Finance with a life of its own

Readers might think I have an issue with the world of finance. Not at all: finance is fundamental in the lives of people, companies and nations. Readers might stop to consider what would happen if there were no banks, money, credit, investments, wealth management… Well, we already knew how that was a few millennia ago, when we lived in  caves. And we perceived what could be repeated with Argentina’s corralito. Banks closed two thirds of the month, bank accounts frozen for days, the inability to make payments and, even worse, to get paid. The prospect of losing an important part of the wealth that we had…

Readers have already seen my comments about John Kay. He just published a book titled Other People’s Money, in which he argues that the financial institutions have abandoned their social function , which was to act as intermediaries between savers and investors, channeling funds from the former to the latter, keeping and protecting the wealth of the former and helping the latter make this wealth productive. Kay says that financial institutions carry out most of their operations among themselves: only 3% of transactions at British banks involve goods and services companies, the real economy. The main function of banks is now “exchanging pieces of paper” among themselves. This obviously generates more liquidity, but the liquidity is for them, for the ones exchanging pieces of paper. And that’s only when they don’t get their profits from fiscal maneuvers, regulatory arbitrage or accounting manipulation. 

I have told my readers previously that the cause of this must be found in the evolution of financial theory, over the last century, culminating in the 1950s with the theory of portfolio management. This theory is informed by the creation of value for capital, given a level of risk. Capital is no longer an intermediary with the real economy, whose profitability depends on it, but rather an autonomous entity, with a life of its own, capable of increasing its value (limited by risk) without reference to the real economy, motivated to do so because resources are scarce (financial ethics is that of economic efficiency, because resources are scarce), and made possible by the creation of institutions, products, markets and agents dedicated to this.

There are many left-leaning people backing this argument, for ideological reasons, related to the collapse of capitalism, which will have to be replaced by another system, about which we currently know only a little background whose totalitarian, dehumanizing and inefficient consequences scare us. But Kay is not to be accused of leftism. What he is saying is that we need to rethink our finance models . A huge task for economists, finance theorists and those who put them into practice… If we are able to inspire visions of a humankind that is wealthier than those of the homo oeconomicus.