The last three or four decades have seen a remarkable evolution in the institutions that comprise the modern monetary system. The financial crisis of 2007-2009 is a wakeup call that we need a similar evolution in the analytical apparatus and theories that we use to understand that system. Produced and sponsored by the Institute for New Economic Thinking, this course is an attempt to begin the process of new economic thinking by reviving and updating some forgotten traditions in monetary thought that have become newly relevant. Three features of the new system are central. Most important, the intertwining of previously separate capital markets and money markets has produced a system with new dynamics as well as new vulnerabilities. The financial crisis revealed those vulnerabilities for all to see. The result was two years of desperate innovation by central banking authorities as they tried first this, and then that, in an effort to stem the collapse. Second, the global character of the crisis has revealed the global character of the system, which is something new in postwar history but not at all new from a longer time perspective. Central bank cooperation was key to stemming the collapse, and the details of that cooperation hint at the outlines of an emerging new international monetary order. Third, absolutely central to the crisis was the operation of key derivative contracts, most importantly credit default swaps and foreign exchange swaps. Modern money cannot be understood separately from modern finance, nor can modern monetary theory be constructed separately from modern financial theory. That's the reason this course places dealers, in both capital markets and money markets, at the very center of the picture, as profit-seeking suppliers of market liquidity to the new system of market-based credit.
Bagehot's World: Separation of Money Markets and Capital Markets
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Do curso por Columbia University
Economics of Money and Banking
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Banking as Advance Clearing
The next four lectures extend the money view to the larger financial world of capital markets, where the price of risk is determined in dealer markets for swaps of various kinds. The first lecture is a kind of conceptual introduction, while the second translates the standard finance account of forwards and futures into money view terms, as key building block for what comes after.
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Perry G MehrlingProfessor
Economics, Barnard College
So today we began the fourth section of the course
which extends the money view to capital markets and asset prices.
I should begin by saying that this is a
very new fangled way of teaching money and banking.
that it's still the case.
That, that these two subjects capitol markets
and money markets are typically in separate courses.
Okay, if you took a course in financial markets, that's, that's capital markets.
And you're learning cap
m, you're learning stuff about securities, security prices and so forth.
And you don't hear anything about money markets.
Okay?
And if you take a money and banking course,
typically you might learn IXLM or, or something like that.
And you never hear anything about financial markets.
Typically their in seperate, seperate courses.
And they're, they're often even in separate parts of the University.
Finance courses are in the business school and banking
cour-, money banking courses are in the Economics department.
So there's a sort of intellectual
disjuncture there.
capitol, between the period capital markets.
Which is the province of finance. And money markets,
which is the province of banking and economics.
As
you can see, with shadow banking, this intellectual
separation is not in line with the real world.
Okay.
In the real world, these things are intertwined.
Intertwined, and more so today than
really, really, certainly since World War II.
Maybe since World War I.
very much intertwined, so we have to be thinking of them in the same, in the,
in, in, we have to, we have to
combine intellectually as well, but the, but the barriers,
the reason why these things are in separate boxes, has a historical origin.
and I think it's helpful to, to build that up, okay.
And, and understand why people thought you could
separate the capital markets from the money markets.
and in fact, the point, the point is that
in Bagehot's day they were kind of separate, okay.
They were, they were more separate than they are, they are today.
So let's just say, in Bagehot's world
we know how banking worked in Bagehot's world.
We've talked about that a couple of times, okay?
That this was about discounting of short term bills.
Bills that were issued by firms to finance goods on their way toward final sale.
banks discounted these things and, and would,
would hold a portfolio of them that matured
at various dates, and the liquidity of a bank was, was ensured by that, that,
the maturation of these bills, that when they
came due there would be a cash inflow.
So the banks would have lined up plans for cash inflow by having all these bills.
Okay. So we had a bank, here okay.
That had bills on one side, discounted bills,
and we'll say deposits on the other side.
Okay.
And these
[COUGH]
these deposits we'll say are the assets of the
primary lender I'm introducing here now, maybe the household.
We've never seen the household in this course before, okay, which
is interested in holding deposits in order to make payments and so forth.
And the issuer of the bills is some primary borrower.
Say a business, which is
using these bills in order to finance part of its working capital here, okay.
So, the bank, from this point of view, is serving the Bagehot bank.
Is a kind of intermediary, okay?
And we're going to be work, a lot of what we're going to be doing
in this next section of the course is thinking of banking as intermediation.
Okay?
And there's inter-mediation that, that this, these
loans essentially to the, these are essentially
loans to the bank, to, to the borrower.
and it's the deposits that are funding those loans.
That's the, that's the idea there.
This is a little bit of a different perspective than we've had up til now.
This is what we call, indirect finance.
And in the Bagehot world, it's in the money market.
This is, this is the money market we're talking about.
Now, in Bagehot's day. There was also capital market, okay?
The government issues bonds.
in fact, there were, there, these were, were bonds without any maturity.
They were they just paid a coupon forever.
and they also issued short term stuff, and corporations sometimes issued bonds, too.
They were, they were bond to finance, various kinds of, of large scale projects.
and there's equity.
Okay. These bond and these equity, were held
by, rich people. This was a form of, a form of wealth.
And they are held directly, bonds and equity
[SOUND].
We might call that direct finance, there's no intermediary in between.
There's no other financial institution there.
It's just the bonds are being held by, by the primary lender.
This is the capital market,
okay?
Now, these markets were, are linked, everyone appreciates, because when the
household is buying these assets, what are they buying them with?
They're buying them with their deposit.
Okay so they're transferring some of those deposits
to the firm, which then uses it to,
to, to pay its vendors or to build
its machine or its factory or whatever, you know.
So that's, that's what the firm is borrowing at the bond, the bond is, the,
the, the borrower is issuing a bond The
primary is buying it by transferring through deposits
to the primary borrower, which is then spending
those deposits, to make an investment of some kind.
Okay.
So there is an interlink between the money market and the capital market there.
Okay.
But that's just at the moment of issuing bonds.
Once the bonds are issued its like all over and is a separate little market.
and there are prices these bonds
that fluctuate and, and there might be a secondary market and so forth.
but it seems like they're, they're kind of separate.
The liquidity issue They comes these bills, these staggered
timing, okay, isn't an issue so much for the
bonds, because no one is making any promise that
these things are going to, are going to turn into cash.
They're making a promise in the bonds that
they'll pay certain coupons, maybe bi-annually or something,
but those coupons are small potatoes compared to the, the value of the bonds.
Most of the principle of the bond is never, is not promised to be
paid until maturity which may be 30 years from now or something like that.
Okay, so it's very different kind of instrument than a bill.
Some people have argued, the economic historians
have argued, some of my professors have argued
that the fact that in Britain, this short term money market thing
was very highly developed, because Britain was the center of the world economy.
You know, the bank of England was the Central Bank for the whole world.
This is where world finance, world trade got finance, in the British money market.
Okay so this is a sort of hyper developed money market.
And they and, and economic historians suggest
sometimes that one of the reasons for, for Britain's
sort of lagging behind the development of much of the
rest of the world after the industrial revolution was because
they didn't have as well developed systems of long-term finance.
Okay, and in particular, they're banks, the notion
that banks might do long-term finance was completely verboten.
You know, it had to be, the banks, banks had to keep liquid.
There was this cult of liquidity that, that prevented banks
from going into the development finance business.
You know, if you wanted to borrow long-term, you
had to issue a bond or something like that.
There was no long-term bank lending.
and, now, I don't know if that's true or not.
I'm not an expert on Britain, but what I will tell you,
is that in the United States, it was a very different situation.
Okay, the new world, was different
than the old world.
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