Money, the crisis maker

While savings can infinitely surge, private debt is limited by borrowers' debt service capacity.

Savers must buy debt instruments to raise their financial savings. The surging desire to save permanently pushes up the debt-to-GDP ratio.

Introduction

Money's debt characteristic is the main reason behind financial crises. It is noted in the post, ''Why financial crises accelerate'', that over-leveraged borrowers' mass defaults imperil the financial system in economic downturns. Nevertheless, restraining the private sector leverage does not yield a sound system. The main driver of private debt is not supply, but demand. The surge in wealth requires debt as a medium of store because all saving forms are debt.

All saving forms are debt

All financial saving forms are debt whereas not all debt forms are risk-free. While treasuries are considered riskless, bank deposit balances over the government's insurance limit bear banks' default risk. For corporate securities, default risk varies based on bonds' ratings.

Governments do not issue ample treasuries to satisfy the risk-free debt demand. Since bank deposits over the insurance limit are unsecured, savers invest in funds created by investment companies which lend to financial institutions in return of collateral. Treasuries once again function as the securer of funds.

Individuals substantially save in debt forms. When public debt increasingly meets a smaller portion of individuals' saving desire, private debt steps in to fill the gap. Nevertheless, the private debt supply is also limited. It is not technically possible to make all private security tranches risk-free. To make the top tranche risk-free, lower tranches absorb losses. While manufacturing risk-free debt, the private sector hence produces a greater amount of risky debt. As the risk-free debt supply is limited, most savers must store value in risky forms such as corporate securities.

Risky debt invokes bank run dynamics in financial upheavals. Uninsured savings flee banks as in old days. Yet, we do not observe bank runs nowadays because the onslaught of uninsured wealth is stored in funds. In financial turmoils, funds stop lending to banks.

Bitcoin is nobody's liability

If a non-debt savings form existed, financial crises would be history. Present saving forms cannot exist independent from debt. They must be either public or private liability. In fact, a debt form, money does not necessarily have to be so. It can exist debt-free as it existed in old days in the gold form or it exists today in cryptocurrency forms. Bitcoin is nobody's liability. Digital currencies can also be designed such as cryptocurrencies. The Fed has not been promising anything in return of the dollar for decades.

Even though the digital dollar is placed on the balance sheet of a central bank, it would substantially alleviate private debt. Imagine a world with non-interest paying limitless government treasuries or imagine savers can store their savings in cash without any security costs. Especially in a low yield environment, savers would prefer to just keep their wealth as cash, refraining from the default risk of a borrower.

The digital currency is risk-free

The digital dollar would be as secure as gold since it does not bear default risk as it remains idle at central bank accounts. Savers would thereby ensure their savings to be paid back in all circumstances. Hence, financial crises would not depress the dollar demand, but accelerate transfers from the dollar's debt forms to the digital form. Would those transfers induce runs?

No. To the contrary, they render the financial system healthier by reducing private debt. Instead of private debt, central banks would inject income to the beneficiaries legitimately determined by parliament. The financial system would relax when the overall default risk falls. During the transition, central banks would conduct asset purchases to keep markets liquid.

In the current practice, central banks build up financial crises. Asset purchases incentivize piling on more debt. Over-leveraged borrowers become fragile against income shocks. Meanwhile, excess liquidity keep risky borrowers alive posing a greater risk in the next shock. The spiral of the surging debt and default risk makes the system unsustainable.

Money, the crisis maker

A reexamination of crisis motives would reveal that money is the ultimate crises maker. Money's debt design necessitates savers to buy debt as a store value. Bank deposits are created through loan generation. As the financial system satisfies the debt demand, it issues deposits or securities. As a result, borrowers have to raise leverage regardless they borrow in bank intermediation or directly from markets. In normal times, this is not a big deal as borrowers' net debt service is minimal. Nevertheless, in financial upheavals, when lenders pull their money out of risky private debt, liquidity dries out, requiring central banks' intervention.

Central banks stimulate banks' money creation through a lower interest rate. When the policy rate hits zero, central banks employ a pass-through tool, quantitative easing. In return of risk-free bonds, central banks transfer reserves to bond sellers' banks. Reserves are the digital currency among banks. As non-banks are not allowed to hold reserves, banks increase bond sellers' deposit balances, as much as reserves. QE hence directly raises the money supply.

At the zero lower bound, bond sellers look for new opportunities to earn money. As risk-free assets' supply and interest rates are falling, they purchase riskier assets. Riskier private debt issuance would bolster issuers' spending. This is how central banks expect QE to boost demand.

The historical QE experience suggests that central banks' liquidity provision cannot be temporary. Central banks cannot shrink their balance sheets, else the risky private debt demand would fall, draining liquidity in financial markets. Each crisis thus results in a bigger central bank balance sheet.

As central banks suck risk-free assets, the financial system manufactures riskier assets. This unsustainable mechanism would end up in a financial crisis triggered by massive credit defaults.

The digital currency can save the system

The digital currency can render the financial system sustainable through increasing the risk-free asset supply. Via digital currency transfers, central banks can boost demand without asking an asset in return. The risk-free asset supply would rise as much as the central bank's digital currency issuance. Beneficiaries would spend the digital currency and, thus, boost demand. The digital currency circulates in the economy until it is stored as wealth.

Money does not have to be liability. It can exist in non-debt forms. When wealth does not need debt to accumulate, the risky private debt volume would substantially diminish. Investors could reserve their wealth at the central bank accounts through the digital currency.

The transition to the digital currency should be smooth and gradual. Central bank should continue to conduct asset purchases until private sector leverages gradually fall. Digital currency would replace private debt, meanwhile. As central banks need to boost economies, they would conduct digital currency transfers.

Conclusion

At present, savers must buy debt instruments because all financial saving forms are debt. The surging saving desire permanently increases the overall debt-to-GDP ratio while the public debt-to-GDP ratio is steady. Excess savings are thus increasingly stored in private debt. Nevertheless, private debt is limited by borrowers' debt service capacity whereas savings can infinitely surge. Overleveraged private entities massively default in economic downturns and trigger financial upheavals.

The digital currency would sustainably store surging wealth. Meanwhile, it would distribute income more equally by replacing debt-based spending with income transfers. Low and middle income groups could lower their debt to income ratios thanks to the digital currency grants.

Being stored in the digital currency, wealth can remain idle and risk-free. The falling demand for private debt would gradually deplete its volume rendering the financial system more resilient against shocks.