What is the relationship between markets, money and their infrastructures? Economists tell us that the relationship is straightforward: money makes markets “fluid” and adequate infrastructures make them efficient. But ongoing attempts at integrating financial markets in Europe teach us a different story.
In a series of three recently published research articles, I analyze the interlacing problems in present-day Europe of (a) creating an integrated infrastructure for financial markets, (b) rendering financial markets liquid and efficient without producing systemic risks, and (c) drawing a line between money as a tradeable commodity in the market and as a fluidifying medium for markets (an infrastructure).
This nexus of problems reveals fundamental contradictions inscribed in the legal and political foundations for still ongoing European financial market integration processes. Mapping these contradictions can recast our understanding of controversies and debates related to integration processes ranging from bureaucratic disagreements over technical issues to open political conflict in the aftermath of the Great Financial Crisis of 2009.
Competition via centralization
Contrary to the US, the European Union (EU) has as its constitutional goal (explicit in its founding treaties) to create a single, fully integrated market. By “market,” European politicians and bureaucrats mean “a level playing field” for free competition. Thus, a seemingly clear division of labor is established where the EU provides the legal framework and other infrastructures for the market to do its job: Fair and efficient allocation of resources across the economy.
However, as soon this is put into practice, a fundamental problem arises of where and how to draw that line between the market and its infrastructures. Again and again, this problem emerges on large and small scales and in technical, legal, political and economic guise. It may be a “theoretical” problem is but it is real in its consequences precisely because it is inscribed in the legal foundations for ongoing financial market integration processes in the EU.
In fact, it is possible to map clear parallels between conflicts arising over European financial market integration and debates found in classical economic theory, for example, over the nature and role of money in markets. Indeed, the concept of “market” inscribed in EU legislation is adopted from mainstream economic theory. The debates over the paradoxical concept follow along with it.
The distinction between market and infrastructure is not at all simple. On the one hand, financial infrastructures, such as payment and settlement systems, provide services that can be offered in the market in competition with other providers. On the other hand, the market itself can be seen as an infrastructure for exchange, setting up a framework where traders can meet and information about prices, supply and demand is immediately accessible.
The recent creation of a pan-European infrastructure for transacting and moving around financial assets is illustrative of this paradoxical doubleness of markets and infrastructures. The system, called TARGET2-Securities (T2S), is the result of almost 20 years of back-and-forth about European financial market integration. Around 2000, immediately after the implementation of the euro, the European Commission wanted private companies to provide the integration on a competitive basis.
However, this did not happen. In hindsight, the reason for this is obvious: how could competing and thus fragmented private players provide a pan-European “level playing field”? That, it seems, would require a monopoly. To address this, the European Central Bank stepped in and created T2S.
However, this could only be done by “in-sourcing” services already provided by private companies. It is indeed a paradoxical result, given the overall ambition of private competition and market integration of the EU. Needless to say, this caused considerable contestation in the small world of financial infrastructures. But the contestation was a revelation of a general problem of financial market integration. Eventually, competition was reached via centralization.
Money at the center of the market-infrastructure problem
Money plays a unique role in the contradictory relationship between market and infrastructure. On the one hand, money is simply a commodity that can be exchanged for other commodities. From this perspective, money should be scarce in order to maintain its value. As a direct consequence, central banks should keep the quantity of money in the economy stable (a policy favored by Milton Friedman and at vogue among economists in the 1980s).
On the other hand, money is an infrastructure that “fluidifies” exchange. The very idea of an efficient market is that the value stored in all other commodities and assets can always and easily be transformed into money via exchange. As a consequence, in stark contrast to the above, central banks should make money freely available as a credit line whenever necessary to smoothen economic transactions (a policy favored by modern-day followers of John Maynard Keynes). The contradiction cannot be solved. In fact, it pops up not only in academic debates of economic theory, but also at the core of European financial market integration.
In the T2S engine, financial transactions are settled across Europe in real time. However, banks and other financial institutions do not always have sufficient cash available on the right accounts at the right time to settle those enormous flows. At the course of a day, such flows tend to largely net out, but if an excess of payments early in the day absorbs all the cash available to a bank in the system then failures to settle can potentially spread like falling dominoes, entailing systemic risks. To avoid that, the European Central Bank provides free settlement credit in the system. Officially, the credit is not money, but it performs monetary functions (settlement). As one central banker put it: “It’s not money, but then it is somehow after all.” By distinguishing somewhat artificially between money and central bank credit, the European Central Bank tries to keep markets (money as commodity) and infrastructures (money as medium) separate.
The financial crisis and its aftermath
At a much grander scale, the contradictory role of money in European market integration sheds new light on monetary policy in Europe during and after the financial crisis. In a certain sense, monetary policy in the Eurozone is all about managing the market-infrastructure problem.
Before the 2009 crisis, the monetary policy worked with a so-called “corridor.” Here, the European Central Bank set both maximum and minimum interest rates within which banks were to trade money with each other. In other words, the price of money, the interest rate, was only allowed to obey supply and demand within a certain band or “corridor” set by the European Central Bank.
What happened with the financial crisis was that European banks stopped lending money to each other. Consequently, the European Central Bank was forced to lower interest rates to zero and even to negative rates in order to stimulate financial activity–banks are paid to take out short-term loans (to “buy money”) at the central bank. This means that in European monetary policy, the market-money-infrastructure nexus has been re-organized so that the role of money as an infrastructure (freely available to make markets run smoothly) has come to dominate that of money as a commodity (scarce and available at a price determined by competitive pressures).
Troels Krarup. “Between Competition and Centralization: The New Infrastructures of European Finance” in Economy and Society 2019.
Troels Krarup. “Money and the ‘Level Playing Field’: The Epistemic Problem of European Financial Market Integration” in New Political Economy 2019.
Troels Krarup. “The Collateral Liquidity Problem in Contemporary Finance and the Resurrection of Quantity Theory” in Competition & Change 2019.
Image: adapted from Euro banknotes by Lukasz Radziejewski, moneypictur.es via Flickr (CC BY-SA 2.0).