Understanding shadow money

The simple mistake of neglecting money has been at the heart of what went wrong in the crisis. Central banks in particular were taken by surprise at the rise of shadow money, which is money created by shadow banks to fund credit extended through securities markets, including securitization markets. Shadow banks use these securities as collateral to issue shadow money via repo markets.

When the fragilities of this new money led to the collapse of Lehman Brothers in September 2008, and ignited the US shadow-banking crisis globally, central banks around the world recognised that the social contract around bank money has become increasingly unsuitable for the structures of modern finance. But, this is not only a question of crisis. Global finance is increasingly organised around securities markets, rendering shadow money the money of the future.

With this, shadow money has become an important theoretical and policy concern to central banks and academia more broadly, at the cutting edge of an emerging macro-finance agenda. In her research, funded by the Institute for New Economic Thinking and by FEPS Brussels, Professor Daniela Gabor explores three distinctive questions raised by the growing importance of shadow money.

Firstly she develops a monetary theory of shadow money(ness) that builds on previously neglected questions of temporality - shadow money supports business models reliant on daily variation in the market price of securities, from hedge funds to market-based banks. This helps conceptualize the distinctive fragilities of shadow-money: its temporality renders shadow money(ness) a complex fiction reliant on securities markets liquidity. The fiction, Professor Gabor’s research argues, requires a new social contract around (shadow) money that re-shapes the relationship between the central bank, the state in its capacity as debt issuer, and shadow money-issuing institutions. These questions are approached through a comparison of shadow money creation in the US, Euro area and China.

Professor Gabor’s approach to shadow money has attracted the attention of central banks and regulators and she has provided expert advice to the European Parliament on the European Commission’s Capital Markets Union project, where she argued that plans to revive securitization markets need to be anchored into a European social contract on shadow money. She has also given numerous seminars to central banks and is engaging in public debates on money through financial and social media (@DanielaGabor). She is writing a book on Shadow Money to be published on the 10th anniversary of the fall of Lehman Brothers in 2018.

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