How financialization began in the western world

only debts grew exponentially, year after year, and they do so inexorably, even when–indeed, especially when–the economy slows down and its companies and people fall below break-even levels. As their debts grow, they siphon off the economic surplus for debt service (...) The problem is that the financial sector’s receipts are not turned into fixed capital formation to increase output. They build up increasingly on the opposite side of the balance sheet, as new loans, that is, debts and new claims on society’s output and income.

                                                          - Michael Hudson (2003)

A couple of years ago I questioned the reality of reported GDP, as it seemed to conflict with the rate of usage of real resources. One figure I used is reproduced below.

Source: Handselbanken Capital

When I think of the 50s and 60s (okay, I'm too young to remember much about the latter), I think of rapidly rising standard of living--at least in North America. The reduction in growth of usage of metals in the 70's I attributed largely to the energy crisis--and a slowing in the real economy. The manufactured GDP numbers kept on growing.

One recurring theme in describing the past few decades is the notion of financialization--which I view as using financial products to wring out profits for banking interests at the expense of producers.

[Companies] are not able to invest in new physical capital equipment or buildings because they are obliged to use their operating revenue to pay their bankers and bondholders, as well as junk-bond holders. This is what I mean when I say that the economy is becoming financialized. Its aim is not to provide tangible capital formation or rising living standards, but to generate interest, financial fees for underwriting mergers and acquisitions, and capital gains that accrue mainly to insiders, headed by upper management and large financial institutions. . . . Instead of labor earning more, hourly earnings have declined in real terms. There has been a drop in net disposable income after paying taxes and withholding "forced saving" for social Security and medical insurance, pension-fund contributions and–most serious of all–debt service on credit cards, bank loans, mortgage loans, student loans, auto loans, home insurance premiums, life insurance, private medical insurance and other FIRE-sector charges.

                                                                               - Michael Hudson (via)

There was a time when all you had to worry about was whether you could provide a service at a profit--even if you bought raw materials from one country, assembled them in a second, and sold the product in a third. Now you need to have a hedging program in place for currency fluctuations and another to manage your exposure to commodity price fluctuations--but there are costs to such programs, both in terms of money and intellectual effort which detract from the core business.

In recent years we have found whenever we send large wires to Ghana for operations, the money is held in transit until there is a sudden swing in exchange rates (not in our favour)--only then does the wire clear, and an unexpectedly smaller amount of money shows up at the bank in Ghana. Each time this happens, it represents a roughly 5% tax on money transferred--in addition to the normal costs of wire transfer.

Between regulation and financialization, the life is being strangled out of the producers. But we are supposed to be the richest people in history.

How did the process get started? The answer might be here.

Via (my annotations).

Creating paper to drive down the price of commodities makes you richer in the short term, but poorer in the long term, as lower prices encourage producers to make less. But if real wealth is copper, zinc, gold, oil, food--products, that is--then having more dollars but less things is a recipe for impoverishment.

For mining companies, lower prices tell them to reduce production and reduce exploration. And that is what the above chart shows. Gold prices began to rise in the 1970s, attracting capital. But what commodities improve your life more? Are you rich stockpiling gold when there isn't enough copper to make a functioning electrical grid or sewer system?

In an earlier posting (based on data sets that ran back to the mid-90s) I showed that gold attracted about 50% of all exploration finance (excluding mineral fuels). Clearly, this is not the normal historical situation, and we have to ask how the system arose.

It looks like in addition to the sudden loss of control of energy, capital was deployed into the commodity that was rising markedly in price. Gold was rising because it had suddenly been cut loose from the US dollar. And the emphasis in mining exploration ever since has been gold.

I think this was the precursor to the financialization of the past few decades--that money should be diverted to creating more money, instead of wealth.

At the World Complex we love gold. But at the same time we recognize that putting all of your effort into mining it doesn't necessarily raise your standard of living.