Still Searching For Those Dollars

There is a great danger to negative interest rates, one that is denied by economists and central bankers because they deny the essence of wholesale finance. Stuck in the 1950’s, their solutions were arguable even then but hold little if nothing of value now. Markets are being reacquainted once more with the possibility (finally). As discussed last week, the Bank of Japan did not unleash more “stimulus” but rather confirmed the ineffectiveness and general impotence of all that came before (which was considerable).

Confusion over terminology is very much understandable in this area on the grounds of complexity alone. However, even in basic concepts there is in enough instances serious ambiguity as to render little but further confusion. In this case, surrounding NIRP, we have the simultaneous distinctions of the “dollar” short and a dollar shortage. While seemingly indistinguishable by virtue of the words’ common root, those terms are very different at least insofar as they can describe opposite perspectives. And it gets even more confusing when attaining those different perspectives requires an indirect angle.

On the one hand, the “dollar” short suggests nothing on its own of a dollar shortage. Indeed, the entire banking system from the first appearance of fractional lending shows that a systemic short position can be entirely stable for long periods of time. Any fractional reserve bank is synthetically “short” money; thus the difference between the short and the shortage was the willingness of the public to maintain equal value in claims. The short is the system, the shortage when it doesn’t work. This is “sound” banking or even “sound” money; the strong dollar.

The short turns to shortage when that confidence is eroded just enough to surpass some critical threshold. Once demands placed upon banks to deliver money become too voluminous, the money short becomes the self-reinforcing shortage – the bank run that leads to a systemic run. The point of the central bank under currency elasticity was to interject currency at that critical moment, so that the shortage might be undercut to allow the short its return to stability (artificial as it may be).

While that is much easier to follow, the wholesale “short” is a degree of magnitude further removed and in several important respects. The angle of perspective is no longer purely banks to the public; in the wholesale framework, especially the eurodollar, banks are “short” each other as well as the public. It is the interbank tangle that so perplexed “elasticity” in 2007 and 2008 as the public largely sat out the affair being stung almost exclusively in asset prices rather than money and convertibility. Outside of a few small outliers (Northern Rock), there were no long lines at ATM’s expressing the public’s growing unease with their perceptions of the currency regime. It was entirely an interbank affair.

The idea of convertibility and short or shortage is tied closely with past regimes which were reducible to something specific, usually money. The eurodollar system is quite different in that various facets can undertake such centrality at any specific moment in time, or even all at the same time. As I wrote in April last year: