Definition of Aggregates and Functions Used

Value. Value is not fixed data and can be determined using several concepts. It should first refer to physical values expressed with an outside stamping benchmark. A concept close to that of accountants' “fair value” of prices practiced between independent counterparties.[1] As we have seen, because financial market prices are independent of underlying original transactions, we totally disregard accounting standards to link values to flow speed from real exchanges. For the purpose of the equations to determine V we will use two methodologies and compare them thereafter. The first will be the monetary unit, applying last prices checked for significance with rotation indexes to the entire number of existing physical units. The second will be to use the financial instruments' prices, accounted for in the books. Other approaches are possible, differentiating original values for short-tenn instruments from long-term instruments and apprising all of them at a value depending on rotation. As developed along the book, instruments have also to be differentiated depending on their attached guarantees. With the E index we may, over certain thresholds, have to disregard the equation when S' slowing becomes a macroeconomic threat to values. We then switch to a resolution formula and define what is the current flowing economy that can be saved from disruption from sectors to be dealt with. That would apply to long-term cycles such as real estate, which are necessarily highly weighted in the balance sheets. Value also has to be looked at with pressures, global or sectorial, that will impact the growing of values in monetary units (for instance generating inflation) or collapses.

Prices. Prices are those observed for original transactions expressed in monetary units. (They are not those for transactions on financial instruments). They are the ones generated by real economic transactions.

Exchange ratios. Prices, as already mentioned, determine or are determined by exchange ratios. As a result, the stamped number is no more than a ratio and the monetary unit is irrelevant within a monetary area. The same comment can be made about financial debt or equity instruments.

S. S is rotation over a time period. It is determined space. Or it can be global: Revenue/M5. If the speed goes up or down from the centre, considering each class of financial instruments, this gives a standard speed average A with the consequence S of differential multiples.

M. M is M5. M5 and M6 are defined in Chapter 6. If sufficient quantities M are provided (QE or LTRO), the model does not explode either when the speed is too high or too low. However, in such circumstances, values or prices may become volatile and the differential again to bring the instability that can lead to an explosion as E shows. Minsky's/Douady's approaches apply. We see that if everything goes the same way, the system remains stable, but because of volatility a disconnection may happen between V and P not satisfied by M available volumes. We have already addressed, in Chapter 5, the collection of data process matters, and in Chapter 4 the matter of offsetting balances in balance sheets.

Time. To have the E formula apply, we need to set time and space boundaries. The starting point is given by observation and legal set-up or transfer of property that is the occurring event allowing, according to accounting standards, the posting on financial ledgers. The time exists independent of the set time scale. Like values, its elapsing is not linear. You have a time before the starting set point. For instance, the trading time of one financial market before clearing of instruments has to be observed – the deformation of the time dimension when walking inside the time space where anticipation will influence realities.

M5, M6 and time. M5 and the entire global formula will be walked over a duration scale where production of new instruments and termination (by pure exchange and term combined) will be considered to determine the standard speed to aim for. This will allow a surveillance of discrepancy.

M5 and M6 risk weighting (M5 RWA). In the dynamic use of M5, weighting will be necessary to include the liquidity of underlying guarantees (for instance, distinguishing between governmental direct signature and real-estate leans). The discrepancy between instrumental values and nominal values of guarantees will be looked at either globally or regionally (for those that are regionally linked, such as real estate).

Optimum monetary area. When collecting M5 and derived aggregates, the matter of scope must be considered. The scope is already defined as a whole by the monetary zone systems. This does not mean that it is optimum. It does not mean that it is fully meaningful. For instance, some zones are tightly interconnected and then external exchanges are a matter to be explored. For instance, Mexico is interconnected with the USA, and North Africa or most of Africa with the Eurozone. Some dependence indexes already exist. Several tentative cuts can be made, since these aggregates give the counterparts. The contagious risk approach developed above is also an interconnection over space discovery, which is useful to monitor economic policies.

E. E is calculated for classes of financial instruments (real estate, consumption over LT financing and holders, enterprises and households as counterpart). The time period is a month.

Ex. Exchangeability between instruments is a factor that will be looked at to discriminate, or not, between each category when determining the various volumes of M5 instruments needed for the functioning of a sector of the economy. The speed of exchanges between instruments will have to distinguish two elements – exchanges for the same, a renewal for the same instruments with new similar duration or an exchange for other instruments different in duration, rate and guarantees. Regulation may change the exchangeability (e.g., the switches for stock markets). The actors are the markets when free, market regulation and general authoritative regulation. Usually, laws and regulation will provide for setting the thresholds allocating the power of who is in charge, meaning who holds the seignorage rights. Ex will vary at certain thresholds but, when crossing them, will impact the valuation process. When exchangeability is certain, value setting follows, as we have seen, a current pattern. When exchangeability is at stake and reduced, it means the nominal value at term becomes meaningless. The underlying value of guarantees becomes the driver for valuation replacing nominal. This is the reason for us to consider two types of equation to determine the M5 and M6 amounts we are using. Over the exchangeability, which is a function, there is different flexibility showing different categories of bounds for each class of instruments. The interest rates are one of them, like the values.

Seg. Seg is the seignorage right. As a financial instrument becomes money when exchangeable, the seignorage right is exercised through the exchangeability factor. The access to exchanges is also a seignorage right. Where is the seignorage right located? How it is shared may vary. Its mapping will be necessary. As a traffic light, it is where regulation may be exercised.

There is a reason supporting our choices (VE). Financial instruments have, by contract, a nominal value; the one they are to be claimed at, related to the price of acquired assets or services, but that can also be sold before being satisfied by payment or exchanged at a new, different price. The value amount will represent by difference the non-realized capital gain or loss from the original price. We are no longer within the universe of actually exchanged goods and services, but in the monetary universe of unsatisfied claims that can only be a representation of the first universe. The two universes can, up to a limit, be disconnected within time and distance brackets. Already in Chapter 5 (Figure 5.3), we saw how the difference represents a stress and a risk when velocity slows down.

As there is a need for immediately exchangeable money at certain points in time, liberated from barter exchanges, the monetary universe has to meet the realities of necessary goods (food, housing and tax collection). The instrument itself should become exchangeable for the figure showing on its face – the nominal value. If the differential with the production prices or the usable assets – both nominal and quantities – becomes too high, the implicit exchangeability vanishes and the whole system comes apart both in value and price until a new balance can be found. However, in the meantime, the producers short of cash money cease to produce: the patient is dead.

The spread between value and price is a dangerous one, as it is only a slice of the production of existing goods that are exchanged. To give an example, if, because of cash needs or sheep-like behaviour, everything in a class of assets becomes for sale (as for real-estate assets with the sub-prime crisis), values and prices collapse and production stops. Values and prices will follow similar trends, but not parallel ones, as with differences in timing. If M5 changes in an incoherent manner with speed and production volumes, they are roots for adjustments. Either there is insufficient or excess in M, and simultaneously a modification in the exchangeability factor of its components, and there is an effect on prices and values, or the three factors combine and operate in a synchronous manner and nothing has really changed until physical limits are met. The various universes of prices and values cannot be totally disconnected from production of fixed assets (fixed ones, without counterparts) in a unique space.

Debt versus Equity Instruments: The Need for Big Data

Our formula did not consider equity instruments but just what we qualify as monetary instruments. Of course, this does not mean that equity instruments are not exchangeable. Shares in equity were historically the first to be exchanged on stock markets, and the first to exist. But their pricing rules and conduct, long observed, cannot be mixed up as by nature they are not claimable. We now have a second level of observation, with debt operating as guarantees in case debt instruments are linked to these equity instruments either through balance sheet debt ratios or comparative prevailing (in appropriate categories) interest rates. When price thresholds, return flow ratios, leverages or guarantees are breached, it is the interconnection of the system that has to be analysed – not as part of the model but as a possible spark plug operating both ways (from the debt to the equity markets and from the equity to the debt markets; they are not reciprocal). The matrix analysis that we have proposed takes care of that with big data and our analysis.

  • [1] Value as it shows in the balance sheets today is totally heterogenous because of being based on banks' individual models and positions taken as to the refinancing (to be kept or not until maturity) (see Chapter 4 for accounting principles and the use of the fair market value standard). We would rather derive it from volumes showing on the P&L compared with prices of inventories and in M5.
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