From: jimruttshow8596
The study of monetary systems and institutions involves understanding their foundational mechanisms and the historical processes that shape them, moving beyond traditional economic theories to consider dynamic interactions and inherent instabilities [00:43:06]. This field examines how institutions determine individual agency, communication, and collective states [00:40:47].
Foundational Views on Institutions and Money
Eric Smith’s work on money and finance was significantly shaped by Martin Shubik, whose career focused on the institutional foundations and nature of money within the polity and society [00:40:47].
Critique of Neoclassical Economics
Shubik, an operations research expert and game theorist, critiqued neoclassical economics for its focus on individual preferences and decentralized actors, which often minimizes the role of institutions [00:40:04]. He argued that institutions are fundamental conduits for what is possible in the world, determining what individuals can know, do, and how they interact [00:41:08].
The Role of Institutions
To understand money and most institutionalized interactions, it’s crucial to grasp the mechanisms possible for institutions and the historical processes that lead to their lock-in [00:41:19]. Smith and Shubik examined issues like bank runs and self-fulfilling prophecies from a mechanical perspective, analyzing how institutional permissions and limitations enable or restrict collective states [00:42:02].
Dynamics over Equilibrium
A core tenet of this approach, influenced by Keynes, is the emphasis on dynamics over equilibrium [00:43:57]. Shubik felt economists had missed Keynes’s point that “in the long run we’re all dead,” highlighting that the focus should be on how systems function during transients, adaptations to changing environments, or the very origin of institutions [00:43:40]. He aimed to “re-instill the dynamical spirit of Keynes” through strategic market games [00:44:26].
The Nature and Value of Money
The Hahn Paradox
The Hahn Paradox, concerning the value of money, illustrates that if money is infinitely durable and only used for trade, its exchange value against other goods should be arbitrary [00:45:05]. If consumption value (e.g., jewelry, taxes) is in the far future, it becomes difficult to anchor this arbitrariness [00:45:26].
Dynamical Stabilization through Fluctuations
Smith’s contribution to this paradox suggests that real-world fluctuations can create stabilizing effects by introducing temporary uncertainties and bringing new actors into the system [00:46:13]. The spectrum of these fluctuations and the uncertainties they introduce become a stabilizing force, taking over from weak policing actions in the long run [00:46:36]. This concept is likened to solar flares in evolutionary games, where large loops of excursion through system dynamics stabilize populations, allowing for a non-arbitrary stable long-term configuration [00:48:40].
Evolution of Monetary Systems
Monetary systems are neither purely endogenous nor exogenous; they are a combination, arising through evolutionary paths of least resistance [00:50:01].
Commodity Monies
Martin Shubik was particularly interested in commodity monies like barley, salt, and gold, which possess high short-term use value and semi-durability, serving as entry points to money systems [00:50:20].
Bootstrapping with State Power
The emergence of complex institutions and more flexible money systems is supported by commodity monies. For example, gold as a commodity money introduced problems of cheating and dilution, leading to the printing of coins and the concept of defacement, where royal authority enforced the value of coinage [00:51:01]. A functioning monetary system can increase state power and its ability to enforce laws, which then allows for the use of base metals in coinage, whose value is entirely supported by legal punishment against defacement [00:51:30]. This demonstrates a bootstrapping relationship between simpler, less flexible forms of money and the support of more complex institutions [00:51:41].
Modern Financial Instabilities
Fractional Reserve Banking and Bank Runs
The 2007-2008 banking meltdown brought renewed focus on bank runs, leveraged instruments, and the inherent instabilities of fractional reserve lending [00:52:21]. The rise of fractional reserve banking in London, documented by Badgett, introduced fragility against bank runs, leading to the emergence of lender insurance as a stabilizing institution [00:52:42].
- Self-Fulfilling Prophecies: A simple statistical model can show how individuals enter fractional reserve banking contracts believing in better payoffs, but then become subject to the instability of a bank run if trust erodes, causing people to “escape from the basin of attraction of trust” [00:53:04].
The 2007-2008 Financial Crisis
The crisis highlighted the instability of markets for repurchase agreements (repo markets) where securities are priced using mark-to-market methods [00:54:26].
- Repo Markets and Mark-to-Market: This system, described as inherently unstable, mechanizes actions so “everybody steps on the same foot at the same time,” replacing intrinsic diversity with algorithmic homogeneity [00:55:12]. While it offers legal defensibility by claiming “best practices,” it creates overnight instabilities on a huge scale [00:55:46].
- Rehypothecation of Collateral: A critical factor in the crisis was the rehypothecation of collateral in the repo market, where securities received as collateral could be re-lent, leading to an infinite expansion of near-money supply [00:56:12]. When trust collapsed (e.g., after Lehman Brothers’ failure), this pseudo-money supply imploded, causing a massive shockwave [00:56:59].
- Problem of Unknown Location of Bad Debt: The system’s collapse was not merely due to the magnitude of bad debt, which was absorbable, but because people “didn’t know where it was” [00:57:38].
Minsky’s Ratchet: The Cycle of Regulation and Deregulation
Hyman Minsky’s work, particularly “Stabilizing an Unstable Economy,” informs the concept of “Minsky’s Ratchet” [00:57:44]:
- During stable times, political will to implement necessary regulation is lacking, allowing the quality of credit to degrade through financial innovations like rehypothecation [00:58:01].
- When a crisis hits, only the central bank and government can act on the necessary scale and short timeframe [00:58:16]. A government will choose to bail out the system rather than collapse its own economic system [00:58:31].
- Regulation can be imposed ex-post, but the system’s entropy is too high; money has been dispersed, and information is lost [00:58:45].
- The meta-question is how to overcome Minsky’s Ratchet and maintain political and legal vigilance for regulation when people are complacent and fail to assess systemic fragility [00:59:01].
Money Substitutes and Alternative Currencies
Near Monies and Monetized Credit
Money is made effective when surrounded by suitable forms of credit that offer flexibility beyond the central money system [00:59:42]. This includes the monetization of personal credit concepts, like the real bills doctrine that supported mercantile capitalism [00:59:57]. These promissory notes, generated locally, require bank credit evaluation to be monetized and stabilized, leveraging their flexibility while giving them stability to function as money on a larger scale [01:00:12]. This highlights the crucial role of trust and institutions as the foundation of money [01:00:49].
Critique of Cryptocurrencies
Cryptocurrencies, while filling a role in distributed authentication by addressing the “who will guard the guardians” problem, are limited [01:02:00].
- They often feature scarcity, which secures value stability, but lack the institutional surroundings that make money predictable [01:02:28].
- A gold-only economy is incompressible, meaning every shock propagates through the entire economy [01:02:32]. Similarly, cryptocurrencies do not offer the stability needed for retirement savings [01:02:44].
- The solution lies in embedding cryptocurrencies within a larger conversation about their contribution to institutional stability, rather than viewing them as a replacement for the entire system [01:03:00].
- The current energy footprint of cryptocurrencies is considered irresponsible, prioritizing speculative gains over contributing to a more robust world [01:03:15]. This is seen as a “naive mistake” common when new technologies are first introduced [01:03:32].