Settle or Die
Payment, Liquidity, and Survival
Welcome to The Survival Constraint. The purpose of this blog is to introduce/supplement Perry Mehrling's online course, Economics of Money and Banking (2012). Whether or not you've previously taken the course, my goal is to help you strengthen your understanding of Mehrling's money view approach.
We all have an intuition for what money is and how it works. And that intuition is basically right. Money is what we use to pay for stuff. It is the economy's standard means of payment—the generally accepted thing we pass around to settle debts.
However, money is deceptively simple. Understanding money any deeper than at the most superficial level is harder than it may seem. Perry Mehrling has made it his life's work to make sense of money for himself and the rest of us.
Clip Length: 1:24 (2017 Lec 1, 15:52–17:16)
Why is it so difficult for me to learn this and figure this out? Why did it take me so long? I don't think I'm stupid.
(2017 Lec 1, 16:36)
Mehrling (2017; 2017a) highlights four key features of money that present psychological hurdles to understanding:
Alchemy — Banks create new money seemingly out of thin air.
Hierarchy — Some forms of money are necessarily "better than" or "above" others.
Hybridity — The monetary system is a combination of public and private.
Instability — Credit structures are fragile and prone to collapse.
It might not be obvious why, but we'll eventually see that these four "problematic" features of money all derive from the constraint that every entity (person, household, firm, government, etc.) has to settle its debts as they come due. This constraint is the survival constraint. If you can't settle, you're done. If nobody can settle, the system grinds to a halt.
Mehrling adapts the term "survival constraint" from Hyman Minsky (1954), who uses it slightly differently.
Firm behavior can be considered as ruled not only by the desire for profits but also by the desire on the part of the firm’s management to avoid failure or bankruptcy: for in failure or bankruptcy the value of the organization disappears. These monetary or financial constraints upon the firm I have labeled the survival constraints.
(Minsky 1954, 96)
The ability to meet your cash commitments and satisfy your survival constraint is called liquidity. Being illiquid means you're dead in the eyes of the monetary system. Everyone being illiquid means the system is dead.
Liquidity kills you quick.
— Perry Mehrling
When liquidity is scarce, the survival constraint acts as an ever-present disciplining force that provides structure to the monetary system and causes it to cohere. It prevents people from promising to make whatever payments they want whenever they want.
However, too much discipline can cause problems. Banks are entities that specialize in relaxing the discipline of the survival constraint. They provide flexibility and elasticity. They provide liquidity. We pay them for it. They run the payment system. They make liquid markets between money and other financial assets.
We haven't answered any hard questions about money, banking, and finance. But we have chosen a starting point. Mehrling (2012) shows us that we can understand a surprising amount by building on liquidity.
References
Mehrling, Perry. 2012. "Economics of Money and Banking." Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking
Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI
Mehrling, Perry. 2017a. "Financialization and Its Discontents." Finance and Society 3 (1): 1–10. https://doi.org/10.2218/finsoc.v3i1.1935.
Minsky, Hyman P. 1954. "Induced Investment and Business Cycles." PhD diss., Harvard University.
What protocol could be implemented in a financial system that guarantees that the survival constraint is always satisfied? As you stated, there is no economy without debts being solvently repaid on time. Abstract to the macro level and assume that everyone is responsible to maintain solvency in the monetary system. Bankruptcy proceedings are replaced by everyone being responsible to maintain solvency of our credit. All borrowers are burdened to a standard degree to repay all lenders. This greatly simplifies the mathematics while assuring that no defaults occur. Having a standard length of time that credit is extended, a standard rate of repayment and reconciliation, and a standard limit on the amount of credit that each of us may extend is a good constitution of simple, coherent rules that work well in a practical accounting system.
It seems to me that understanding that money is a debt owed by a bank to the holder makes everything pretty clear and intuitive:
1. Alchemy. Banks create money by writing an IOU. Its NW↓ and the holder's NW↑.
2. Hierarchy. Some banks' IOUs are trusted more than others, so more widely-accepted and more desirable to hold.
3. Hybridity. There are different banks, including central banks, issuing IOUs. See 2.
4. Instability. When confidence is lower, more people would rather have what the debtor promised than the promise itself, leading to deleveraging, which can itself decrease confidence.