Onshore and Offshore Transaction Clearing Customs

[Joe Leote]

Even under the gold standard, and under modern fiat banking, all the financial assets, bank liabilities, and owner's equity on the books of a bank or banking sector necessarily represent legal claims, better described as financial claims, generated from "thin air" as financial deals. One way to view this is to look at the transaction accounts TA (in the M1 money supply) which exist as liabilities of the aggregate domestic bank sector:

TA = Accounting Assets - Other Accounting Liabilities - Accounting Equity

The market value of equity for a public or private bank does not usually equal the book value or accounting value. If the assets or liabilities of a bank undergo an accounting revaluation then this can be called adjusted equity. Otherwise equity is the residual book value of assets minus liabilities driven by recording the nominal accounting transactions.

Transaction accounts are what non-banks used to clear payment typically dominated by what we call checking accounts. These are liabilities of the aggregate bank sector and financial assets of the nonbank owners. The aggregate bank sector generates net new TA by increasing Accounting Assets typically in two ways: (1) purchase a security from a nonbank or government issuer while in turn issuing a net new TA amount to the seller; or (2) make a new loan to a nonbank issuing a net new TA amount to the borrower. In this way financial deal making on the asset side of the aggregate bank tends to increase the transaction accounts on the liability side of the balance sheet.

On the asset side of the balance sheet each banks must force a flow of bank reserves into the bank to clear interbank payments. These reserves or exchange settlement funds are central bank liabilities and bank assets operating similar to the checking account for each bank. To replenish reserves that flow out for interbank settlement the bank can convert TA balance to Other Accounting Liabilities that pay interest or can issue new equity claims. A bank that loses the ability to generate Other Liabilities or Equity when necessary will default on interbank payments due to illiquidity. If the asset portfolio of the bank is sound, and if there is no run on the bank to withdraw liability and equity claims, then it can usually borrow from the central bank or another bank to provide liquidity when nonbanks are not doing so. The point is that transaction accounts tend to increase with Assets and tend to decrease with Other Liabilities and Equity. The residual level on the aggregate balance sheet is the TA component of M1 money. All the financial instruments on the bank balance sheet arise from financial deals from "thin air" backed by nothing but the commercial, legal, and accounting customs in the bank and nonbank social institutions.

Domestic Eurodollars are liabilities in Other Liabilities. These domestic Eurodollars are similar to transaction accounts for clearing the payment of offshore loans via a daisy-chain of financial instrument generation coupled to the domestic bank liabilities. Loans that specify collateral in payment for default are secured loans. Loans or claims that do not specify collateral for repayment in default are unsecured loans. When asset values plunge it damages the financial sectors claim on collateral in repayment because the collateral is falling in value. When the financial sector rolls over and grows its balance sheet asset prices tend to rise and when financial markets attempt to shrink the intermediary balance sheet collateral values tend to also fall.

Joe

[Joe Leote]

This is a more accurate simplified model for the generation and destruction of Transaction Accounts in M1 money supply on the aggregate bank balance sheet:

Transaction Accounts = Reserves + Securities + Loans - Other Liabilities - Paid-in Equity - Adjusted Equity

where an increase of Loans or Securities in Bank Assets increases Transaction Accounts, an increase of Other Liabilities decreases Transaction Accounts, and an increase of Paid-In Equity decreases Transaction Accounts.  If the Central Bank purchases securities via Open Market Operations from the nonbank sector, with payment clearing via the aggregate bank, then the OMO injects both Reserves and Transaction Accounts into the aggregate bank sector.  When banks earn profits from operations, or accounting rules call for the revaluation of assets or liabilities, then the accounting operations would not affect Transaction Accounts but rather Adjusted Equity.

Joe