Is it Possible to Curb Financialization Excesses Without Crashing the Economy?

Understanding the Dominance of Finance in Socio-economic and Political Status Quo

People often perceive the world as it is today, failing to notice the underlying tectonic shifts unless they make a conscious effort to do so. One such shift is the rise of finance as the dominant force in our socio-economic and political status quo. To illustrate this dominance, consider that in 2023, the finance, insurance, real estate, rental, and leasing industry contributed 20.7% to the United States' gross domestic product (GDP), a significant increase from the long-term average of 7.29%. In 1947, the finance industry accounted for only 10% of non-farm business profits, but by 2010, it made up 50% of non-farm business profits.

The Rise of Financialization

Non-bank financial institutions' assets as a percentage of GDP provide a clear picture of the rise of financialization. Before this era, non-bank financial institutions' assets hovered around 40% of GDP for decades. However, with the advent of financialization, everything, including labor, capital, risk, currencies, commodities, income streams, and real-world assets, is converted into a financial doppelganger that can be arbitraged and traded for profit. The actual use-value is no longer the "value" being "created;" the "value" is "created" by generating an entirely abstract financial shadow cast by the collateral of the real world.

The Impact of Financialization

The global economy's transformation into a fully financialized shadow-world began in the early 1980s when financiers were first given access to unlimited credit and other financialization tools. Non-bank financial institutions' assets soon soared from 40% of GDP to 140% of GDP, and in the final blow-off phase of hyper-financialization that we're experiencing now, these assets are 200% of GDP, five times the pre-financialization era levels. However, the wealth generated by financialization and hyper-financialization isn't shared; it's concentrated in the hands of those with access to credit and the other tools of financialization, currently epitomized by private equity.

The Cost of Financialization

Financialization isn't cost-free to the economy. The total cost of the financial system is comprised of rents, misallocation costs, and the costs of the 2008 crisis. These costs can be divided into two types: transfers and inefficiencies. When combined together, they total to $688bn a year, or 4 percent of GDP. Cumulatively, from 1990 to 2023, this number would add up to $22.7 trillion. Adjusted for inflation, this sum totals $30.2 trillion in today's dollars, larger than America's entire GDP of $27 trillion.

The Dilemma of Dealing with Financialization

An economy that's dependent on the distortions of financialization for its "growth" and profits is not a stable system; the gross imbalances generated by the distortions undermine its stability, and the system collapses under its own weight once the imbalances destabilize society and the real-world economy. The question then arises: how do we reduce the destabilizing excesses of financialization without crashing the economy? This is a concern because the immense suffering that would result once the speculative bid of financialization collapsed would be inevitable if even the most modest restrictions were put in place.

Options to Deal with Financialization

One option is to deflate the financialization bubble, defang its predatory tools, and take the lumps now rather than dump the ever-expanding destructive consequences on the next generation. This can be viewed as our civic / moral duty. Alternatively, we can wait for the inevitable collapse of the bubble and then clean the nation's financial house of both the wreckage and the causes of the catastrophe, financialization. Either way, the implosion of the Everything Bubble will occur, and the suffering will be great. We can try to deflate the bubble slowly via restoring the Glass-Steagall, etc., but given the extremes of speculative excess, even modest reforms might trigger the collapse.

Bottom Line

Can we rein in the excesses of financialization without crashing the economy? Unfortunately, no. Now that the economy is dependent on the speculative excesses and distortions of financialization, there is no way to avoid the banquet of consequences that has already been served and is only awaiting the seating order. But we can do what's right, and take the pain now rather than let it pile even higher before it implodes on the next generation's watch. This issue raises a thought-provoking question about the future of our economy. What are your thoughts on this matter? Feel free to share this article with your friends and sign up for the Daily Briefing, which is everyday at 6pm.