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.

I always try to think of economic issues in terms of underlying material facts, meaning, basically resource allocation on the supply side and patterns of consumption on the demand side. The current recession is clearly related to excessive investment in housing; i.e., the housing bubble. Other categories of consumption stimulated by cheap and easy credit, such as automobiles, will also have been part of the bubble. A true "cure" for the recession requires slowing production of excessively produced and consumed goods and services until demand can sustainably catch up with supply. Consequently home builders, automakers and every industry that supplies them is in for a difficult time -- and that, of course, includes the employees of these businesses.

The process of correction would go fastest if it were also very painful. Businesses with a lot of over-capacity and much over-supplied demand that will not recover soon should liquidate, their tools and facilities sold quickly at auction to businesses in other, less weak, sectors. Laid-off employees need to follow. As a matter of public policy, however, nobody wants to go the "liquidationist" route.

There is the politically attractive "inflationist" alternative. This means partly attempting to re-inflate the original bubble and partly stimulating speculative growth in sectors beyond the requirements of current demand. Even some economists, the ones with political mindsets, are out advocating inflationist policy. Today's example of this is Paul Krugman:

"We're doing half-measures that help the economy limp along without fully recovering, and we're having measures that help the banks survive without really thriving," Krugman said.

"We're doing what the Japanese did in the nineties," he told a small group of reporters during a visit to Beijing.

He said it was not clear that China would suffer sub-par growth as a consequence of the fallout of the present crisis.

"I'm mostly worried that the U.S. and the euro zone will have Japanese-type lost decades," he said.

Krugman said he expected little or no employment growth this year or next in the United States, where the jobless rate in April hit a 25-year high of 8.9 percent.

"A second stimulus is becoming clearly urgent. They need a very, very strong stimulus," said Krugman, a Princeton University professor and a New York Times columnist.

The problem with this is that the next boom-bust cycle is set up even before the current bust ends, but one cannot judge economic policy in purely economic terms. "Policy" means politics and politics must have its way.