David Stockman: Financialization is a Product of Monetary Central Planning

I have written a lot about how the evolution towards “financialization”—where the finance industry has practically grown in such a huge size to eclipse traditional economic sectors as the industry and agriculture—has been due to the US dollar standard and how this has reconfigured today’s global financial and economic structure. As examples see here, here here and here. 

I have also noted that financialization has been an unintended consequence from Triffin Dilemma also brought about by the US dollar standard. 

Former politician and current iconoclast David Stockman eloquently explains how the tampering of the incumbent monetary system, or specifically the conversion from Bretton Woods 'fixed exchange standard' to the US dollar standard operating mostly on ‘floating exchange rate’ has sired “financialization” that has benefited mostly Wall Street.(from David Stockman’s Contra Corner) [bold mine, italics original]

Under the fixed exchange rate regime of Bretton Woods—ironically, designed mostly by J.M. Keynes himself with help from Comrade Harry Dexter White—there was no $4 trillion daily currency futures and options market; no interest rate swap monster with $500 trillion outstanding and counting; no gamblers den called the SPX futures pit and all its variants, imitators, derivatives and mutations; no ETF casino for the plodders or multi-trillion market in “bespoke” (OTC) derivatives for the fast money insiders. Indeed, prior to Friedman’s victory for floating central bank money at Camp David in August 1971 there were not even any cash settled equity options at all.

The world of fixed exchange rates between national monies ultimately anchored by the solemn obligation of the US government to redeem dollars for gold at $35 per ounce was happily Bloomberg-free for reasons that are obvious—albeit long forgotten. Importers and exporters did not need currency hedges because the exchange rates never changed. Interest rate swaps did not exist because the Fed did not micro-manage the yield curve. Consequently, there were no central bank generated inefficiencies and anomalies for dealers to arbitrage. Stated differently, interest rate swaps are “sold” not bought, and no dealers were selling.

There were also natural two-way markets in equities and bonds because the (peacetime) Fed did not peg money market rates or interpose puts, props and bailouts under the price of capital securities. This means that returns to carry trades and high-churn speculation were vastly lower than under the current regime of monetary central planning. Financial gamblers could not buy cheap S&P puts to hedge long positions in mo-mo trades, for example, meaning that free market profits from speculative trading (i.e. hedge funds) would have been meager. Indeed, the profit from “trading the dips” is a gift of the Fed because the underlying chart pattern—mild periodic undulations rising from the lower left to the upper right–is an artifice of central bank bubble finance.

And, in fact, so are all the other distincitive features of the modern equity gambling halls—index baskets, cash-settled options, ETFs, OTCs, HFTs. None of these arose from the free market; they were enabled by central bank promotion of one-way markets—that is, the Greenspan/Bernanke/Yellen “put”. The latter, in turn, is a product of the hoary doctrine called “wealth effects” which would have been laughed out of court by officials like William McChesney Martin who operated in the old world of sound money.

In short, Wall Street’s triumphalist doctrine—claiming that massive financialization of the economy is a product of market innovation and technological advance—is dead wrong. We need “bloombergs” not owing to the good fortune of high speed computers and Blythe Master’s knack for financial engineering; we are stuck with them owing to the bad fortune that Nixon and then the rest of the world adopted Milton Friedman’s flawed recipe for monetary central planning.

In short, the US dollar standard has spawned one colossal global bubble finance.

I recommend that the article be read in the entirety: via the link here

 

Another beneficiary of the financialization, of course, has been the government. Such has been accommodated through exploding global debt markets as shown in the chart above. 

And as pointed out earlier, 

"the real reason why governments promote the quasi permanent inflationary boom is to have access to money (via credit markets and taxes) to support their pet projects. And proof of this is that global debt, according to the Bank of International Settlements have ballooned to $100 trillion or a $30 trillion or a 42% increase from 2007 to 2013 due mostly to government spending. Such colossal diversion of resources is why the world is now faced with a clear and present danger of a Black Swan economic and financial phenomenon." 

In other words, financialization functions as a key instrument to rechannel or divert economic resources from society to political agents and their cronies backed by guarantees from central banks. And bubble blowing is just one of the major consequences. 

Yet what is unsustainable will eventually stop.