This post is part of a series of notes (which begins here) for a two-week intensive course on the political economy of finance that I taught at Al Akhawayn University in Ifrane, Morocco. Each note looks at a political-economic concept and an institutional structure. The notes are the skeleton of the course, fleshed out in the classroom with lectures, analytical techniques, discussions and supplementary texts.
Credit is asymmetrical
When a borrower enters into a credit relationship, they receive money now and promise to pay it back in the future. The borrowed money gives them some flexibility: they can spend it to pay for goods or services, or to settle other debts. They gain flexibility for a period of time, but it comes at a cost: the borrowed money will eventually have to be paid back.
Hyman Minsky called this the survival constraint: when the time comes to settle a debt, the borrower’s actions are constrained: they must pay, or face legal consequences. It is a matter of survival, figuratively at least, because a borrower who does not pay can be quickly put out of business. By this same fact, the lender gains a right, namely the power to use the legal system to collect their due. A lender who has not been paid can, within the bounds of the law, force a borrower to fulfill the debt contract.
In other words, credit introduces an asymmetrical relationship, which takes from one side and gives to the other. Lenders have power over borrowers, and that power is felt ever more acutely as the payment deadline approaches.
From asymmetry to hierarchy
In this asymmetry at a small scale, we find the origin of financial hierarchy at a large scale. A bank, we have said, is a specialist in credit—a bank is lender to many borrowers. By lending widely, the bank gains the power to bring money in. The bank has no need to resort too frequently to the force of law—the threat is enough to steer most borrowers to a habit of timely payment.
The bank’s micro-level power, multiplied by its many borrowers, has a self-reinforcing character. Everyone knows that the bank can force its borrowers to pay, and that as a result the it has a steady stream of money coming in. Its ready cash flow means that the bank’s own liabilities are quite safe. No one can be more certain to pay than the one who can quickly collect from everyone else. So the bank’s liabilities are the safest liabilities, not so much borrowing as accepting deposits. A bank might even feel free to issue demand liabilities, promising to pay not at a specified point in time, but whenever its depositors might ask.
But then, if the bank’s credit is the best credit, then the bank is also in the best position to lend, because simply by issuing more liabilities—more deposits—it can create funds to lend out to anyone who wishes to borrow. By lending widely, the bank gains a central position in financial relationships; this central position gives it an advantage in lending.
There are limits to this (not all bankers are wise; accidents happen; success breeds jealousy), but the basic point holds: the asymmetry of credit creates financial hierarchy, with banks at the top.
Recognizing banks’ power, states (governments) have rarely been content to let financial systems operate as purely private affairs. These days every nation-state has a central bank with a special relationship to local laws. Central banks are reserve banks, with other banks as their customers, and they serve also as bankers to governments themselves. They are banks among banks, specialists in credit among specialists in credit, maximally asymmetrical.
Political economy of finance
Hierarchy (this post)