Description and definition of financialization.
The 1970s crisis, known as the ‘oil crisis’, marked one of the toughest challenges that capitalism had to face. The oil issue was only the beginning of a convulsive decade that led to a stagnation of the global economy. The difficulties to get profit out of production and the excessive power of labor provoked that capital looked for alternatives to follow its mantra: constant grow. The recipe was to apply the neoliberal economic policy. Less state; privatization of public companies. Globalization; factories relocation. Financial deregulation; financialization of the economy.
EU member states turned in a defensive nationalism mood. President Ronald Reagan in the USA and Margaret Thatcher in the UK were the main drivers of the new neoliberal paradigm. Both mandatories detected that labor was gaining an excess of power and that unions started to be seen as a distortion element for the competitiveness of the companies suffering from other countries lower salaries. The recipe for the excess power of labor was to discipline it. One of the effects of these policies was that wages got frozen for a huge part of the population. Low wages meant no money to spend so banks invented and promoted credits cards to keep the business wheel well greased. As labor union power declined, national share of middle-class income also declined. By 1985 capitalists gained access to the world labor supply (E.g. China). Nobody then blamed the greedy unions anymore. Then the problem was not an excess power of labor anymore, it was the excess power of capital and in particular the excess power of finance capital which is the root of the problem.
Capitalism is lasting so much thanks to the ability to introduce changes in the system so the whole system doesn’t have to change. As Karl Marx said, “The circulation and accumulation of capital cannot abide limits. When it encounters limits it works assiduously to convert them into barriers that can be transcended or by-passed. Feudalism and communism collapsed, capitalism didn’t. It’s been able to avoid all the barriers. The combination of increased access to credit in financial markets and the new policy framework described by the neo-liberal box, have together created a new business cycle since 1980. An overvalued dollar, trade deficits, disinflation or low inflation, manufacturing job loss, asset price (equities and housing) inflation, widening income inequality, a detachment of worker wages from productivity growth, and rising household and corporate indebtedness.
The late 70s deregulated financial markets neoliberal approach with the aid of new communication and technology systems, created new and sophisticated financial instruments like the derivatives, (financial asset whose profitability derives from another asset), a very speculative and hard to follow. New and sophisticated products such as the exchange of bonds, shares, funds, etc. emerged as a phenomenal business creating a growing acceleration of international financial markets. The new game rules allowed to finance growing trade expansion, bypass national regulations, elude political and fiscal control and reduce the portfolio risk with a wide investment diversification. Capitalists were happy because consumers kept on buying, banks were happy because they made money with each and every transaction, governments were happy because everything looked smooth. But people were getting trapped in a never-ending debt way of life. American and British households tripled their debt in a few years. Non-financial corporate and household sector debt rose sharply relative to GDP, with the break happening in 1979.
Logics and drivers of the financialization.
“Financialization refers to the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy and its governing institutions, both at the national and international level”. Financialization transforms the functioning of economic systems at both the macro and micro levels.
Financialisation contributed to elevate the significance of the financial sector relative to the real sector, transfer income from the real sector to the financial sector, and increase income inequality and contribute to wage stagnation. One of the capitalism mantras is that everything can be marketed. Capitalists soon realized that to make a lot of money it was so much effective lending it than producing a good. So they switched into a creative greed mood and started to give credit to people with low incomes to buy expensive houses. As financial profits grew, industry in core countries went downhill. Human beings became a resource instead of a person. The global shopping center was being created for the glory of capitalism and the utopian idea of happiness for the indebted middle class. In the United States, in the mid-1970s, the richest 1 % of the population captured about 8 % of national income; by the 2000s, this group received double that proportion or 16 %. So we have a situation where the financial market owns the means of production, money.
The defining feature of financialization in the U.S. has been an increase in the volume of debt. The financialization of economies refers to the imbalance between circulation and production, linked to changes in the relationships between financial entities, companies, and workers. Using peak business cycle years for purposes of control, from 1973 to 2005 period, total debt rose from 140 to 328.6 % of GDP. At the macroeconomic level, the era of financialization has been associated with economic growth. Financial sector debt also grew much faster than non-financial sector debt, from 9.7 to 31.5 % of total debt over the same period. 1979 appears to mark a breakpoint, with financial sector debt increasing much more rapidly relative to non-financial sector debt thereafter.
The financialization paradigma creates an artificial market were huge amounts of money travel at speed light with enormous profits for few actors over the real economy. Banks tend to abandon their traditional business of lending money and prefer to sell financing products. Everything becomes a financial asset like mortgages, state debt, and speculative investors penetrate in every sector. States becomes an accomplice of the financial sector by eliminating capital control, deregulating markets and applying deflationist monetary policy. Central Banks manipulate the amount of money circulating with the Interest rate. High-interest rate to restrict the capacity of demand and increase savings, low-interest rate increases demand. When consumption is based on credit, it is disconnected from the real capacity. We live in debt. Debt is supplied by global capitals.
Another characteristic of financialization is the capital concentration and centralization. Companies become bigger by merge and acquisitions deals encouraged by the financial sector. The main drive of this kind of operations is not an industrial or sectorial one but the financial savings, the debt accumulation and the so-called structural synergies which means an enormous amount of job losses for the benefit of the shareholders. A lot of money is needed to run or to compete against a large corporation. The only stock market, banks, and states have access to that amount of money so finance markets run the industry. The logic of finance is to get a profit in the short run, they are not entrepreneurs. This creates high volatility of the industry value. The emergence of finance led to a drain of resources from the real economy so the productivity went down. Corporations policies evolved in the 70s prioritizing shareholders’ satisfaction before anything else. Top management compensations with stock option grants changed the way companies are managed. The goal switched into presenting great numbers for the next trimester. A very short-term focused management that derive into financial decisions over sustainable and long-term ones. Non-financial corporate borrowing changed. Before the 1980s it financed investment spending, but since 1980 a significant portion of borrowing appears to be for purposes of equity buybacks. The difference between the value of the real economy and the financial economy is a bubble.
What are the main impacts on national economies?
The 30 year period between the end of the second world war and the seventies have seen very few global crises. But from the 70s on the world entered in a dangerous crisis recurrency every three or four years. Financial globalization generates micro and macroeconomic impacts on national economies, causing both direct and indirect costs.
The main impacts in national economies are:
Globalization trilemma: Countries either have an independent monetary policy that let them freely decide their economic policies or encourage free capital mobility with no restrictions for moving money or guarantee a stable exchange rate. No country can have the three options running at the same time, that’s why it is called a trilemma.
Financial crisis: Financialization transforms the functioning of the economic system at both the macro and micro levels leading to a financial fragility made evident in the 1990s and early 2000s crisis.
Overborrowing: “Borrowing is supported by steady financial innovation that ensures a flow of new financial products allowing increased leverage and widening the range of assets that can be collateralized. Additionally, credit standards have been lowered in recent years, which has made credit even more easily available to households, firms and financial investors. Meanwhile, cheap imports ameliorate the impacts of wage stagnation, widening income inequality, manufacturing job loss, and increased economic insecurity.”
The 2008 crisis is an example of how the deregulated markets of financialization led to a global crisis that began in the US and spread all over the world. Investors used to buy Treasury bills from the US treasury as it was the safest investment. But Alan Greenspan lowered the interest rate to only 1% after the 9/11 terrorist attacks to keep the economy strong. A 1% was not enough for the investors so they stopped buying bills from US treasury. The banks from Wall Street started to borrow money from the Fed at only 1% cost and it created a huge amount of cheap credit. Banks got crazy with that much money and raise the attention of the investors who began to create sophisticated and obscure products. There are some cultural origins to the crisis that must be taken into account: for example the US obsession to own a house – 68% of US households are homeowners for 22% in Switzerland – supported by the mortgages interest tax deduction (a huge subsidy promoted since the 1930s so that debt incumbent homeowners don’t go on strike.). The mortgage market was growing at two digits due to the abundance of credit that led banks to give a mortgage to high-risk families. Investors added insurances to that high-risk mortgages, relying on prices never going down, and designed sophisticated financial products with creative names such as ‘Collateral Debt obligation’, CDO to resell them. When some of the homeowners defaulted on their mortgages, banks started ‘collecting’ houses and put them for sale at a higher price. But as more and more monthly payments turned into houses that the prices went down – more supply than demand-. Homeowners still paying their mortgages to find out that their debt was bigger than the value of the house and they stop paying – even do they could – and walk away from the house and the prices go down in the whole.
Financialization impacts also on how wealth is being distributed. Increasing inequality in the last 40 years is the most painful consequence. Some inequality is inevitable but when it becomes a problem, democracy is at risk. Of all the developed nations, the United States has the most unequal distribution of income and wealth by far. The richest 400 Americans own more wealth than half the population of the United States. There is parallelism on what happened after the 1929 crisis and after 2008 one in terms of income concentrated in few hands. The wealth flew into the financial sector in both periods and middle class suffered from wages stagnation and dragged into a debt spiral to maintain their living standards and that created a debt bubble. A strong middle class is vital for any economy, is what keeps the economy going. This kind of capital accumulation in the hand of few doesn’t help the economy running. The wealthiest spend a small amount of their wealth to live and invest the rest of it on non-productive assets with the highest returns at the global capital market.
GDP growth, productivity, and stock market shows a steady curve in the Core countries for the last 40 years… One of the reasons why corporations did so good is because they were keeping pay down with all sort of excuses while at the same time CEOS were paying themselves large multiples of what workers were getting. Globalization and technology have reduced the number of jobs available for Americans and living costs increased: rent, homes, health care or higher education. Between 1997 and 2007 finance was the fastest growing part of the American economy. In 2009, the year after of the 2008 crash, the seven highest paid hedge fund managers were making more than 1 billion dollars each. This is one of the consequences of deregulating Wall Street. Middle-class families fought against wage stagnation by incorporating woman to the labor market, working more hours per week and going into debt. When the middle class is no longer consuming, the virtuous circle turns into a vicious one.
When so much money is accumulated at the very top, this money can have the capacity to control politics. In the 2012 elections, billionaires contributed with huge sums of money to individual candidates. Liberal and conservative billionaires spend billions in lobbying for bailouts, subsidies, and taxes. Taxes of the richest never lowered 70% until the Ronald Reagan administration did it. Billionaires like Warren Buffett raised his voice about the unfairness of his tax rate, 17’7%, compared to his office workers, 32,9 %. Polarisation of political options matches with inequality periods. The Tea Party movement was born in the wake of the Wall Street bailout as a way to gather the neoliberalism protest against government intervention. On the other side, the Occupy Wall Street movement erupted has focused its anger on Wall Street and the big corporations. The society is starting to pull apart
Financialization like global warming or terrorism thread cannot be addressed by a single country. Countering financialization calls for a multifaceted agenda that restores policy control over financial markets, challenges the neoliberal economic policy paradigm encouraged by financialization, makes corporations responsive to interests of stakeholders other than just financial markets, and reforms the political process so as to diminish the influence of corporations and wealthy elites. This is the utopic policy that should be considered if core countries agreed to act together. Corporations and wealthy elites are not interested at all on this kind of changes. The problem for them could come when the global and exhausted middle class explodes due to an unbearable debt and the awareness that the technological revolution will destroy jobs faster than creates new ones. Occupy wall street in New York, 15M rallies in Madrid and the yellow vests protesters at France could be the beginning of the change. But, as I said at the beginning of the essay, capitalism has the ability to evolve and make changes in the system so the system doesn’t have to change.
Blanquerna–Ramon Llull University, School of Communications and International Relations. Master’s Degree in International Journalism.
Subject: International Economic Structure.
Writer: Roger Valsells Aguilà
Professor: Xavi Martí