Saturday, August 17, 2013

Financialization of the economy

When financial markets have more liquidity than can be invested in the real economy then it goes into speculation. The speculators, which includes banks, other financial institutions such as hedge funds and some wealthy individuals, are plainly getting rich so if it isn't coming from producing valuable products and services for consumers then it is necessarily extractive; i.e., it comes from claiming a bigger share of the pie. Better regulation is a fine idea but by itself it will be largely defeated because ways to speculate will always be found as long as liquidity is excessive.

Why is liquidity excessive? It has been at least since the 70s when the last link between the US Dollar and gold was severed allowing the Fed freedom to manage the money supply mainly for the purpose of avoiding recessions. The strategy for accomplishing this was to aim for a steady, moderate rate of price inflation. In an economy without a fiat money supply a certain amount of price deflation is natural due to technological advance and accumulation of capital resulting in rising productivity. I believe persistent excess liquidity resulting in speculation, excessive debt and the financialization of the economy is due precisely to the anti-recessionary strategy of the Fed, (also adopted by other central bankers). Unless we find a better way to either avoid or live with recessions, speculation and anti-productive financialization of the economy is sure to continue regulatory reforms notwithstanding.

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