THE ABC'S OF FINANCE CAPITALISM
Contrary to the title of my book, When Corporations Rule the World, it's actually the global financial system that's in charge. Much of the dysfunction in our economic system can be explained by the fact that the ruling financial elite has largely detached itself from most everything real. It pursues its own independent agenda and in the course of doing so is wreaking havoc on human societies everywhere.
While the stock market is booming and we are assured that we are getting richer by the day, we are also told that there is no longer enough money to provide an adequate education for our children, health care and safety nets for the poor, protection for the environment, parks, a living wage for working people, public funding for the arts and public radio, or adequate pensions for the elderly. How is this possible? What's gone wrong?
The Real Economy vs. the Money Economy
To start with, we must get one basic point absolutely clear: money is not wealth. Money is a claim on wealth. Money itself is merely a number, sometimes printed on a piece of paper or embossed on a coin; other times existing only as blips in a computer. But basically it is an abstraction. An idea. Money isn't really much use, except as others will accept it in exchange for things that are of real value: i.e., real wealth.
What we normally call "the economy" is in truth two separate systems. One is a real world system of natural and human wealth-creation. It consists of factories, commodities, farms, stores, transportation and communications facilities, the natural productive systems of the planet, and people going to work in hospitals, schools, stores, restaurants, publishing houses, and elsewhere to produce the goods and services that sustain us. Call it the real economy or the wealth-creating system.
The second system, which we can call the money system, creates and allocates money itself. The money system is rather the less substantial system, as it is constructed solely of abstractions: buying and selling currencies, futures, stocks, etc.; money creating more money. Its importance comes from the power it has to determine how the real wealth created in the first system is ultimately distributed. It is a curious division of responsibilities. In the first system, people work to create the world's useful goods and services. The people in the second system devote themselves to creating and maintaining a system of numbers that decides who will benefit from the work done in the first system.
Finance Capitalism: An Economic Disease
In a healthy economy, the money system is not the dominant value, nor is it the sole or even dominant medium of exchange. In an institutionally sick economy, the money system becomes dominant, as it has today. For example, as Bernard Lietaer also points out, 97.5 percent of foreign exchange transactions in the world are now that of the money system rather than the real economy. The creation of money has detached from the real economy. There is a name for this economic disease. It's called "finance capitalism."
When financial assets and transactions grow faster than growth in the output of real wealth, it is a strong indication that finance capitalism has taken hold. The returns to the money system escalate and the wages of working people decline. The biggest profits are going to those who deal in pure finance. For 1996, the shareholders of the seven largest U.S. money center banks reaped an average total return of 44 percent. The 24 largest U.S. diversified financial services companies yielded their shareholders an average total return of 38.4 percent. Mutual funds specializing in finance averaged a 26.5 percent return, besting all other industry categories by a wide margin. But funds specializing in much touted technology stocks came in at 21 percent.
The term "international capital flow" used to conjure up images of large ships transporting products, machine tools, and capital goods from one country to another to add to productive capacity. Most often, however, it involves nothing more than a bank transferring some numbers from one account to another-quite possibly solely within its own computer.
Creating "Financial Bubbles"
In today's world, every financial market on the planet is linked to the same computer system. Money managers all around the world sit in front of their computer screens, watching prices move. If prices are moving up especially fast in a particular market, others want to be in on the action. They start competing to buy stocks in that market. The prices then rise even more quickly, creating what is called a financial "bubble."
One example of a speculative "bubble" economy bursting was provided recently in Albania, which suffered a national crisis brought on by the collapse of fraudulent investment schemes. Westerners wise in the ways of the market were bemused by the naiveté of the Albanians who fell for "investment" schemes promising returns as high as 25 percent a month with no real business activity behind them. Using the classic pyramid scam, the perpetrators used money from new investors to pay the promised returns to earlier investors. The result was a national speculative frenzy. Farmers sold their flocks and urban dwellers their apartments to share in the promised bonanza of effortless wealth. The inevitable collapse sparked widespread riots, arson, and looting when the Albanian government failed to make up the losses.
Those inclined to laugh at the innocence of the Albanians should first consider their own response to the promises of those who propose investing social security contributions in a stock market that even Alan Greenspan, chairman of the Federal Reserve, says is substantially over valued. Such speculative financial bubbles - whether in stock market or currency pricing - that involve bidding up the price of assets far beyond their underlying value are little more than a sophisticated variant of the classic pyramid scam.
Betting on bubbles is a favorite pastime in the big cyberspace casino known as the global financial market. The stock markets of newly emerging industrial countries are among the bubble-betters favorites. When stock prices soar on the exchanges of countries such as Mexico, Malaysia, and Thailand, investment advisors talk about the high rates of return available in emerging markets. These rapid increases in share prices are in part a function of booming economies (based on gross domestic product), but they also reflect that the total market for shares in these countries is relatively small. When outside investors start bidding feverishly on a finite pool of stocks, the price goes up. It's a basic law of the market.
When Bubbles Burst
Of course, bubbles have a tendency to burst. And when financial bubbles burst, the money flows out even faster than it flowed in and prices then plummet. That is what we saw in the Mexican peso crisis. The experts say that probably no more than 10 percent of the $70 billion that flowed into Mexico over five years during the boom went into anything resembling productive investment. Most of it was used to pay off other foreign debts, import luxury goods, and to finance capital flight. The big losers were the working and middle classes. Wall Street bankers and investment houses holding peso denominated stocks and bonds turned to President Clinton for help, who assembled a bailout package of loans and guarantees that put up as much as $50 billion in U.S. taxpayer money to shore up the speculator's holdings.
Financial bubbles are not limited to emerging markets. Over a number of years, financial bubbles inflated stock and land values in Japan well beyond any realistic underlying value. At the peak of the bubble, the total value of Japanese real estate exceeded that of all North America. The bubble burst in 1989, sparking a major financial crisis.
How Is Money Created?
Where does the money come from to fuel a financial bubble? Much of it comes from the same place where most of our money originates - from borrowing. Most of our money is created by banks loaning it into existence. A bank is allowed to lend out as much as 90 percent of the money it has on deposit. The deposits continue to exist as money of the depositor, while the loan creates a new account against which the borrower may withdraw cash or write checks. Almost by magic, $1,000 in deposits is thus turned into $1,900 in available money. Both stocks and land are assets against which the asset holder is able to borrow.
Most small shareholders may invest their savings in stocks or land. The big players are able to supplement their savings by borrowing to purchase stocks or even borrowing against stocks to gain "leverage." If the margin requirement on stock purchases is, for example, 30 percent, one need only put up $300 for every $1000 worth of stock purchased. The higher the market value of the asset (e.g. stock) goes, the larger the loan it can be used to secure. It is important to remember that stocks are value created assets, meaning they have no real intrinsic value. A financial bubble thus actually creates money out of virtually nothing.
The bubble can grow without apparent limit until something makes the players nervous and too many of them decide to sell out and claim their profits. Then the bubble collapses and the value of the assets plummet, sparking a crisis among the banks that are left with substantial portfolios of uncollectible loans and governments are almost always forced to step in with a bailout to stop a banking collapse - as the U.S. government did in the savings and loan crisis. Financial bubbles are one mechanism that creates money without creating value. Of course, the finance capitalists have a considerable variety of other mechanisms for transferring money - a claim on wealth - to themselves without commensurate contribution to the wealth-creation process. These include speculating on price movements and derivatives, and engaging in arbitrage to profit on minor time lags between markets. Their very transactions can create instability in currency markets, which forces governments to intervene with public monies that flow directly into the speculators' pockets. In each case the finance specialists transfer claims to real wealth to themselves at the expense of those who actually do productive work.
While economists have become exceedingly facile in rationalizing how these predatory activities actually benefit society, they are in truth more accurately described as forms of legal theft, by which a clever few expropriate rights to the real wealth of society while contributing more to its depletion than to its creation.
Competing for Money
William Greider, in his book One World, Ready or Not, observes that real-economy corporations are caught in the trap of having to compete for investment funds against the often more lucrative games of the world of pure finance. That places intense pressure on them to increase their profits way beyond what otherwise might be considered reasonable and responsible.
The profit levels demanded by investors are most readily achieved by externalising a major portion of production costs, that is, getting tax payers to subsidize pollution clean-up, workers' benefits, trade infrastructure, and other costs so that the corporation doesn't have to foot the bill. Companies also move to nations where they can pay less than a living wage, break up labour unions and bargain down labour unions with the threat of moving their jobs, and where they can dump their toxic wastes into the ground. The companies use their financial clout to bribe politicians to get more tax breaks and subsidies, and to reduce government expenditure on education, welfare, infrastructure for mass transit, and other public goods.
One of the many consequences for corporations such as General Electric, Cargill, Proctor & Gamble, and others is that they are compelled to create their own in-house financial operations to play the markets. That's where the money is.
Over the last several years, the biggest corporations have been increasing their profits by an average of 20 percent a year. This sets a floor under the market's expectation. Fund managers are becoming increasingly aggressive in demanding such performance from companies. If a company starts lagging in its growth, it may act to replace its board of directors and CEO. The socially conscious CEO is well aware that professional buy-out artists are drawn like bees to honey by a firm that is being socially responsible by such acts as internalising environmental costs, or by paying union wages, investing in worker training, fully funding pension funds, and paying a full share of taxes. To financial traders, these policies are likely to be seen as inefficiencies to be eliminated, or pools of funds to be raided.
My key recommendations focus on returning the money system to its proper role of servicing the wealth-creation process. This will require corrective measures that need to:
1) make speculation unprofitable;
The purpose of such measures is not to increase global growth and competition. Rather it is to create healthy and prosperous societies that provide economic security and just rewards for productive contribution to their members, that have a strong and caring social fabric, and that live in balance with their environment. The required measures will surely inconvenience corporations and financial speculators, but theirs are not the interests that human societies exist to serve.
There are some specific measures that can be taken. The following suggestions are put forward as possibilities meriting further examination: