Mervyn King, formerly of the Bank of England, in "The End of Alchemy" has a great parable of an island populated by fishermen. It starts with a pretty basic need of financing the nets and boats to do the fishing, where the lender then gets slowly repaid with the fish caught.
At some point a finance person steps in and introduces a credit lending facility, which overall is a good thing for the health of the economy. Then, in decision to not take on too much risk, the said finance person offloads the loans in a securitized fashion to other wealthy islanders who then benefit from fishing booms and receive below average returns in years that are dry.
Then another finance person figures out the futures contracts, which act as insurance to fishermen and guarantee a reasonable price even at times of market over-supply.
At some point trading the loan securities and fishing future contracts starts paying more than humble fishing, which means that the best and brightest switch into finance, creating a stigma for fishing as less desirable occupation for under-achievers. Majority of island's GDP is now comprised of fishing-related loans and futures, with fishing itself occupying a relatively small niche.
This, of course, collapses at some point, but the problem is that it's hard to point out that one step that's completely irrational and bonkers - everything created by finance industry has found some demand among fishermen and simplified their lives.
Many years ago I was chatting with a friend who is an economics professor about debt. It basically boils down to a simple rule, debt that is invested in something productive is a good idea and debt that isn't isn't.
Take the parable and replace the finance industry with a Casino that lets you gamble on credit. The fisherman will all stop fishing, take credit, and play the roulette. For some time their debt will keep growing but they could end up with more cash vs. fishing. As long as the Casino makes sure they are fishing enough to pay back their debt then the Casino will get richer and the fisherman will get poorer. But that's what they get for gambling. If the government steps in and says you can borrow from the Casino forever, at zero interest rate, and you never have to pay it back, why wouldn't I go play the roulette?
Futures make perfect sense when the two sides to the trade are protecting themselves against complementary eventualities and are simply seeking insurance. If they each consider the cost of that insurance there's no problem and that takes into account the cut the intermediary takes. If banks are making bad loans because they know that if the loan doesn't get repaid the government will step in and save them and if it does they'll make a lot of money, that's the point where the system breaks.
EDIT: Also consider that without insurance, one bad year of fishing, and everyone on the island is dead. This is not hypothetical, in the not so distance past a draught was a death sentence to entire communities. The key is IMO speculation vs. legitimate use. The government needs to step in to discourage speculation through regulation and various other policies.
Taken in the broadest sense of the term, insurance could be long term food reserves or a contract with a neighboring village for assistance in times of need in exchange for premiums.
Maybe I'm jaded or missing something obvious, but the point that seems bonkers to me is the part where the loan originator offloads 100% of the risk in the loans they originated. That seems like a very clear principle / agent problem where the originator no longer bears any risk for loan failure, only failure to sell the loan. That creates incentives for increasingly complicated/opaque packaging of loans that fail to sell - CDOs.
Having the pendulum swing to another opposite (requiring 100% of the loans to be kept on books) creates two problems I can see. Only wealthiest institutions can participate, so in good times rich get richer. It also creates a monopsony of loan buyers, likely increasing the costs of borrowing.
Fundamentally, the problem with loan writers unloading the loans is that it decouples their incentives. You end up with a fundamentally unstable system, where the loan writers are incentivized to further increase the spread between what the loans say and what the collateral or debtor is capable of, while offloading their liability so that it's evenly spread among the entire financial system.
It doesn't matter that it makes loans more accessible (in fact to some degree that's part of the problem); it doesn't matter that it makes the market more efficient when the market is up. The decoupled incentives make the system prone to extremely painful crashes that are unfair to everyone.
I think you are getting to the core of the issue, which is that when the underwriter is decoupled from the result, they must either be regulated or their customers (the real creditors) must have skin in the game. The regulations have been ineffective (so far), and the creditors have always been bailed out; we should not be surprised that creditors are unscrupulous about lending to questionable borrowers.
Or you know we could enforce our laws. Many of those loans were fraudulent and outright criminal to grant. The threat of years in jail is a pretty good way to keep people honest.
Both good points. I'd also note that it would be very hard if not impossible to legislate for the 'right' kinds of risk arbitrage and against the 'wrong' ones.
I suspect that legislation will never be able to run ahead of the human capacity to rapidly and efficiently paint oneself into a corner.
Rather than trying to prevent the resulting busts at all costs, it seems that it would be more effective to work towards building support systems that are antifragile in the face of economic downturns.
So the best plan seems to be just to break the banks up to the point where they can be allowed to fail; be sure to allow them to fail when the time comes; and let natural selection do its thing.
Mostly by accident I am reading "Capital in the 21st Century" by Thomas Piketty and "Debt" by David Graeber.
Piketty is a liberal economist who is writing about the nature of income inequality. His thesis is that income inequality is basically inevitable without political intervention.
Graeber is an anarchist anthropologist exploring the history of debt, and its relationship to social control.
They are both very interesting in their own right, and they provide interesting counterpoint to each other. Using the framework of economics, Piketty sort of lays bare some serious structural problems. Graeber steps outside of that framework and challenges it.
Highly recommend both of these to anyone interested in these things.
Perhaps having a rule where the originator must keep some meaningful percentage of the loan on its books would help, say 30%? Then the originator always has skin in the game.
Or simply require verification of income. In Canada if you want a mortgage loan you are required to show proof of income, ie. a gov tax return showing your income. My understanding is that in the US verification of income was often waived making it possible to grant bad loans.
Exactly. If you don't believe finanicialization is a problem, you have a tendency to believe more financial instruments are a good solution in all cases. You have only a hammer, everything looks like a nail.
My answer would be that any change that did not help increase the fish production was a change too far. The insurances over market over-supplies are designed to break a fundamental feature of free-market and were not installed with a central planning to counteract, so I would draw the line there.
> everything created by finance industry has found some demand among fishermen
Casinos and drug dealers use the same excuse. "People want our shit!"
I really believe that, while it is interesting to measure economical activity by the amount of money exchanged, it should also be measured by the amount of actual "stuff" produced: MWh for energy, calories for food, etc... It is much harder to measure, but it helps notice when an economy's growth relies too much on the financial sector.
I see finance a bit like the cardboard box industry: it does help and is necessary, and its activities grow when other activities grow, but it is an anomaly when it grows without the rest of the industry following it.
So how would you take into consideration over-fishing? Having constantly increasing production would be good for a while until it is not. There would have to be some sort of artificial limit set, either by the fishermen themselves (which would be a cartel and well, frowned upon), or by another authority on the island (which in that case would be regulation).
Outside of that there would be an ever increase in fishing, until a crash in fish numbers. Though perhaps this could be the cause of the crash in the story, an absence of fish unraveled the whole economy.
Over supply happens because we don't have a reliable measurement of demand to base our production on. Demand has traditionally been extremely poorly estimated with slow, out of sync, paper-based processes. Now that information can be relayed instantaneously.
Perhaps a smart demand system which measures current and future demands for fish based on information input directly (P2P) from the end-user to the supply network, using some sort of utility model (which would factor in diminishing returns per user), could keep demand and supply in better balance.
The post I answered to assumed that only two entities existed in the island: financial actors and fishermen and explores what it means for the economy when we apply the basic assumptions of free-market : individual agents planning for short-term gains.
I worked within those bounds, I am actually a pretty strong advocate of sane regulation of free-market, partly because I agree with the GP: free-markets unchecked lead to some insane financial cons. And also to the tragedy of the commons that you explain.
It sounds like you're saying that markets should adhere to a first-year university understanding of Microeconomics 101, because that's your definition of a free market.
State a clear criticism then, instead of vague and smug dismissal.
Does my (indeed) simple model of free market misses something a more complex model shows?
Decreasing prices are usually the consequence of oversupply and lead to a decrease of production. That's indeed econ 101: a free market regulates production.
If you offer an insurance that proposes to shield people from such an effect, you are either lying to them or you are planning to replace this regulation by another mechanism, most likely planned production (which can actually perform better than free-market in some cases).
Banks are not in the business of managing industries. They are in the business of making profits (another simplistic yet surprisingly accurate model!), so I doubt that it would turn down possible profits in order to protect an industrial field.
Insurances conceived by a state, as a braking mechanism to dampen the results of market regulation, they can work. Insurances designed to generate financial profits and sold under the promise to shields agents from industry-wide effects? This is a clear step out of the land of useful financial tools that helps production.
The irrational step is when people start to believe that they need money, when in fact they need fish. When people start to believe that they need loans, when in fact they need nets and boats. In the end, they deem this made up number called GDP more important than fish and hunger.
See, with fish, it's obvious that catching more than the community needs to survive and piling it up in one's basement is wasteful and counter-productive. Yet, with money, not only does it seem like a good idea but it quickly becomes the ultimate goal of the participants.
Money (especially with positive interest rates) is a terrible abstraction of value.
This is the most spot on comment in the whole discussion.
We have become so utterly focused on the specifics of lending rules and incentives, yet the biggest problem is more simple: there are not actually enough homes available to house all the people that want to buy a home to live in. There would be no housing crisis if we had a regulatory environment that encouraged the housing market to produce enough homes to actually meet demand, at prices people can afford.
That means smaller individual spaces (be they single family or multi-family buildings, built with vastly more automated processes, and streamlined permitting and approval processes.
It is mind-boggling that today that in a major city today in the US a working person should have to pay 30+ years of income just to afford a space to sleep.
Travel a little to actual first world countries and it is not hard to find places with far more sane balance of housing construction to population, with prices at far lower multiples of average income.
The irrational and bonkers part is where that giant financial industry ceases to believe that it could be risky to lend boat money to a fisherman.
It's not necessarily irrational and bonkers for there to be more money changing hands in the fishing financial industry than among fishermen themselves. By itself, what does that really mean? It doesn't mean that money is being created out of thin air. People are making bets in that system, they are loaning money and taking specific complex risks, and as a result some people will lose everything. But also, some fishermen will be able to buy a boat or survive a season of poor catch, even in situations where many fishermen experience misfortune simultaneously.
The question is how it affects the community. Maybe there's a big crash and people in the island lose their livelihoods. Or maybe the very existence of their livelihoods is due to financial services that make the fishing industry large, robust, and prosperous.
> But why do you only blame the the financial industry, and not the fisherman?
Because the fisherman has no alternative. If loans are given too freely then taking the loan becomes necessary to compete in the market against competitors who do.
> At some point trading the loan securities and fishing future contracts starts paying more than humble fishing
This analogy relies on the financiers being either good speculators and arbitrageurs of risk, or charging high fees, ie: they need to get their high "fish salary" from somewhere.
Point is that the two reasons the financiers are being well paid are either that they're good at their job (a good thing), or that they're bilking the fishermen out of their output (which relies on the fishermen being conned into paying for overpriced financial services).
If each fisherman is willing to pay some trivial amount say $3 each year for some service that they find significant value out of than they are happy. Finance seems to often behave like programming where they do it at scale.
When there are 12.3 million fisherman you could argue that the fisherman are indeed being conned into paying for overpriced financial services. But then you get into a question of value. Perhaps it is actually worth $300/year to each fisherman for this service and that is where it started and was only driven down to $3 by competition (and yet still very profitable as it only actually costs say 30cents on average)
I'd speculate that it's the point at which the insurance and futures markets allow for buyers that are unprepared or unable to prepare for actually receiving a shipment.
This leads to a market in which speculation is allowed, instead of biding on the actual outcome of supply/demand interacting.
This isn't necessarily so clear cut. Some percentage of market activity due to speculation helps to smooth capital flows over time. In an industry like fishing, profitable speculation can keep the industry afloat in tough times (e.g buying up fishing debt in a slump for pennies on the dollar because you know the fish are still there and this was just a bad season) or damp down an overheated and unsustainable market (e.g. shorting fishing futures).
To me the bottom line is: people and companies who want to cut the pie to get crumbs. The more they cut, the more crumbs. But also the more likely it is that the pie crumbles.
> It starts with a pretty basic need of financing the nets and boats to do the fishing, where the lender then gets slowly repaid with the fish caught.
> At some point a finance person steps in and introduces a credit lending facility
It sounds like there was already a credit lending facility? As far as I can tell, "credit lending" just means giving someone a loan now in exchange for being paid back (more, usually) later.
> At some point trading the loan securities and fishing future contracts starts paying more than humble fishing
Historically, the point at which this occurs is the introduction of loans and futures. There's no transition point.
Assuming an economy consisting solely of fishers and financiers, compensation for financiers is limited by the amount of fish produced, but it's quite possible even then that one financier produces more fish than one fisherman does. And your example presumes other classes of workers when fishing requires nets and boats as capital goods.
> This, of course, collapses at some point, but the problem is that it's hard to point out that one step that's completely irrational and bonkers
You say that like a collapse demonstrates that a mistake occurred at some point. Everything collapses some of the time.
Pretty much by definition, the financier is not producing any fish. Their utility is in providing finance for the industry. While this does seem to have utility, in and of itself it doesn't produce anything. It is a role that exists to manipulate and imaginary construct (money).
They mat, through directing caputal flows, have enabled more fish production. They certainly did not produce a single anchovy.
More likely, they inserted themselves into the production cycle somewhere they weren't needed, and started creaming off a proportion of the fisb trade, while actually adding nothing of value to the process.
Assuming this island is a closed system (it is an island after all), where did the initial lender with the capital and the "other wealthy islanders" come from?
This is a great comment. I hope it reaches many people.
In the spirit of this comment, and I can't find the particular article I'm looking for right now, but Paul Krugman many years back was writing about how financial services should move more towards a public utility model.
The argument is, we would all be better off if we separate off all the risk-taking in finance to for-profit companies that can fail without posing greater risk to the economy.
The more mundane, more-necessary, day-to-day financing that we all need (home loans, etc.), according to Krugman, should move to the public utility model. It's not complicated and if the companies that do these jobs fail they pose enormous risk to the entire economy.
This is the analogy I can think of: If our water company became bigger, more risk-friendly, and more profit-oriented, people would obviously know that is ridiculous. Basic financial services is not any more complicated, to be honest.
The welfare of humanity would benefit enormously from an even more robust version of Glass-Steagall, but the finance industry is so entrenched in US politics I don't see it happening.
The business of a bank is to understand and trade in risk. That's simple when the risks are simple, but complex as the risks get more complex; 40 years ago it would have seemed obviously ridiculous for programming to be the proportion of our economy that it is now, but programming has grown more complex in proportion to the businesses it's applied to. So it is with finance. (Water supply doesn't require understanding the business; supplying water to a simple business is the same as supplying water to a complex business, whereas making a loan to a simple business and making a loan to a complex business are very different).
What line would you even try to draw? It's very difficult to trade risk without a central clearinghouse. It's very difficult to run a central clearinghouse without being willing to guarantee at least some of the risk at least some of the time (you can limit how much, but we already regulate bank capital ratios etc.). Diversification is the banks' best defense against the risks they're taking, so if you require the separation of two more-or-less independent categories of risk (as Glass-Steagall does) that seems likely to make bank failures more likely, not less.
> day-to-day financing that we all need (home loans, etc.), according to Krugman, should move to the public utility model
I couldn't disagree more. Making home loans "too necessary to fail" pretty much guarantees a catastophic speculative bubble in residential property. Which, coincidentally, is what we're seeing in many places.
I quite like the idea of ringfenced utility banking, possibly even nationalized, but would set the "necessary" bar a lot higher.
Presumably doing this right would restrict these loans to "financing". Which is to say, to people with reasonable cash-flow who are seeking up-front capital for a purchase. A good public utility lender would offer low rates, but would have to reject more home-loan applications than the existing speculative players. By this measure, of course, Fannie and Freddie were the opposite of public utility lenders.
Done right, I'd like to think that utility lending would constrain bubble growth. Low-risk borrowing would get utility loans, producing actually-guaranteed-AAA investments. High-risk borrowing would remain with private lenders looking for risk, much like business loans do today.
The daylight between the two would (hopefully) prevent both housing price bubbles (by offering a stable rate floor) and credit bubbles (by clearly dividing safe, non-profit-seeking loans from speculation). It would likely price up risky loans, but we saw in 2008 that those were dangerously underpriced to begin with.
It's an interesting idea anyway, as is a utility model for 'safe' banking activities - non-interest-bearing deposits and financial services.
> Low-risk borrowing would get utility loans, producing actually-guaranteed-AAA investments.
I think this is where it falls over. Providing an actual guarantee for things that are low- but not zero-risk is just another way of saying "mispricing risk", and it creates the wrong incentives for pretty much everyone. Borrowers want to push the definition of "low-risk" so they can borrow at a subsidized rate. Lenders (in which I'm including the people buying your "actually-guaranteed-AAA investments") want to push it so that they can lend at zero risk but still make nonzero profit. Governments administering a public utility banking system want to push it because jam today gets votes today, and who cares about tomorrow?
IMO this is all happening already with the artificially-low interest rates being pushed by central banks almost everywhere; if they wanted to repeat 2008 I'm not sure they could do a better job.
My idea of "utility banking" would exclude any kind of loans. It would include only things which are genuinely risk-free, like transfers and deposits.
The distinction I was hoping to draw was between cash-flow loans and investment loans, where the former are (like interbank overnights) non-zero risk but immensely reliable. But it's probably impossible to set up that system without people manipulating it to get profitable rates (...like interbank loans).
Certainly, we don't have a great track record of the government properly evaluating what's actually for real safe. I was thinking that we could keep limit lending by preventing rate-based profits (like electric companies, which profit on coverage but not prices), but realistically that just moves the incentive from profit to popularity. Hand out good loans to bad risks, get reelected, blame the markets when they explode. Sounds painfully familiar, actually.
So yes: likely better to treat financial services as different from risk-bearing products altogether. You'd have utility "money storage" that does deposits, transfers, maybe offers financial advice, but doesn't extend any credit/investment of its own.
What practical form would this separation entail? If they're really lower-risk then they'll naturally attract lower interest rates; what do you envisage beyond that?
> In the spirit of this comment, and I can't find the particular article I'm looking for right now, but Paul Krugman many years back was writing about how financial services should move more towards a public utility model.
Fanny Mae and Freddie Mac ... do exactly that. They are abused by politicians for achieving social ends (which should not be their function), first time the politicians know they won't be in office when it blows up (making loan decisions on any factor other than risk should not be done, unless you're prepared to bail out, but that of course means no positive discrimination without bailouts). The second and subsequent set of politicians know they're not really creating a risk, just modifying an existing one slightly. And that's when these companies don't just directly preferentially treat connected investors. Imho Fannie Mae is on track to need another bailout some 6-10 months after the election.
> The argument is, we would all be better off if we separate off all the risk-taking in finance to for-profit companies that can fail without posing greater risk to the economy.
Given that the government rescues "systemic risks", and CDS contracts are an easy way to transform local risk into systemic risk. Widely-held CDS for a large percentage of loans, like currently exists, means either loan defaults have no effect on the system or crashes the entire thing.
Now you could say. "Easy, let's just outlaw CDS contracts". But that's stupidly easy to circumvent, secondly it would disadvantage smaller players further. Or you could say you need more than 2% collateral, but that would immediately collapse pretty much all banks (and they're strongly incentivized to make damn sure that won't change) so can't be done.
> from an even more robust version of Glass-Steagall, but the finance industry ...
That's equivalent to demanding more collateral for loans. Yes if you can get to the end state the chances of getting your money back when things go south would go up by a lot, but how do you get there ? If you demanded that happens from day 1, all banks would collapse right then and there.
I think the more important lesson to be drawn from Glass-Steagall and the related changes of that era is the timing of those regulations : it was introduced just too late. Just barely too late ... to help anyone. It was a PR measure. The same is true for bank guarantees : always remember that the government will never pay those guarantees. If it ever comes to it, the government will withdraw the guarantee before they pay anything. Or do it like Greece and Brazil did : pay it out in worthless non-currency "dollars" that you can't actually buy anything with.
Actually, that's not exactly correct. What FNMA and FHLMC do is buy mortgages on a secondary market and securitize them into MBS securities, and provide loan guarantees. I'm sure you know that. I'm sure you also know that the goal here of those two is to make home loans more accessible to all of us. They are also GSE's, so I see the comparison to utility companies. OK, but if we think about it, are these enterprises necessary? What I mean is and what you have to understand is that the goal here is not: "let's lend people money for homes through heavily-regulated entities (banks) which do not then go and gamble with that money (what Glass-Steagall wants to prevent," which is what Krugman was discussing, but rather, "let's create a government sponsored bureaucracy that writes some contracts down on pieces of paper to manipulate market equilibrium in an effort improve home loan lending."
>They are abused by politicians
It is certainly true that politicians are prone to be corrupt, I can't argue with you there. You know everyone knows the expression, "as crooked as a politician." I think what we have to concede here is that there's no perfect solution here. Economics is, at its very foundation, not a natural science--it is about people, and people are never, and will never be, perfect. Some people are inspiring, but in fact, some people are awful. It's my belief that we should learn from history and not repeat the same mistakes, again, after we repealed Glass-Steagall and paid the price for it in 2008.
Originally, Glass-Steagall placed a firewall between commercial and investment banking. That isolated deposit banking from high-risk securities and investment trading.
It wouldn't have prevented every part of the subprime crisis (Bear Stearns wasn't even a deposit bank), but it would potentially have lessened the scope of the crisis.
- Preventatively, it would have restricted the size of the CDO/CDS market. Without access to commercial banking deposits there would have been much less money to invest there.
- Reactively, it would have better protected deposits and saved the FDIC a small fortune. Indymac alone ran the FDIC $9 billion and depositors another $0.27 billion.
Its decline and repeal completely reshaped US investment banking, to the point where the entire industry would have looked completely different if the law had been applied 1933-2008. Of course, that's not entirely a good thing.
Some chunk of the pre-2008 growth has to be attributed to a flexible banking industry keeping us out of liquidity traps, and that was a genuine, non-special-interests reason to alter the law. Clinton didn't (exactly) repeal Glass-Steagall, he formalized a change that regulators had made far earlier by limiting enforcement of the firewall.
I can't say that long-term enforcement of Glass-Steagall would have been better, but I can certainly say that it would have altered the entire landscape that the subprime crisis happened in.
But surely RMBS would have ended up on the deposit-banking side? I mean fundamentally Indymac owned a lot of bad mortgages - with perhaps more intermediation than there would have been otherwise, but we expect retail deposit banks to own mortgages, that's a large part of their raison d'etre.
Please remember, in reading explanations of this, that the entire financial industry has a vested interest in complicating what they do to the average person.
The basic theory of Glass-Steagall is to separate risk-taking in finance with the "mundane," finance, as Krugman was saying.
On one side of the coin in finance, you have the boring finance: home loans, small business loans, that day-to-day stuff is not complicated and is necessary service to the economy. By the way, we can't let these banks "fail," or go out of business. That would cause economic destruction beyond what is reasonable. Fortunately, this type of banking is not very risky, either.
Now, you have the other side of banking, which involves risk-taking. Some of this is stuff such as investment banking and private equity which is actually very necessary for efficient allocation of resources. These types of businesses need to be allowed to fail, though, since not letting them fail would be a redistribution of wealth from the taxpayer to the rich, and it would also mean people who are not good at efficiently allocating resources get to keep their jobs while smart people who can do it better, get crowded out by the politics of government handouts.
Also on the risk-taking side of finance you have securitization and a lot of "financial alchemy," stuff. Fannie Mae and Freddie Mac arguably even fall in this category. This side of finance needs to also be allowed to fail for the same reasons.
I hope that makes sense. I recommend picking up an intro and intermediate-level macroecon textbooks for further reading.
But the crisis was a failure of home loans - which are as risky as anything that merchant banks do. There really was a collapse in house prices, there really were a lot of people who defaulted on their mortgages.
My oft-recommended book Doing Capitalism in the Innovation Economy [1] hammers on this idea of that financing of speculative vs. mundane ventures are fundamentally different games. The author argues that speculative finance is a good thing, as long as it's not just speculating on finance itself. In fact, it's so useful that the government should encourage it. He cites the long-term advancements produced by incredible amounts of public money injected into the defense industry, the space industry, the National Institutes of Health, the NSF, and so forth. But, he argues that such speculation needs to be cordoned off from the mundane economy, so that when bubbles burst, they don't take down the systems everyday people rely on.
I've also seen the suggestion that regardless of where lending goes, "safe" financial services should be moved out into a utility format. That is, investments and loans shouldn't be conflated with non-interest-bearing deposits and money movement.
Right now, people are caught in a weird double-bind that mostly serves a small part of the finance industry.
- If you don't have a bank account with a balance, you pay through the nose to access money and paperwork (e.g. notary fees, high fees on welfare debit cards, wire transfer prices).
- If you do, you expose yourself to the risk-taking of the banking industry. That means losing your deposits with Washington Mutual or IndyMac, and if you stay below the FDIC cap it still means getting scammed when Wells Fargo opens you a fraudulent account.
There are some good reasons to combine these things, and some of the costs for non-account-holders reflect the actual price of moving money. But it's not obvious that access to non-investment services should be inescapably bound up with exposure to investment risks and pressures.
Would that be the same Paul Krugman who only a few months ago said the big banks are not a systemic threat anymore, in an effort to undermine Bernie Sanders' anti-big bank message?
As far as I can tell his point that shadow banking, Lehman et al, and not the regular banks were the main villains in the GFC is actually pretty accurate.
Yes I know... I stopped reading Krugman. I don't know, it seemed like he used to give a shit and write informatively. Now he just tows the party line and even seems disingenuous at times to be honest.
Those banks turned around and raised fees for everyone. Don't loan to most small business. Don't loan to most self-employed. Are just horrid institutions.
They have just seemingly given the wealthy credit?
They have given the wealthy so much money; somedays these 1 percenter's appear to be just gambling?
Literally just gambling, except in the realestate market. That market is still a sure thing for them, and very rich investor knows it. And they know so many of us will never qualify for loans; so jack up that rent Thurstan!
This recovery hasen't helped guys like me, or my mother who relied of safe cd rates to get ahead. (And no--I'm not blaming banks on low fed interest rates. I probally shouldn't have even wrote that last sentance.)
I probally should comment--I'm no expert.
I just wonder if we severely regulated credit default swaps, and the derivitave markets--the crash in 2008 would have been less dramatic?
The one thing I liked about Bush is he wanted the poor/middle class in homes. He believe little guys should be given a chance. I just wish he went about it with more regulations, on the big boys.
My brother in-law used to flip houses. He now is a yoga instructor. The banks won't talk to him. Houses are still being flipped, but only by the wealthy. They are making a killing in my county. They are buying up everything. Why not, at these interest rates, and banks that are literally bending over.
>Those banks turned around and raised fees for everyone. Don't loan to most small business. Don't loan to most self-employed. Are just horrid institutions.
>
>They have just seemingly given the wealthy credit?
Let me relate a short story about my experiences with my regional retail bank.
Since I don't have my paperwork in order with Vanguard after changing my address, I haven't been able to put my saving money into ETFs and bonds and such like I should. So it's been piling up for more than a year (yeah, irresponsible of me, I know!) in my retail bank accounts, checking and savings.
When it piled up to more than $25k, the bank "invited" me to join their "Platinum" accounts. These would impose a whole bunch of minimums on how much I have to keep in my accounts (minimum $10k in checking, minimum $15k in savings, something like that), in exchange for which they would... waive a few fees. And raise my interest rate on savings to the highest heights of 1% annually!
Whereas for the normal account, you get 0.02% interest annually, and for a credit card, you can get 1.5% cash back on your spending. They'll pay you more to spend than to save!
To the banks, us tech workers with our measly six-figure annual incomes are just more plebs, not even worth an interest rate above inflation.
I wonder if what good we see in capitalism is just the period of it when there's plenty of low hanging fruit for everbody.
What I mean is, we could praise a system where any guy can buy a cheap house, renovate it and call it his own. Now, take it to its logical conclusion and you'll soon have agents with access to credit leveraging all the capital to acquire every single flipable house out there and extracting maximum rent out of the people who would have got them renovated themselves in less "efficient" times.
> the said finance person offloads the loans in a securitized fashion to other wealthy islanders who then benefit from fishing booms and receive below average returns in years that are dry.
This part. This was the part that was fucking bonkers.
"An economy based increasingly on rent extraction by the few and debt buildup by the many is, in essence, the feudal model applied in a sophisticated financial system."
The financial services sector adds value to society by providing mechanisms to diversify risk, price assets, and make capital available for productive uses.
These mechanisms are valuable, but are gamed to extract economic rents greater than their value to society. Extract too much, and you kill the underlying economy.
>The financial services sector adds value to society by providing mechanisms to diversify risk, price assets, and make capital available for productive uses.
Capital isn't an object, it's a belief system, with a strong faith-based component. So in a purely rational sense it's impossible to "make capital available."
Capital is actually an executive instantiation of social patronage. Someone says "I want to try this..." and someone else with capital - usually of higher status - says 'OK, I think that's a good idea. Here are some imaginary social credits you can swap for resources because everyone believes in them. Now that you have credits, your project looks more believable too."
Nothing real changes hands. There's simply a nod of political approval from interests who stand to gain status if the project succeeds.
The system would work just as well without the credits. The credits are really only there to hide the politics.
Risk doesn't exist at all in the market sense, because risk is only defined by loss of capital - i.e. loss of face and status - and not by any other possible losses, no matter how physical. (E.g. loss of biosphere and future carrying capacity, social opportunity costs, loss of life through profitable war, and so on.)
I doubt you can have an economy without at least some executive decision-making and planning. But the current system is so completely disconnected from true social and economic value creation that it's actively hampering real growth.
Property is the belief system. Capital is just an optimization of it.
Resources are finite. Not everyone is equally efficient at allocating resources. Not everyone specializes in analyzing the most effective way to distribute resources. Capitol is intended to fit this role: those with past success in correctly distributing resources in productive areas make a profit, and thus have better ability to select correctly.
Of course, there are are a few great problems with capitalism under this perspective.
- Inheritence only makes sense as an incentive to keep being optimal close to death, but after the generation gap, the "wealth belongs to proven optimizers" is no longer true.
- Benefit of the system is skewed significantly towards the wealthy, which is counterproductive if happiness scales logartithmically with wealth, as it seems to.
- (What this article talks about) Wealth is encouraged to create more wealth, even if it is to the detriment of overall production in some cases.
> Risk doesn't exist at all in the market sense, because risk is only defined by loss of capital - i.e. loss of face and status - and not by any other possible losses.
Why is social status not something that has value? Almost everyone wants more social status and would trade things for it, so it seems that it has value.
You're drawing a distinction that I don't understand between things that are "real" and "not real".
> Capital isn't an object, it's a belief system, with a strong faith-based component. So in a purely rational sense it's impossible to "make capital available."
If I have a bunch of gold in a safe, then that's very much an object. If I decide you have a good project and could use that gold to finance that project, then I can "make capital available" to you.
Sure, but replace the term "gold" above with lumber/steel/concrete/apartment buildings/oil/prepaid employees/automobiles/etc.
If I have a bunch of stuff which I can loan to someone else then I have "capital". That "capital" can just as easily be physical as it can be financial.
Capital has universal value. The value of food is the preservation of life. That has value. That is objective reality for all life on Earth. If an animal can store food (read capital) then it improves it survivability.
Once basic needs are satisfied you cannot double-satisfy them. Paying for twice the amount of food does not make you live twice as long. So that's a fixed demand, while luxury goods are unbounded in their potential costs.
If you subtracted all that value spent on basic needs there there still would be a lot of capital flowing around.
I think the ancestor comment is arguing that there basically are two separate value circulations. One to distribute and allocate the essentials and the rest for social-value-signalling. Maybe that's also something UBI gets wrong. That we actually would need two currencies.
Post-scarcity scifi settings often feature something like that
a) all the basic stuff including housing is essentially given away for free
b) you get a fixed amount of luxury resource allocations on top of that
c) you can gain additional ones via some kind of work
d) they can be traded if others find whatever you're doing valuable.
so you don't have to work for the government or megacorp.
> Once basic needs are satisfied you cannot double-satisfy them.
Yes you can, food can be stored! At a later date less food can be consumed with no work was needed to harvest it.
> Paying for twice the amount of food does not make you live twice as long.
No but using your acquired food (read capital) to trade for medical supplies will increase your longevity. And it will increases the doctor's because he gets to eat!
> If you subtracted all that value spent on basic needs there there still would be a lot of capital flowing around.
Yes and isn't it wonderful? Its what allows things like food stamps and vacations to exist. Excess capital allows things like scientific research to occur.
> ...the rest for social-value-signalling.
That's a pretty pessimistic view of wealth.
---
I think I've been pretty realistic in my assessments of capital and its uses. But now, I'm going to enter territory where I'm wildly speculating.
I don't believe post-scarcity can exist or should exist. I don't believe it can exist for two reasons:
1). There simply is not an infinite amount of energy and matter (but there may be enough that it doesn't matter that its finite).
2). Even if there is enough resources, time will always be the limiting factor. Time contributes to scarcity the same way money does.
I don't believe it should exist because I believe that is the end of human progress. Scarcity, whether its a desire to own an iPhone or to acquire knowledge of quantum gravity, motivates humans to achieve.
In regards to "value" for food, let's consider beyond a certain universal unit of sustenance. For example, imagine two pieces of fish that are identical in size, nutrition etc... However, one was simply grilled by a fisherman, while another was "expertly" prepared by a specialized chef. The latter costs 10 times as much. This extra cost is the social value that is being added to the food.
Basically, the value associated with the fundamental nutritional benefit of food is objective and is something everyone can agree on. If this value is the only thing we cared about, the world would not be organized in the capitalist structure that it is today. Everyone would fish and equally distribute the produce. However, we as a species are hardwired to compete, to be "better". All capital is derived from "social-value-signaling".
My argument is that the "fundamental nutritional benefit" value is present in both types of fish while the fisherman/chef-prepared aspect is value-add on top of that baseline.
And the fixed baseline vs. subject-to-infinite-want value-add aspects make them categorically different.
One reason for post-scarcity to not exist is that the more resources we have, the more we will reproduce which will end up in consuming more and more resources. It degrades the ecosystem and brings down the quality of living for everyone involved.
This is pretty much what is happening around us. As we get hold of better resources, we reproduce more to make it impossible to have everything for everyone.
Again, we will have to re-discover the definition of scarcity because we have too many people unhappy with the system.
> This is pretty much what is happening around us. As we get hold of better resources, we reproduce more to make it impossible to have everything for everyone.
How does that jive with the fact that every developed country's reproduction rate has dropped as they developed?
> Once basic needs are satisfied you cannot double-satisfy them
why is there a boundary to surplus essentials? if you store enough essentials for one person, then storing more of them means you're increasing the number of people (or amount of time) you're storing essentials for.
storing them doesn't give you the same value. instead of enabling people to be alive you're now only increasing a safety margin for those who are already living. and there are rapidly diminishing returns for increasing the storage factor.
That's why it's categorically separate in my mind. For a fixed amount of people you only need a bounded amount of resources to satisfy their essential needs, which can be met with a relatively small fraction of the population's work capacity.
Everything beyond that is subject to drastically different dynamics where your want (not need) for luxury goods can gobble up a practically infinite amount of work capacity.
I think you might want to reconsider this. Arguably the first ever accumulation of capital in human history was grain storage in the ancient river civilizations (Egypt, Sumeria, Indus, etc.). Stockpiling capital in the form of grain reserves allowed these civilizations to shift labor efforts from subsistence farming to a more diverse range of economic activities.
That sounds like your opinion, so I can't say that it's "wrong", but according to the dictionary "capital" is defined as follows[0]:
> wealth in the form of money or other assets owned by a person or organization or available or contributed for a particular purpose such as starting a company or investing.
Capital is just wealth in some form which is available for investing. You don't have to ascribe a dollar value to tree trunks to say they could be used to build houses. That's capital.
Sounds to me like there some cross purpose debating going on here.
To me it is simple. If by "Capital" you mean "money" then of course it has no intrinsic value, it is based on faith. Zimbabwe's currency is an obvious example of that.
If we are talking about other stuff that is useful to our lives, then the value is relative to the beholder and their situation. Water is more valuable than gold from a survival point of view, but not from a $ point of view.
You're spot on, and this is a bit of an issue - there are a huge number of cross purposes in economic definitions, and the word "capital" is one of them.
My personal take on the word (informed by the dictionary source I gave above and a rather pragmatic approach to economics) is that "capital is stuff". Typically this "stuff" is in the form of either physical goods (lumber, food, concrete, gold, etc) and services (and I know services can't really be 'physical' but I can have a reasonable claim on the labour of someone through prepayment of salary, or a labour contract, etc); or financial assets (such as bank balances, stocks, bonds, etc).
Ultimately though, the "financial capital" is just a slightly divorced claim on the physical capital, and all anyone really cares about is the real stuff which they can eat or build with or develop, etc. You might have a big bank balance, but all you really care about is what you can ultimately cash it in for.
Ok, how about this. I have a bunch steel in by vault. Steel is worth something and can be used to build things. I loan you this steel in order to build a factory (perhaps even a steel mill!), on the hope that your project will be successful and you will pay me back even more steel.
No it's not. It's just a lump of metal that sits there.
> and can be used to build things.
Only if I want things. And I only want things if I value them, and I value things, just because, there is no fundamental value to things, only what value we believe there is.
How about food? Is that basic enough for you? I lend a hunter food so that he can take that temporary supply of food to eat while he is hunting and then potentially bring back more food.
You make a good point about the connection between money and social power etc. Very good point.
But I disagree in what seems to be your conclusion which is to simply do away with credits i.e. money.
I believe the solution to these types of problems is A) to understand the true nature of money as you have pointed out and then B) to use technology come up with a better type of money or better credit or overall system.
The problem I believe is that the universal point system we have (money) is to simplistic and too easily gamed. Its like the whole world is stuck playing Dungeons & Dragons, as if computers and the internet didn't exist -- its like every bank is a Dungeon Master. Only its worse than that, because even D&D tracks more than one number for each entity.
The universal application and transfer of these points, and the relative ease with with they are created or allocated (at least by certain entities), is key in our current system. I think we need a more sophisticated framework though both on a conceptual level and a technological one. We should not rely on regulation by decree. Its as if the World of Warcraft system administrators were not allowed to talk to the developers or even edit data in the system, and could only make announcements about new rules for types of gaming that were not allowed, could only stop people from hacking the system by sending them threatening chat messages or actually getting police to put them in jail. Because there is no server or common protocol really and there is only one number for each entity that is really integrated into the system.
I get your broad point, and I agree completely that money-getting is too often divorced from (or inimical to) value creation. But I think you take it too far here:
> So in a purely rational sense it's impossible to "make capital available."
Suppose I start a business making pies. I sell them to cafes and restaurants. I don't have a truck, but I need one for deliveries. However, my brother has a truck. I go to him and say, "Let me borrow your truck Tuesdays and Thursdays and give you a pie each time." The truck is a capital asset. By him letting me use it, he has made capital available. Risk too is real; there's a chance each time something will happen to his truck.
We can take this through various degrees of abstraction (e.g., my dad brokers the deal; a professional brokers the deal; I pay in free-meal coupons from restaurants; we develop a generic coupon for all goods) and end up where we are today. At no point is the next step obviously insane. But each abstraction strips information and increases the cognitive load to understand what's really going on.
So in practice yes, we definitely get to the point where people treat it as a faith-based system. Before the 2008 crash, more astute industry observers were pointing out that a lot of risk was somewhere, but nobody knew where. Everybody else was too busy pocketing money to think.
And I think the real problem is the extent to which profit paralyzes the brain. As Upton Sinclair wrote, "It is difficult to get a man to understand something when his salary depends upon his not understanding it." The real limit isn't human comprehension, it's the human capacity for willful ignorance. Capitalism works adequately in the small, but left to its own devices it will keep growing beyond our power to understand.
> Risk doesn't exist at all in the market sense, because risk is only defined by loss of capital - i.e. loss of face and status - and not by any other possible losses, no matter how physical.
Tell that to someone who loses their life savings and their house.
Capital is an economic system, but it absolutely governs people's physical lives.
The Bank of International Settlements ("the central bank of central banks"): Why does financial sector growth crowd out real economic growth? (2015) [0]
"In this paper we examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity."
IMF: Rethinking Financial Deepening: Stability and Growth in Emerging Markets (2015) [1]
"The analysis uncovers evidence of 'too much finance' in recent years—that is, beyond a certain level of financial
development the benefits to growth begin to decline and costs in terms of economic and financial volatility begin to rise."
On the optimal size of the financial sector, a speech by Benoît Cœuré, Member of the Executive Board of the European Central Bank (2014) [2]:
"While finance per se is necessary for growth, an oversized financial industry can be detrimental to real economic activity."
In their article, “Too Much Finance?” Jean-Louis Arcand, Enrico Berkes, and Ugo Panizza (2011) argue that expectation of bailouts may lead a financial sector to expand in size beyond the social optimum. They use a variety of empirical approaches to show that “too much” finance starts to have a negative effect on output growth when credit to the private sector reaches 110 percent of GDP. Stephen G. Cecchetti, M.S. Mohanty, and Fabrizio Zampolli (2011, 1) likewise argues that, “beyond a certain level, debt is a drag on growth.” The authors estimate the threshold for government and household debt to be around 85 percent of GDP and around 90 percent for corporate debt. Likewise, as we were writing this article, the OECD and the IMF both issued reports warning of a financial overgrowth (OECD 2015; Sahay et al. 2015).
I've often wondered how much money is spent on the money system itself. There are people whose entire days are spent devoted to the goal of keeping the money system flowing. They could be off somewhere else, tending gardens, nurturing children, cooking, educating, repairing, cleaning, healing from stress and trauma, etc. But no, they are at some office working for the all mighty dollar. Keeping tabs on society at large.
I'm not saying that it is overall evil to count supply and demand of resources. I'm merely wondering if the current state of money systems is really well suited to do this without devastating collateral damage on its host, the "human resources."
The great success of capitalism is to allocate resources efficiently. Fundamentally, someone is paying banks for their services; either the value they're providing is more than they charge for it, or not, but in the latter case people would stop buying their services (conspiracy theories notwithstanding). Then at the individual level, the bank is willing to pay someone x amount for the value they provide the bank, and either that's where they can earn the most (because it's where they can contribute the most) or the person will be paid more elsewhere.
There are of course inefficiencies, but they're self-correcting. A bank that overpays its bankers will be undercut by one that doesn't. A company that overpays its banks will be undercut by one that doesn't. It works better than any alternative that's been tried.
Why not? There's a cost to keeping it clean. There's a finite amount. Some people consume more than others.
Answer: because keeping track of those costs and assigning them to individual persons would be way more expensive than just keeping the air clean and letting people consume as much as they want.
Food should be the same way - now that we produce so much of it, it's kind of insane to expect to keep diligent tabs on how much people are consuming.
This is why i think a basic income makes perfect economic sense. People already have the ability to consume society's resources without paying (medical care or prison care still cost money) - so we might as well just give everyone a small amount 'voice' in the system and then dismantle the barriers to entry that are ostensibly in place to protect poor folks.
Interesting question. This expense is something I'd classify as upkeep - costs that are necessary waste. Inefficiency. You need to pay them to keep the thing running, but we would do well to minimize them as much as possible.
The question of how much do we have to pay to get various financial services should in theory be solved by competition. The problem is that some financial institutions are behaving like a cartel and the government is undermining competition by stepping in to save failing financial institutions.
The problem isn't that Finance is "bad" any more than energy companies are "bad" or retailers are "bad". There are people accumulating wealth in a whole bunch of industries, why is the service Google or Facebook provides more valuable than what Bank of America provides?
I think its more than just what we pay for these services, I think there is the variability that is introduced to a market when people invest in that market not for the value of the good or service, but merely as an instrument of financial leverage.
If people bought houses merely to live in, prices would probably be lower and would be subject to much less volatility. Of course, there would be downsides as well (no houses available for rent, etc.) so I'm not suggesting we do away with finance.
In fact, I have no suggestions. I'm just pointing out that finance (treating goods and services as abstract financial instruments) creates opportunities for growth at the expense of added volatility to the markets being abstracted.
>The question of how much do we have to pay to get various financial services should in theory be solve by competition. The problem is that some financial institutions are behaving like a cartel and the government is undermining competition by stepping in to save failing financial institutions.
This is the endgame of all capitalist markets. There isn't any other end game, no matter how much people would like there to be one to satisfy their personal ideologies.
> There is also plenty of evidence for the narrative of capitalism as spontaneous collaboration and growth.
There is? Has capitalism developed in any region of the world without the explicit help of a state? Even the birth of capitalism in Europe was facilitated by governments forcibly enclosing land into larger estates.
The endgame is the endgame, not the beginning or middle. Ultimately, there is no capitalist mechanism to prevent the sale of the market, or the tragedy of any other commons.
That is a great question -- but there are also other aspects to the problem -- human talent is one. Finance can extract rents from society, and it can also lure away promising PhDs, academics and many of the brightest with superior salaries (financed via rents extracted.) I'm not passing judgement on the workers here -- I was one, trapped in the system for 10+yrs with golden handcuffs and nothing to show my family on what I actually created.
It's way too hard to have a career in research or even get into a decent PhD program at all for the "finance brain drain" to matter. Research salaries are low, the conditions are hit or miss and yet, somehow, a faculty job is one of the hardest positions to get. We can worry about that when mid-tier universities stop getting hundreds of resumes for tenure-track positions.
For now, the fact that technically minded people can have a backup plan that pays well is most definitely a feature, not a bug.
I had a professor who gave up a good job at Harvard because he was tired of losing his best students to investment banking. It wasn't a field in any way directly related to business or finance, but Harvard students are highly recruited into lucrative investment banking positions.
What do you mean by kill? To me it's likely that finance represents a depressingly large drain on growth in output/welfare compared to a better regulated alternative but I can't see it making things bad enough to cause anarchy/ rebellion.
Ok, that's a reasonable view. How do you a) estimate the tipping point were finance becomes so dysfunctional that it causes a revolution B) measure the dysfunctionality of anther system relative to this benchmark level. To me this can only ever be a qualitative line of enquiry.
Correct. Many nonlinear systems cannot be modeled beyond describing their qualitative phenomena. The "butterfly effect" prevents precise estimations. You wouldn't expect the weatherman to tell you whether it'll rain this day next year.
Ok, but there are other less ambitious questions you can answer within the paradigm of economics. What are the losses caused by the current system vs an alternative according to a specific welfare measure?
But we don't yet even have a good model of the dynamics of the current system, let alone any good predictions for specific welfare measures of alternate systems.
Even if we don't understand higher order dynamics of the entire system, we have an approximately understanding of parts of the system and can use total intermediary fees as a welfare measure.
Imagine two worlds, one where American financial regulations remain unchanged, and one where financial advisers are not allowed to be paid a referral fee by asset managers they recommend to clients. What would you expect to happen to intermediary fees in this situation? Would you support the policy? Or are you totally agnostic because of 'Chaos Theory', 'Higher Order Effects' and 'Economics is a pseudoscience'.
Not exactly. The question is whether a capitalist society has a stable equilibrium growth path. Mainstream economics assumes a stable equilibrium, because that makes the math work nicely.
Physicists have known for a long time that many systems have unstable equilibria, where a random deviation knocking the system from equilibrium can result in catastrophe. This is the general field of nonlinear dynamics and chaos. The economists, the most famous ones at least, reject the idea without discussion, that the economy could be a chaotic system or even have manifolds where it might enter a chaotic regime.
Things get bad even before extractors enter the picture [0]; just a disadvantage in strategy update rate will result in the formation of cartel structures.
The economy will function as long as there are sufficient physical resources and human will. Finance cannot kill it.
For various definitions of human will. I think humans are somewhat fickle. Society might change its mind more easily than you expect. Case in point, Trump.
I would imagine the increase non-linear. As finance takes more ever more people catch on and realise there is no point working. This removes well-educated wealth creators from wealth creation and into finance. We've seen this in the UK where biologist, physicists and mathematicians are engaged in arbitraging each other.
No point working when work doesn't pay. UK is about to implode if Brexit goes ahead and all the fake fiat from The City evaporates with the confidence.
I can't help but put my own related ideology out there.
My belief is that whether you start from a fundamentally cooperative approach (communism) or a primarily competitive one (capitalism) you are ultimately going to run into the same main problem: over-centralization. This could be a large bureaucracy of state-run corporations or just large companies in a primarily capitalistic society that evolve into monopolies over time.
It seems in both systems whether they start with the sharing or competing idea that ideology gets diluted by practicalities over time. Which makes sense because we must be able to cooperate on some level in order to have a holistically functioning society, and we must also be able to compete in order to have some freedom for things to evolve.
But also in both systems we have conglomeration and over-aggregation. My belief is that we have proven that the basic structures are missing some key components that might prevent this from happening.
I think that the key is really to improve the basic technology of money and government as it intersects. To do that we need to examine carefully the underlying assumptions of what money and government are, and take a contemporary approach to improving those systems, employing our high technology. And as I said, one of the key problems we have with the relatively primitive systems in place is over-centralization. Capital/power accumulates and that makes it hard for the system to adjust to local circumstances, hard to evolve, and even hard to function.
So I subscribed to subreddits like r/rad_decentralization, r/bitcoin, r/btc, r/ethereum, r/polycentriclaw. I think those kinds of technologies and ideas are the general direction we need to go.
The most important part is that the fundamental structures and mechanisms are assumed to be unchangeable and correct. Unquestionably. As part of the belief system. To the degree that they are invisible. And the these basic societal technologies of money and government are not evaluated from the ground-up in a high technology context.
We exchange money for goods and services. It is paper or some digital token. It has universal application. It is scarce to some particular degree. It is one-dimensional even though it is universal. It is issued and maintained by authority. It is stored in digital or real form by banks. The allocation of money to various purposes is tracked internally only.
Government has absolute authority and power over deadly force. Government is monolithic or at least has a monopoly on public control. Government has a central control system. Government is primarily organized and operated by actual human beings in hierarchical groups. Government is enforced by traditional taxation, manually applied fees determined by repetitive human judgement, legal writings, groups of human lawyers, and physical policemen or agents with physical force.
You can take a best practices approach: are we spending more, but getting no more, or even less than other industrial economies? The same could be applied to any part of the economy that does not directly produce goods: criminal justice, health care, military.
I fear that a measure of GDP that takes overspending on non productive activities into account would leave the US looking much worse.
It sounds like our measure of GDP needs to be narrower. For example, why are legal services revenues included in GDP? In theory, value created by the legal industry should already be reflected in the real economy. If two companies enter into a joint venture to produce widgets, in reliance on the legal system enforcing their joint venture agreement, that will be directly reflected in additional widgets being produced. But the cost of paying people to draw up the contracts is a transaction cost that should be excluded from GDP. Similar reasoning can be applied to the financial system. If two companies rely on financing to jumpstart the joint venture, the value created by the financial system will be reflected in the production of widgets. The investment banking fees and interest are transaction costs that should be excluded from GDP.
Of course, doesn't the same reasoning apply to everything that isn't consumption? For example, any value created by Google Search should be reflected in the productivity of the real economy. Any revenues to Google from search should be excluded from GDP, right?
It's not like GDP doesn't have other major flaws. For example, after Fukushima, Japan's GDP went up due to rebuilding. I.e. GDP is susceptible to the broken window fallacy!
You also have the converse problem, that a lot of value isn't transactionalised at all - if two people who look after their own children switch to paying each other to look after each other's children, GDP goes up.
So what should we be measuring? Value consumed by natural persons? That's the end goal of all economic activity, right? (But even then - if someone receives (privately purchased) medical treatment for an on-the-job industry, that would contribute to my "value consumption" measure but it shouldn't)
There's a long and involved discussion around this.
Adam Smith defined a nation's wealth as "the annual labour and produce of the nation". Which the astute reader will note is a flow rather than a stock. Smith's editor Cannan makes just this observation.
Simon Kuznets, who came up with GDP in 1934 when the United States (and much the rest of the world) suddenly discovered it had a pressing need to determine just how much stuff it was doing on a national basis, cautioned strongly about overreliance on the metric (there's some level of parallel here with Ansel Keys' cautions on his highly mis-used body mass index -- devising good, measureable, but proxy indices for a large, hard-to-measure thing, is hard.
Going back to Smith, he also states unambiguously that the only use of money is to stimulate the exchange of consumable goods, a definition which raises all kinds of interesting questions.
It's worth noting that Smith's economy essentially had three currencies: one aimed at retail, one at wholesale, one at finance. These were conducted in copper (pence), silver (shillings), and gold (guineas), respectively. That is, England had a tri-metallic system, and the values of the currencies floated, somewhat, relative to one another.
Yet another aside: in a great many instances, the name of a currency devolves to either a unit of weight, a denotation of authority, or a description of quality. Pound, mark, penny, peso, frank, and sheckel are all units of weight. Real, crown, kroner, and the like, denote royal authority, and arguably terms such as Euro could be taken as equivalents. "Dollar" comes from "Thaller", that is, "Jochinsthaller", referencing the quality of silver coin mined at the town of Jochin in Germany. Guinea refered to African gold, and nickel to the metal originally comprising it. A principle exception to this rule are names based on subdivisions: dime, quarter, possibly "shilling" according to some etymologies, dinar, denarius.
The question of how to measure net economic throughput strongly suggests a concept similar to that of biological or ecological metabolism. Leslie White, an anthropologist, suggested that civilisations and cultures be ranked according to their net energy consumption. Evidence I've seen suggests a very strong fit, though you'd likely want to impose an efficiency constraint. Just as a feverish animal's metabolic rate isn't a reasonable measure, you'd want a healthy economy's energy consumption.
GDP and economics generally suffers greatly from incomplete cost and value accounting.
Too reductive, and disingenuous. Of course some finance is a needed part of a healthy economy. But financialization generally isn't. At best that rent seeking is shifted onto overseas "customers."
Similarly, saving lives is good, but costing a multiple of other industrial nations makes that part of health care a drag on the rest of the economy.
Comparables can be compared. It's not as complex or inscrutable as you imply.
Obviously finance creates value, by enabling transactions that wouldn't otherwise happen. I'm not sure what "financialization" is other than "finance I don't like." My question is a specific one--what should be included in GDP?
That's an easy question with an obvious practical answer:
Include finance activities that are not out of line with comparables. Comparables: You know. Like the G7. Who do things like we do. Except sometimes they get it done for less. There is no reason to come up with a pure or dogmatic answer. Just a practical one.
Or do you think all medicine/pharma creates value, too? All prisons? All cops? All the military spending?
Some of all that is just self-injury. And you don't have to have a moralizing answer. All you need to know is that other nations get better results with less spending in those areas to know we are pissing that money away, not creating wealth, not improving quality of life.
And when I say disingenuous, I mean don't play stupid. You know very well what financializtion is.
Again, what does financialization mean other than "finance I don't like?" Comparing to other countries isn't a very objective way to establish what should be included in GDP. It renders your measure useless in analyzing trends that affect the whole G7. It's not like large finance industry profits and exploding real estate prices are unique to the US.
Surely there are some objective measures that can be derived in a principled way?
Roughly the same way you measure returns against a market index, or currency value against a weighted "basket" of currencies.
But some things should be obvious: The US vastly overpays for health care. The US is also a far outlier in prison spending. Finance probably isn't the biggest offender in soaking up money while failing to deliver quality of life or material output.
Money needs to be classified into two types- money derived from financial transactions and money derived from stuff - the exchange of goods/services. 'Financial' money should only be used for stuff. Only 'stuff' money should be used for finance. This would avoid the uncontrolled feedback loop that leads to financial money revving itself into a massive force that exceeds the real world on which it should be based.
It's a lot more than electric bits. Banks and other financial institutions allocate capital in the economy. By efficiently and effectively injecting capital into the right companies/sectors, the economy and standard of living will be drastically improved. It is in our best interest that it is the smartest and brightest making these decisions. Of course they should be compensated for these incredibly important services they provide.
But that was my point. Financial institutions USED TO inject capital into companies. Now they inject MOST of their capital into other financial instruments. Their 'investments' are actually just wagers - bets - because nothing is ACTUALLY manufactured and people are not actually serviced. Financial institutions should be outlawed from 'investing' money in any other financial institution or instrument.
An interesting read but I think it's just the same old "pushing on a rope" situation that people who have been following economic news are already familiar with.
The problem is that central banks are tasked with trying to solve something they are fundamentally incapable of solving on their own. They can QE or reduce rates until the end of time to try and stimulate growth but it has a limited effect on the real economy. Note that it does have some effect on the real economy so it's not completely useless but on its own it isn't good enough.
The players in the market, including both the finance system and individuals, take note of the low interest rates and just increase their leverage into bubbles. As the central banks keep pumping, so do those bubbles inflate. Why would anyone invest in productivity or infrastructure when the governments are signalling you will make a lot more money speculating on bubbles and we will keep backing you up in doing that. Cheap money is a double edged sword.
The real solution IMO is two-fold. First we must accept that at least right now we will not grow our economy as fast as we used to. Second is that rather than trying to stimulate the economy by QE and lower rates the governments should be investing in infrastructure and start normalizing rates (with respect to new realistic growth targets).
The crazy thing about all of this is that at a time governments should be borrowing like crazy (like everyone is doing) to finance their investments because it's so cheap to borrow they are trying to reduce their debt and expenses (with the extreme being "austerity"). Everyone else is acting fairly rationally except the governments.
EDIT: As some of you already know, there is a direct connection between interest rate expectations and asset pricing. So in a sense it is inevitable that the expectation of long term low interest rates will result in asset bubbles. If the long term rate expectation is zero then assets with any non-zero return should be valued at infinity, i.e. dividend stocks, houses etc. Central bankers are absolutely aware of this as they are aware that raising rates will cause asset prices to go down with all the implications. That's why they are stuck at the token 0.25% raise. If the US ever goes negative rates then you'll know we're in real trouble.
The article is about the distinction between the financial economy and the real economy. Everything you wrote seems to lump them together, and then make inferences assuming both economies are one in the same. (Missing the point of the article, from the title down)
I feel that you're the one "pushing on a rope", when the best you've got in your framework of the world is that some components of monetary policy correlated to asset prices sprinkled with some vague ideas of government spending.
Apologies for having a strong opinion about the roots of the crisis which I think is reasonably well informed. And yes I am operating within some sort of framework.
I'm always willing to adjust based on new information.
I think I have a pretty good idea about how asset pricing relates to interest rates expectations and inflation expectations. If you want a better idea of where I'm coming from I recommend Coursera's Financial Markets course.
I'm not lumping them together. I said: "Why would anyone invest in productivity or infrastructure when the governments are signalling you will make a lot more money speculating on bubbles and we will keep backing you up in doing that. Cheap money is a double edged sword."
So I differentiate (to some extent) between the "real" economy (which no one is incentivized to invest in) and what the authors call the FIRE economy. I just disagree where I think the authors are pointing to a root cause where I see something that is just a symptom. I do agree with the authors points about the negative impact of bailouts but this is only part of the equation in my opinion. Also at the end of the day it's really hard to separate the "real" from the "financial". You can use the money created to go buy things in the real world.
There is not much new in the paper. Lots of people have talked about the role of debt in the crisis. Lots of people have talked about how bailing out the banks encourages bad banking practices.
The paper's intent is to articulate a particular ideological element within the current mainstream(finance being equated to the real economy), identify its appearance, and set the stage for a counter ideology that pushes finance away from power; it's more historical-political in nature than anything.
So yes, saying it says nothing new is missing the point, because it's not really aimed at economists who have already started critiquing these distinctions. If it aimed to craft new theory or policy, it probably wouldn't be referencing more detailed, years to decades old, sources in every other paragraph.
I see. I guess I'm not that familiar with ideologies in the world of economics academia.
In the real world I don't think there's anyone, including central bankers, who currently thinks (or really ever thought) that bailing out banks that give bad loans is a good idea or e.g. that companies taking debt to buy back shares is a good idea. Central bankers also don't think (any more) that QE or reducing rates can restore real economic growth to the pre-crisis levels.
What do you think looking at "finance" vs. "real" economy is going to get us? How will it impact policies? What does it mean to "push finance away from power" and what are the implications?
Not to mention the futility of trying to track what's finance and what's real. Is VC "real" or "finance"? When Microsoft buys LinkedIn is this "real" or "finance"? Is Facebook a part of the "real" economy? Disney? My retirement savings that are sitting in the bank, is that "real" or "finance"?
It's not surprising that interest income has been reclassified from rent to natural profit. One only needs to consider who is doing the classification to understand it.
Actually, when the central banks are so scared of the implications of letting companies fail that they start propping them up through QE, it's probably safe to say that Finance is the Economy.
Most people don't even realize economics is a social science, not a business discipline. Business schools don't issue economic degrees, even. But whatever. This country thinks it's full of experts on everything if they have an internet connection.
> Most people don't even realize economics is a social science, not a business discipline. Business schools don't issue economic degrees, even
What point are you trying to make with this statement? Indeed research universities are the ones which offer economics degrees as it seems they should?
Isn't the finance industry in conflict between supporting stable growth of 'real' economy by providing capital vs. their ability to gain during volotile times. Or can someone enlighten me why they are so oblivious to asset bubbles, with no effort to restrain borrowing in a particular bubbly asset, unless volatility is seen as no issue - or even an opportunity.
Its precisely the opposite! The financial industry supports stable growth. If the crops fail, insurance contracts keep farmers from going out of business. If you grow old and can't work, your retirement fund keeps you from being a weight on society.
Asset bubbles are always identified in hind-sight. Volatility does not create asset bubbles. If anything volatility keeps investors bearish.
We can't control what we don't measure. For better or worse it is a time honored tradition to optimize for that measurement. It generally leads to fast improvements until the system is gamed to a degree that measurement and reality decouple.
This is either weird propaganda or very funny.
Maybe he or she meant backwardation?
If i remember correctly "The big short" is about something that happened in 2007 though, so check your futures, and do not taunt happy fun negative interest rates!
David Graeber's Debt: The first 5000 years, is a great anthropological exploration of some of the things Polanyi was saying about how market economics were forced on people rather than being the natural state of affairs (though grain of salt is needed in later chapters due to factual errors)
Also I really think Liaquat Ahmad'a Lords of Finance is a useful exploration of gold bug central bankers causing global instability, this one focuses on WW2 more
Thinking about it, the 1930s Great Depression was after a US trade surplus. Today US have a trade deficit. If the banks actually failed in 2008-2009 and caused another depression, it would be probably harder to recover from.
But failing in 2008 more likely would have caused a recession, What happens next will likely be 2008 with a multiplier. Nothing has structurally changed. We have a bunch more debt globally. Most of the problem children are treading water and many getting into a worse position.
I think we're heading for either 1) A pretty solid crash where a bunch of banks and pension funds are going to get smashed by the domino effect of finace going low risk or 2) High inflation (not hyper) as nations increase current monetary policy tactics to try and revive things ongoing, eroding value of wages/cash savings followed by a bigger crash.
And the elephant in the room for me is US/China national debt. The economies are so influential the world over. For US most forecasts have it stabilising at existing levels (relative to GDP). I just can't see strong economic growth to back up debt growth, or a desire for fiscal responsibility with existing political candidates. You'd need incredibly strong conviction (and political majority/backing) to pull back hard on required social/military spending to achieve this. And a vision for the future. I see the current candidates as short term responders.
For trivia the last president to reduce national debt during their term was Calvin Coolidge!
I know. I was thinking that the FDIC would convert banks into DINBs with the insurance limit raised to $250k per account holder. All debts including mortgages would be discharged tax-free automatically (making the topic of mortgage notes moot). Bank charter restrictions would be loosened so that new banks can be created as soon as possible.
I tried to read this article, but sometimes it degrades into an incoherent string of words that barely make any sense.
Here is a random sentence where I stopped reading: "By viewing capital gains as transfers instead of as income, we define the long-term sustainability of capital gains and asset prices in terms of trends in disposable income plus debt growth."
It's half gibberish to me. People think because they can sprinkle citations it makes it well written.
That's completely comprehensible to me, and I sport all of an incomplete undergraduate-level understanding of economics. And it's not citing its sources because its authors think that makes it "well-written"--it's citing its sources because it's an academic work and citing one's sources is important for future research.
I have seen a lot of middlebrow dismissals around here. (Made a few myself). It is rare to see a lowbrow one.
OK, so then why don't you try to explain that sentence as a good rebuttal (to his assertion that the article feels like half gibberish)? You're dismissing him as much as he's dismissing the article.
I agree with you that I am dismissing his post. If he had asked for an explanation, instead of frothing that it was "gibberish", I most likely would have given him one. If you aren't (currently) capable of understanding the contents of an academic journal article, but insist on going on about how you don't understand it and how it is a failing of the authors that you do not, it requires angels of a significantly better nature than I possess to help you.
I think you're missing a bit of jargon. A transfer (wealth transfer) is one person getting richer and another poorer without either participating in economic activity. A gift of sorts. For example, social security is a transfer from workers to retirees. The nuance is that many government policies result in transfers indirectly. For example, the mortgage interest tax deduction sounds like a transfer from taxpayers to home buyers, but its real effect is a transfer to home sellers, which is slightly different. Not surprisingly, many government policies are indirect transfers from the general population to capital holders and the elderly, because that's who give money and vote.
I suppose if you think of this as an article, then it might be seen as unapproachable, but as far as I can tell, this is actually a paper from The Journal of Economic Issues. This being the case, I'm surprised I understood it as well as I did.
It's only natural that if you're unfamiliar with the topic (and vocabulary!), you would have difficulty understanding most papers no?
rather than just that sentence, here's a tldr; for the problem the article describes.
There is a difference between a loan taken to build a fishing boat and a loan to buy an existing apartment building.
A fishing boat loan is paid off by producing real objects with real value (food) some of which wealth repays the loan.
The apartment building loan is paid of by raising rents and, rather than producing anything of value, actually takes wealth out of a productive part of the economy (consumer's pockets).
By considering both kinds of loans the same we have made a financial mess of things.
I'm actually fairly favourably impressed by the piece. I'm discounting it slightly due to the publisher (Ron Unz is a bit of a conservative political nut in California), but am crediting it for references to Frederick Soddy, principally known as a Nobel-prize winning chemist, somewhat less recognised for his work in economic theory and foundations, for which he's largely considered a bit of a nut. I think that's unfounded, and his name's been popping up in a few places lately.
If you'll consider my endorsement, from what I've read of the piece (it's long and I've not gotten fully through it), it's actually rather better than most treatments, mainstream or otherwise, of the topic.
Suppose I have a house I bought for $1000 (2015 USD), but the realtor tells me I can now sell it for $2000 (2015 USD). When I sell, that $1000 eventually comes from someone else's productive labour, which will be transferred to me.
As the buyer, I can pay the $2000 by borrowing from someone else and servicing that debt from my income.
The $1000 capitals gains that got pocketed are of course the buyer's future income.
So we can have ponzi asset bubbles in housing all we like, but right at the heart of it, the drivers are how much actual working people are willing and able to borrow, and how much they can pay to service their debts.
Put another way, their statement is that when everyone is maximally indebted and has no disposable income, the music has to stop.
At some point a finance person steps in and introduces a credit lending facility, which overall is a good thing for the health of the economy. Then, in decision to not take on too much risk, the said finance person offloads the loans in a securitized fashion to other wealthy islanders who then benefit from fishing booms and receive below average returns in years that are dry.
Then another finance person figures out the futures contracts, which act as insurance to fishermen and guarantee a reasonable price even at times of market over-supply.
At some point trading the loan securities and fishing future contracts starts paying more than humble fishing, which means that the best and brightest switch into finance, creating a stigma for fishing as less desirable occupation for under-achievers. Majority of island's GDP is now comprised of fishing-related loans and futures, with fishing itself occupying a relatively small niche.
This, of course, collapses at some point, but the problem is that it's hard to point out that one step that's completely irrational and bonkers - everything created by finance industry has found some demand among fishermen and simplified their lives.