Speaker 1: Hello, and welcome to another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe Wisn't so Joe. This
Speaker 1: is a very special episode of All Thoughts. It is
Speaker 1: a live recording. That's right, We did a live recording.
Speaker 1: There was a big I don't want two hundred something
Speaker 1: people came out, really packed house to talk about Finn Red.
Speaker 1: That's right. Everyone got really into Finn Red. No. So
Speaker 1: this is basically a follow up from the episode we
Speaker 1: did with Josh Younger, one of our favorite guests, in
Speaker 1: which he was talking about the origins of the repo market,
Speaker 1: and we decided that we needed to talk more about it,
Speaker 1: and we wanted to bring in Josh's research partner, Love Men,
Speaker 1: and yeah, that's right. And so we have this sort
Speaker 1: of sprawling financial system, you know there, as you mentioned,
Speaker 1: there's a repo, there's euro dollars, there's crypto stable coins, PayPal, Venmo,
Speaker 1: all of these things that have sort of like some
Speaker 1: banking like qualities but aren't really banks. And so the
Speaker 1: frame after that great episode with Josh I guess that
Speaker 1: was in October is basically like, how did we get here?
Speaker 1: How did we get in this position where we have
Speaker 1: all these sort of various bank entities that aren't traditional
Speaker 1: banks that in somewhere or another, the FED is responsible
Speaker 1: for regulating or backstopping, right, And I think there's a
Speaker 1: lot about the financial system that we tend to take
Speaker 1: for granted. But there's a reason that all of these
Speaker 1: different things exist, for better or worse, and they do
Speaker 1: come with, you know, advantages and drawbacks. So that's really
Speaker 1: the theme of this particular episode, talking about how we
Speaker 1: got here and why and what it means now. So
Speaker 1: please enjoy it. Thank you everyone for coming to a
Speaker 1: very special live recording of the All Thoughts podcast. I'm
Speaker 1: Tracy Alloway and I'm Joe Wasn't so I am very
Speaker 1: pleased to say that to day we have Josh Younger,
Speaker 1: one of our favorite Odd Thoughts guests. We also have
Speaker 1: his research partner, Love Men and he is an associate
Speaker 1: professor of law at Columbia also the author of The
Speaker 1: FED Unbound. And one of the reasons we wanted to
Speaker 1: hold this live event is because we recorded an episode
Speaker 1: with Josh Younger earlier this month, I believe, where we
Speaker 1: talked about the origins of the shadow banking system, specifically
Speaker 1: the repo market. And one of the themes that emerged
Speaker 1: from that discussion is that even if you think the
Speaker 1: shadow banking market has a lot of issues and problems today,
Speaker 1: the reason those issues and problems exist sort of stems
Speaker 1: from these decisions that were made many, many decades ago,
Speaker 1: conscious decisions by regulators, notably the FED, that combined to
Speaker 1: create the shadow banking market as we know it today. Right,
Speaker 1: even if you're not interested in shadow shadow banking market,
Speaker 1: shadow banking market is interested in you basically. So yeah,
Speaker 1: I'm really excited about this. Um plenty to learn, plenty
Speaker 1: to sort of look through history to sort of understand
Speaker 1: where we are now, plenty of finnregg and financial stability
Speaker 1: issues always popping up. So let's go for it. It's
Speaker 1: a good time to talk about financial stability. Good time.
Speaker 1: Just one note before we begin, I think our producer
Speaker 1: already walked you through some of the housekeeping, but we
Speaker 1: are taking questions from the audience. Please write them down
Speaker 1: on your index cards and they will be put into
Speaker 1: the magic box that we have on stage. Alright, So,
Speaker 1: without further ado up, Love, why don't we start with you?
Speaker 1: I mean, researching the evolution of modern banking. How did
Speaker 1: you get into that? And why? So it's really a
Speaker 1: product in my biography in some sense. I graduated from
Speaker 1: college in the midst of the global financial crisis and
Speaker 1: the and it's aftermath, the Great Recession, and I, in
Speaker 1: a in a weird turn of events, got a job
Speaker 1: at the Federal Reserve Bank for New York. So I
Speaker 1: was I was thrown into an economy that was in turmoil, UH,
Speaker 1: financially induced turmoil. And so I was naturally very curious
Speaker 1: about that. And then suddenly I had a job that
Speaker 1: gave me an opportunity to UH to learn about that
Speaker 1: problem and and to confront it UH directly. And so
Speaker 1: I got to work on the first ce CAR, the
Speaker 1: first stress test, and developed that. And I also got
Speaker 1: to UM. I was seconded to the Financial Stability over
Speaker 1: s ACOUNTIL. I got to work on UM preparing the
Speaker 1: first Financial Stability Report for the United States. UH. And
Speaker 1: then you know, once you find a problem that is
Speaker 1: interesting to you, you know, I guess my personality. I've
Speaker 1: just continued sort of chewing at that ever since. UH
Speaker 1: and and and in part because I don't think that
Speaker 1: we've solved the solved the problems from two thousand and eight,
Speaker 1: and I think that the consequences of two thousand and
Speaker 1: eight are are extremely momentous across a number of dimensions
Speaker 1: of society, many problems that we're experiencing today, political, economic, social,
Speaker 1: Two thousand and eight was a was a major shift
Speaker 1: in how we address those problems. In nature of those
Speaker 1: problems made a lot of them worse. And I think
Speaker 1: that monetary and financial stability, what we lost for that
Speaker 1: one moment is a key social good that we need
Speaker 1: to do a better job of preserving and protecting over time.
Speaker 1: So one of the do in um, Josh, you know,
Speaker 1: in terms of like, okay, we had you on recently,
Speaker 1: we talked about the nineteen fifties, What is it about
Speaker 1: the history? Why is it important to take a historical
Speaker 1: lens to think about some of these problems and to
Speaker 1: think about, Okay, what does an optimal financial regulation system
Speaker 1: look like? Why is like the historical lens is sort
Speaker 1: of useful approach for that. Yeah. So I have, in
Speaker 1: many ways the opposite story to live. So I was
Speaker 1: trying as a physicist. I got my PhD two thousand nine, UM,
Speaker 1: and so when the financial crisis was raising, I had
Speaker 1: no idea what was going on. I mean, I was
Speaker 1: entirely focused on I was using a telescope in Hawaii
Speaker 1: like a collecting other physicists or to blame for the
Speaker 1: financial crisis. So at least your blameless, right, I'm not
Speaker 1: going to take a view on that. But um, so
Speaker 1: I think when you're a physicist, like you're turning to
Speaker 1: figure out what the rules are that the input um
Speaker 1: in a sense, and so they're taking you know, I
Speaker 1: just try to post to figure out how the world works,
Speaker 1: because it works a certain way and that's not up
Speaker 1: to me, but it's interesting to figure out what like
Speaker 1: what that is. Um. Financial markets are opposite of that,
Speaker 1: which is we get to set the rules to achieve
Speaker 1: an outcome. And so you know, as I went into
Speaker 1: the industry and and uh sort of got deeper into
Speaker 1: the really fundamental questions of market structure. First you have
Speaker 1: to get your sea legs because I didn't know like
Speaker 1: what bond math was, for example, and then these things
Speaker 1: so you figure out like yields up, prices down. I
Speaker 1: got that right, um. But after you do that, you
Speaker 1: start to think about why the system operates the way
Speaker 1: that it does. And and because it's a construct because
Speaker 1: it's a set of choices that we don't necessarily like
Speaker 1: all the aspects of where it ended up. Raises the
Speaker 1: question as to why we made those choices in the
Speaker 1: first place. Is this just a function of markets, um,
Speaker 1: you know, having their own mind um and going their
Speaker 1: own way, or is this really a set of conscious
Speaker 1: decisions where maybe we don't love some aspects of the system, um,
Speaker 1: but it was set up to solve other problems, right,
Speaker 1: And so the history tells you that, it tells you
Speaker 1: what the intent was, and that's important. One to just
Speaker 1: understand why things are the way they are because to
Speaker 1: a to a new observer, they seem a little odd sometimes,
Speaker 1: but but also to think about the limits of what
Speaker 1: you can do to fix it, because because the the
Speaker 1: entrenched interests that are created by that process are really important.
Speaker 1: So why don't we talk about one of the rule
Speaker 1: making episodes or one of the like conscious decisions that
Speaker 1: was made that reverberates to today. And Josh, this is
Speaker 1: something we spoke about with you on the episode the
Speaker 1: nineteen fifties and one of the outcomes of that particular
Speaker 1: era was the repo market as we know it today.
Speaker 1: But love you have also talked about how the FED
Speaker 1: chair at the time, William Martin, made a big decision
Speaker 1: about breaking with traditional banking and shifting the system into
Speaker 1: something and part of that involved the role of primary
Speaker 1: dealers in the repo market. But talked to us about
Speaker 1: that that break and why it matters today. William Martin
Speaker 1: is one of the most consequential twentieth century figures and
Speaker 1: played a huge role in creating the world as we
Speaker 1: know today. Things that we take for granted, like the
Speaker 1: repo market, the eurodollar market and their centrality and how
Speaker 1: our financial system works, how our economy works. These were
Speaker 1: projects of William Martin, and they were things that he
Speaker 1: tried to construct and bring about. UH. And he was
Speaker 1: not painting on a blank canvas. UH. He was UM.
Speaker 1: He was actively trying to re engineer a system that
Speaker 1: had been set up in the wake of the Great Depression,
Speaker 1: the New Deal banking system UM. And that system was
Speaker 1: constructed around a separation between banking and other financial and
Speaker 1: commercial activity. And banking was a franchise business UH. And
Speaker 1: the point of the business was monetary to issue deposit
Speaker 1: it's deposits with the primary form of money still are
Speaker 1: the primary form of money in the economy. When there's
Speaker 1: more deposits, you get inflationary pressures. When they're seward deposits,
Speaker 1: you get disinflationary pressures. This was the banking franchise banks.
Speaker 1: We're going to do this subject to a bunch of regulations.
Speaker 1: Other things we're gonna happen outside of banks. UM. William
Speaker 1: Martin in an effort to solve a series of problems,
Speaker 1: one of which you talked about with Josh previously, UH
Speaker 1: is keen to UH break down some of these borders.
Speaker 1: So the birth of the repo market is a way
Speaker 1: to allow broker dealer firms who had been pushed out
Speaker 1: of the banking business to UH find a way to
Speaker 1: fund themselves like banks UM by copying the business model
Speaker 1: of banks. UH. And so they're legally barred by the
Speaker 1: New Deal banking laws from maintaining deposits because there's a
Speaker 1: provision in the Banking Act of three that says that
Speaker 1: only a bank can take deposits. UH. So they create
Speaker 1: a structure that mimics UH deposit UH and Martin is
Speaker 1: instrumental in facilitating this, allowing this to happen, providing a
Speaker 1: backstop for it. UM in the fifties. And this is
Speaker 1: really the birth moment of the shadow banking system, UH,
Speaker 1: the idea that we're not going to have a money
Speaker 1: supply that's entirely provided by either the government in the
Speaker 1: form of cash or the banking system in the form
Speaker 1: of deposits, where the deposits are the sort of the
Speaker 1: big the big event, and the cash is a small side.
Speaker 1: So there's actually room in this system for non bank money,
Speaker 1: other forms of private money, UH, namely repo. And this
Speaker 1: starts UH in earnest in the fifties, and and everything
Speaker 1: else that sort of comes along, and I think we'll
Speaker 1: get to it. The eurodollar markets, UH, money market, mutual funds,
Speaker 1: commercial paper of very short duration UH. Stable coins are
Speaker 1: a sort of variation on this same theme. And all
Speaker 1: of these UM are more or less viable based on
Speaker 1: a sort of in more relationship that they can develop
Speaker 1: with with the central bank. You know, if you have
Speaker 1: a central bank back stop, you can you can make
Speaker 1: a viable money alternative. If you don't have access to
Speaker 1: the central bank, you really you can't get very big.
Speaker 1: You can't you can't do that UM. And so Martin's
Speaker 1: key role was to UH was to re arctact the
Speaker 1: system and make it clear that the FED would provide
Speaker 1: backstops for various time types of non bank money UM too.
Speaker 1: In particular that become the dominant the repo market and
Speaker 1: then the euroinour market. So use this word border, which
Speaker 1: I think is interesting, and you describe, okay, the expanding border.
Speaker 1: And there's all these sort of like non bank shadow
Speaker 1: bank type entities that issue deposit like instruments even if
Speaker 1: they're not technically bank deposits, uh nearly defined. What is
Speaker 1: accomplished by this? What is sort of for either of you?
Speaker 1: What is it? What do we get from having the
Speaker 1: benefits from having more of these entities that can issue
Speaker 1: deposit like money. Isn't having this relationship with the Federal
Speaker 1: Reserve outside of like the sort of normal banking system. Well,
Speaker 1: so I'll let Josh sort of get into the details
Speaker 1: on on RIPO and the treasury markets in particular, but
Speaker 1: just sort of at a high level. The banking system
Speaker 1: is heavily regulated under the New Deal banking law framework,
Speaker 1: and so there are lots of requirements on banks and
Speaker 1: UM there's an effort to direct the sorts of assets
Speaker 1: that banks invest in, so they are expanding the money supply.
Speaker 1: Where is the privilege of that going Who gets access
Speaker 1: to that UM money issued based credit that monetary financing,
Speaker 1: And there's lots of rules the government has put in
Speaker 1: place on who who benefits, and there's lots of restrictions
Speaker 1: on the design of the banking system. So at this
Speaker 1: time we have something that looks a lot more like
Speaker 1: a unit banking system. It's very uh decentralized. There's thousands
Speaker 1: and thousands of banks UM. There's limits on how big
Speaker 1: banks can be. There's limits on how much banks can
Speaker 1: pay their depositors. This is rg Q, which exists from
Speaker 1: the thirties until the early a these. And so the
Speaker 1: incentive to create non bank money is an incentive to
Speaker 1: have some UM to direct the benefits of monetary financing
Speaker 1: in some other way not subject to all of these constraints. Uh.
Speaker 1: And so there's just large rents or surplus to extract
Speaker 1: from being able to expand the money supply outside of
Speaker 1: all these constraints. And so that's the impetus that everybody
Speaker 1: that's always leading people to try to create private forms
Speaker 1: of money is to do it without the without all
Speaker 1: the costs. And this is exactly what goes on with
Speaker 1: stable coins as well. So I think the treasure mark
Speaker 1: is a great example. So, like, what do we want
Speaker 1: from the treasury market, Well, the investors want liquidity. Um.
Speaker 1: That means dealers that can expand and contract their balance
Speaker 1: sheets and take on a lot of leverage, because a
Speaker 1: low margin business means lots of liquid it means low
Speaker 1: transaction costs. But like you still have to pay the
Speaker 1: rent um and and so you need to take on
Speaker 1: more leverage to make than a profitable business. And so
Speaker 1: that that doesn't work in a traditional banking framework, in
Speaker 1: part because it shouldn't work in a traditional banking favorite
Speaker 1: in certain ways, like banks are providing this incredibly central
Speaker 1: social service of making money, uh, and so like they're
Speaker 1: held to a higher standard in a sense, and so um,
Speaker 1: you know, dealers get access to money like financing, even
Speaker 1: if it's not strictly money in the classic sense, and
Speaker 1: that gives the market liquidity depth and in particular low
Speaker 1: transaction costs. That's what we're really talking about, right, I
Speaker 1: don't want to pay a lot to trade by treasuries,
Speaker 1: and I want to do it in arbitrary size. Um,
Speaker 1: So for the treasury that beans lower yields liquidity premium. Right,
Speaker 1: liquidity premium means I'm going to pay more because this
Speaker 1: thing has liquidity value, and that's just a lower overall
Speaker 1: cost of debt service um. So all of these things
Speaker 1: are are valuable. And then you rewrap all of that
Speaker 1: in the context of having a lot of elasticity, meaning
Speaker 1: if there's a shock like in for example, people need
Speaker 1: to monetize their treasures, if everyone needs to sell at
Speaker 1: the same time, there has to be new money to
Speaker 1: provide the proceeds of those sales um. Because those bonds
Speaker 1: are held outside of the banking system. When they come
Speaker 1: into the banking system, that gets turned into bank as
Speaker 1: sets and that means they're funded with new money. And
Speaker 1: so then the holders of those bonds now hold money
Speaker 1: in the classic sense, and so that elasticity is not
Speaker 1: easy to provide um within the context of traditional banking.
Speaker 1: And so you know, the shadow banks in a sense
Speaker 1: like augment the money supply as needed under stress in
Speaker 1: a very desirable way. But it comes to costs and
Speaker 1: that that's that's the issue. It's it's a means to
Speaker 1: an end. It's not a generic good. Just to put
Speaker 1: a finer point on what happened in the fifties. Uh,
Speaker 1: the Federal Reserve is providing the elasticity for the treasury
Speaker 1: market coming out of the forties. And so if there
Speaker 1: is the need for balancing capacity, if you want liquidity
Speaker 1: in the market, where's that Where's that elasticity coming to
Speaker 1: the Federal reserves balance sheet? Can the banking system take
Speaker 1: that roll over? Given the regulations in the banking system,
Speaker 1: the liquidity that the amount that of elasticity that they
Speaker 1: can provide is going to be much less. What if
Speaker 1: we turn to broker dealers and provide them with a
Speaker 1: similar ability. Oh, they're not sust all of these restrictions
Speaker 1: on their bountary capacity. They're going to be able to
Speaker 1: mimic the elasticity at the Federal reserve balance sheet was
Speaker 1: able to provide um. But now we don't have the
Speaker 1: Federal Reserve directly in the market anymore. And that's that's
Speaker 1: how this all gets going in the mid fifties, Josh,
Speaker 1: could you maybe talk a little bit about the birth
Speaker 1: of the euro dollar market, because this is also something
Speaker 1: that happens by deliberate policy choice. And I feel like
Speaker 1: nowadays a lot of people talk about the euro dollar
Speaker 1: market like it's some mysterious like shadow pot of synthetic
Speaker 1: dollar deposits just floating around. But why did it happen?
Speaker 1: Why does it exist? There's kind of two euro dollar
Speaker 1: markets in the beginning. Um, there's the original euro dollar market,
Speaker 1: which is a communist creation. So uh in the in
Speaker 1: the late forties. Yet it wasn't expecting to hear that. Yeah,
Speaker 1: and so that one of the most important capital markets
Speaker 1: is a communist invention, which is in the late forties.
Speaker 1: People usually when they tell this history, they point to
Speaker 1: the Suis incident where the US froze Soviet assets and
Speaker 1: they said, oh, I don't want to take that risk
Speaker 1: of the U s sezing my my assets. But actually
Speaker 1: goes back a lot further, even before the Korean War. Um,
Speaker 1: there's declassified CIA documents that track the flow of dollars
Speaker 1: from Soviet accunts in New York into Europe. Uh, and
Speaker 1: y Europe. It's because in Europe you could have the
Speaker 1: deposits denominating currencies other than the local currency. That wasn't
Speaker 1: true in the US. So you can get a dollar
Speaker 1: depositent Paris, get a dollar depositent Belgium, and so in
Speaker 1: the late forties, the CIA is reporting a list of
Speaker 1: six or seven banks have taken communist dollars um. The
Speaker 1: problem with that is it's not scalable. But there's a
Speaker 1: lot of problems with that, But like they're it's not
Speaker 1: scalable in the sense that what are you gonna do
Speaker 1: with these dollar liabilities? You need assets to match the liabilities.
Speaker 1: And so they were used primarily for East West trade finance,
Speaker 1: so trade in dollars from from the Communist block to
Speaker 1: the West UM. For a lot of reasons, the Soviet
Speaker 1: Union didn't want a lot of that because they wanted
Speaker 1: to be independent UM, and so they restricted it. And
Speaker 1: so like there was a very small market in the beginning.
Speaker 1: The key development is in ninety four when the UK
Speaker 1: liberalizes convertibility and I can exchange my sterling for dollars
Speaker 1: on shore among banks and specifically in the forward market.
Speaker 1: And the key there is now I can hedge it, right,
Speaker 1: so now I can take a dollar deposit, I can
Speaker 1: hedge it back to sterling, put those sterling into the
Speaker 1: local market, and maybe there's an arbitrage and it turns
Speaker 1: out much like today, people didn't know how to price
Speaker 1: effex forwards, and an arbitrage free framework. And so like
Speaker 1: the the the FX forward market of the of the
Speaker 1: mid fifties had a large cross currency basis, meaning it
Speaker 1: wasn't priced it precisely the interest rate differential, wasn't price
Speaker 1: perfectly fair to take free money borrowing dollars in your
Speaker 1: dollar market going to the f X forward market, swapped
Speaker 1: them for sterling on a forward basis and just buy
Speaker 1: local bills in the UK. And and so then the
Speaker 1: market starts to grow because now there's something I can
Speaker 1: actually do. It's still narrow. There's a lot of like
Speaker 1: echoes of stable coins in this right, it's a specific application.
Speaker 1: We said stable coins three times, so I'm just gonna say, okay,
Speaker 1: it's like nineteen minutes in stable coins have mentioned three times.
Speaker 1: What are we talking so much about stable coin? And
Speaker 1: what is it specifically in the context here? You know,
Speaker 1: you're talking about, Okay, this whole like all these non
Speaker 1: deposit deposits that exist sort of an arbitrage purpose is capables,
Speaker 1: Like how does stable coins fit into this? In your
Speaker 1: your dollars are a great example where you create a
Speaker 1: product for very narrow purpose. So initially it's like sanctions
Speaker 1: of Asian by communist block countries, and like, that's obviously
Speaker 1: not gonna grow. We try that. It's not a great
Speaker 1: business model again for a lot of reasons. So like
Speaker 1: that stays relatively small UM. But but once you find
Speaker 1: a use case, in this case cross border interest rate arbitrage,
Speaker 1: which is still narrow but bigger, the market starts to
Speaker 1: grow and then and then you eventually get to the big,
Speaker 1: big event. Right, so after twenty years you get to
Speaker 1: something really massive, But over time that product starts as
Speaker 1: a seed. In the case of stable coins, it's the
Speaker 1: lack of access to traditional banking among large cryptocurrency exchanges,
Speaker 1: and so stable coins are a way to transfer dollar
Speaker 1: equivalents into a new ecosystem. UM, you're you're a dollars
Speaker 1: were way to transfer or create dollars. In case UM,
Speaker 1: which you could say of algo stable coins as well,
Speaker 1: it's way to create new money UM in the new
Speaker 1: ecosystem that is native to the new ecosystem. In this
Speaker 1: case it's European trade finance UM. And as global trade increases,
Speaker 1: and specifically intra European trade increases, there is demand for
Speaker 1: dollars is the currency of trade UM, and now you
Speaker 1: have a new market, and so that I think the
Speaker 1: interest here for stable coins is we're kind of at
Speaker 1: the beginning of that narrative that we're in where there's
Speaker 1: one bank taking major ear dollar deposits for the purposes
Speaker 1: of cross border arbitrage. And the question is what's the
Speaker 1: next phase in that, and what are the what is
Speaker 1: required of the market and regulators to get to those
Speaker 1: next phases where there's real exponential growth, and will we
Speaker 1: do that and do we want so leve One of
Speaker 1: the things we've been discussing is how how the FED
Speaker 1: basically seded some money creation powers. And I feel like
Speaker 1: nowadays one of the criticisms that you hear about central banks.
Speaker 1: And maybe this is because I spent too much time
Speaker 1: on Twitter, as we all do, but you know, there's
Speaker 1: a perception on Twitter that the FED controls everything, and
Speaker 1: you know, all markets are artificially manipulated by the central bank.
Speaker 1: And so I guess my question is does the FED
Speaker 1: control too little or too much or the wrong things?
Speaker 1: Like how would you view that? It's a it's a
Speaker 1: hard question to answer at the sort of level of abstraction.
Speaker 1: Um I would say that in some senses the FED
Speaker 1: controls too little UM. The FED was designed two UM
Speaker 1: manage the money supply, the bank issued money supply. We
Speaker 1: have an outsourcing system. We don't have a money supply
Speaker 1: that's issue directly in bulk by the government. UM. But
Speaker 1: we have a central authority, the Federal Reserve, whose job
Speaker 1: it is to manage the size and composition of bank
Speaker 1: balance sheets and the rate of expansion. And there's a
Speaker 1: specific mandate they want to UH ensure that that expansion
Speaker 1: continues sufficient with the economy operating at its full capacity
Speaker 1: over the long term, which is what Section two A
Speaker 1: is about. And the FED has a much harder time
Speaker 1: doing its job keeping the money supply expanding at a
Speaker 1: rate consistent with the economy's full capacity potential over the
Speaker 1: long term. UM. When a lot of the money UH
Speaker 1: in the system, that's critical to the system's functioning. UM.
Speaker 1: If it disapplines, you get huge disinflationary deflationary pressures. Is
Speaker 1: exactly what happened in two thou and eight UM. If
Speaker 1: that's being issued outside of the banking system. Because the
Speaker 1: FED has all these tools that allow it to monitor
Speaker 1: and adjust the size and position of bank balance sheets,
Speaker 1: and it has many fewer tools with respect to broker
Speaker 1: deal or balance sheets um and certainly with respect to
Speaker 1: the balance sheets of foreign financial institutions UM that are
Speaker 1: issuing lots of your dollars or stable coin issuers UH.
Speaker 1: And so the more of the money supply that is
Speaker 1: outside of the mut of the fed's tools, the more
Speaker 1: it's going to be um uh over relying on tools
Speaker 1: like emergency lending, which it can then repurpose. And so
Speaker 1: there's a discount window that's built into the Federal Reserve
Speaker 1: Act for the banking system. That's one of the key
Speaker 1: tools that's built in so that they can manage the
Speaker 1: bank money supply. But then they create all these ad
Speaker 1: hoc facilities. They're basically air sets discount windows for all
Speaker 1: the other shadow moneys that have come along. And you
Speaker 1: see them roll out those facilities, and you see them
Speaker 1: roll them out again because you need those discount windows.
Speaker 1: That's like, that's one of the only mechanisms we have
Speaker 1: now to ensure the monetary stability that the FED is
Speaker 1: there to do. Otherwise you fail on the section to it,
Speaker 1: you get monetary shrinkage, which is which causes recession and depression.
Speaker 1: So in that sense, the FED doesn't have nearly nearly
Speaker 1: enough control. Um. But then in another sense, um, you know,
Speaker 1: it's too involved, because in order to make up for
Speaker 1: the lack of ex anti tools, it becomes ex post
Speaker 1: extremely involved in financial markets in ways that I think
Speaker 1: even FED policymakers are sometimes uncomfortable with. And so you
Speaker 1: have a much much larger balance sheet that's a product
Speaker 1: of of not being able to control the money supply
Speaker 1: in in ordinary traditional ex anti ways. Uh that that
Speaker 1: Congress at least designed the institution to carry out its task,
Speaker 1: you know, and you you've written about this, but I
Speaker 1: wanna following up on this point. I mean one of
Speaker 1: the things that people is like, oh, the FED is
Speaker 1: there to fight inflation because politicians can't be trusted because
Speaker 1: if it weren't for the FED, they would just spend
Speaker 1: and maybe ramp up spending before every election, etcetera. So
Speaker 1: we need this independent FED. And your argument is that
Speaker 1: just really not about that that actually like the deeper
Speaker 1: history of the FED. Your story is like, that's a myth,
Speaker 1: that that's why the FED exists more or less, Yes,
Speaker 1: I mean, the FED almost exists for the opposite reason.
Speaker 1: So we set up the privately owned, investor owned banking
Speaker 1: system we outsourced. We didn't do green backs. This is
Speaker 1: the this is the direct money issue. During the Civil War,
Speaker 1: we we moved away from green backs. We created the
Speaker 1: National Banking System in eighteen sixty three. That was to
Speaker 1: prevent over issue by politicians UH. The idea that we
Speaker 1: just don't want to have the government issue and all
Speaker 1: of the money supply. We need to outsource that some
Speaker 1: of the money is going to have to be lent
Speaker 1: into circulation. We don't want the government to be doing that,
Speaker 1: lending itself having to evaluate credits. This could lead to
Speaker 1: corruption and problems. So we set up the National Paining System,
Speaker 1: and then fifty years later we create the FED because
Speaker 1: what we discover is that the national banking system is
Speaker 1: prone to break downs under issue of money and it
Speaker 1: needs UH an institution to avoid those kedowns UH basically
Speaker 1: to avoid deflation, UH, to avoid contraction, and to ensure
Speaker 1: that the money supply UH grows over time consistent with
Speaker 1: the ability of the economy to grow. And so the
Speaker 1: FED doesn't actually get its section to a UH mandate
Speaker 1: until nine seventy seven. It has a mandate under what's
Speaker 1: called the Employment Act of ninety six, which is to
Speaker 1: pursue maximum employment, maximum purchasing power. But that's that's a
Speaker 1: mandate that applies to the whole federal government. This is
Speaker 1: born of Kansian thinking. Uh, following the Second World War,
Speaker 1: it gets Section two A and I thine seventy seven.
Speaker 1: And the concern of Congress when writing that is about
Speaker 1: high unemployment in the nineteen seventies. Uh, you know, you
Speaker 1: you would think that their concern was the high inflation rate,
Speaker 1: but they were concerned this is the highest unemployment since
Speaker 1: the nineteen thirties, and the FED was was not providing
Speaker 1: enough growth in the money supply. And uh, what's amazing
Speaker 1: is that it's just three three years after this that
Speaker 1: you get the vocal shock and changes our whole way
Speaker 1: of thinking about what the FED is for. And then
Speaker 1: the vulgar FED success or perceived success and taming a
Speaker 1: decade of inflation that various politicians and government officials tried
Speaker 1: to address and we're understood to have failed. Leads to
Speaker 1: a whole reconceptualization of what the purpose of the FED
Speaker 1: is and what a central bank, what role central bankser
Speaker 1: performed in an economy. So, just on this note, like
Speaker 1: I realized we're kind of having an abstract conversation about
Speaker 1: the purpose of the FED. But can you can you
Speaker 1: maybe draw a direct line between that conceptualization of what
Speaker 1: the FED should be doing or could be doing, to
Speaker 1: what happened in for instance, two thousand eight, Like, can
Speaker 1: you connect those two events? Yes, So two thousand and
Speaker 1: eight is the FED confronting it's need to perform its
Speaker 1: fundamental purpose, which is to prevent monetary contraction, the core
Speaker 1: or of its men, the whole reason it was created,
Speaker 1: the reason it's for it's key modifications. Seven. It's all
Speaker 1: about do not allow for a monetary system breakdown to
Speaker 1: cause a terrible recession. That's the FEED is there to
Speaker 1: prevent that from happening. Uh. And they're now they're facing
Speaker 1: this monetary system breakdown and uh it's a product of
Speaker 1: this whole shadow banking system that they had been involved
Speaker 1: in developing over the years. It turns out to be
Speaker 1: unbelievably fragile, UM and need an enormous amount of central
Speaker 1: bank support in ways that they had not anticipated. And uh,
Speaker 1: and ultimately they don't keep all the balls in the air. Um.
Speaker 1: The Lemon Brothers ball falls, and we have a whole
Speaker 1: conversation about UM you know, whether there were other ways
Speaker 1: to keep that ball in the air and what the
Speaker 1: right response to that was. But the reality is when
Speaker 1: you have shooge chunks of the money supply collapsing like that,
Speaker 1: you get a very acute recession. And that's exactly what
Speaker 1: we have UM. And so the FED does a sort
Speaker 1: of you know, in the period maybe a B B
Speaker 1: plus job. I mean, I'm rucking sort of give it
Speaker 1: a great because it's sort of like, in some ways
Speaker 1: they failed completely and in other ways they succeeded. They
Speaker 1: avoided a much worse crisis. But the Great Recession is
Speaker 1: fundamentally the product of monetary system breakdown that was a
Speaker 1: complete own goal. From a social design perspective, we didn't need.
Speaker 1: It's like the electricity grid turning off for two months.
Speaker 1: Imagine what would happen if the electricity grid is sort
Speaker 1: of shut down for six weeks UM you'd have a
Speaker 1: huge drop in gdp UH. And the monetary system is
Speaker 1: like the electricity grid for the financial system, and if
Speaker 1: you turn it off, you can have an activity just
Speaker 1: sort of grinds to a halt. And and the Fed's
Speaker 1: job is to keep the lights on, and they didn't
Speaker 1: totally nail it, so, Josh, you know, with each of
Speaker 1: these crisis and the two big ones obviously that we've
Speaker 1: experienced recently two thousand and eight, and then all the activity,
Speaker 1: the flurry of activity and spring two thousand twenty when
Speaker 1: COVID hit, you know, obviously there's all these sort of
Speaker 1: de facto discount windows that open up for the non
Speaker 1: banking sector. But then there's also like seems to be
Speaker 1: this legal fight that emerges in terms of like, well,
Speaker 1: what tools are really available under the law? Is there
Speaker 1: any real limit to what the FED can justify to itself?
Speaker 1: Like are there actually hard constraints on what the FED
Speaker 1: can do? Where is it always sure to either one
Speaker 1: of you? Or is it always the sort of like
Speaker 1: the only constraint is the creativity of the lawyers. This
Speaker 1: is an invitation to make fun of lawyers. I think, yeah, well,
Speaker 1: that's fraught for many reasons. But I think the answer
Speaker 1: that question is the answer to any question related to
Speaker 1: the legal constraints on a public institution, which is that
Speaker 1: any public institution can quote unquote get away with whatever
Speaker 1: they can justify. The question is like, is there a
Speaker 1: long history of doing it? Um, that's not enough on
Speaker 1: its own, but like it helps, right, So the fen's
Speaker 1: been doing repost since nineteen seventeen, that's a long time. Um.
Speaker 1: You know it's been doing f X operations since then,
Speaker 1: since the sixties. That's also a long time. And so, like,
Speaker 1: you know, the was like the open and notorious doctrine
Speaker 1: I guess you call it. Is it called the doctor
Speaker 1: and I'm not really sure. Basically, if you walk into
Speaker 1: somebody's house, set up shop and never leave and they
Speaker 1: never kick you out, of call anyone, it's your house. Um,
Speaker 1: And so you know someone who tried to do that, Yeah,
Speaker 1: usually doesn't work. But for real property, that's like a
Speaker 1: real adverse possession, yes, which which shouldn't necessarily apply to
Speaker 1: like administrative practices, but like the principle of the thing
Speaker 1: sort of applies to some extent. I'm kind of avoiding
Speaker 1: your question in the sense that like the answer is
Speaker 1: yes and now, um. But but ultimately you have to
Speaker 1: be answerable to the public. And so you know, I
Speaker 1: think that's on Congress in a sense to say we
Speaker 1: don't like what you did, Um, you can't do it anymore.
Speaker 1: I'm going to write that down. We're all going to
Speaker 1: vote on it and the President's going to sign it.
Speaker 1: Now it's a rule. UM and they've done that in
Speaker 1: the past. UM And and for example, in also nearly fifties,
Speaker 1: there's a voluntary credit restraint program in UH around the
Speaker 1: Korean War, and basically the Congress removed ability to do
Speaker 1: that and they brought it back later. But like there've
Speaker 1: been examples of powers being moved by Congressional action, and
Speaker 1: that's ultimately to another in the remedy. Right, it's not
Speaker 1: that people sue the Fed, it's that Congress passes. Is
Speaker 1: also a great example Dive Frank Act Section thirteen three,
Speaker 1: which is one of the core authorities that the FED
Speaker 1: leans on. In two thousand and eight, Congress makes significant
Speaker 1: modifications because it wasn't pleased with certain ways in which
Speaker 1: Congress use thirteen three in two thousands and its specifically
Speaker 1: Congress made thirteen three launch to support UM the rescue
Speaker 1: of bear Stearns and UH to a I G. And
Speaker 1: the modifications in say that thirteen three lending has to
Speaker 1: be through facilities with broad based eligibility UM, and the
Speaker 1: FED can't make loans to save a particular specific failing
Speaker 1: financial company. And so just recently we had seen that
Speaker 1: mechanism at work, though, I would say in general, the
Speaker 1: government is full of administrative agencies that exercise delegated authority
Speaker 1: from Congress pursuantto enabling statutes, and the ordinary mechanism for
Speaker 1: checking that exercise of authority by those agencies is the
Speaker 1: courts is the judicial process. So so so what the e
Speaker 1: PA decides to regulate air pollution, uh, they often get
Speaker 1: sued and then they have to go and explain why
Speaker 1: the statute authorizes them to regulate air pollution in that way.
Speaker 1: And then there's a bunch of judges who you know,
Speaker 1: are either convinced or not convinced, and they apply various
Speaker 1: doctrines and that process. The FED is subject to very
Speaker 1: little of that, for variety of reasons we can get into.
Speaker 1: And so, unlike many agencies that were familiar with, the
Speaker 1: FED tends to be the final interpreter of its own
Speaker 1: enabling statute. UH. And so it's the FED General Council's
Speaker 1: Office that sort of decides what Section fourteen means because
Speaker 1: there's basically no cases where a judge has ever been involved,
Speaker 1: So we haven't developed a bunch of precedents, and it's
Speaker 1: uh not sort of come about that anybody has sued
Speaker 1: the FED for a variety of reasons, uh, and gotten
Speaker 1: a judge involved in the issue. And that's why the
Speaker 1: sort of main players that are constraining what the FED
Speaker 1: can do are its own General Council's office and then
Speaker 1: Congress Um, which can intervene. It must be nice to
Speaker 1: be able to be the arbiter of your own your
Speaker 1: own powers. Um. I'm going to reluctantly fast forward to
Speaker 1: two and you know, we've been talking a lot about
Speaker 1: this on the podcast. There's been a lot of air
Speaker 1: being taken out of the sort of most frothy parts
Speaker 1: of the market, and there's been a lot of talk
Speaker 1: about the FED raising rates until something breaks. But the
Speaker 1: standard opinion seems to be that the financial system is
Speaker 1: safer than it was in two thousand eight. You don't
Speaker 1: have the build up of leverage that you had back then.
Speaker 1: Is that right? I'd love to hear from both of you,
Speaker 1: like where are the pockets of vulnerabilities right now? And
Speaker 1: should we be worried about financial stability? So the interesting
Speaker 1: answers there's some like idiosyncratic source of leverage that no
Speaker 1: one talks about. And I'm going to tell you right
Speaker 1: now and then we'll have the answer. But I'm not
Speaker 1: going to do that because I tried, Yeah, well I
Speaker 1: can't do that. I should say no, I'm not going
Speaker 1: to do that. But but I think an interesting case studies.
Speaker 1: So I hated to rewind to that. But two eight
Speaker 1: is a credit crisis that is deflationaring in the sense
Speaker 1: that the money that was created to fund new loans
Speaker 1: is now not money good because the loans are bad.
Speaker 1: When the loans go bad, the money goes away, and
Speaker 1: you have deflation. Um in we have a big much
Speaker 1: bigger economics. Then we head into thousan Nate and by
Speaker 1: lots of measures. And yes it was short lived. Yes
Speaker 1: it was like quote unquote V shaped or whatever. Maybe
Speaker 1: it's sort of a check mark shape because we kept
Speaker 1: going up. But like the that wasn't obvious at the time. Um,
Speaker 1: but we don't have a credit crisis, Like nobody's really
Speaker 1: worried about the underlying stability of the banking system in
Speaker 1: a meaningful way at any particular point in that. Now
Speaker 1: we do stress tests, we make sure we're but it's
Speaker 1: more about checking your answer than it is about coming
Speaker 1: up with a new one. And so like that's a
Speaker 1: success in that it's not a credit crisis, it's a
Speaker 1: liquidity crisis. Central banks are designed to deal with liquidity crisis.
Speaker 1: So um, now you could ask the question, should there
Speaker 1: be that much liquidity in the market in general? That's
Speaker 1: ultimately the question of shadow banking, is there's more liquidity
Speaker 1: than necessarily is sustainable. And if the FEDS going to
Speaker 1: or central banks in general are going to backstop liquidity,
Speaker 1: like they should have some limit to what they're willing
Speaker 1: to do. Um. If you think about the current environment,
Speaker 1: you know, just this the simple fact of rising rates
Speaker 1: doesn't seem with some idiots and credit cases left the side,
Speaker 1: like the global economy and for the US economy, um
Speaker 1: is problematic in much more boring ways. Meaning it used
Speaker 1: to be really cheap to our money, it's not so
Speaker 1: cheap anymore. And like that's not a financial system meltdown
Speaker 1: kind of thing. Um Because now you know, that's a
Speaker 1: sanguine look and that's like classic like you know, final
Speaker 1: word on the like it's not going to go well,
Speaker 1: I make that prediction, but like the I think that
Speaker 1: the problem is different, and there's this tendency to say,
Speaker 1: you know, there's this stressor that's applying pressure to the system,
Speaker 1: and the system is vulnerable, and this crack is going
Speaker 1: to open, and it's all going to spread wide, and
Speaker 1: we're going to find out that what we didn't know
Speaker 1: is the only thing that matters. And and I think
Speaker 1: we should open ourselves up with the possibility that this
Speaker 1: is kind of just a rate cycle, and that there's
Speaker 1: no obvious source of monetary and stability UM and that
Speaker 1: it's still gonna be painful at times because it's more
Speaker 1: expensive our money, but it's gonna be about that real
Speaker 1: economy stuff as opposed to like the mechanical or the
Speaker 1: plumbing or the financial your side of things, love did
Speaker 1: did Josh just jinx us into a major credit crisis?
Speaker 1: I'm going to hazard the other position, the other side
Speaker 1: of this um UH. It's certainly the case that we've
Speaker 1: made a lot of improvements UH since two thousand and eight,
Speaker 1: but we still have a fundamentally unstable monetary financial system.
Speaker 1: It's just inherently fragile. The run risk is lurking constantly.
Speaker 1: And that's because repo market, the your dollar market, repo
Speaker 1: issuers and your dollar issuers are not in fact banks.
Speaker 1: There is no deposit insurance, so you can have repo insurance,
Speaker 1: and so there's enormous incentives that are just always hanging
Speaker 1: over to run. You can think of a of a
Speaker 1: cash provider in a repo or a euro dollar depositor
Speaker 1: as picking up pennies. Um, they're getting paid more interest
Speaker 1: than if they're in a bank deposit, and then good times, great,
Speaker 1: pick up those pennies in front of the steam roller.
Speaker 1: But then all that has to happen is a change
Speaker 1: in expectations about the future uh any concern and there's
Speaker 1: just an incentive for the cash providers and your dollar
Speaker 1: depositors to just go back to a regular bank deposit
Speaker 1: or t bill um, you know, to to get out.
Speaker 1: And so Ben Bernanke I think it was his famous
Speaker 1: comment about the subprime mortgage issue. He thought that that
Speaker 1: was contained. He was like, this is too small to
Speaker 1: cause a crisis. But the lesson in some sense of
Speaker 1: two thousand and eight is that if you have an
Speaker 1: inherently fragile monetary system, it doesn't have to be huge losses.
Speaker 1: It just has to be sufficient uncertainty about the distribution
Speaker 1: of those losses to cause all of the shadow money
Speaker 1: people to try to rush into the good money. And
Speaker 1: I would say that right now, where we're looking at
Speaker 1: is balance sheets of of shadow banks that are under
Speaker 1: pressure from a frustrate rises because they have a lot
Speaker 1: of dead instruments that become less valuable when interest rates
Speaker 1: go up. And so the more pressure the assets side
Speaker 1: of financial institutions UH that are issuing money instruments, the
Speaker 1: more pressure that that is under, the higher the likelihood
Speaker 1: that there will be a moment where everybody looks down
Speaker 1: and says, wait a second, I don't know if this
Speaker 1: guy is UH is such a good bet anymore. Let
Speaker 1: me just move my money to JP Morgan Chase. And
Speaker 1: that's what happened in two thousand and eight some sense. Alright,
Speaker 1: we're forty minutes in and we'll get to audience questions
Speaker 1: in a second. But there's one since I want to
Speaker 1: bring it up. You know, Tracy mentioned like, well, nothing
Speaker 1: is broken yet, but one thing has broken and it's
Speaker 1: the crypto market or there was a pretty big break there.
Speaker 1: But here's the thing. People hate bailouts. So thank god,
Speaker 1: nothing so far knock on wood with the FTX story
Speaker 1: has like caused any sort of financial institution to need
Speaker 1: to bail out what should be done so that never
Speaker 1: in my life do I have to hear about a
Speaker 1: crypto company getting built out. What would you like to
Speaker 1: go first? Either one of you is how do we
Speaker 1: avoid that risk forever? So the crypto ecosystem is I
Speaker 1: think eager for And if they're not eager for it,
Speaker 1: they should be uh some official sector recognition that will
Speaker 1: allow ordinary financial institutions to hold and trade and deal
Speaker 1: in cryptocurrencies, because right now what they have is a
Speaker 1: whole little world that just exists on the internet, is
Speaker 1: completely divorced from any economic activity in the real world.
Speaker 1: It's like the apopiosis of finance. The purpose of finance
Speaker 1: is to help us allocate real resources in the real world,
Speaker 1: and here's crypto and they're doing it, except they're not
Speaker 1: allocating any resources in the real there's no there's no
Speaker 1: connect The only point of connection between the crypto world,
Speaker 1: the only significant point of connection with crypto world right
Speaker 1: now and real economy is stable coins, which is the bridge.
Speaker 1: It's how you get in and out. And so the
Speaker 1: stable coin issues actually have real dollar assets, they're the
Speaker 1: only ones um. And so the way you avoid ever
Speaker 1: having a crypto bailout is you keep it that way,
Speaker 1: you don't have the actual economy ever become reliant or
Speaker 1: exposed to the value of these tokens, and you don't
Speaker 1: end up with massive stable coin issuers that you know
Speaker 1: are issuing stable coins that people use to buy real
Speaker 1: goods and services. If the only use of a stable
Speaker 1: point is to buy a token with no value, then
Speaker 1: you know, it's just not it's not a real risk.
Speaker 1: But if people are using stable coins to buy actual stuff,
Speaker 1: then it becomes part of the money supply, And if
Speaker 1: all those stable coins disappear, you could get contractionary pressures
Speaker 1: that have to be counteracted by some official sector action
Speaker 1: and doesn't have necessarily be a bailout, but a bailout
Speaker 1: is often the most efficient means. You know, UH, it
Speaker 1: would have been easier to have bailed out leaving brothers
Speaker 1: than to try to get the money supply expanding through
Speaker 1: other UH central bank actions. So I think it's um, Like,
Speaker 1: I completely agree with that. I mean, maybe I'm exposed
Speaker 1: to be supposed to Twitter flame by saying that, but like,
Speaker 1: I mean, I think the sorry you're not on Twitter,
Speaker 1: there's another Jeosh Younger on Twitter who's not him, not me, Um,
Speaker 1: very very much, but there's probably more than one fairness. Um,
Speaker 1: but I think that the thing that money is supposed
Speaker 1: to do something for you, right, So that's kind of
Speaker 1: along the lines of less argument, which is like it
Speaker 1: has some real economy purpose and so like, ultimately bank
Speaker 1: deposits are good and good money in the sense that
Speaker 1: I can guess by goods and services, but there's an
Speaker 1: underlying transfer of federal reserve liabilities behind that, like banks
Speaker 1: interact with them between each other in federal reserve money,
Speaker 1: and so and then and and that bank deposits value
Speaker 1: in the sense that I can go to the bank
Speaker 1: and get paper money and then in principle pay my
Speaker 1: taxes with it, right, because that's definitely use of government
Speaker 1: issue money. Is that, oh, the government a hundred dollars,
Speaker 1: I take my hundred dollars, I give it to the government.
Speaker 1: I don't go to jail. Much better outcome. And so
Speaker 1: like the question is in crypto, like where's that convertibility?
Speaker 1: And so this is where the your dollar analogy comes up,
Speaker 1: which is like building up an infrastructure that guaranteed that
Speaker 1: convertibility in the way that let the market scale was
Speaker 1: a lot of work and took a long time, and
Speaker 1: it involved the direct involvement of the Federal Reserve at
Speaker 1: many steps and all the other central banks. And so
Speaker 1: you know, the crypto ecosystem is similarly offshore, involving many
Speaker 1: different regulatory authorities. Um. And if I can't take my bitcoin,
Speaker 1: turn it into a tether, turned it into a dollar,
Speaker 1: turn it into a paper dollar, and give it to
Speaker 1: the treasury to pay my taxes, like, if that chain
Speaker 1: is not guaranteed, it's hard to see how it scales,
Speaker 1: um and so like to last point, you just don't
Speaker 1: do anything, and you're gonna end up not necessarily with
Speaker 1: crypto exchanges being like iron clad, because probably won't get
Speaker 1: that either. But it won't have like a real economy impact.
Speaker 1: It won't be a major component of the monetary system.
Speaker 1: It won't be a major component of the financial systematic
Speaker 1: can be segmented off. You know, the the FTX stuff
Speaker 1: like is mostly about crypto um and there's real economy complications.
Speaker 1: But like you and there's really like bad outcomes for
Speaker 1: lots of people, and I don't want to diminish that
Speaker 1: at all, But like the banking system will survive, should
Speaker 1: we take some audience questions? So We have some really
Speaker 1: good ones. I have to say about half of them
Speaker 1: are about crypto. But this is where we did them
Speaker 1: buy a card? Yeah, they are. They're good crypto questions.
Speaker 1: It's not like would you buy bitcoin? But but okay,
Speaker 1: when you hold the magic box, you're gonna get that
Speaker 1: to that one on on this convertibility point, um, here's
Speaker 1: one question. So do you think that some of the
Speaker 1: shadow banking solutions or other types of solutions could reach
Speaker 1: the retail level through payment solution companies such as PayPal,
Speaker 1: so that, for instance, you could have repoat availability for
Speaker 1: your average person on the street. And this person didn't
Speaker 1: mention this, but I'll just tack this on central bank
Speaker 1: digital currencies. I mean, one of the use cases for
Speaker 1: those is this idea that people could potentially have access
Speaker 1: to the FED directly in some way. You do have
Speaker 1: that right, that's a money market fund. So the money
Speaker 1: market fund gives you direct access. Fore, it gives you
Speaker 1: direct access to FEDS balanchie the reverse repot facilities and
Speaker 1: money market fund asset almost exclusively. And so like that
Speaker 1: functionality exists, and people are utilizing at the government money
Speaker 1: market fund complex, which is this like risk free component
Speaker 1: of money market funds, multi trillion dollar business, so so
Speaker 1: it's happening. I think with central bank digital currencies, the
Speaker 1: question is what problem we're trying to solve. That's what
Speaker 1: everyone starts with when they talk about CBDCs. They say like, well,
Speaker 1: what are we trying to solve? And I think, like
Speaker 1: a center bank digital currency has two like unique aspects.
Speaker 1: One is it is a digital asset blockchain or not uh,
Speaker 1: and the other is it is not a bank, it's
Speaker 1: the central bank. So if we want a central bank
Speaker 1: digital currency available to retail investors because wholesale has access
Speaker 1: to the central bank's balance sheet. Um, the questions, do
Speaker 1: retail investors have a have serious concerns about the stability
Speaker 1: of commercial banks that would warrant a different counterparty right there?
Speaker 1: Their counterparty is currently a commercial bank. They'd rather be
Speaker 1: the central bank. And you only do that if you
Speaker 1: really don't think that commercial bank is gonna be good
Speaker 1: for the convertibility and everything about the way bank depositor
Speaker 1: price tells you people are perfectly comfortable with with the
Speaker 1: ability to the banking system to deliver on their promise
Speaker 1: of convertibility. So then it's a question of the settlement
Speaker 1: cycle and the payment system. And one of the things
Speaker 1: that I think is really interesting about the the discussion
Speaker 1: of payments. Anyone who's like talk to me is probably
Speaker 1: brought up the statistic at some point. But the FED
Speaker 1: does a survey, They say, have you used a check
Speaker 1: hasher or another non bank financial media in the past year,
Speaker 1: so Casher's paid loans, all that kind of stuff, um,
Speaker 1: and people say yes or no. It's multively small fraction people,
Speaker 1: but it's it's non trivial. And then they say, do
Speaker 1: you have a bank account? And so of people who
Speaker 1: use a check casher also have a bank account. So
Speaker 1: this is about the payment system for those folks, and
Speaker 1: that's why the financial inclusion bit of CBDC. I think
Speaker 1: the question is can the backing system solve that through
Speaker 1: a better payment system of faster settlement cycle. Is it
Speaker 1: really about access to central bank money or is it
Speaker 1: access to faster payments? And that's why segmenting the problem
Speaker 1: is useful because then you can look at the technology
Speaker 1: and say this piece is useful, this piece is not.
Speaker 1: So the banking system has been telling us that they're
Speaker 1: going to solve the unbanked under banked problem since the
Speaker 1: nineteen eighties when Congress had a hearing and UH and
Speaker 1: the Fed actually said, don't worry, the bank banking system
Speaker 1: is going to address this. Will will will get that
Speaker 1: number of unbanked down to the level of other advanced economies, which,
Speaker 1: by the way, is plus other advanced economies are banked.
Speaker 1: And we have actually made a lot of progress in
Speaker 1: the last ten years UM for reasons having to do
Speaker 1: with technology making it cheaper to offer bank accounts, but
Speaker 1: we still have around five of households unbanked, which is
Speaker 1: millions of people. And so I do think that's one
Speaker 1: reason why central bank money UH, public option for central
Speaker 1: bank money could be appealing. Obviously agree with Josh that
Speaker 1: there's not a safety stability deficiency for bank account money.
Speaker 1: Of course, that's because the public stands behind that through
Speaker 1: deposit insurance and the discount window UH. And so the
Speaker 1: government has given a franchise for the banking system to
Speaker 1: create that safe money. And so fundamentally, the question should
Speaker 1: we have a CBDC is a question about do we
Speaker 1: want to re engineer or change that arrangement and change
Speaker 1: the nature of the banking franchise and and and and
Speaker 1: introduce a public option that competes with the banking franchise.
Speaker 1: Do we think that will lead to a solution of
Speaker 1: the on bank problem that's more robust, uh, a solution
Speaker 1: to the payments problem. The banking industry has spent decades
Speaker 1: um not investing in fast payments because banks have an
Speaker 1: interest in the float and in having additional time to
Speaker 1: prevent fraud, which because of federal law, generally they have
Speaker 1: to absorb those costs. And so whereas other advanced countries
Speaker 1: have had real time growth settlement, real time payments the
Speaker 1: retail level for decades, uh, here we are in two
Speaker 1: and it's it's patches here and there in the u
Speaker 1: S where you can move your money quickly. And this
Speaker 1: is part of the reason why you end up with
Speaker 1: the stable coins. In some sense, stable coin issues make
Speaker 1: this argument it's going to be more efficient transaction. So
Speaker 1: I think there's a question on those sort of bread
Speaker 1: and butter dimensions. Would a public option for bank accoun
Speaker 1: out money improve the private options that exist? And then
Speaker 1: there's the larger question about the shadow bank money. What's
Speaker 1: a major reason why you have repo market, what's a
Speaker 1: major reason why you have money funds? Because ft I
Speaker 1: C insurance caps out at two fifty dollars, and there's
Speaker 1: actually a deficiency in the nature of the bank franchise.
Speaker 1: We don't actually have this level of safety that we
Speaker 1: would want. And so there's large corporations that have very
Speaker 1: large balances. Maybe they want to have a five hundred
Speaker 1: million dollar cash balance, and there may be not so
Speaker 1: comfortable about having that all in one bank, and do
Speaker 1: we need to fix that? And maybe should Apple be
Speaker 1: able to just hold a billion dollar cash balance at
Speaker 1: the federals or that's nondefaultable. Why not make non defaultable
Speaker 1: money more widely available? And that's I think that's sort
Speaker 1: of the the pro case. Or central bank digital currency,
Speaker 1: not necessarily like on the blockchain, uh, not token eye,
Speaker 1: central bank digital currency, but just what you know, fed
Speaker 1: accounts for all, which is something that I've been in
Speaker 1: favor up for many years now. So I don't know
Speaker 1: if you guys knew that that that I was for that.
Speaker 1: But by the way, future episode we should do one,
Speaker 1: just like why there's no instant payments in the US.
Speaker 1: I think that would do really well and just like
Speaker 1: some of the yeah, that's a good future episode. Can
Speaker 1: you um you know you've written about like the sort
Speaker 1: of coevolution or the different evolution. So we talked about, Okay,
Speaker 1: the FED having to like come up with all these
Speaker 1: new mechanisms um to deal with the growth of deposit
Speaker 1: like things outside of the banking system. Can you compare that, like,
Speaker 1: what does it look like for the other major central
Speaker 1: banks and their evolution E, C, B, B, O, J.
Speaker 1: Have they also roughly had to do the same thing,
Speaker 1: or is because there is not as similar like sort
Speaker 1: of as big offshore market for some of these other currencies,
Speaker 1: has it not been pressing up an issue? So Josh
Speaker 1: might be deeper on this than I am, But generally
Speaker 1: the dollar based shadow banking system is vastly larger than
Speaker 1: for other currencies, and there's a variety of reasons for this.
Speaker 1: One has to do with exactly what we were talking about,
Speaker 1: the stance of US policymakers, in particular Treasury Department and
Speaker 1: the Federal Reserve in the latter half of the twentie
Speaker 1: century to actually facilitate its growth um and to allow
Speaker 1: for the sort of impairment of the bank franchise, not
Speaker 1: just to allow to nurture it. Another has to do
Speaker 1: with the fact that in a lot of other countries,
Speaker 1: the currency that everybody wants to be in as dollars.
Speaker 1: And so for US where we just we just use
Speaker 1: dollars here, but in a lot of other countries there
Speaker 1: are there is the presence of multiple currencies. The other
Speaker 1: currency is dollars and UH and so in European countries,
Speaker 1: the sort of shadow banking problem that they have is
Speaker 1: the creation of dollar deposits, which then they have to manage.
Speaker 1: As Josh pointed out, one way to have managed that
Speaker 1: is just to prohibit institutions in your country from issuing
Speaker 1: deposits denominated in another currency. If you don't, if you
Speaker 1: allow it, you're gonna want to regulate it because if
Speaker 1: these liabilities build up, you the central bank um you
Speaker 1: know of Japan or UH in the UK, you can't
Speaker 1: create dollars. And so now you have a run in
Speaker 1: your economy amongst your institutions, and you call up the
Speaker 1: federal Reserve and ask for a swap line. You need
Speaker 1: to phone a friend or you're gonna lose your economy
Speaker 1: and you can't carry out your mandate. And so I
Speaker 1: would say that's that's been the big shadow banking problem.
Speaker 1: And I do think that in a lot of these jurisdictions.
Speaker 1: The Euro dollars are are issued by banks, but they're
Speaker 1: often issued by other types of financial companies, which we
Speaker 1: would consider sort of traditional shadow banks for here, so UH,
Speaker 1: you know in Asia life insurance companies, they're of various
Speaker 1: companies engaged in short term don a liability creation. And
Speaker 1: how did the Bank of Japan deal with that in
Speaker 1: when it when it ran it borrowed over three hundred
Speaker 1: billion dollars from the FED to online. I think that
Speaker 1: it's all part of the plan basically, which is that
Speaker 1: in the in the fifties and sixties, the goal was
Speaker 1: to cement and entrenched UH and grow the dollar system
Speaker 1: because it offered all of these benefits. This is exorbitant privilege.
Speaker 1: This is the idea that I borrowed my own currency.
Speaker 1: There's also the currency of global trade, and so like
Speaker 1: the first generation of your dollars, this is a benefit
Speaker 1: to other countries as well, right, because there's the idea
Speaker 1: of a global currency. So of all trade happens in
Speaker 1: the same currency, I can finance it in that currency.
Speaker 1: I can deposit the proceeds of my trade in that currency,
Speaker 1: and now I'm sort of all in all in the
Speaker 1: family kind of thing. And so the first generation of
Speaker 1: your dollars is primarily deposits of central banks. So central
Speaker 1: banks are the seed for the modern euro dollar market. Uh,
Speaker 1: they are the depositors. Um. So they're making a choice
Speaker 1: to park their funds added your dollar issue or and
Speaker 1: not in T bills or other sorts of dollar denominated assets.
Speaker 1: Is because they see value in that system for themselves.
Speaker 1: And and the FED goes one step further and says
Speaker 1: like you need to find a friend, call me right,
Speaker 1: which is here's some swap lines. It's two start with Switzerland,
Speaker 1: move on to the b I S and the Bank
Speaker 1: of England, and and grow that that network which sort
Speaker 1: of connects all central banks into one globalized dollar system.
Speaker 1: So you can do open market operations in the your
Speaker 1: dollar market. Because ultimately the chain leads back to the
Speaker 1: issuer of dollars, which is which is the Federal Reserve.
Speaker 1: I think you guys have paramariland on recently. I was
Speaker 1: going to say, we've come full circle to our previous limber.
Speaker 1: You know, has a book about Charlie Kinda Burger, uh,
Speaker 1: and the and the point that Charlie Kindle Burger makes
Speaker 1: uh and that Paramariland makes is that the huge network
Speaker 1: effects and money, and so it's much more efficient if
Speaker 1: we're all on the same sort of currency. And so
Speaker 1: the construction of the euro dollar market, which is apparently
Speaker 1: in stale market in a lot of ways UH is
Speaker 1: also it's a more efficient market. And so for all
Speaker 1: of the other countries that have different currencies, if they
Speaker 1: can get dollar funding, it's going to be cheaper, it's
Speaker 1: gonna be better for their businesses. And so this system
Speaker 1: was built up over decades too because of its superiority
Speaker 1: on certain efficiency dimensions. When pots Namors never really worked
Speaker 1: out was how to keep it stable in a business
Speaker 1: cycle downturn, and also various governance and distributional issues which
Speaker 1: are sort of shoved under the rug and are really
Speaker 1: significant in terms of who wins and who loses in
Speaker 1: terms of adopting what is a currency issued by the
Speaker 1: United States and what that means for businesses in the
Speaker 1: United States UH and also businesses in other countries. UM,
Speaker 1: we are running out of time, so I'm gonna ask
Speaker 1: one more audience question, and I would encourage you all
Speaker 1: to to seek out Josh and Love after this because
Speaker 1: we will be having drinks um over there, but in
Speaker 1: the meantime, h This question is from Yakov, who is
Speaker 1: on Twitter at Yakov, and the question is what does
Speaker 1: pal fantasize about doing? What is poal fantasize about doing
Speaker 1: if he wasn't constrained by the dual mandate. I'm going
Speaker 1: to rephrase this slightly and say, like, if the FED
Speaker 1: could start over today when it comes to designing the
Speaker 1: financial system, what do you think it would do differently?
Speaker 1: And since there's another question that's very similar to this,
Speaker 1: I'll just add what would you do different you know,
Speaker 1: it's like someone else basically like, well the one the
Speaker 1: one changed you'd like to see. I'm not I actually
Speaker 1: don't have a can answer that question, in part because like,
Speaker 1: for all of its issues, like chatter, banking has yielded
Speaker 1: great benefits to the United States, and so like is
Speaker 1: it too much to pay the boatman? I'm not sure, um,
Speaker 1: But I think that the key is it takes a
Speaker 1: crisis to figure out how to fix it, and so like,
Speaker 1: in some sense, the hypothetical is if you knew all
Speaker 1: the things that could go wrong, would you just build
Speaker 1: in systems that can handle it? Um. The other version
Speaker 1: of this is to say, Look, you know the money
Speaker 1: supply should be issued by banks and investments are for investors,
Speaker 1: and you know there should be some lubrication into the system.
Speaker 1: But the continuum of money is sort of too diffuse
Speaker 1: in a sense, like it's hard to see where one
Speaker 1: ends and the other begins, and and so you know,
Speaker 1: either drawing very clear lines, not necessarily at bank deposits,
Speaker 1: but like being very explicitly behind certain forms of and
Speaker 1: not others in advance. UM. Again with some policy goal
Speaker 1: in mind. In this case, probably the global dollar system
Speaker 1: is worth preserving UM in lots of ways, and so
Speaker 1: that kind of force it would be useful. What would
Speaker 1: I do? UM? Maybe I should have pretended like I
Speaker 1: didn't remember that that part of the question. Um. You
Speaker 1: know that that the the old Lombard Street logic I
Speaker 1: think applies really strongly, which is a lend against good
Speaker 1: collateral at a penalty rate. UM. So liquidity should never
Speaker 1: be the reason why the financial system goes down. UM.
Speaker 1: Now that means making sure you're comfortable with what people
Speaker 1: are doing the providers of that liquidity are doing with
Speaker 1: the proceeds of it. UM. So like data collection, transparency
Speaker 1: to regulators, not necessarily to the public, but certainly transparently
Speaker 1: to regulators and the public where it's useful and beneficial
Speaker 1: and in the public interest. I think that's all really important.
Speaker 1: And part of the big problem with with markets structured
Speaker 1: with this continuum of money is transparency is very hard
Speaker 1: to achieve um and so policymakers don't really know what
Speaker 1: they're looking at. They don't have all the information. And
Speaker 1: we tend to sort of put together a data collection
Speaker 1: program that solves the last crisis. So we're getting really
Speaker 1: good at the treasury market now, and I'm not convinced
Speaker 1: that's going to be the next big thing that breaks,
Speaker 1: you know, And we have to avoid this tendency to
Speaker 1: kind of like investigate the thing after it goes wrong
Speaker 1: and then have all the information about it. But the
Speaker 1: next thing is not is not on a rator. So
Speaker 1: I mean, I'm gonna take a stronger position against the
Speaker 1: shadow banking system. I would say that the the benefits
Speaker 1: tend to be very overstated and to often be articulated
Speaker 1: and stated by members of the financial sector who tend
Speaker 1: to reap a lot of those benefits. And on the
Speaker 1: other side of the ledger, I think the costs tend
Speaker 1: to be under a appreciated the full range of costs
Speaker 1: of the shadow banking system, and so you know, there's
Speaker 1: one way of thinking about the euro dollar system as
Speaker 1: you know, a form of Dutch disease that has had
Speaker 1: all sorts of bad UH consequences within the US economy.
Speaker 1: Although that's not my main reason to be concerned about it,
Speaker 1: I do think that those issues should be looked at
Speaker 1: much more closely than policymakers seem to have looked at
Speaker 1: them so far. There's such a focus on stability for
Speaker 1: the system, but there's huge political economy effects of having
Speaker 1: a system like this, and what you have is sort
Speaker 1: of an open ended government backstop for financial sector risk taking.
Speaker 1: And you know, I don't get great comfort in the
Speaker 1: sort of invocation of the badget rule. Uh. Walter Badgett's
Speaker 1: second half of the nineteenth century vision for how society
Speaker 1: should be structured is not one that I think many
Speaker 1: of us would find appealing today. This was a monetary
Speaker 1: financial system for an imperial power in a highly liberalized
Speaker 1: economy in the second half of the nineteenth century, and
Speaker 1: I think that there's uh a real concern that we
Speaker 1: should have about a system that is as unstructured as
Speaker 1: the one we have where the public sector is um
Speaker 1: so frequently on the back foot. And I think that
Speaker 1: the solution isn't as hard as it sometimes seems, and
Speaker 1: that the history that Josh has done such a good
Speaker 1: job of elucidating on the other podcast about the fifties
Speaker 1: and we talked a little bit about eurodollars, shows that
Speaker 1: the public sector actually has huge control over whether you
Speaker 1: have an inherently unstable system or a stable system. And
Speaker 1: we just sort of we have experience of this in
Speaker 1: other areas, and so think about other areas of financial
Speaker 1: regulation with the speck to the regulatory perimeter. The reasons
Speaker 1: securities regulation works is that we have a functional definition
Speaker 1: of a security, and anything that comes within the functional
Speaker 1: definition as supposed to a formalistic definition, you can't dress
Speaker 1: it up as something else and then not comply with
Speaker 1: securities regulation. Anything like it's covered by the functional definition
Speaker 1: of security is subject to the same set of rules. UH.
Speaker 1: Insurance regulation works like this. You know, if you call
Speaker 1: it an insurance document, obviously you have to follow the
Speaker 1: insurance regulation rules. UM, but there's an incentive if you
Speaker 1: could maybe dress it up as something else. There's so
Speaker 1: many ways to dress up an insurance agreement and not
Speaker 1: call it insurance. UM. If you could dress it up
Speaker 1: as something else and not be covered by the insurance rules,
Speaker 1: the insurance rules are going to fall apart. And this
Speaker 1: is true for mortgages. UH. There's so many areas of regulation,
Speaker 1: and financial regulation in particular. The fundamental problem we've had
Speaker 1: in money and banking going back forever is that we
Speaker 1: have not had a functional definition that had has been
Speaker 1: UH in force. And Josh is right there there's a spectrum,
Speaker 1: but you can pick ninety day you know, ninety day maturity.
Speaker 1: Any instrument that matures in ninety days or less is
Speaker 1: a banking instrument that has to be UM issued by
Speaker 1: an entity that is subject to the same sort of
Speaker 1: coherent body of banking regulations. And that would just sort
Speaker 1: of regularized, rationalized, normalized, put some logic on on a
Speaker 1: system that has become very ad hoc and unpredictable in
Speaker 1: a way that I think is on that not in
Speaker 1: the in the public interest. And are there challenges like
Speaker 1: preserving the benefits of Parian Marylyn Charlie Kendall Burger's UM
Speaker 1: you know, international finance system with low frictions. Yeah, we've
Speaker 1: got to figure out some ways to preserve the benefits.
Speaker 1: But I think there are ways to preserve the benefits. Uh,
Speaker 1: And the costs of doing nothing are large, and we
Speaker 1: could be facing the consequences, uh, you know, in more
Speaker 1: on that order of months and as opposed to years.
Speaker 1: Shall we leave it there. Yeah, I was gonna say,
Speaker 1: we could talk for hours on this, but let's leave
Speaker 1: it there. So many future episodes. I know a ton
Speaker 1: of ideas here. Um, Josh Younger and love Men, and
Speaker 1: thank you so much. Fantastic discussion. Really great to have
Speaker 1: you here. Thank you to the audience for coming into
Speaker 1: the Bloomberg Offices to actually listen to this. Thank you
Speaker 1: for your excellent questions. Sorry we couldn't get to more
Speaker 1: of them. Thank you everyone. So that was our live
Speaker 1: recording with Josh Younger and Love Men, and thank you
Speaker 1: to everyone who came to Bloomberg's offices to you actually
Speaker 1: watch and listen and engage in that conversation. Thank you
Speaker 1: as well to our producers Carmen Rodriguez and Dash Bennett.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway. And I'm Joe wisntal. You can follow me
Speaker 1: on Twitter at the Stalwart, follow Carmen on Twitter at
Speaker 1: Carmen armand follow Dash on Twitter at Dash but oh,
Speaker 1: and follow Levi Menon on Twitter at lev men And.
Speaker 1: And we're probably gonna do several more of these, or
Speaker 1: hopefully we plan and tend to do several more of
Speaker 1: these three. So keep a listen on the podcast, follow
Speaker 1: us on Twitter so that you know about the next one,
Speaker 1: and YouTube can join in person, and odd lots listeners,
Speaker 1: Tracy and I are going to be doing an A
Speaker 1: M A Ask Me Anything episode where you can ask
Speaker 1: us questions, send us a voice memo, state your name,
Speaker 1: where you're from, and one question. Put it in an
Speaker 1: email to odd Lots at Bloomberg dot net, and we
Speaker 1: will give you our answers. Thanks for listening to