possible if that is the only investing they are allowed to do and then lend out whatever they thought was reasonable. Also why did/are banks doing insane lending like what was done with Long Term Capital Management.  In LTCM's case, it was converting 4 billion into 1.25 trillion in assets that makes me ponder where did that money come from in the first place? What bank would approve of a loans that were built upon .0032% equity?
"It's not the fed that matters.... it's the global banking system, hidden shadow system mostly located offshore from the united states... 1960,Ben Bernanke in 2005 was saying hey, 45 years ago we stopped being able to define and measure money.  They never finished the project." - Jeff Snider, https://youtu.be/Q0oZmEUxxn4?t=482
"The over the counter derivatives market was estimated at about 700 trillion...  That's right, it's getting close to a quadrillion." - https://youtu.be/OkNVmfMaSsU?t=2406
Demetri Kofinas/James Rickards, 2017
If I understand it correctly, there should always be at least as much money/credit supplied as the last given price paid for every asset on earth. The M's are basically trying to track the places that money is stored while setting aside the assets that were exchanged for those dollars. Inflation in that sort of view could be said to be the number of dollars increasing faster than the number of assets being generated.  That is to say, every house on earth that was purchased and not just hand built from non-economic sources of material should have at least the amount the owner spent to buy the house in money, sans any defaults that have occurred. Perhaps the answer is velocity, with money trading back and forth, but in 2017 it was less than 1.5 per the fed using M2.  Credit Suisse says global wealth reached USD 351.5 trillion around the end of 2017.  M2 roughly proxies 1-2x GDP in major nations.  At a global GDP of 90ish trillion, we are still only around 180 trillion. If velocity matters, we might get up to 525 trillion on the high end of the estimates I can find.

Therefore if there really are 1 quadrillion of derivatives, where is that money?  Even if it is only 500 trillion as claimed here where is the extra money coming from, as I doubt all other transactions world wide only add up to be 25 Trillion?  That is to say, how can there be 500+ trillion in just one sector, in a world that doesn't have much more than 500 trillion dollars?  What funds those things?  I can just hear someone say leverage.  But leverage is just debt which means money is somewhere in this.  Where is it?  What am I missing? Since I can't seem to answer that, I was trying to build up from first principles what is money and who creates money so I can try to really understand questions like if the fed balance sheet increase is really that impressive. It sounds like there is good evidence banks can create money. Can anyone else? Maybe derivatives are money and thus we really do have enough money. Maybe rehypothecation creates fake assets that allow derivatives to become money. Again, I'm not saying this is true, I'm trying to model how this world is possible given it exists and given the the numbers don't even make sense to me.

Qazwer
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Re: What is Money and how does it come to be?

Post by Qazwer »

It sounds like you consider money as relating to some physical thing.
Try reading John Searle’s work on money as a social construction. It is an agreed upon construction. Once that construction is built, subsequent constructions can be built upon them as infinitum

plantingtheseed
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Re: What is Money and how does it come to be?

Post by plantingtheseed »

Money is a tool that performs these functions:

1. serves as a medium of exchange
2. stores value (of one's contribution to the economy)
3. delays purchase
4. universally recognized and accepted

Without these features, it's just a colored piece of paper or some useless number embedded in a piece of plastic. (i.e. not all places accept AXP)

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