WEBVTT - Perry Mehrling Explains Why "The Money View" Is Key To Understanding Financial Markets 0:00:10.680 --> 0:00:14.200 Hello, and welcome to another episode of the ad Thoughts Podcast. 0:00:14.320 --> 0:00:17.959 I'm Tracy Allaway and I'm Joe. Wisn't thal Joe? We 0:00:18.079 --> 0:00:20.800 like to talk about money on this show, don't we? We? 0:00:21.120 --> 0:00:24.520 We sure do both sort of things that are implicitly 0:00:24.560 --> 0:00:29.160 about money, which is everything, and then also explicitly about money, 0:00:29.200 --> 0:00:32.800 which is what, what is it? Where does it come from? 0:00:32.840 --> 0:00:35.600 What are some different theories of how it exists? Definitely, 0:00:35.600 --> 0:00:38.960 I would say it's one of our favorite topics. Yeah, 0:00:39.120 --> 0:00:41.839 and we also like to talk about the repo market. 0:00:42.440 --> 0:00:45.400 And one other thing we like to talk about is 0:00:45.560 --> 0:00:50.479 the inadequacies of traditional economic models. So what if we 0:00:50.479 --> 0:00:53.280 were going to talk about all three of those in 0:00:53.479 --> 0:00:57.360 one big episode? Oh? I like that, like a true trifecta. 0:00:57.480 --> 0:01:01.040 Like we had a recent episode on the repo market 0:01:01.120 --> 0:01:04.480 with the Alton posts Are that was great. We had 0:01:04.640 --> 0:01:09.160 UH We talked to Lord Skidelski recently on the failure 0:01:09.319 --> 0:01:13.920 of traditional UH in traditional economists to understand money, and 0:01:13.959 --> 0:01:16.040 as you mentioned, we talked about money all the time. 0:01:16.640 --> 0:01:19.520 So I agree that if we could sort of combine 0:01:19.560 --> 0:01:25.039 all of these themes economist failures, money, repo, all these things, 0:01:25.080 --> 0:01:29.199 that would be a very satisfying discussion. All right, well, 0:01:29.240 --> 0:01:31.840 I have a feeling you're in for a satisfying discussion 0:01:32.120 --> 0:01:35.040 because our guest today is funny that you should mention 0:01:35.120 --> 0:01:38.440 Sultan Posar, but it's someone who has worked with Sultan 0:01:38.840 --> 0:01:42.679 in the past, someone who result In actually quoted when 0:01:42.760 --> 0:01:45.720 he did that episode of All Bots back in November, 0:01:46.560 --> 0:01:51.000 and someone who Sulton says, has informed his thinking on 0:01:51.040 --> 0:01:54.920 the repo market and the reason we're sort of focused 0:01:54.960 --> 0:01:58.120 on the repo market particularly. But and it's going to 0:01:58.200 --> 0:02:01.800 become clear as we embark on this conversation, but there 0:02:02.080 --> 0:02:07.200 was this moment during the big rebo madness in September 0:02:07.840 --> 0:02:11.440 where even though we had repo rates shoot up to 0:02:11.560 --> 0:02:17.120 ten cent, we didn't see market participants come in and 0:02:17.200 --> 0:02:21.360 actually take advantage of that rate and actually arbitrage it out. 0:02:21.440 --> 0:02:24.680 And this was one of the big questions of that event, 0:02:24.800 --> 0:02:28.519 like why didn't JP Morgan come in and earn ten 0:02:28.600 --> 0:02:33.600 percent overnight in September in the repo market? Right that 0:02:33.720 --> 0:02:37.200 whole incident. So we got through the year without another 0:02:37.760 --> 0:02:42.400 major hiccup. Obviously, the FED sort of realized that things 0:02:42.440 --> 0:02:45.080 were problematic, that there was a shortage of liquidity and 0:02:45.120 --> 0:02:48.280 so on. And so they took a number of steps 0:02:49.080 --> 0:02:53.120 basically in the final quarter of to prevent another blow 0:02:53.200 --> 0:02:56.160 up like we saw an early September. But that doesn't 0:02:56.200 --> 0:02:59.880 take away from the fact that that incident in early September, 0:03:00.160 --> 0:03:03.720 when REPO rates sword, raised a whole host of new 0:03:03.800 --> 0:03:07.000 questions about the current structure of this sort of bank 0:03:07.080 --> 0:03:10.440 liquidity system and whether it's adequate and whether people really 0:03:10.520 --> 0:03:13.880 understand it well. So even in the absence of another 0:03:13.919 --> 0:03:16.680 blow up, there's still just tons of discussion about what 0:03:16.720 --> 0:03:20.640 really needs to be done to um to address flaws 0:03:20.639 --> 0:03:24.280 in the plumbing of the system. That's exactly right, and 0:03:24.360 --> 0:03:26.840 we're going to be looking at that particular REPO example 0:03:27.160 --> 0:03:31.360 through the prism of money and also an economic model 0:03:31.600 --> 0:03:36.240 that takes into account a sort of new definition of money. So, 0:03:36.840 --> 0:03:39.760 without further ado, why don't I bring on our guests. 0:03:40.000 --> 0:03:44.240 I'm very excited. It's Perry Maryland, the professor of International 0:03:44.320 --> 0:03:48.200 Political Economy at the Party School of Global Studies at 0:03:48.200 --> 0:03:54.800 Boston University. Perry, thanks for coming on. Nice to be here. So, uh, 0:03:54.960 --> 0:03:57.080 you can tell Joe and I are both excited to 0:03:57.160 --> 0:03:59.640 talk with you, and we have a lot to get through. 0:03:59.760 --> 0:04:03.560 But maybe just to begin with you walk us through 0:04:04.200 --> 0:04:09.320 your definition of what money actually is and how your 0:04:09.920 --> 0:04:12.800 you call it the money view. How does that differ 0:04:13.000 --> 0:04:18.279 from a traditional economic model? UM, Well, the money view 0:04:18.640 --> 0:04:24.800 U is an approach to thinking about UM economic interactions 0:04:25.240 --> 0:04:27.960 that emphasizes when you when you say it's a different 0:04:28.040 --> 0:04:31.039 view of money, it treats money. The essential quality of 0:04:31.080 --> 0:04:33.360 money is that it's a means of settlement. It means 0:04:33.360 --> 0:04:37.320 a payment of settling bills. UM that most of the 0:04:37.360 --> 0:04:42.679 economy is organized as an interlocking UH set of balance 0:04:42.760 --> 0:04:46.680 sheets promises to pay, and what you're promising to pay 0:04:46.800 --> 0:04:51.680 is money. So the settlement constraint is the essential constraint 0:04:51.720 --> 0:04:54.279 on the economy as a whole that keeps it sort 0:04:54.279 --> 0:04:58.520 of coherent that people are focusing their minds on I'm 0:04:58.560 --> 0:05:01.719 not going to actually satisfy that promise that I've made, 0:05:02.000 --> 0:05:06.680 and so clearing and settlement becomes very central. Now you 0:05:06.680 --> 0:05:09.440 you mentioned in the intro that that's something that he's 0:05:09.520 --> 0:05:13.000 not really central in standard economics. UM. Standard economics is 0:05:13.040 --> 0:05:16.559 thinking about intertemporal budget constraints and and essentially a wealth 0:05:16.600 --> 0:05:20.279 constraint that that if you have wealth, then you can 0:05:20.320 --> 0:05:23.920 convert that wealth into consumption or investment or whatever, and 0:05:23.960 --> 0:05:29.120 it it pretty much assumes an economy of infinite liquidity 0:05:29.160 --> 0:05:31.440 that you can convert from one form of wealth to 0:05:31.440 --> 0:05:34.440 another form of wealth with no problem at all. Okay, 0:05:34.640 --> 0:05:39.120 now that's a useful abstraction for some purposes. Um. But 0:05:39.240 --> 0:05:41.919 if what you're interested in is money, Uh, it's not 0:05:42.000 --> 0:05:45.480 a useful thing. It's abstracting for money essentially, and looking 0:05:45.520 --> 0:05:48.840 behind the veil of money. The money view says, let's 0:05:48.880 --> 0:05:51.480 look at the veil of money. The veil of money 0:05:51.520 --> 0:05:54.479 is the essence of what's happening in the economy, not 0:05:54.720 --> 0:05:58.720 something that's obscuring what's happening at some deeper level. Um. 0:05:58.880 --> 0:06:01.839 So we look at the plumbing as a very serious 0:06:02.520 --> 0:06:06.600 piece of instrumentation for a market economy, and that settlement 0:06:06.600 --> 0:06:10.479 constraint is is the first key thing that we focus on. 0:06:11.160 --> 0:06:15.880 So we were talking recently with the economist Robert Skidelski, 0:06:16.600 --> 0:06:21.800 and there's this recurring theme that mainstream economists, still more 0:06:21.920 --> 0:06:25.279 or less in their head, think of the economy as 0:06:25.320 --> 0:06:28.520 a barter system. You have a couple of bananas, I 0:06:28.520 --> 0:06:32.400 have some apples, and uh, money solves for the dual 0:06:32.440 --> 0:06:36.719 coincidences of wants in case there's some sort of you know, 0:06:36.960 --> 0:06:39.200 time lag issue. Maybe I don't want bananas, so we 0:06:39.200 --> 0:06:42.240 find someone with pairs and so on, and money solves. 0:06:42.279 --> 0:06:44.839 In the mainstream view of economics more or less, money 0:06:44.880 --> 0:06:49.320 just sort of lubricates barter. And he sort of explained 0:06:49.320 --> 0:06:51.440 all the reasons why this is a flawed view. And 0:06:51.480 --> 0:06:54.280 I guess what you're saying is the money view, which 0:06:54.320 --> 0:06:56.800 is the framework that you put in really makes the 0:06:56.880 --> 0:07:00.200 money the central part. That our lives are not about 0:07:00.240 --> 0:07:04.680 exchanging bananas for pairs or oranges or apples or whatever, 0:07:05.040 --> 0:07:10.400 but about meeting a series of financial obligations. Yes, that's right, um, 0:07:10.560 --> 0:07:14.680 And I would what Satowski is referring to there is 0:07:14.720 --> 0:07:17.679 that in standard economics, money is treated as a medium 0:07:17.680 --> 0:07:20.640 of exchange, okay, And that's what you're saying between the 0:07:20.680 --> 0:07:23.920 bananas and apples on so forth, Um, that it's just 0:07:24.120 --> 0:07:27.440 greasing the wheels, um, not means of payment. So that's 0:07:27.560 --> 0:07:31.760 that's the contrast that I'm trying to make and the media. 0:07:31.880 --> 0:07:35.080 This this money view, I should mention, is by no 0:07:35.200 --> 0:07:37.640 means an invention of my own. There's there's it's a 0:07:37.720 --> 0:07:42.880 long tradition in in economics of people thinking in this way. Um, 0:07:42.920 --> 0:07:44.920 and I've learned a great deal from them, but it's 0:07:44.960 --> 0:07:48.000 always been a kind of minority position. There seems to 0:07:48.040 --> 0:07:52.679 be something attractive about looking through the veil of money 0:07:52.680 --> 0:07:56.880 to see something deeper. Um and Uh, but that does 0:07:57.000 --> 0:08:00.240 prevent you from seeing what's right in your face, and 0:08:00.520 --> 0:08:03.280 sometimes it's very much in your face. Um. As this 0:08:03.360 --> 0:08:06.480 repo business that you were mentioning, Um, suddenly the only 0:08:06.520 --> 0:08:09.880 thing that's important is means of payment? Is means of payment? 0:08:10.400 --> 0:08:13.240 Can you just clarify something you said, what is the 0:08:13.320 --> 0:08:20.480 difference between money as a means of payment versus money 0:08:20.560 --> 0:08:23.720 as a settlement mechanism? You sort of drew a distinction. 0:08:23.800 --> 0:08:27.440 I'm not sure if I totally the same thing I'm meaning. 0:08:27.520 --> 0:08:30.960 I'm meaning that to be settling a debt is paying 0:08:30.960 --> 0:08:34.160 the debt saying yeah, So I'm just using different words 0:08:34.160 --> 0:08:38.559 that might appeal to different people or different intuition. So 0:08:38.720 --> 0:08:41.800 I definitely want to dig into the repo market. But 0:08:41.920 --> 0:08:45.000 before we do, UM, I wondered if you could talk 0:08:45.000 --> 0:08:48.880 a little bit more about how the money view informs 0:08:49.000 --> 0:08:53.320 your understanding of capital markets, Because if we think that 0:08:53.400 --> 0:08:56.800 money is sort of a promise to pay, and that 0:08:56.920 --> 0:09:00.800 every day those promises need to be settled, which means 0:09:00.840 --> 0:09:04.079 every day, you know, ideally you have a balance between 0:09:04.480 --> 0:09:07.560 the promises or the io use that were made and 0:09:07.600 --> 0:09:11.160 the actual cash inflows that are coming into the system. 0:09:11.280 --> 0:09:14.679 But I think on most days you wouldn't have that. 0:09:14.760 --> 0:09:17.440 You would always have some sort of borrower in the 0:09:17.480 --> 0:09:20.720 financial system that doesn't have enough cash on hand to 0:09:20.920 --> 0:09:24.839 satisfy it's promised to pay or it's iou. And that's 0:09:24.920 --> 0:09:28.480 kind of where the capital market comes in. Well that's 0:09:28.480 --> 0:09:31.600 where so so let me make a distinction here between 0:09:31.600 --> 0:09:34.320 the capital market and the money market. Um. If you 0:09:34.400 --> 0:09:38.160 are on on on in today, um that your cash 0:09:38.200 --> 0:09:43.960 inflows are uh not sufficient to meet your cash commitments. UM, 0:09:44.160 --> 0:09:46.880 then you are a deficit agent at the settlement and 0:09:46.960 --> 0:09:49.640 you have to find a way to meet that deficit, 0:09:49.800 --> 0:09:53.959 and that might be borrowing overnight okay in the money market, um, 0:09:54.040 --> 0:09:56.240 in order to in order to meet that. So you're 0:09:56.320 --> 0:09:59.400 just pushing off that day of settlement by one day. 0:09:59.440 --> 0:10:02.840 The overnight rate of interest is essentially the cost of 0:10:02.960 --> 0:10:06.240 delaying settlement by one day in the money view. That's 0:10:06.240 --> 0:10:09.000 how you think of it. Now, the capital markets come 0:10:09.040 --> 0:10:13.160 in because there are longer term assets there are bonds, 0:10:13.360 --> 0:10:17.360 for example, um which are not promises to pay tomorrow right, 0:10:17.440 --> 0:10:20.280 their promises to pay in ten years or various coupons 0:10:20.360 --> 0:10:22.960 over the next ten years. But they have a certain 0:10:23.280 --> 0:10:28.400 market value today. So their value today is as collateral okay, 0:10:28.400 --> 0:10:31.720 that you can use that that their form of wealth 0:10:32.080 --> 0:10:34.880 that you can use as collateral for borrowing overnight to 0:10:34.960 --> 0:10:38.800 make your settlement. So there's this connection between money markets 0:10:38.880 --> 0:10:42.880 and capital markets that that the capital values are collateral 0:10:43.200 --> 0:10:45.920 for borrowing overnight in the money markets, and that's basically 0:10:45.920 --> 0:10:50.680 what a repo is. So repo is side going back 0:10:50.720 --> 0:10:53.240 to just this key question of this of the money 0:10:53.320 --> 0:10:56.839 view as you put it, you're not really the first 0:10:56.840 --> 0:10:59.520 originator of this view, but that it's kind of been 0:10:59.800 --> 0:11:04.839 my minority view all along. How would you describe, uh, 0:11:04.960 --> 0:11:09.160 the negative consequences to economics and to the understanding of 0:11:09.200 --> 0:11:14.480 our system from uh the veil perspective, from the traditional 0:11:14.640 --> 0:11:18.760 perspective on economics and banking which sort of abstracts away money. 0:11:18.800 --> 0:11:21.880 What are the what are the downfalls of that system 0:11:21.920 --> 0:11:25.040 of that approach? Well, to follow up just from where 0:11:25.040 --> 0:11:27.640 we were talking about the capital markets, there's one in particular, 0:11:28.040 --> 0:11:32.559 which is that you wind up having an an adequate 0:11:32.640 --> 0:11:37.120 theory of where asset prices come from. That asset prices, 0:11:37.760 --> 0:11:41.560 the price of these capital assets is formed in dealer 0:11:41.600 --> 0:11:45.960 markets UM by dealers who are quoting buy and sell prices. 0:11:46.520 --> 0:11:50.120 UM and are and and and so that the economics 0:11:50.200 --> 0:11:54.240 of the dealer function is key for understanding the market 0:11:54.320 --> 0:11:58.040 value of of of of these capital assets and hence 0:11:58.280 --> 0:12:01.960 the collateral that can be used in burrowing overnight UM. 0:12:02.000 --> 0:12:06.080 This is another thing UM that the standard economics view 0:12:06.400 --> 0:12:10.520 abstracts from. There are no dealers right in standard economics. 0:12:10.679 --> 0:12:13.000 It's supply and demand. There are the people who want 0:12:13.040 --> 0:12:15.040 the assets and the people who want to sell the assets. 0:12:15.040 --> 0:12:18.800 There's no one in between them that's making markets. So 0:12:18.920 --> 0:12:22.520 this market making function of dealers is a second key 0:12:22.559 --> 0:12:25.280 piece of the money view. They're really that those are 0:12:25.280 --> 0:12:27.840 the two key pieces. One is the settlement constraint and 0:12:27.880 --> 0:12:31.839 the second is the dealer function. UM. Bringing those up 0:12:31.880 --> 0:12:34.720 to the center of attention things that have been abstracted 0:12:34.720 --> 0:12:39.120 away in in standard economics. You said the economics of 0:12:39.360 --> 0:12:43.520 the dealer function are are crucial to understanding what's happening here. 0:12:43.640 --> 0:12:48.120 Can you walk us through exactly how you incorporate those 0:12:48.440 --> 0:12:51.400 into your model, and the thing I'm trying to get it, 0:12:51.520 --> 0:12:53.920 or the thing that I'm curious about, is whether or 0:12:53.920 --> 0:12:56.360 not you're sort of looking at the dealers from a 0:12:56.480 --> 0:13:01.640 behavioral perspective in the sense that they might all react 0:13:01.840 --> 0:13:05.880 in a not necessarily logical or rational way because of 0:13:05.960 --> 0:13:10.600 some behavioral pattern um that they've experienced before, or are 0:13:10.679 --> 0:13:16.239 you incorporating them from a sort of purely economic technical standpoint, 0:13:16.280 --> 0:13:19.320 how are you actually doing that? Well, so you bring 0:13:19.400 --> 0:13:24.400 up the topic of behavioral economics. The the money view 0:13:25.080 --> 0:13:30.199 is is not a an argument that people are irrational 0:13:30.559 --> 0:13:34.720 or something like that. What the money view emphasizes is 0:13:34.760 --> 0:13:38.079 that a lot of the behavior of people is what 0:13:38.120 --> 0:13:40.880 we would call in mathematics a corner solution. That you're 0:13:40.960 --> 0:13:43.440 forced to do something. You know, that's what the settlement 0:13:43.440 --> 0:13:47.880 constraint does. Right, you have to pay, and you promised 0:13:47.920 --> 0:13:49.640 to pay, and now you have to pay, and if 0:13:49.640 --> 0:13:51.760 you don't pay, you are out of the game. Liquidity 0:13:51.840 --> 0:13:55.040 kills you quick. And so that means that in order 0:13:55.120 --> 0:13:58.320 to meet that settlement, you might have to pay ten 0:13:58.360 --> 0:14:02.360 percent overnight. That the it's not a it's not a choice, right, 0:14:02.440 --> 0:14:04.560 it's a it's a corner solution in order to keep 0:14:04.640 --> 0:14:07.800 in the keeping the game. Now, why is it a 0:14:07.800 --> 0:14:11.800 corner solution. Okay, it's because the economy as it actually 0:14:11.800 --> 0:14:15.720 exists in reality is not an intertemporal general equilibrium. It 0:14:15.840 --> 0:14:20.320 is period by period, day by day settlement by settlement. Um. 0:14:20.400 --> 0:14:23.400 If people behaved in the actual world the way they 0:14:23.440 --> 0:14:25.560 behave in economic models, they would be out of the 0:14:25.600 --> 0:14:29.120 game very soon. So it's irrational to be a rational 0:14:29.160 --> 0:14:32.320 actor in the real world. In the real world, the 0:14:32.360 --> 0:14:36.320 settlement constraint actually exists. You can abstract away from it 0:14:36.480 --> 0:14:39.120 in an economic model, but not in the real world. 0:14:39.640 --> 0:14:43.400 In the real world, prices are formed by in dealer markets. 0:14:43.560 --> 0:14:46.360 You can abstract from dealers in the in the in 0:14:46.400 --> 0:14:49.840 the abstract economic model, you cannot abstract from from dealer 0:14:49.880 --> 0:14:53.920 from the dealer function in actual in actual performance and 0:14:54.120 --> 0:14:57.600 dealing in the real world. So this is what people 0:14:57.720 --> 0:15:00.240 get people. This is what attracts people to the money view, 0:15:00.560 --> 0:15:04.280 that it's very much more rooted in the reality of 0:15:04.400 --> 0:15:07.520 market practice. And that's why the money view, as I say, 0:15:07.680 --> 0:15:10.640 is not an invention by me um. It's a natural 0:15:10.720 --> 0:15:13.320 point of view of people who live in the world 0:15:13.360 --> 0:15:16.600 where you're facing these settlement constraints where you are you 0:15:17.080 --> 0:15:19.280 are a dealer, you're you're you're carrying on a dealer 0:15:19.320 --> 0:15:23.479 function or or something like that. You are a central banker. Um, 0:15:23.520 --> 0:15:26.320 this is the natural point of view for somebody who 0:15:26.360 --> 0:15:29.080 lives in that part of the system. They can't abstract 0:15:29.080 --> 0:15:50.400 away from these things because that's their business. I remember 0:15:50.480 --> 0:15:53.880 when we did our interview with Sulton, he talked about 0:15:54.000 --> 0:15:57.040 repo being I think he described it how you live 0:15:57.120 --> 0:15:59.280 to see another day. And of course that's very similar 0:15:59.320 --> 0:16:02.120 to what you're saying. Go talk talk to us a 0:16:02.160 --> 0:16:05.200 little bit about the financial crisis, because something you hear 0:16:05.240 --> 0:16:09.440 from a lot of people is that mainstream economist, traditional 0:16:09.480 --> 0:16:12.920 economics was ill equipped to see the financial crisis coming 0:16:13.200 --> 0:16:16.160 to explain it. It didn't fit into their sort of 0:16:16.480 --> 0:16:20.360 general equilibrium models and so forth. Connect the dots for 0:16:20.480 --> 0:16:25.440 us between the sort of corner solutions that absolute requirements 0:16:25.520 --> 0:16:27.480 of the dealers to do whatever they had to do 0:16:27.560 --> 0:16:31.120 to survive another day, and the money viewers perspective on 0:16:31.200 --> 0:16:35.400 how the financial crisis came about. Um. Well, I've written 0:16:35.560 --> 0:16:39.480 a book about the financial crisis, The New Lombard Street. Um. 0:16:39.520 --> 0:16:42.320 The short answer is that to understand you're talking about 0:16:42.320 --> 0:16:47.280 the two thousand nine. Yeah. Yeah. So the way that 0:16:47.320 --> 0:16:50.720 I would understand this is that this was a test 0:16:51.120 --> 0:16:55.160 of this emerging market based credit system UM, sometimes called 0:16:55.160 --> 0:16:58.800 shadow banking UM. And the the the notion of shadow 0:16:58.800 --> 0:17:01.400 banking that I would urge UM on your listeners is 0:17:01.440 --> 0:17:04.439 to understand shadow banking as money market funding of capital 0:17:04.520 --> 0:17:07.320 market lending. It's the form of banking that's sort of 0:17:07.400 --> 0:17:11.920 natural for a modern globalized, financialized economy. UM. Where you're 0:17:11.920 --> 0:17:15.760 talking about the money market funding UM is wholesale funding 0:17:16.080 --> 0:17:20.359 in money markets UM, not deposits right as in banks. UM. 0:17:20.440 --> 0:17:24.439 And the capital market lending is is capital markets you know. 0:17:24.520 --> 0:17:28.240 This is again wholesale pricing in dealer markets UM, not 0:17:28.640 --> 0:17:32.080 bank loans you know that are that are specific to 0:17:32.359 --> 0:17:36.560 the relationship between a bank and and the borrower. UM. 0:17:36.600 --> 0:17:40.760 This is the modern form of of banking that evolved 0:17:40.800 --> 0:17:45.080 as we were globalizing, UM the market system, but we 0:17:45.160 --> 0:17:48.600 hadn't yet developed the systems for backstopping it and supporting it, 0:17:48.640 --> 0:17:51.280 and so we had a little crisis there where when 0:17:51.359 --> 0:17:54.800 you're doing shadow banking money market funding a capital market lending, 0:17:55.119 --> 0:17:58.280 that means that periodically you have to roll your funding. 0:17:58.440 --> 0:18:00.560 And if you can't roll your funding. You have to 0:18:00.640 --> 0:18:04.240 sell your asset um and that's a fire sale, and 0:18:04.520 --> 0:18:08.080 that's the liquidity aspect of it. The central banks put 0:18:08.240 --> 0:18:11.359 a floor on this crisis basically by taking the shadow 0:18:11.359 --> 0:18:14.320 banking system onto their own balance sheet, doing shadow banking 0:18:14.720 --> 0:18:16.800 on the balance sheet of the central bank, and that 0:18:16.920 --> 0:18:18.800 put a floor on it. But it took a while 0:18:19.000 --> 0:18:22.280 to to sort all this out, and meanwhile there is 0:18:22.280 --> 0:18:25.240 a bit of a crisis. So what are the implications 0:18:25.320 --> 0:18:31.359 for financial stability now? Based on your definition of shadow banking, 0:18:31.440 --> 0:18:36.680 so money market funding of capital market lending, when when 0:18:36.720 --> 0:18:40.720 most regulators talk about shadow banking, they usually use a 0:18:40.720 --> 0:18:46.080 definition that's something like financial intermediation by non bank entities, 0:18:46.119 --> 0:18:50.520 which basically sounds like it's a bunch of unregulated activity 0:18:50.840 --> 0:18:54.800 that it's probably nefarious in some way. But your definition 0:18:54.880 --> 0:19:00.440 seems much more neutral. You're basically talking about extending credit 0:19:00.720 --> 0:19:04.560 just through a slightly different channel. So how shall we 0:19:04.600 --> 0:19:08.160 be thinking of that in terms of financial stability. Well, 0:19:08.200 --> 0:19:13.560 that my definition is meant to um include that form 0:19:13.720 --> 0:19:15.640 of lending if it's even if it's on a bank 0:19:15.680 --> 0:19:18.600 balance sheet, which in most cases in two thousand seven 0:19:18.880 --> 0:19:21.560 it was on bank balance sheet in Europe, okay, but 0:19:21.600 --> 0:19:23.119 it was not on the bank balance sheet of the 0:19:23.160 --> 0:19:26.640 United States, and that had to do with regulation, okay, Um, 0:19:26.680 --> 0:19:29.920 But the economics of it was very similar whether it's 0:19:29.920 --> 0:19:31.960 on a bank balance sheet or on some other bank 0:19:31.960 --> 0:19:34.040 balance or some other balance sheet. That's why I want 0:19:34.119 --> 0:19:38.320 to use that definition, so that we're not reaffying sort 0:19:38.359 --> 0:19:42.600 of regulatory categories, but thinking about economic categories. So in 0:19:42.600 --> 0:19:46.960 in in today's world, the important place where you see 0:19:47.840 --> 0:19:50.600 money market funding of capital market lending is in fact 0:19:50.680 --> 0:19:53.960 in the emerging market. UM. As you, as I'm sure 0:19:54.000 --> 0:19:58.159 your listeners know, the the major amount of credit growth 0:19:58.200 --> 0:20:00.600 since the financial crisis has re we've been in the 0:20:00.640 --> 0:20:04.879 periphery in the emerging markets. These are these are dollar borrowers, UM, 0:20:05.160 --> 0:20:08.360 long term dollar borrowers. But the actual funding of that 0:20:08.480 --> 0:20:11.440 has been happening in the global money market dollar money 0:20:11.440 --> 0:20:14.960 market system, sometimes using for exchange swaps in order to 0:20:15.240 --> 0:20:19.359 in order to move it into domestic domestic funding in 0:20:19.400 --> 0:20:22.600 other currencies. UM. This is the system that's been building 0:20:22.680 --> 0:20:26.920 up since the since the financial crisis of two thousand seven. UM. 0:20:27.080 --> 0:20:29.080 And this is a system that it seems to me 0:20:29.200 --> 0:20:32.359 is most likely to be tested in in the next 0:20:32.680 --> 0:20:36.040 uh critical moments of the of the system, and hopefully 0:20:36.080 --> 0:20:38.240 we'll get through that and we'll find out where it 0:20:38.280 --> 0:20:41.000 breaks and we'll fix that. So that's the place that 0:20:41.080 --> 0:20:44.639 I'm watching. So let's just to spell it out for 0:20:44.680 --> 0:20:48.840 the listeners. We're talking about. Okay, money market funding of 0:20:48.920 --> 0:20:53.600 capital markets activities. You're seeing it growing in emerging markets globally, 0:20:54.200 --> 0:20:59.880 so essentially people borrowing short term overnight in dollars then 0:21:00.080 --> 0:21:03.879 using that funding for longer term projects. Talk to us 0:21:03.960 --> 0:21:06.719 about uh, you know, you're saying, this is what you're watching. 0:21:06.840 --> 0:21:10.560 What are the stresses that you're looking for, and what 0:21:11.119 --> 0:21:14.560 you know from a financial stability perspective, what kind of 0:21:15.040 --> 0:21:18.159 red flags or yellow yellow light should people be on 0:21:18.200 --> 0:21:21.440 alert for. Well, what I watch is this sort of 0:21:21.720 --> 0:21:26.119 circular loop where just imagine the following that you have 0:21:26.440 --> 0:21:30.439 a let us say a Brazilian national champion firm that 0:21:30.600 --> 0:21:35.359 is borrowing five year bond dollar bond okay um, and 0:21:35.400 --> 0:21:40.240 they're using those funds for whatever their businesses. Okay, that 0:21:40.440 --> 0:21:43.600 that bond, where does the money come from? Okay, that 0:21:43.640 --> 0:21:49.200 bond is bought let's say by some uh Asian bank 0:21:49.520 --> 0:21:52.120 that is then going to fund that in three months 0:21:52.640 --> 0:21:55.760 dollar money markets. It's borrowing from some French bank that's 0:21:55.800 --> 0:21:59.600 issuing that's buying that three month paper, which is funding 0:21:59.640 --> 0:22:03.879 in overnight repo in in in global money markets, which 0:22:04.320 --> 0:22:07.119 or maybe in the eurodollar market. And then the Central 0:22:07.119 --> 0:22:11.119 Bank of Brazil is acquiring dollar balances as its reserves. 0:22:11.119 --> 0:22:13.879 So that's you see how that's a round trip. Okay, 0:22:13.920 --> 0:22:18.800 So Brazil as a country is borrowing five year in dollars, 0:22:18.840 --> 0:22:22.880 that's its on the non financial corporate um and lending 0:22:23.359 --> 0:22:26.440 um in the in the global dollar money markets as 0:22:26.520 --> 0:22:31.360 the central bank reserves. So all of that loop work okay, 0:22:31.640 --> 0:22:34.920 until it doesn't. Their number of links right that we're 0:22:34.920 --> 0:22:37.800 looking at, and any one of those lengths that if 0:22:37.800 --> 0:22:41.000 it were to fail, would cause a would cause problems 0:22:41.000 --> 0:22:43.080 in the system as a whole that that loop has 0:22:43.119 --> 0:22:46.480 to close in order for in order for the system 0:22:46.520 --> 0:22:50.320 to be maintained. One place that loop might not close 0:22:50.600 --> 0:22:55.199 is that Brazil is is borrowing long and lending shorts, okay, 0:22:55.440 --> 0:22:58.920 and the rest of the world is is lending long 0:22:58.960 --> 0:23:01.919 and borrowing short. Thing, So the rest of the world 0:23:02.280 --> 0:23:06.040 is acting like a bank for Brazil, right, and and 0:23:06.080 --> 0:23:09.960 Brazil's source of liquidity is its deposits in that rest 0:23:09.960 --> 0:23:12.320 of the World Bank, which is which is not in 0:23:12.320 --> 0:23:14.680 the United States at all. By the way, you noticed 0:23:14.760 --> 0:23:17.320 that I haven't mentioned the United States. Okay, it's all 0:23:17.359 --> 0:23:19.600 in dollars, but it's not in the United States. So 0:23:19.640 --> 0:23:22.199 there's another little link. What is the link between the 0:23:22.280 --> 0:23:25.959 lender of last resort, the actual source of dollars, the FED, okay, 0:23:26.040 --> 0:23:30.480 and this global dollar system that is offshore. So all 0:23:30.520 --> 0:23:34.480 of these links are, they exist, there are lengths um 0:23:34.520 --> 0:23:37.840 and they will be tested. That's what financial crisis are 0:23:38.160 --> 0:23:43.240 for at some high level, to to to see if 0:23:43.320 --> 0:23:46.480 you have the proper links and to and to improve them. 0:23:46.520 --> 0:23:49.639 That we learn in each crisis where exactly is the 0:23:49.640 --> 0:23:52.199 weak link, and then we fix that link and we 0:23:52.320 --> 0:23:55.160 go on and then we find out where the next 0:23:55.160 --> 0:23:57.760 week oft link is. And this is how the system works. 0:23:59.560 --> 0:24:02.120 I've forgot to mention at the beginning. There's actually a 0:24:02.200 --> 0:24:06.800 fourth major odd thoughts topic that your research also touches on, 0:24:06.880 --> 0:24:09.399 and that is the dominance of the US dollar in 0:24:09.480 --> 0:24:12.600 the global financial system. Of course, and we've spoken to 0:24:13.080 --> 0:24:16.480 people like Hun Song Shin from the Bank for International 0:24:16.520 --> 0:24:22.960 Settlements about this centrality of the dollar in global markets. 0:24:23.000 --> 0:24:27.640 Mostly via funding markets and capital markets. As you point out, UM, 0:24:27.680 --> 0:24:29.760 I do want to talk about the repo market. But 0:24:30.440 --> 0:24:32.399 before we do, and since we're on the topic of 0:24:32.440 --> 0:24:37.439 emerging markets, what is the money view actually say about China? 0:24:38.040 --> 0:24:41.200 About China? I guess one of the things that I've 0:24:41.200 --> 0:24:44.240 said about China is that the notion that the R 0:24:44.320 --> 0:24:48.280 and B is going to be the global currency is 0:24:48.359 --> 0:24:51.960 not any time soon. UM. I think that's now the 0:24:52.119 --> 0:24:54.919 usual point of view. But when I was writing about 0:24:54.920 --> 0:24:58.320 this or five years ago, UM, maybe you remember, there 0:24:58.400 --> 0:25:02.880 was some excitement about R and B replacing the dollar. UM. 0:25:02.920 --> 0:25:05.879