>Doug Noland makes a good argument that money market funds have become
>money creators not subject to reserve requirements. The crux of the
>argument is that people regard money market investments as both
>stores of value and media of exchange, just like checking accounts.
>Deposits on money markets can then be re-lent without keeping reserves,
>and as long as borrowers deposit them on other money market accounts,
>the multiplier is, in principle, infinite.
>
>http://216.46.231.211/credit.htm
>
>A counter argument by Paul Kasriel
>
>http://www.ntrs.com/rd/rd35/rd35fr.html
>
>
>If Noland is right, and his argument does sound more persuasive, the Fed
>has effectively lost control over the US financial system. The
>Bubblemeister could not keep consumers from going into hock to buy SUVs
>and internet stocks even if he wanted to. This may explain his bizarre
>refusal to comment on debt levels. Comments?
I'm with Kasriel on this one. Private extensions of credit must ultimately be validated by the central bank.
Both of them act as if the U.S. is a closed economy though: both ignore the inflow of foreign capital that has subsidized the Clinton boom.
Sorry to quote myself, but here's a bit on endogenous money theory from Wall Street:
>Robert Pollin (1991; 1993) usefully divided the two major schools of
>post-Keynesian endogenists into the accommodative and the
>structural. Accommodative endogeneity holds that the central bank
>has no choice but to validate private credit demand by providing
>whatever reserves the banking system needs to accommodate the loans
>that it has already made; that means there is no effective
>constraint on credit. Leading proponents of this school include
>Nicholas Kaldor and Basil Moore. Structural endogeneity -- the
>branch that appeals to both Pollin and me -- holds that central bank
>attempts to constrain the growth of credit are frequently evaded
>through creative finance.
>
>Moore (1988a, p. 139), the leading living accommodationist, takes a
>good idea way too far, as he did in this surreal passage:
>
>The process of monetary accommodation, the validation of money wage
>increases which the data reveal, is mistakenly viewed, by both
>monetarists and post-Keynesians alike, as the result of a process of
>active policy intervention by the central bank. The notion appears
>to be that the monetary authorities keep their eyes focused on the
>state of the economy in general, and on the level of unemployment in
>particular.
>
>Instead, Moore argues, the central bank passively validates
>decisions made by private creditors.
>
>In fact, the Fed scrutinizes the real economy closely. Take, for
>example, the minutes of the December 22, 1992 meeting of the Federal
>Open Market Committee (Federal Open Market Committee 1993, p. 323)
>
>The information reviewed at this meeting suggested that economic
>activity was rising appreciably in the fourth quarter. Consumer
>spending, in association with an apparent upturn in wage income and
>a surge in confidence, had improved considerably; sizable gains were
>being registered in the sales and starts of single-family homes; and
>business spending for capital equipment remained strong. There also
>had been solid advances in industrial output, and private payroll
>employment had turned up. Data on wages and prices had been slightly
>less favorable recently [that is, wages have been rising, always a
>danger -- D.H.], and on balance they raised the possibility that the
>trend toward lower inflation might be slowing a little.
>
>The minutes went on to report detailed observations regarding
>employment, the average workweek, industrial production, retail
>sales, business invesment, construction, and the trade picture. (To
>give a measure of how detailed: "sales of heavy trucks rose sharply,
>and business purchases likely accounted for some of the recent
>sizable increase in sales of light trucks; on the other hand,
>shipments of complete aircraft were weak.") All this discussion of
>the real economy preceded discussion of financial and monetary
>affairs, and far exceeded it in volume as well. The central bank
>runs a huge economic data generation and analysis apparatus, which
>confidently second-guesses official statistics, and, a Fed economist
>once told me, frequently prompts corrections that are buried in
>routine monthly revisions in Commerce and Labor Department data.
>Every twitch in the statistics is noted and mused over to death.
>
>And those conclusions are based on public releases of the Fed's
>minutes. According to Drew University economist Edwin Dickens
>(personal communication), who's read the full transcripts -- which
>are released only 20 years after the fact, and read by almost no one
>-- policymakers are exceedingly obsessed with wage increases and the
>state of labor militancy. They're not only concerned with the state
>of the macroeconomy, conventionally defined, they're also concerned
>with the state of the class struggle, to use the old-fashioned
>language.
>
>When things look too bubbly for the Fed's satisfaction, it tightens
>policy, by lowering its targets for money supply growth and raising
>its target for the fed funds rate. In doing so, it hopes to slow
>down the economy, but there's often many a slip between tightening
>and slowdown. The reason for this gap was explored nearly 40 years
>ago by Hyman Minsky (1957) in a classic paper modestly titled
>"Central Bank and Money Market Changes." Minsky pointed to two
>innovations of that relatively sleepy time, the federal funds
>market, which allows aggressive banks to transcend the limits of
>their own reserves by borrowing from surplus banks, and the growing
>presence of nonfinancial corporations, eager to make money on spare
>cash, as providers as well as users of credit. Both were responses
>to rising short-term interest rates, which, as Minsky wrote, pushed
>actors "to find new ways to finance operations and new substitutes
>for cash assets." Market innovations, Minsky stressed, would
>complicate the work of central bankers, since tight policy could be
>partly offset with new instruments. Innovations, as Minsky (1975, p.
>76) later pointed out, allow capital asset prices to continue rising
>(and economies to continue expanding) against the dampening
>influence of rising interest rates.
>
>Over time, with the proliferation of financial innovations, the
>"compounded changes will result in an inherently unstable money
>market so that a slight reversal of prosperity can trigger a
>financial crisis," wrote Minsky 40 years ago. This would require an
>extension of the central bank safety net to the entire financial
>matrix, not merely the commercial banks that were its legal charges.
>Fighting inflation might entail a terrible financial cost, and so
>the Fed would be forced to err on the side of indulgence whenever
>the credit system looked rocky.
>
>Perhaps Minsky was a little early -- the first financial crisis of
>the post-1945 period was the credit crunch of 1966 -- but he
>described the mechanism perfectly: first the rising inflation of the
>1960s and 1970s, followed by the Volcker clampdown, which was lifted
>when it looked like Mexico's default would bring the world banking
>system down. But the Volcker clampdown required driving interest
>rates far higher, and for a longer period of time, than anyone would
>have expected, to shut the economy down, so creative are the
>innovators at evading central bank restraints. In the 1980s and
>1990s, innovations proliferated, as interest rates remained high by
>historical standards (despite their declining trend). Capital was
>mobilized as it hadn't been in 60 years, as it became clear that
>while the poor could expect no indulgence from the new economic
>order, the rentier class, some notorious bad apples aside, could
>count on a blank check.
>
>Of course, Minskian innovations can't evade the tightening hand of
>the central bank forever. Perhaps the most sensible view of the
>whole matter was that expressed by a central banker, Alan Holmes
>(1969, p. 73), then a senior vice president at the New York Fed,
>speaking at a time when the monetarist challenge was marginal but on
>the rise: "In the real world, banks extend credit, creating deposits
>in the process, and look for the reserves later. The question then
>becomes one of whether and how the Federal Reserve will accommodate
>the demand for reserves. In the very short run, the Federal Reserve
>has little or no choice about accommodating that demand; over time,
>its influence can obviously be felt." This is a refreshing antidote
>both to the mechanistic nostrums of the monetarists and to the
>vision of limitless elasticity of the extreme endogeneists like
>Moore. The Fed, like all central banks, is mighty, but it is not
>almighty.
>
>Why does this matter beyond the world of scholarship? If the
>endogenous money theorists are right -- and they are -- then money
>and commerce are inseparable; neutrality is a fantasy. That has
>several implications. It locates tendencies towards financial
>instability and crisis at the heart of the system, rather than
>outside it, as Friedman and other state-blamers would have it. It
>makes conventional monetary policy more difficult to manage, since
>"money" becomes a very slippery thing. And it makes radical reforms
>more difficult than many populists would like, since policies aimed
>at finance aim at a moving target, and one not easily separable from
>production, or from ownership.
>
>Marx (1973, p. 126; 1981, p. 674; see also de Brunhoff 1976, pp. 80,
>98) anticipated modern Keynesian endogenists, arguing (against
>Ricardo and the classical quantity theorists) that the quantity of
>money in circulation is determined by economic activity, and not the
>other way around. Not the least of the reasons for this influence is
>that the extension of credit is such a short step from simple
>exchange for money; an IOU can be exchanged between any agreeable
>partners, and it's only a small matter to bring in a bank to
>formalize the transaction. This was true even under a gold standard;
>these spontaneous contracts make the line between money and credit a
>porous one, and that explains why the modern money supply is so
>flexible. Of course, in Marx's view, these extensions of credit
>become worthless in a crisis, as everyone scrambles for gold; this
>kind of crisis hasn't been seen in this century, as central banks
>have learned how to contain crisis and make short-term government
>paper seem as good as gold.