ABSTRACT
Financial instruments are fundamentally promises. This can be easily seen by considering the money which we use in our daily life. It contains an implicit promise. A $100 note is understood to be good for buying goods and services worth that much. It is formally backed by a certain amount of gold, or treasury bills and bonds, or the government’s declaration that it is a legal tender. But at closer look, gold does not have too many practical uses, treasury paper is only another type of promise, and government fiat is good only as long as the government has the power to enforce it. Promises are fluid. They can (and hopefully will) be kept, but they can also be broken. The breach can be open, as when the government declares that it will delay interest payment and amortization of its debt. Or it can be disguised, as when it covers a budget deficit by using the printing press and thereby debases the money, with which it later redeems its paper. And still, government the government generally considered a good risk, a baseline from which other risks are calculated. When we know this and realize that a financial system is actually a pile of promises, although organized, we also understand that it can occasionally collapse if left unattended. To call it a house of cards may be too extreme, but it certainly resembles more a bamboo structure than a concrete construction.
