The
Financialization of the Economy
John Mauldin
Roger
Bootle once wrote:
The whole of economic life is a mixture of
creative and distributive activities. Some of what we ‘‘earn’’ derives from
what is created out of nothing and adds to the total available for all to
enjoy. But some of it merely takes what would otherwise be available to others
and therefore comes at their expense.
Successful societies maximise the creative and
minimise the distributive. Societies where everyone can achieve gains only at
the expense of others are by definition impoverished. They are also usually intensely
violent….
Much of what goes on in financial markets
belongs at the distributive end. The gains to one party reflect the losses to
another, and the fees and charges racked up are paid by Joe Public, since even
if he is not directly involved in the deals, he is indirectly through costs and
charges for goods and services.
The genius of the great speculative investors is
to see what others do not, or to see it earlier. This is a skill. But so is the
ability to stand on tip toe, balancing on one leg, while holding a pot of tea
above your head, without spillage. But I am not convinced of the social worth
of such a skill.
This distinction between creative and
distributive goes some way to explain why the financial sector has become so
big in relation to gross domestic product – and why those working in it get
paid so much.
Roger
Bootle has written several books, notably The
Trouble with Markets: Saving Capitalism from Itself.
I
came across this quote while reading today’s Outside
the Box, which comes from my friend Joan McCullough. She didn’t
actually cite it but mentioned Bootle in passing, and I googled him, which took
me down an alley full of interesting ideas. I had heard of him, of course, but
not really read him, which I think may be a mistake I should correct.
But
today we are going to focus on Joan’s own missive from last week, which she has
graciously allowed me to pass on to you. It’s a probing examination of how and
why the financialization of the US and European (and other developed-world)
economies has become an anchor holding back our growth and future well-being.
Joan lays much of the blame at the feet of the Federal Reserve, for creating an
environment in which financial engineering is more lucrative than actually
creating new businesses and increasing production and sales.
There
are no easy answers or solutions, but as with any destructive codependent
relationship, the first step is to recognize the problem. And right now, I
think few do.
What
you will read here is of course infused with Joan’s irascible personality and
is therefore really quite the fun read (even as the message is sad).
Joan
writes letters along this line twice a day, slicing and dicing data and news
for her rather elite subscriber list. Elite in the sense that her service is
rather expensive, so I thank her for letting me send this out. Drop me a note
if you want us to put you in touch with her.
I
am back in Dallas after a whirlwind trip to Washington DC. I attended Steve
Moore’s wedding at the awe-inspiring Jefferson Memorial; and then we hopped a
plane back to Dallas and Tulsa to see daughter Abbi, her husband Stephen, and
my new granddaughter, Riley Jane, who was delivered six weeks premature while
we were in the air. The doctors decided to bring Riley into the world early as
Abbi was beginning to experience seriously high blood pressure and other
problematic side effects. Riley barely weighs in at 4 pounds and will spend the
first three years of her life in the NICU (the neonatal intensive care unit).
Having never been in one before, I was rather amazed by all the high-tech gear
surrounding Riley and all of the usual medical devices shrunk to the size where
they can be useful with preemie babies. The doctors and nurses assured me that
the frail little bundle I was very hesitant to touch would be quite fine. And
Abbi is much better and already up and about.
As
I was flying back to Dallas later that afternoon, it struck me how, not all
that long ago, in my parents’ generation, both mother and daughter would have
been at severe risk. Interestingly, both Abbi and her twin sister were
significantly premature as well, some 30 years ago in Korea. The progress of
medicine and medical technology has allowed so many more people to live long
and productive lives, and that process is only going to continue to improve
with each and every passing year.
And
now, I think it’s time to let you get on with Joan McCullough’s marvelous
musings. Have a great week!
Your
glad I’m living at this time in history analyst,
John Mauldin, Editor
Outside the Box
The
Financialization of the Economy
Joan McCullough, Longford Associates
October 21, 2015
October 21, 2015
Yesterday, we learned that lending standards had
eased and that there was increased loan demand from institutions and
households, per the ECB’s September report. (Which was attributed to the
success of QE and which buoyed the Euro in the process.)
This has been bothering me. Because it is a
great example of the debate over “financialization” of an economy, i.e., is it
a good thing or a bad thing?
The need to further explore the topic was
provoked by reading this morning that one of the larger shipping alliances, G6,
has again announced
sailing cancellations between Asia and North Europe and the Mediterranean. This
round of cuts targets November and December. The Asia-Europe routes, please
note, are where the lines utilize their biggest ships and have been running
below breakeven. So it’s easy to understand why such outsized capacity is
further dictating the need to cancel sailings outright. G6 members: American
President, Hapag Lloyd, Hyundai Merchant Marine, Mitsui, Nippon and OOCL. So as
you can see from that line-up, these are not amateurs.
We have already discussed in the past in this
space, the topic of financialization. But seeing as how the stock market keeps
rallying while the economic statistics have remained for the most part, punk,
time to revisit the issue once again. Is it all simply FED or no FED? Or is the
interest-rate issue ground zero and/or purely symptomatic of the triumph of
financialization over the real economy?
Further urged to revisit the topic by the
seemingly contradictory developments of the ECB banks reportedly humming along
nicely while trade between Asia and Europe remains obviously, significantly
crimped.
Let’s make this plain English because it takes
too much energy to interpret most of what is written on the topic.
Snappy version:
Definition (one of quite a few, but the one I
think is accurate for purposes of this screed):
Financialization is characterized by the accrual
of profits primarily thru financial channels (allocating or exchanging capital
in anticipation of interest, divvies or capital gains) as opposed to accrual of
profits thru trade and the production of goods/services.
Economic activity can be “creative” or
“distributive”. The former is self- explanatory, i.e., something is
produced/created. The latter pretty much
simply defines money changing hands. (So that
when this process gets way overdone as it likely has become in our world, one
of the byproducts is the widening gap called “income inequality”.)
You guessed correctly: financialization is
viewed as largely distributive.
So now we roll around to the nitty-gritty of the
issue. Which presents itself when business managers evolve to the point where
they are pretty much under the control of the financial community. Which in our
case is simply “Wall Street”.
This is something I saved from an article last
summer which ragged mercilessly on IBM for having kissed Wall Street’s backside
... and in the process over the years, ruined the biz.
... “And of course, it’s not just IBM. ... A
recent survey of chief financial officers showed that 78 percent would ‘give up
economic value’ and 55 percent would cancel a project with a positive
net present value—that is, willingly harm their companies—to meet Wall Street’s
targets and fulfill its desire for ‘smooth’ earnings.... http://www.forbes.com/sites/stevedenning/2014/06/03/why-financialization-has-run-amok/
IBM is but one possible target in laying this
type of blame where the decisions on corporate action are ceded to the
financial community; the instances are innumerable.
You probably could cite the well-known example
of a couple of years back when Goldman Sachs was exposed as the owner of warehouse facilities that
held 70% of North American aluminum inventory. And how that drove up the price
and cost end-users dearly. (Estimated as $ 5bil over 3 years’ time.)
First link: NY Times article from July of 2013,
talking about the warehousing
issue.
Second link: Senate testimony from Coors Beer,
complaining about the same situation.
http://www.banking.senate.gov/public/index.cfm?
FuseAction=Files.View&FileStore_id=9b58c670-f002-42a9-b673- 54e4e05e876e Well, here’s another
from the same article which makes the point quite clearly:
... Boeing’s launch of the 787 was marred by
massive cost overruns and battery fires. Any product can have technical
problems, but the striking thing about the 787’s is that they stemmed from
exactly the sort of decisions that Wall Street tells executives to make.
Before its 1997 merger with McDonnell Douglas,
Boeing had an engineering-driven culture and a history of betting the company
on daring investments in new aircraft. McDonnell Douglas, on the other hand,
was risk-averse and focused on cost cutting and financial performance, and its
culture came to dominate the merged company. So, over the objections of
career-long Boeing engineers, the 787 was developed with an unprecedented level
of outsourcing, in part, the engineers believed, to maximize Boeing’s return on
net assets (RONA). Outsourcing removed assets from Boeing’s balance sheet but also made
the 787’s supply chain so complex that the company couldn’t maintain the high
quality an airliner requires. Just as the engineers had predicted, the result
was huge delays and runaway costs. ... Boeing’s decision to minimize its assets
was made with Wall Street in mind.
RONA is used by financial analysts to judge
managers and companies, and the fixation on this kind of metric has influenced
the choices of many firms. In fact, research by the economists John Asker,
Joan Farre-Mensa, and Alexander Ljungqvist shows that a desire to maximize
short-term share price leads publicly held companies to invest only about half
as much in assets as their privately held counterparts do.” ...
That’s from an article in the June, 2014,
Harvard Business Review by Gautam Mukunda, “The Price of Wall Street’s Power” also
cited in the Forbes article. This is the link; it is worth the read though you
may not agree with parts of the conclusion: https://hbr.org/2014/06/the-price-of-wall-streets-power
The upshot to this type of behavior is that the
balance of power ... and
ideas ... then migrates into domination by one group.
Smaller glimpse: Over-financialization is what
happens when a company generates cash then pays it to shareholders and senior
management which m.o. also includes share buybacks and vicious cost cutting.
This is one way, as you can see, in which the real economy is excluded from the
party!
Part of the financialization process also
includes ‘cognitive capture’ where the big swingin’ investment banking sticks
have the ear of business managers.
And the business managers/special interest
groups, in turn, have the ear of the federal government. See? The control by
Wall Street is still there, but sometimes the route is a tad circuitous! The
clandestine formulation of the TPP agreement is a perfect example of this type
of dominance. (Congress shut out/ corporate lobbyists invited in.)
So the whole process goes to the
extreme.
Therein lies the rub: the extreme.
So that business obediently complies with the
wishes of these financial wizards. Taken altogether, over time, our entire
society morphs to where it assumes a posture of servitude to the interests of
Wall Street.
An example of that? John Q.’s sentiment meter
(a/k/a consumer confidence) is clearly known to be tied most of the time to the
direction of the S&P 500. Which of course, is aided and abetted by the
foaming-at- the-mouth Talking Heads who pretty much .... dictate to John Q. how he is supposed to be feeling.
Forty years on the Street, I am still agog at
the increasing clout of the FOMC to the extent where we are now hostages to
their infernal sound bites and communiqués. Another example of the process of
creeping financialization? I’d surely say so!
This is not an effort to try and convict
“financialization” as indeed it has its place. When it is used
prudently. Such as to facilitate trade in the real economy! Sounds kind of
Austrian, eh? You bet. The simplest example of this which is frequently cited
is a home mortgage. The borrower exchanges future income for a roof via a bank
note.
And so it goes. Financialization humming along
nicely, facilitating trade in the real economy.
Unfortunately, along the line somewhere, it got
out of hand. Which is where the World Bank comes in.
As they have the statistics on “domestic credit to private sector (% of
GDP)”
Why do we wanna’ look at that? Well the answer
is suggested by yet another institution who has studied the issue. Correct. The
IMF. Which espouses the notion that:
... ““the marginal effect of financial depth on output growth
becomes negative
... when credit to the private sector reaches 80-100% of GDP ...
Does the above sound familiar? Right. Too much
financialization crimps growth.
That’s when we turn to the above-referenced
World Bank table. Which shows the latest available worldwide statistics (2014)
on domestic credit to private sector % of GDP.
Okay. Maybe we oughta’ read this bit from the
World Bank before we get to the US statistic:
... “Domestic credit to private sector refers to
financial resources provided to the private sector by financial corporations,
such as through loans, purchases of nonequity securities, and trade credits and
other accounts receivable, that establish a claim for repayment. ...
The financial corporations include monetary
authorities and deposit money banks, as well as other financial corporations
...
Examples of other financial corporations are
finance and leasing companies, money lenders, insurance corporations, pension
funds, and foreign exchange companies.” ...
Clear enough. Again, the IMF suggests that 80 to
100% of GDP is where it gets dicey in terms of impact on growth:
In 2014, the US ratio stood at 194.8. In 1981
(as far back as the table goes), our ratio stood at 89.1.
For comparison, also in 2014, Germany stood at
80.0; France at 94.9. China at 141.8 and Japan at 187.6. Which is suggestive of
what can be called “over-financialization”. So what’s the beef with that, you
ask?
For all the reasons mentioned above which led to
increasing dominance by the financial sector on corporate and household
behavior, the emphasis leans heavily towards making money out of money. Which
I’d like to do myself. You?
But when massaged into the extreme which is
clearly, I believe, where we find ourselves now ... at the end of the day, we create nothing.
By creating nothing, the economy relies on the
financialization process to create growth. But the evidence supports the notion
that once overdone, financialization stymies growth.
“ ... The whole of economic life is a mixture of
creative and distributive activities. Some of what we “earn” derives from what
is created out of nothing and adds to the total available for all to
enjoy. But
some of it merely takes what would otherwise be available to others and
therefore comes at their expense. Successful
societies maximize the creative and minimize the distributive. Societies
where everyone can achieve gains only at the expense of others are by
definition impoverished. They are also usually intensely violent.” ... Roger Bootle quoted
here: http://bilbo.economicoutlook.net/blog/?p=5537
In short, corporate behavior is dictated by Wall
Street desire which in turn results in a flying S&P 500. Against a
backdrop, say, of a record number of US workers no longer participating in the
labor force.
So instead of cogitating the entire picture and
all of its skanky details, we have so
farbeen willing to accept a one-size fits all alibi for stock
market action where financialization still dominates; the only choice is what
financialization flavor will trump the other: “FED or no FED”.
I now wonder if when Bootle said a few years
back ... “they are usually intensely violent”, if this wasn’t
prescience. Which can be applied to the current political landscape in the US
where the financialization of the economy has so excluded the average worker
... that he is willing to put Ho-Ho the Clown in the White House. Just to
change the channel. And hope for relief.
As you can see, I am trying very hard to understand how as a
society we got to this level.
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