Fair value gains as monetary base – even better than the real thing April 3, 2012 at 6:25 pm

An old speech of Paul Tucker’s, made me think. (Danger, Will Robinson.)

To begin, two unconnected facts.

First, fair value gains are unlike most (not quite all, but run with me) other accounting gains, in that there isn’t necessarily a matching loss. If I issue 100 shares, and you buy 50 for $1, then I sell a further ten for $1.50, you can mark your 50 up to $1.50 without anyone having lost anything. Thus unlike a growth in credit (where there is an obligation to repay and hence a liability matching the asset), fair value gains are asymmetric.

Second, the monetary base is asymmetric; the central bank can create (or destroy) it out of nothing. When the central bank opens the window to repo in assets, it usually creates new money.

Thus in a certain sense, fair value gains are like the monetary base in that they are money with no matching liability. Both are forms of money that banks can use without worrying about liquidity risk. Indeed, fair value gains are in a sense even better than M0 in that audited FV gains count as retained earnings and hence as part of a bank’s capital. They can thus be used to lever broad money (that is, deposits), something central bank liquidity doesn’t do.

This of course means that asset price growth has inherent leverage: buy a share for $1, mark at $1.50, take $0.50 as P/L, count that as capital, use it and borrowed money to buy some more shares.

This leads me to suspect that you can’t really think about money and the Ms without thinking about capital too. Broad money creation – as we said before
here – doesn’t just depend on credit demand, it also requires both funding and capital.

Update. More on the modern view of money multipliers (and that whole Krugman vs. the Minskians thing) can be found here, here and here.

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