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Bill: I feel like the credit - money distinction is like the chicken and the egg. If the repo market for AAA MBS collapses like in did in 2008, are we observing an outright contraction in the money supply or a credit contraction which creates excess demand for money?
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Doesn't defining the medium of exchange mean understanding Gorton's point that there is a difference between information insensitive securities (e.g. a dollar, where there is no asymmetry of knowledge - you can count on $1 being worth $1 tomorrow) and information sensitive securities (e.g. AAPL stock, where there is an asymmetry of knowledge - someone could know something that others don't which could effect its value and potentially leave a lender holding the bag), and that securities can oscillate between the two? For example, in 2005 AAA MBS and other AAA structured products indeed functioned like money because there had never been a historic default in these products, etc. Through repurchase agreements, one could borrow on such collateral at 2-5% haircuts (almost a substitute for money). But of course, in 2008, those who demanded collateral realized that some of these structures contained a ton of subprime and that defaults could eat up to the AAA tranche. Suddenly, the repo market for AAA MBS collapsed (completely unmoney-like) and when it eventually came back, haircuts were sometimes as onerous as 30-50% (still not money-like). To me this means, that the money supply depends on what securities the market considers money-like at any given moment and its never a fixed basket.
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Nick: No comment on the BoJ's announcement that it is looking into buying ETFs and REITs??
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*Doesn't this create more demand for closer-to-money (2 year t-notes rather than a construction loan) substitutes (assets)?
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JKH: Okay that makes sense, but like you said: it's like a poor assumption to think that debt is always paid down with savings. It seems like incomes are currently being disproportionately allocated to debt repayment in which case, incomes are deposited. A higher fraction of which is used to pay down debt. Thus, net-net, the banks' liabilities drop LESS than its assets. Doesn't this create more demand closer-to-money substitutes?
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On Beckworth's blog you said.... JKH: If a bank loan is paid down, and so loans and deposits both fall (and stay down, let's assume), and if those deposits were (say) chequable demand deposits, and so a medium of exchange, then the supply of money falls. If the demand for money stays the same, we now have an excess demand for money. Do deposits necessarily fall when a bank loan is paid down? Banks receive a prepayment, but they don't send their depositor's money back. They buy 2-year t-bills or a FRE Hybrid arm.... hence, if anything, the private sector's negative demand for debt (bank loans) means that we will still have an increase in demand for more-money-like securities. or am I crazy?
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Oct 4, 2010