Archive for July 22nd, 2021

Ending shadow banking means ending modern central banking

July 22, 2021

Anantha Nageswaran in his GoldStandardSite blog quotes from this Prospect magazine article by Ann Pettifor.

Ann argues how central banks have allowed shadow banking to proliferate.

The vast “shadow banking” system, which has grown out of the same flawed monetary thinking, is another matter. Comprising pension funds, hedge funds, insurance companies and other investment vehicles, it now manages a $200 trillion stock of assets, dwarfing that $2 trillion cryptocurrency valuation, and also vastly exceeding the annual income (or GDP) of the world as a whole, estimated at $86 trillion. Being in the shadows, then, no longer means being on the margins.

Central bankers have permitted and sometimes encouraged this sector to expand beyond the regulatory frameworks of governments. But the real roots are deeper, lying in the great structural shift of pension privatisation. Between 1981 and 2014, 30 countries fully or partially privatised their public mandatory pensions. Coupled with cross-border capital mobility, the move to private retirement savings steadily generated vast cash pools for institutional investors.

Today one asset management firm, BlackRock, manages in excess of $8 trillion of the world’s savings. Such companies have outgrown the capacity of “main street” banks to provide services. No traditional commercial bank could absorb these sums; few governments are willing to guarantee individual accounts of more than $100,000. The new form of “banking” answered the need to accommodate the enormous sums of globalised capital.

Like pawnbrokers, who practised an earlier form of unregulated credit, shadow banks exchange the savings they hold for collateral. But instead of watches and wedding rings, they lend out on the strength of government bonds and other securities.

Replete with cash, they can provide “liquidity” on a vast scale to businesses or investors who need it. In return, the borrowers offer up a security—and write an IOU offering to repurchase it later, at a higher price. This markup is, in effect, the interest on the loan. These repurchase deals are struck in the “repo” markets which form the heart of the shadow banking system.

Note that this whole system avoids reliance on the social construct of credit, upheld by trust and enforced by law, which traditional banks had to work within. Instead, the system is one of deregulated exchange in which cash is simply one more commodity—no more regulated than any other.

She goes onto argue how QE programs of central banks have allowed shadowy banking to continue.

The reason why emergency injections of money are increasingly needed is that the shadow banking system is structurally prone to volatility and debt crises. The borrower’s promise to repurchase an asset at a higher price is relatively easy to uphold when the value of that asset remains stable. But the value of assets can rise or fall suddenly, which in this system can set in train self-amplifying feedback loops—with catastrophic consequences.

Anantha goes a step further that ending shadow banking will mean end of modern day central banking:

It clarifies a lot of things, actually. In other words, without QE, the shadow banking system will cease to exist. If it ceases to exist, then the real economy crashes. So, central bankers can assuage themselves by saying that by providing the liquidity that the leveraged shadow banking system needs, they are indirectly supporting the real economy or preventing the real economy from collapsing.

Her conclusion is quite appropriate:

Whenever the vast shadow banks wobble, there is the threat of a disastrous contraction of the credit for the real economy, which could bring everything crashing down. As long as the system is allowed to stand, there is no alternative to taxpayer-backed central banks rescuing private markets.

The only way to call time on QE, if that is what we truly want, is to deconstruct and then reconstruct, regulate and stabilise the whole financial system, so that the extraordinary privilege of credit creation is always balanced by a responsibility not to take undue risks. And if footloose capital responds by skipping across borders and away from oversight, then we may also need to look at controls on that front too. Only then will the world stand any chance of kicking the QE habit, address those dangerous imbalances and finally escape this grim shadowland of money.

But, on their own, central banks will be afraid to do the job of deconstructing and reconstructing. It is a political project because, in reality, it would amount to cutting both shadow banking and central banking to size. That is why central bankers would resist it actually. Ending the last forty years of financialisation will also end central banking as it has evolved in the last forty years. Central bankers will go back to operating in the shadows, if shadow banking were to be ended!

Will politicians be up to the task? I doubt.

The risk is that, in doing so, the ‘House of cards’ aka ‘the real economy’ will collapse. No one wants it on their watch. If the world of shadow banking has to end, it will happen through exogenous shocks. Both QE (i.e., modern central banking) and the world of shadow banking have to collapse from being unable to bear the sheer weight that they have grown into.

Hmm..worth thinking about..

Prof Pranb Bardhan’s academic journey – I

July 22, 2021

Prof Bardhan has started writing on his academic journey from Calcutta to Cambridge to Berkeley and beyond. I came across his first post on Business Standard which has been reblogged from

This anecdote from Amartya Sen’s childhood reminds one of several stories around children:

In periods when our house was particularly over-crowded with relatives, my father often sent me and my sister and mother off to our maternal uncle’s home in Santiniketan, a small town about a hundred miles north of Kolkata. This town was famous in India for having the residential educational institution established by Rabindranath Tagore.


Even though I was not a student at Santiniketan, I used to accompany my friends in the neighborhood who were students to attend the numerous cultural events that took place in the campus every week. Every Wednesday morning there used to be a solemn gathering where the master of ceremony was Kshitimohan Sen (Amartya Sen’s grandfather), a professor of Sanskrit, who used to recite verses from ancient texts and interpreted them, which were almost completely unintelligible to us children; we all used to wait for the beautiful Tagore songs that the sermons were frequently interspersed with.

Amartya-da’s (I have always addressed Amartya in that typical Bengali younger-brotherly way) mother told me that when he was a small child she once took him to that Wednesday gathering where Tagore was the master of ceremony. The child was obviously bored by Tagore’s sermons and the hushed silence around him, so he started blabbering away, and his mother shushed him. At this the child pointed his finger at Tagore, and loudly said, “why is that fellow talking then?” Clearly a pointed argument from an ‘argumentative Indian’! 


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