Today the Mises Institute faculty provide excellent responses to Paul Krugman and his query re Austrian economics, MMMF, and financial intermediation.
But even legitimate intermediation can be a source for bad policy. Re MMMF and the past crisis see some interesting commentary by Garett Jones at
http://econlog.econlib.org/archives/2012/10/bailouts_are_fo.html
Some highlights:
During the worst days of 2008, something strange happened. During the Eight Days of Terror, the S&P 500 fell by 23% but there were no loud calls for the government to guarantee the value of stocks (Aside: TARP was signed into law on Day 3 of the 8).
By contrast, about two weeks beforehand, Treasury guaranteed the solvency of many money market mutual funds, the de facto bank accounts created by investment companies. Why the guarantee? Because of the panic induced by one money market mutual fund (MMMF) when it announced that its value had plummeted: Instead of being able to repay 100 cents on the dollar, the Reserve Fund would only be able to pay—-wait for it—ninety-seven cents.
Yes, the Reserve Fund was an historically important MMMF–it was the first. And surely its failure contained a signal about the health of the others. But three cents on the dollar? That set off a mad scramble for safety that spurred the Bush Treasury to create a new government guarantee?
No Paul, Austrians do not want to ban financial intermediation just bad or inappropriate policy responses which keep gains private but socialize losses.
Mises, in particular, was one of the best at clearly differentiating intermediation from credit creation.
Follow Circle Bastiat
From a Misesian perspective, the exclusion of MMMF shares from the money stock is not correct.
Technically, accounts at credit unions and mutual savings institutions, like MMMF accounts, represent shares of ownership in an an asset portfolio. Nobody questions the monetary character of credit union shares, etc., so why should MMMF shares be viewed differently?
The fact that MMMF shares (like credit union shares and mutual savings shares) have a fixed redemption value gives them the economic character of a fixed claim on money, not of an equity stake in a pool of credit instruments. Moreover, they can be transferred from person to person as a final means of payment much like any deposit account balance. While some MMMFs have rules discouraging small size transactions, generally speaking MMMF accounts are just as useful for most monetary purposes as traditional deposit accounts.
The only distinctive trait of MMMF accounts that might disqualify them from being counted as a money substitute is the possibility of “breaking the buck” and having the redemption value of a share sink below par. However, such a possibility is widely viewed by the market as being an outright failure of the MMMF, not as a normal risk one assumes by investing in MMMFs. A mere three-cent impairment in Reserve Fund’s shares did indeed set off the equivalent of a bank run, largely because the primary competition for MMMF shares is federally-insured savings accounts, not other mutual funds. Once the illusion of never breaking the buck was shattered, the entire MMMF industry was threatened with rapid extinction.
In this respect, the MMMF is no different than a bank having a legal right to delay redemption of its savings accounts. While such impediments to the full monetary character of savings accounts exist too, no one would actually entrust their money to an issuing institution that resorted to such legal expedients to impair at-par redemption on demand. As Rothbard correctly pointed out regarding savings accounts, for purposes of calculating the monetary character of a claim it is the de facto treatment of the claim by the market that matters, not the de jure legal technicalities.
Another point about MMMFs to keep in mind is that under current rules a given deposit into the account actually does initially function as an extension of credit (usually for fifteen days); after that, one can redeem or transfer them on demand. For purposes of calculating the money stock, one might want to deduct the number of shares that are temporarily frozen due to such rules. A similar observation could be made about the sums in savings accounts in U.S. banks that are temporarily frozen due to the six transactions per month rule.
As for Krugman, the correct Austrian response is that we ought to repeal the special provisions of the SEC regulations that distinguish MMMF’s from other mutual funds, and the legal system ought to enforce the laissez-faire principle that all negotiable instant claims to dollars are in fact documents of title to money that actually should be in the issuer’s possession (i.e. a money bailment), even if such claims are masquerading as equity or as loans. Something like MMMFs would still exist under laissez-faire legal principles, but without the intentional confusion of shares with dollars and without the SEC’s governmental stamp of approval for misleadingly labelling certain short-term credit funds as “money market” funds.
Finally, in analyzing the boom that led up to the 2007-2008 panic, Austrian cycle theorists should not overlook the vital role that MMMF’s played in creating credit without savings via the commercial paper market. One cannot really begin to understand the peculiar nature of the preceding credit expansion, particularly the role of the “shadow” banking system, without considering the role of MMMFs.