Unconventional Monetary Policy, Financialization & Economic De-Industrialization


Financialization involves a shift in economic gravity from production & from the service sector to the financial sector. Similarly, financial assets are diverted away from the private sector to the public sector as deficits remain high & debt accumulates at a worrying rate.

What should be seen is that what we are witnessing is a monetary-policy induced de-industrialization of the US economy.

Knowing that all this is happening is one thing, but it is important to know what is the fundamental cause behind this transformation. There are many that would blame globalization or economic liberalization & reply by suggesting that there must be more regulations or government interventions. Alas, those that believe this tend to be in the majority of economic advisers.

What they overlook is that the process of financialization of the US economy is driven by non-conventional monetary policies that have kept interest so low for so long and financial markets awash with excess liquidity. In turn, these monetary policies are also the culprit behind a sluggish & incomplete recovery from the Great Recession of 2007-2008.

Whereas such artificially-low interest rates were justified as a means to encourage business investments or home purchases, banks face weak incentives to offer credit to either firms or households. The reason is that it is more costly & risky to make loans to start-up businesses or households than to trade financial assets.

To issue new loans, banks must hire more loan managers to review applications, other staff to assess value of collateral (or to collect it & dispose of it) & accountants to keep track of all this. The above graph clearly indicates that there is very little loan growth.

And low interest rates also discourage saving by firms & households that are more likely to seek a “flutter” in placing surplus income in more risky & (hopefully) more remunerative financial assets, like bonds or stocks. Inasmuch as there have been fewer IPOs for new companies, most of the trading of shares is of companies that already exist.

Despite the slow growth in new lending, many of the largest banks are earning record profits, especially those banks that are “primary dealers” & act as exclusive counter-parties to support the Feds open market operations. “Quantitative easing” programs involved the New York Fed purchasing Treasuries from primary dealer banks, including Goldman Sachs, J.P. Morgan and 18 others.

These banks receive payment for Treasures they received as part of the bailouts in exchange for toxic assets that came off of their balance sheets, all of this done at taxpayer expense.

Before the introduction of “unconventional” monetary policy, financial assets served as contingent claims such that expanding the scope of financial markets and instruments would tend to increase overall efficiency. In turn, markets could do a better job pricing future outcomes to improve current allocation of resources relative to anticipated future needs and economic actors could seek portfolios with higher returns relative to risks.

With central bankers around the world following the lead of the FED, financial assets are busy chasing bubbles around the world with little left to spark a solid economic recovery and sustainable new job creation. As long as these bubble opportunities exist & yield high rates of returns, earnings will continue to be skewed in favor of the already-rich with little growth real wages of workers, worsening income disparities.

There are those that think that increased concentrations of income, diversion of resources to the financial sector & an AWOL recovery require more regulations, more stimulus & perpetuation of current monetary policy. But all of these are symptoms of the same cause: “unconventional” monetary policy.

I often suggest that had I described the current policy as a sensible scenario during my doctoral-level studies on monetary policy during the 1970s, the professor would have failed me on the spot. (And probably thought I was a candidate for the looney-bin!) But today, these policy choices go unquestioned despite their perpetual failures.

It is imperative that we begin reversing the ruinous course that is being plotted that is disrupting investments in sustainable industrial projects as the basis for long-term economic growth. This can & will only begin when central bankers stop acting like central planners in setting interest rates.

Ironically, economic recovery might only return when interest rates begin to rise toward their higher natural rate.

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About christopher

Content of "Natural Order" attempts to reflect the commitment of Universidad Francisco Marroquin to support the development of a society of free & responsible individuals. The principal commentator for this blog is Christopher Lingle.

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