“It's a good thing people don't understand our banking and money system, because if they did, I think there would be a revolution by morning,” said Henry Ford. In fact, the financial markets heavily condition the development of societies and the choices of the political institutions that created and protected them. Since the XNUMXs, the large financial intermediaries have fought for the freedom of capital movements, the deregulation of the markets, the liberalization of financial activity, the passage from direct to indirect supervision.
And they won, gaining enormous power: they determine the conditions for business development; the growth processes of nations; the sustainability of their governments' policies. They condition the positions of political parties and leaders. Do they use this power, good or bad? The theory assigns to the markets the functions of allocating resources, managing risks, transmitting monetary policy, making the payment system work. He conceives them as a system which, if barriers are removed and left to work undisturbed, will increase the well-being of the world. And it disregards evaluations of a moral or political order.
Indeed, “in the last thirty or forty years, public life has been animated by the belief that the mechanisms of the markets can answer any question and solve any problem. Thus, political life has lost its sense of morality and public purpose: it seems that reasoning inspired by the market allows us to uncritically allocate goods and incomes. Instead, in many cases, we have to make moral judgments. The analysis of the behavior of intermediaries and of the markets must therefore extend to the stability of the latter; their ability to influence the balance of power between the different economic and political areas of the world; the relationship with governments and non-financial companies; the propensity to favor processes of reduction of inequalities.
Given that living in a less unequal system represents a benefit for every type of institution, social group, person. We will focus on these issues below. Finally, we will draw some conclusions regarding the need – or not – to reform and better control the markets. The latter are not an end, as some superficially seem to believe, but a formidable development tool, powerful and delicate at the same time: it must be handled with care.
1- We start from two assumptions. The first is that finance – which also represents "one of humanity's great intellectual achievements" – is concerned with "transferring purchasing power over time" and with "transferring and managing risks" but does not "create value" in sense in which the production of non-financial goods and services does. The second is that, Minsky demonstrated, financial markets are intrinsically unstable and have also made market economies inexorably unstable, dominated by the financial superstructure that has grown upon them.
The markets have always been subject to controls. The gold standard allowed XNUMXth century finance to work well thanks to: an automatic mechanism for adjusting imbalances; a single reference currency; one financial center and one regulatory system; a single hegemonic country that was also a net exporter of capital. Of course, excess was not prevented – which, moreover, seems to be one of the hallmarks of capitalism – and the powerful banker of the City «could create or scuttle any enterprise, raise or lower the cost of money as he pleased».
But the system was inherently stable and helped finance the Industrial Revolution, develop international trade, and build a pleasant world for those few who could enjoy it at the time. It was the emergence, from the XNUMXs, of the social question connected with the expansion of democracy that decreed its end, followed by a period of instability where trade, currency and financial wars were fought. The lesson was a weighty one: a global financial system works if it is regulated, it becomes a problem once left to its own devices.
It seemed that the lesson had been learned. In designing the financial order after the Second World War, for the first (and so far last) time in history «social objectives and the national economy were placed ahead of the global economy» and the markets. The Bretton Woods system was founded on the belief that excessive freedom of capital movements undermined financial stability, hindered the development of international trade and excessively constrained the policies of individual countries. Therefore, reducing the transaction costs of trade required the imposition of high transaction costs in international finance: in other words, it was necessary to introduce capital controls, especially on short-term ones which «will be desirable for most countries not only in the years to come but also in the long term».
2. Actually the lesson was not memorized. As memories of the instability of the interwar period faded, financial interests began to weigh more and more in shaping economic policy. The abandonment of the fixed exchange rate system led to the expansion of markets, which were required to manage the new exchange rate and interest rate risks. The volume of assets traded on them increased from 30 to 90 trillion dollars between 1975 and 1985, values that are, moreover, ridiculous compared to that of 2015 (over 700 trillion). The size of the intermediaries grew and required freedom of capital movements, homogeneous and less regulated markets in which to seek profit opportunities, necessary to support the share price and carry out substantial capital increases which are in turn essential to finance growth.
Advances in information technology made it possible to exploit economies of scale and range which justified the propensity to increase volumes and expand the geographical presence of the operators. The process was completed with the transition from a direct surveillance system (everything that is not expressly permitted is prohibited) to an indirect one (everything that is not expressly prohibited is permitted) and with the introduction of capital ratios which leave "free intermediaries to assume any risk provided they have a capital commensurate with their size".
The latter is not a completely effective and efficient system. The regulators themselves have probably perceived this if over time they have tried to make the rules both more extensive and stringent: from 1988 to 2014, the number of calculations that an international bank must make to determine its capital ratios went from less than 10 million to more than 200 million; in the UK in 1980 there was one regulator for every 11.000 people employed in finance, in 2012 one for every 300! Financial globalization has therefore upset the relations between countries, between banks and governments, between markets and companies. And, left to itself, it risks triggering large and unpredictable crises and conflicts.
Historically, the main interlocutors of Western governments have been the energy and defense industries. The financial one has, in many ways, taken their place. And the liberalization of the capital markets was an initiative by the British and US governments to impose the rules and role of the Anglo-Saxon banking system. A necessary condition is the prevalence of "financial technology" over capital. The latter, once at the center of the system, has lost weight. It has become a "raw material": as such it is worth little because the freedom of movement makes it practically infinite and it only acquires relevance when it generates an adequate return, that is, once it is "processed" by the banks which incorporate it into financial assets to be placed on the markets .
A system in which the relevance of the capital accumulation process – today concentrated in emerging countries and in particular in Asia and the Middle East – is subordinated to financial technology, which is the prerogative of Western banks, clearly affects conflicts for distribution of power between the West and the rest of the world. The 1986 reform of the British financial system (the “Big Bang”); the US Banking and Branching Efficiency Act of 1994, which eliminated restrictions on interstate banking; the abolition, in 1999, of the Glass-Steagall Act, the 1933 banking law which separated commercial banking from investment banking; the frustration of attempts to implement the 2009 Dodd-Franks Act by reintroducing restrictions on the activity of intermediaries after the 2007-2010 crisis; expanding the ability for pension funds and insurance companies to invest their portfolios in the US stock market; the OECD's elimination of the distinction between short-term capital and long-term investment in the XNUMXs; the merger between the London Stock Exchange and Frankfurt are tools for supporting the Western financial system and controlling capital flows on the basis of Anglo-Saxon rules.
Thus a hierarchy was created on the markets:
– intermediaries (commercial banks, investment banks);
– “intermediate” capital bearers (institutional investors);
– “pure” capital bearers (savers, institutions with credit balances: for example, emerging countries);
– capital borrowers (non-financial companies and governments of deficit countries).
With the liberalization of capital movements and the growth of the power of intermediaries, the preconditions for the well-being of a country and its influence in the world reside in the ability to govern enormous transfers of liquidity, controlling the markets and creating or destroying wealth. Whoever controls capital movements finances the development paths of technology and industrial systems and therefore the distribution of power on the markets of goods and services. And it is not true that the financial markets cannot be controlled because they are too large, made up of too many operators, with low transaction costs and therefore very competitive.
The liberalization processes have precisely served the big banks to consolidate their influence on the markets and acquire global capabilities.
In 2015, the five largest US banks held 45% of US banking assets, up from 25% in 200015. Worldwide, 42 banks manage 50% of financial assets. A hierarchy of intermediaries has been determined on the basis of their ability to take risks and to collect and place resources on the global market (the so-called placing power):
– global banks: 6 (3 American, 1 British, 1 German, 1 Swiss);
– international banks: 14 (including 4 American, 2 French, 2 British and 3 Japanese);
– regional banks: 9 (of which 1 Italian);
– domestic banks: 13 (including 5 Chinese)
Note that the presence of Chinese banks depends on the intermediation of the huge debt incurred by domestic companies, equal to 160% of GDP, but they are not able to play a significant role globally. In other words, Chinese lenders "work" the capital accumulated by their own country, but are unable to place it on international markets, let alone influence their performance. Activity, the latter, which succeeds very well to global and international intermediaries, which accumulate
revenues from Investment Banking (ie with higher added value) equal to 54% of the global dimension of this sector; they have a cost of capital (WACC) 15% lower than the average of the banking system and a return on capital (ROE) 17% higher. They are the only ones to generate profits in Mobile Banking since they are the only ones able to make the required investments.
The West, therefore, has not lost power compared to the rest of the world: if anything, governments have less power, but financial globalization has increased the influence of North American and European intermediaries. Power therefore remained in the West, but it moved from political to financial institutions.
3. Is the growth of finance useful for development? It is not certain: when credit to the private sector exceeds the value of GDP, the size of the financial system slows down the overall increase in productivity and hinders economic growth. However, the freedom of capital movements has undermined the relationship between national savings and public debt: the large intermediaries place government debt on the market, setting maturities and yields. Since the XNUMXs, a process of transferring governments to the power markets has begun to determine the areas within which countries are eligible for funding and set the constraints of economic and fiscal policies. Is this an evolution to be welcomed and satisfied?
The orthodoxy of globalization maintains that the markets stimulate governments to embark on paths of progressive solidity of public finances: the resulting economic growth will make it possible to reabsorb the social imbalances generated by the stabilization policies necessary to embark on this virtuous path. The financial crisis that began in 2007 has, on the other hand, favored a polarization of the world between virtuous countries and others considered incapable of fulfilling the commitments undertaken with their creditors and therefore unacceptably risky for the markets. The former have been assured, at advantageous interest rates, resources exceeding their needs; the scarcity of capital supply and their high cost have forced the latter to pursue rigorous policies which have produced a contraction in consumption and investment and a consequent weakening of the productive and social fabric.
But finance is pro-cyclical, it amplifies the waves of the economic situation. Thus, in free capital markets, information technologies translate operators' decisions into immediate behavior, generating shocks that are not compatible with the adjustment processes – necessarily much slower – of the real economy and fiscal policies. From a political point of view, the dilemma is intricate. Proponents of the "virtue" of the markets believe that, since the principle of financial stability is not necessarily incorporated in the preference function of governments, it is a good thing that the latter are subject to an external constraint that conditions their policies. How acceptable are these limitations for a government elected according to procedures that respect popular sovereignty?
How much does all this affect the concept of liberal democracy? What legitimacy do the markets (and the intermediaries that manage them) enjoy?
to enforce the income and wealth transfers implicit in stabilization policies? It's not easy to answer. On the one hand, the inclusion of a country in a context of financial globalization derives from treaties, ratified by Parliament, which seem to attribute to the markets an implicit right to influence political choices. On the other hand, the structural slowness of the latter - "democracy does not run, it takes more than a day to decide on the well-being of citizens", said Tocqueville - is hardly compatible with the immediacy of the sanctions imposed by banks and investors on creditors unreliable.
The fact remains that the "deep globalization" in which we are immersed has subordinated national policies to supranational rules in which it is often difficult to recognize objectives of protecting citizens with respect to pervasive and oligopolistic financial systems.
4- «Speculators can be harmless if they are bubbles above a regular flow of economic enterprises; but the situation is serious if companies become a bubble suspended above a vortex of speculation». In 2015, the value of world financial assets at the end of the year reached 741 trillion dollars, the world Gross Domestic Product 77 trillion. Approximately a third of this financial mass (249 trillion) consists of assets referable to the production of goods and services (shares, bonds, bank loans), while 492 trillion are represented by derivative instruments. Which cannot be repaid with the return on productive investments since they were not the ones to finance them: but they determine – completely independently of the demand for investments and their expected return
– the interest rates applied to capital raised by manufacturing companies.
Developments in the real economy are conditioned by financial structures disconnected from industrial activity. The latter encounters problems in sustaining its development. Financial globalization has caused the relationship between a country's savings and the financing of its production system to disappear, while market evaluation criteria are based on self-referential systems such as the oligopoly of rating agencies. Which, burned by their incapacity as issuers to which they had assigned positive valuations, tended in the years following the crisis to chase, rather than anticipate, the mood of the market: thus accentuating the pro-cyclical nature of finance, which has limited interest for the long-term evolution of companies and is very attentive to their creation of liquidity in the short term.
Between 2000 and 2015 – with the exception of the 2007/2011 crisis period – companies listed on world stock exchanges distributed to shareholders – in the form of dividends, share buybacks, company purchases – almost 30% of more than they collected in the markets. The system finances shareholders, not companies. In turn, the capital ratios of banks - based on the principle that the more liquid an asset is, the less capital it needs - tend to favor intermediaries who invest in assets - including synthetic ones - traded on organized markets rather than in corporate loans.
Credit to companies is therefore discouraged and the institutions that practice it have greater capital needs than their competitors. Other conditions being equal, a higher capitalization is reflected in a lower relative profitability of the assets, which in turn leads to a lower share capitalization, with the consequent difficulty in carrying out the capital increases necessary to comply with the solvency ratios. With this system, it is difficult to finance growth; easier to increase inequality.
5- A polarized society has been created, where wealth and inequality coexist: mainly due to a technological process that favors an unprecedented redistribution of income, reducing real wages, de-linking them from productivity and jeopardizing the survival of the middle class, the real distinctive feature of advanced capitalist societies. Since the beginning of the century – contrary to what happened in the second half of the twentieth century – about 35% of business income has been allocated to labor and 65% to capital, whose liquidity is ensured by intermediaries. The World Bank has estimated that while equality between nations has increased, inequality within countries has also greatly increased.
Finance amplifies the phenomenon. The tendency to ask less solid countries for rigorous policies that often become recessive, the preference for company liquidity and for their short-term results, entrusting our well-being to the markets (in the film Gran Torino, Clint Eastwood is fired because the pension fund of the neighbor's company had demanded a restructuring that would increase the profits of the company for which Eastwood worked…) are as many drives towards a more polarized world.
According to the Bank of England, even Quantitative Easing generates inequality because «by driving up the prices of a basket of securities, the financial wealth of households kept outside pension funds has grown; but assets are heavily distorted, given that 5% of households hold 40% of these securities». Compared to the past, the rich who do not work have grown and even more the poor who work. Financial wealth weighs more than income from work: the former is concentrated, the latter insufficient.
"We can have democracy or we can have wealth concentrated in the hands of a few, but we can't have both." It is not certain that Western societies support excessive levels of inequality to which the globalization of finance forces them: a democratic system postulates an acceptable level of equity, without which social cohesion is at risk, the sense of belonging weakens and the principle of sovereignty. The West is in significant danger: Nations fail when their once inclusive institutions become exclusionary and bend the economy and the rules of the game to serve established elites.
6 – According to the philosopher Emanuele Severino, «capitalism is on its way out because conflicts for the domination of finance marginalize the capitalist economy and the competition that is its essence» and threaten freedom, which needs markets to survive . And in fact, a great finance scholar, Robert Shiller, argues that "a democratic financial system is what is needed to reduce uncertainty and promote human values". The current democratic financial system is not. But financial globalization is a pervasive and profound phenomenon: the markets - controlled by a few intermediaries - have gained power to the detriment of governments and businesses and now the latter can no longer ignore the former.
Nevertheless, the imposition of global rules and the attempt to homogenize a world in which the preference functions of societies differ from one another have perhaps gone too far. The global financial markets themselves often require political – sometimes even military – interventions of a national order since politics continues to be an eminently local fact. The introduction of a more "moderate multilateralism", in the context of which adapting global rules to the specificities of systems would make it possible to reap the benefits of globalization by mitigating some of its distorting effects and making it more acceptable to a public opinion which often feels itself subjected to unshared choices.
Let's say right away that, to be less unstable and self-referential, more controllable and more compatible with the needs of society and the needs of businesses, markets must become smaller. How to intervene? A modest rate of tax on the nominal value of capital transactions (something like the Tobin Tax) would limit short-term capital flows – the real cause of market instability – would not discourage long-term financial investment and would restore unbundling between “beneficial” and “harmful” capitals.
In a less extensive market it would be easier to introduce forms of operational separation and functional specialization of intermediaries.
On the one hand, by segregating activities carried out on one's own behalf (own portfolios, loans to customers) from those carried out on behalf of third parties (asset management); on the other, distinguishing securities trading activities from investment support activities. The average size of banks (which would no longer be "too big to fail"), the need to increase assets under management and capital requirements would decrease. And therefore the anxiety to show growing profits at any cost would be less pervasive. In this context, a reform of capital ratios would be useful – and easier – so as to incentivize the financing of industrial investments and limit the propensity to issue derivative instruments not correlated with production and commercial initiatives.
More generally, it should be noted that the indirect regulation of intermediaries alone is insufficient when not distorting and imagine a more effective combination of direct and indirect supervision, compatible with the functional specializations hypothesized above. Equity markets could adopt a more reflective and forward-looking attitude if management compensation parameters were restructured; buyback operations were regulated more stringently; companies were forbidden to pay infra-annual dividends, dampening the search for short-term profits; and inheritance taxes were reintroduced: preventing immense fortunes, rather than being put at the service of new entrepreneurial initiatives, from ending up in the hands of heirs who will live on income and without merit for many generations.
In a financial market without borders, who could ever introduce these rules? Immediately, it seems, "regulatory arbitrage" would kick in and the capital would go where the regulation is more favourable. But, it has been said, the system is, so to speak, "Western-driven". If the United States, Great Britain and the European Union jointly defined measures to make the financial markets more "manageable" and "useful", the rest of the world, by conviction or by force, would follow. And the West would recover, at least in part, that leadership that many say has been lost.
