Last Wednesday (November 22, 2023), the Tory government in Britain released their fiscal update known…
Next week, I am attending a meeting which I hope will finalise discussions I have been having with some key prospective partners in putting together a major MMT-Green New Deal initiative in Australia which will have global ramifications. It will bring together MMT with climate action and indigenous rights interests. We propose to begin a ‘roadshow’ in November to start our campaign. Our discussions to date have been very productive and we will issue a ‘White Paper’ in the coming months to articulate what we conceive as a jobs-first, equity-first MMT-Green New Deal might look like. This work will also form the basis of talks I am giving in the coming month throughout Europe and the UK. I have already started sketching elements of my thinking on this topic under the category – Green New Deal – which also contains a long history (now) of relevant commentary. Today, I am focusing on another element that I consider to be a core part of a progressive MMT-Green New Deal campaign – dealing with unproductive financial markets. I am not for one minute thinking any of the analysis today (or any of the GND stuff) is likely to be implemented without a massive and lengthy struggle. I think I understand vested interests. So a valid retort to the ideas is not to accuse me of being politically naive. My role, as an academic, is to work through things and lay out blueprints to guide directions of activity based on that thinking. It is not to assess the likelihood of success of the blueprints being implemented. I sort of see these blueprints as being benchmarks – to assess where we are at and how far it is to go. And as debating vehicles which define what opponents have to address. But, moreover, I do see them as being guides for campaigning strategies, which can then be implemented by those who know more about those things than I ever will. This is a two-part series.
Keynes and ‘long-term expectation’
In John Maynard Keynes’ – The General Theory of Employment, Interest and Money – we learned (long ago) in his discussion in Chapter 12. The State of Long-Term Expectation, that capitalist investment decisions depend on “the prospective yield of an asset”.
That return takes into account “future events which can only be forecasted with more or less confidence”.
These future events include “the strength of effective demand from time to time during the life of the investment under consideration” and other facts such as possible cost fluctuations.
He termed these guesses the “state of long-term expectation”.
Keynes noted that the problem is that the “development of organised investment markets … which facilitate investment but sometimes adds greatly to the instability of the system.”
In the absence of security markets, there is no object in frequently attempting to revalue an investment to which we are committed. But the Stock Exchange revalues many investments every day and the revaluations give a frequent opportunity to the individual (though not to the community as a whole) to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and II in the morning and reconsider whether he should return to it later in the week. But the daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and another, inevitably exert a decisive influence on the rate of current investment.
He was clear that there was a lot of daily ‘wealth shuffling’ going on in the financial markets which distorts the choice between long term productive investments and shorter-term speculative investments.
He noted that “organised investment markets” generated a sense of security among investors because ” the only risk he runs is that of a genuine change in the news over the near future” rather than committing to a “old-fashioned type … decisions largely irrevocable, not only for the community as a whole, but also for the individual” – by which he was meaning investments in large productive infrastructure (factories, plant etc).
In other words, the short-term fluctuations in the financial markets are “unlikely to be very large” and are thus “reasonably ‘safe'” as long as “convention” is maintained (habits and behaviours).
The investor “need not lose his sleep merely because he has not any notion what his investment will be worth ten years hence”.
He believed that these properties of financial markets undermined the possibility of “securing sufficient investment” (in productive ventures).
1. The growth of financial products meant that “real knowledge in the valuation of investments by whose who own them or contemplate purchasing them has seriously declined”.
2. “Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market.”
3. “the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield” – the lemmings charging over the cliff mentality.
4. “the energies and skill of the professional investor and speculator … are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.”
That is, the financial markets have emerged not to provide for general public well-being, which historically required broadening the scope and quality of long-term productive capital, but, rather to extract as much as possible financially in the shortest period of time for specific interests.
He noted that it was rational (“not the outcome of a wrong-headed propensity”) for people to behave in this way – “an inevitable result of an investment market organised along the lines described”.
But while it was rational to pursue short-term ‘liquidity’ gains – none of the “maxims of orthodox finance … is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of ‘liquid’ securities.”
This ‘fetish’ ignores the well-being of the “community as a whole”.
It has engendered a culture where the:
… actual, private object of the most skilled investment to-day is ‘to beat the gun’ … to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.
He considered that conceps such as long-term value disappear in these markets:
For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs – a pastime in which he is victor who says Snap neither too soon nor too late, who passed the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.
These markets are like casinos – eventually losses are incurred.
They also undermine the probability of long-term productive investment, which:
… needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun.
Less intelligence … and anyone “who is entirely exempt from the gambling instinct” finds the “game of professional investment” to be “intolerably boring”.
Taken together, these factors lead to markets being organised which create a dominance of “speculation … forecasting the psychology of the market” over “enterprise … forecasting the prospective yield of assets over their whole life”.
Not only is there a misallocation of investment resources to short-term speculative ventures, but, also, the increased risk of speculative “bubbles” harming “a steady stream of enterprise”:
When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street … regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez- faire capitalism – which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.
Keynes provided some suggestions for “mitigating the predominance of speculation over enterprise”.
1. the financial market “casinos should, in the public interest, be inaccessible and expensive”.
2. “introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available”.
3. “make the purchase of an investment permanent and indissoluble, like marriage”.
4. “The only radical cure for the crises of confidence which afflict the economic life of the modern world would be to allow the individual no choice between consuming his income and ordering the production of the specific capital-asset …”
He also considered that in the case of productive investments in say buildings – “the risk can be frequently transferred from the investor to the occupier, or at least shared between them, by means of long-term contracts”.
In the case of another important class of long-term investments, namely public utilities, a substantial proportion of the prospective yield is practically guaranteed by monopoly privileges coupled with the right to charge such rates as will provide a certain stipulated margin. Finally there is a growing class of investments entered upon by, or at the risk of; public authorities, which are frankly influenced in making the investment by a general presumption of there being prospective social advantages from the investment, whatever its commercial yield may prove to be within a wide range, and without seeking to be satisfied that the mathematical expectation of the yield is at least equal to the current rate of interest,-though the rate which the public authority has to pay may still play a decisive part in determining the scale of investment operations which it can afford.
In other words, when assessing public infrastructure investment “commercial yield” should not come into it.
I have written about that in the past, for example – Public infrastructure does not have to earn commercial returns (December 20, 2010).
The “general presumption of there being prospective social advantages” should always guide public infrastructure spending.
The neoliberal period has marked the shift away from that logic towards user-pays, commercial returns, private BOOT arrangements, all of which skew the type and scope of investments.
Coupled with the austerity bias and the downplaying of fiscal policy and we end up with diminished investments in essential infrastructure, while trillions get poured in the financial market speculation.
Keynes preferred solution – yes, published in 1936, is apposite today:
I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment …
He didn’t trust the ‘markets’ to correctly price in these long-term advantages and that “fluctuations in the market estimation ” of the returns on capital … will be too great to be offset by any practicable changes in the rate of interest.”
Which meant that he was “somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest” in influencing sensible investment behaviour.
These insights are, of course, at the centre of the debate now – the growing acceptance of the Modern Monetary Theory (MMT) position that reliance on monetary policy has not been a success and that a period of fiscal dominance is emerging.
Part of that shift in policy focus should be to frame the challenges of the Green New Deal in a much more sensible way – avoiding ridiculous questions such as ‘how are we going to pay for it’ and statements such as ‘we cannot afford it’ when the proponents are constructing those questions purely in terms of not having ‘enough currency’ to facilitate the required real resource shifts.
Growth of financial markets
Clearly, Keynes would have been astounded by what has happened over the last several decades in the proliferation of financial markets and the increasingly unproductive nature of their activities.
On February 4, 2019, the Basel-based Financial Stability Board, which says it “is an international body that monitors and makes recommendations about the global financial system”, published its latest – Global Monitoring Report on Non-Bank Financial Intermediation 2018 – which is also accompanied by the supporting datasets.
In assessing the likelihood of “bank-like financial stability risks” arising (what they term a “narrow-measure of non-bank financial intermediation”) the, latest report (the 8th in its series since the GFC) shows that:
1. “The narrow measure of non-bank financial intermediation grew by 8.5% to $51.6 trillion in 2017, a slightly slower pace than from 2011-16.”
2. “The narrow measure represents 14% of total global financial assets.”
3. “Collective investment vehicles (CIVs) with features that make them susceptible to runs continued to drive the overall growth of the narrow measure in 2017.”
4. “In 2017, the wider “Other Financial Intermediaries” (OFIs) aggregate, which includes all financial institutions that are not central banks, banks, insurance corporations, pension funds, public financial institutions or financial auxiliaries, grew by 7.6% to $116.6 trillion in 21 jurisdictions and the euro area, growing faster than the assets of banks, insurance corporations and pension funds. OFI assets represent 30.5% of the total global financial assets, the largest share on record.”
The terminology has shifted to “non-bank financial intermediation” from “shadow banking” to massage favourable public perception. But the reality remains.
And increasing number of banks are reliant on “loan provision that is dependent on short-term funding” (speculative) and the proportion is growing.
The FSB introduced what they called ‘macro-mapping’, which uses aggregate data to compile financial risk indicators for the so-called Shadow banking system.
The broad measure includes all institutions in the financial sector except banks, insurance companies and pension funds.
I used the FSB data to compile the following graphs for the Eurozone.
The first graph shows the growth of assets held by the OFIs from 2002 to 2017.
By 2017, total assets held by OFIs were $US37,423.1 billion having grown by 430 per cent since 2002. Similar graphs can be compiled for any number of companies.
The following table shows the overall growth rates in OFI assets for the nations (groups) and periods that the FSB publishes data:
And just in case you might think otherwise, the next graph shows the cross-plot with the growth in OFI assets on the horizontal axis and the real GDP growth rate between 2002 and 2017 for the Eurozone.
The dotted line is a simple linear regression. While simplistic it would be hard to get a positive relationship out of this data between these variables using more sophisticated techniques.
You can see that when real GDP growth was negative (2008 and 2009 and 2012) the OFI assets growth was strong.
The relationships shown in these graphs are common across most jurisdictions.
The focus of regulators has been on trying to come up with risk assessment frameworks.
They obviously avoid the deeper question as to why we should tolerate the growth of this sector, when the outputs are as Keynes knew full well – not conducive to long-term well-being.
And it is clear to date that regulators have not been able to contain the risks that meltdowns in these markets cause damage to the real economy – output, employment, workers’ incomes and job security.
In Part 2, I will discuss what I see as the way forward if we are to integrate financial market reform within a MMT-Green New Deal framework.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.