Money itself is an institution that is defined and harbored by monetary institutions. Be it government, central banks, commercial banks, regulators or markets, they all play their role in harboring money.
Institutions dominate our (modern) world. They help us coordinate our interpersonal actions to create mutual trust. Embedded in an institutionalized set of laws, they should ensure stability, consistency, and reliability. Institutions can also be called are our exogenous brain. Institutions are not sacrosanct though. They can also institutionalize injustice, which then leads to instability, brittleness, and mistrust. A current example that is relevant here is the institutionalized monetary socialism of our day. But let us start at the beginning: money itself is an institution that man has discovered (others would argue that he invented it, which makes a difference in epistemological terms).
What is today commonly understood as money is currently dominated by three institutions: -State -Central Bank -Commercial banks Today, these three institutions operate on the financial market alongside many other players such as households, companies and financial institutions. The financial market can be divided into three parts too: -Money Market -Capital Market -Credit Market
The fact that today's financial markets are so complex is ultimately due to historical events. Historically worth mentioning is the intermingling of banks and royal houses, cities and later states. Especially for financing wars, princes, kings and cities had to turn to the banks again and again. Soon the first forms of the bond market were used to raise money. Forerunners of today's government bonds were the medieval war bonds. Banks and "states" were thus closely intertwined at an early stage. Private banks were, to a certain extent, repeatedly chartered, i.e. hired by the rulers to help them finance their projects and undertakings.
Modernity is also characterized by a monetary revolution in installments. Authorities and nobility recognized that a symbiosis between the public and private sectors would scale the purposes and goals of both parties. With the founding of the Bank of England, the first systematic attempt was made to cover the debt needs of the Crown (state) via the capital market in a capitalistic manner. The entire 18th century was then marked by the development process necessary to turn this "innovation" into permanent institutions and to gear the entire economic process to it. From an objective point of view, it is to a certain extent a new kind of alchemy that outshines the attempts of the old alchemy. One can speak of a "monetary revolution", whose importance for the modern economy is largely overlooked or underestimated.
One remnant of the world wars is that the central banks today hold government bonds as their largest asset on their balance sheets. This is a de facto monetization of government debt and this monetization becomes ever more prevalent. States can finance themselves in two ways: taxes and bonds. With taxes, they collect the money directly. In the case of bonds, they postpone the payment date for the taxpayers into the future. Viewed soberly, government bonds are vehicles for participating in the legalized plunder of their population. The state thus finances itself to a certain extent in a "capitalist" way via the market. Its ability to borrow and go into debt is limited by the market's assessment of the cumulative tax morale of all its (future) citizens. However, this limitation is being increasingly weakened today. Because central banks hold more and more government bonds. This means that the state, as a creditor, increasingly has the central bank as its counterparty.
Today, it is generally accepted that central banks were created to create financial stability - after all, commercial banks operate an inherently risky business model (in a dynamic uncertain world this is inevitable). However, as history clearly shows, the real reason for its creation is different: war financing. It was the Bank of England that was one of the first "central banks" to be chartered and commissioned by the royal house to finance war. Also, the world wars would never have been possible on such a devastating scale without the existence of central banks. Interestingly, it was the National Socialists who perfected the symbiosis between the central bank, the state, commercial banks and private investors as well as companies. In impressive efficiency and "functionality", they anticipated state financing.
Financial market participants who need to finance themselves in the short term (for a few days or up to a few months) do so via the money market. The short-term demand for money meets the short-term supply of money. Meanwhile, the borrowing of money happens through different mechanisms. On the money market, various short-term financial instruments can be offered for trading (usually as collateral) in order to obtain liquidity in the course of a financial transaction (usually a credit transaction). The money market is mainly there to provide the global financial system and the capital market with liquidity.
On the money market, money market papers of various kinds are traded, while bonds and shares are used on the capital market. At the heart of the money market is the interbank market, where banks lend money to each other at interest. In addition, trading companies, the public sector, central banks and money market funds also appear on the money market. The best-known instruments used on the money market are: -Bank reserves (Federal Funds) -Repurchase agreement (repo transactions) -Short-term government bonds (Treasury Bills) -Bills of Exchange (real bills) -Bank acceptances -Eurodollar Financing -Asset-backed securities
The relevance of the money market is enormous today. The commoditization of money (more precisely base money) has created a pyramid of financial instruments, which in turn follows a hierarchy of money. To maintain this pyramid, a functional money market is essential. If this market comes to a standstill, the entire financial system, especially the capital market, will be in trouble. This is exactly what happened in the financial crisis of 2008. The players in the money market actually act as dealers or market makers. They are either buyer/seller or borrower/lender in one market or another. However, if these private actors withdraw from their function as market makers or dealers, liquidity will dry up. During the last major financial crisis, central banks have therefore had to intervene on an unprecedented scale. Since then, they have had to do so and intervene in each and every tensed-up situation. This was also the case in 2020 in the so-called corona crisis. Today, central banks are lenders and dealers of last resort.
In a sense, the money market and capital market are, of course, credit markets. Institutions of all kinds finance themselves on these markets, in the short or long term. However, the term credit market is also sometimes used for specific credit transactions between commercial banks and households, i.e. their depositors. In this particular case, we have in mind in particular the issuance of mortgages and other loans, which are made directly between depositors and banks.
On the capital market, the state and companies raise medium and long-term funds and make investments with a term of at least one year or longer. Capital market transactions revolve around the issuance of securities (shares, bonds, investment funds, etc.). While companies can issue shares or bonds to raise capital, the state does so exclusively via the bond market. An initial issue of a share or bond is made on the primary market, where the corresponding security is placed for investors. Via the secondary market, investors who have already invested can resell previously purchased shares or bonds to other investors.
Capital markets today are distorted because of interventions by central banks. The latter have always intervened in the money market, through so-called open market operations. Especially since the money market is in some significant way responsible for providing liquidity to finance the capital market in a timely manner, this has had an impact on the capital market. After all, central banks are ultimately price-insensitive buyers, what is readily priced in by market participants. Through programs such as Quantitative Easing (QE), central banks have bought government bonds and thus become active in the capital market. The US Federal Reserve has even supported corporate loans through "Primary and Secondary Market Corporate Credit Facilities". These distortions are producing strange results after all. For the first time in the history of the younger capital market, in May 2020, an already bankrupt company announced the issue of shares worth one billion. Absurdity at its finest.