Janeway on McArdle's Law
By Arnold Kling
In an interview, William Janeway says,
When I was a kid growing up in this business in the 1970s, we thought of illiquidity and insolvency as two fundamentally different conditions. You were illiquid if the expected net present value of the cash inflows that I am entitled to by contract exceed the expected present value of the net outflows. All I have is a timing problem. You can tide me over. You are insolvent if the reverse applies. I’m bust. In this world, when you mark to market, liquidity drives insolvency.
…the non-financial sector lives on the provision of working capital and fixed investment, to be able to spend money before money is received. For being able to pay workers and vendors before receivables are collected. And to increase capacity before the revenues from higher sales are received.
…All of the assets and liabilities of the financial sector, at the end of the day, come down to whether or not, back to Minsky, the cash flows from the non-financial sector validate them. The integration of the financial and non-financial sectors of the economy is complete.
You can think of these excerpts as explanations for what I call McArdle’s Law: Money is weird. Finance is weird.
Thanks to an email from Mencius Moldbug for the pointer.I should also excerpt the opening quote from a reader of the Institutional Risk Analyst:
Letting credit default swaps (“CDS”) redefine insolvency as failure to post collateral means systemically critical counterparties such as Lehman Brothers or Bear are certain to fail once they wobble and, even worse, that there will be NOTHING LEFT for traditional creditors (including commercial paper) when they do.