2017-10-31 10:23:33
We are better at creating new claims on wealth than wealth itself
DONALD TRUMP is fond of pointing out that the stockmarket has reached many
record highs under his presidency. It is a capricious measure to boast about,
and one that may not fully reflect the concerns of those who voted for him and
probably care more about real wage growth. A look at the ratio of stockmarket
capitalisation relative to GDP shows that this measure is close to a record
high. That led me to reflect on a sentence I wrote a few years ago: we are
better at creating new claims on wealth than at creating wealth itself.
That sentence was written in the context of the huge rise in debt in the 40
years leading up to the 2008 crisis, and on the multiplication of obscure
financial instruments that preceded it. It reflected the huge rise in the
economic role of the finance sector, and the wages of those who work within it.
But it also relates to the way that the authorities have helped economies
recover from the crisis. One of the main tools was quantitative easing (QE),
creating money (new claims on wealth) in order to buy assets.
The motivation for QE was perfectly understandable. The financial pressure on
banks was causing them to shrink their balance sheets, and thus the supply of
credit to the rest of the economy; when that happened in the 1930s, the result
was the Great Depression. Nevertheless, successive rounds of QE, accompanied by
other forms of monetary stimulus, have resulted in very high asset values and
ultra-low interest rates. What was initially sold as a short-term crisis
expedient measure looks set to last longer than a decade.
Total debt levels in the economy have not fallen; the debt has been shifted
away from the financial sector and onto the government (and via QE, on to the
books of central banks). For as long as it stays on the books of central banks,
the system is more stable but if QE is ever fully unwound, the system will be
just as risky as before.
Creating money is the solution to a particular problem; a shortage of demand.
It is harder to make the case for this at the moment when economies have been
growing for a significant period, and when unemployment in both America and
Britain is under 4.5%. Back in 2013, Mervyn King, then the governor of the Bank
of England, warned that
there are limits on the ability of domestic monetary policy to expand real
demand in the face of the need for changes in the real equilibrium of the
economy. I do not believe that the present problems in the United Kingdom stem
only from a large negative shock to aggregate demand. In common with many other
countries, our problems also reflect the underlying need to rebalance our
economy, requiring a reallocation of resources both within and between nations.
It is not simply a question of boosting aggregate demand, but of helping to
bring about a shift to a new equilibrium.
One of the great economic puzzles of recent years has been the slowdown in
productivity growth across Western nations. There are many potential
explanations for this: the continued survival of zombie companies in a low-rate
era; mismeasurement of the gains from technology; new tech being less
significant than older innovations (the Robert Gordon thesis); a preference
among businesses to use extra labour when wages are low. And so on. Without
productivity growth, long-term economic growth will be sluggish, especially
given the ageing nature of western populations. And it is not clear how
monetary policy can be much of a help.
The same goes for the frenzied activity of the financial sector. Finance has
four important functions: operating the payments system; channelling funds from
savers to the corporate sector; providing liquidity to the market by buying and
selling assets; and helping the rest of society to manage risks, both financial
and non-financial. So one can justify all the activity the endless
multiplication of funds and instruments or the frenetic trading activity along
these grounds. More liquid asset markets potentially lower the cost of capital;
the creation of instruments such as derivatives allow risk to be allocated more
efficiently, to those who have the appetites (and balance sheets) to handle it.
But that argument is much harder to make in the wake of the 2008 crisis. It
turned out that the banks had not kept the risk off their balance sheets and
the apparent liquidity of many assets was an illusion. In the wake of the
crisis, the banks have shored up their balance sheets, in part by reducing the
capital they devote to trading activities, with the result that, in a crisis,
markets may be even less liquid than before.
We know that every time a financial asset gets traded, someone in the industry
takes a cut a commission, a fee or a bid-offer spread. It is hard to calculate
whether the gains made by the rest of society in terms of a lower cost of
capital etc are more, or less, than the finance sector's take. Many within the
industry will point to the falling cost of trading. But that is offset by the
number of times assets are traded; Thomas Philippon s study found that the
proportionate cut taken by financial intermediaries is as large as it was in
the 19th century.
Winston Churchill famously said that he would rather see finance less proud
and industry more content . A lot of people might be happier if the stockmarket
was less buoyant and the average standard of living was more so.