What is an economy?
Perhaps the greatest difficulty I have talking about the economy is that most people don’t understand what an economy is.
An economy is what people produce and the relations that make that production possible.
An economy is not money. Printing more money does not automatically increase the size of the economy as various episodes of hyperinflation clearly indicate, but also as the giant printing of money in the last five years should have shown to people.
Money is created by printing in a fiat economy, whether it is physically printed or not. When a bank creates a loan it simply adds numbers to various accounts, and it does not have to “have money to loan”. The same is true of brokerages offering loans for stock purchases and so on. There is no direct organic relation between the amount of money in the economy and the amount of economic activity.
Moreover it is quite possible to increase the amount of money in the economy while decreasing activity. When a huge loan is taken out to buy a company, and then the company has employees slashed and plants closed, real economic activity decreases, even as the amount of money increases. When you insist on 15% profits and obtain them by refusing to do needed maintainance, firing employees, doing stock buy-backs and so on, real economy activity decreases.
If you measure the output of an economy in money you get a very distorted picture of what is actually going on. There is less employment in the US in percentage terms than there was at peak, and absolute numbers are only now about getting even, yet people have been blathering on about a “recovery”.
It is quite possible for people to be doing things that are, on net, negative. Every dollar earned by the financial industry in the 2000s was lost and then more in the financial collapse: real damage to real productive capacity was done. We were earning more money, GDP was increasing, and (at least) houses were getting built, but the cost was offshoring and outsourcing of jobs and decreased actual wellbeing (it is in the 2000s that American height, for example, began to decrease.)
Money is not the economy, and increases in money do not necessarily mean the economy is getting better or even bigger, let alone actually increasing the welfare of the population.
Now increases in money SHOULD reflect increases in the welfare of the people, or at least in the size of the economy. Money should have an organic relationship to the economy. But for it to do so we must want it to.
Take the classic post-war economy (pre 70s.) You can borrow money if you have a house or a business. The house is valuable not so much because you can live in it, but because living in it means you are close to a job. It is the job that allows you to afford the house, and if you lose the job, the house still has value because there are other jobs nearby for someone else. If you do not believe this, I invite you to look at what happened to housing prices in Detroit when the auto industry left that city.
The house is secondary, though, the jobs come first. A farm has value because you can grow food and sell it, a business has value because it makes money. All of these things, presumably, produce goods or services that people want or need, and if you no longer want to run your farm or business, someone else can. A loan just allows you to take some of the future value of what you own, and use it today.
Economic financialization seems like an extension of this system. If you have a money flow of any type, why not borrow against it? Why not borrow against its appreciation? Why not then sell those money flows for money today? There are three problems: the first is pyramiding. You borrow against a money flow, then you use leverage and buy other money flows and then you leverage on them, and soon the underlying asset is a tiny fraction of the money you have. (No leverage on loaned money is thus the first principle of avoiding problems, loaned money is already leverage.)
The second problem is printing money with no underlying asset at all. When the Fed is creating 82 billion out of midair every month, half of which is spent on treasuries, there is no organic relation to the underlying economy.
The third is that some people get to borrow money for much less than other people. Banks get prime (or less). Large investors get close to prime, ordinary people get Prime ++, if they can get less than 20% on a credit card. This is justified by “risk”, but the risk is mostly that the person doesn’t have access to essentially free (prime rate) money. It also distorts the economy, because it favors financial companies since the interest rate is the cost of money, and the cost of money is a cost of business, which means financial operations are cheap even before you get to the fact that financial operations also have access to the highest amounts of leverage.
The problem here is that finance creates NOTHING of worth itself. It exists (or should exist rather) only to facilitate creating goods and services with actual value: food, housing, entertainment, medicine, art, philosophy and so on. Those goods and services, or rather the people, equipment and relationships that produced them, are the economy. Finance’s purpose is only to help allocate money between those activities, and it is only one mechanism of allocation. The market will not allocate money properly to many goods because it undervalues the future (so, for example, education, especially in the humanities and basic science), cannot account for externalities not embedded in the valuation system (that you are getting sick from my pollution is not the market’s problem), and cannot value anything that is not denominated in cold hard cash (like love, or friendship or a sunny day free of smog or the health of someone who doesn’t make money.)
Any society which makes all or most of its decisions about how to allocate money through the market mechanism will be hell on earth and will devalue those things most important to human happiness and meaning. It is not an accident that the depression rate in the US has increased by an order of magnitude in the last hundred years.
If you give outsize money returns to finance then, it drives out actual productive investment in the real economy. If you make the market your primary method of allocating funds, it doesn’t allocate resources to the future or to intangibles and ignores externalities which are key both to long term growth and avoiding negative outcomes (like your kid having cancer, or your spouse dying of cancer, or your sibling having a debilitating case of depression.)
But the problem is worse than this. Money, as my friend Stirling Newberry has noted, is permission: it is the right to decide what other people do with their time. Money lets you buy up people who spend all day lobbying government, it lets you create political movements, it lets you buy up think tanks and universities, it lets you create your own mercenary army. If you are throwing off more money than other industries, it lets you take over those industries. It lets you buy government, and thus control the rules.
If some group, in an economy, has a consistently higher rate of return than other groups over a long period of time, they WILL become dominant in that society absent a reaction by violent men. Period. Because they can use that money to decide what other people do. This is true not just of finance, it is true of any group of people controlling a bottleneck resource (see: oil, among others).
You can solve this one of two ways: you can make sure no one gets these consistent outsize returns in the first place (remember, basic economics, if an industry is making more than average profits, they are not in a competitive market, there is an inefficiency). Or you can just take their excess profits away from them.
IF you choose not to do so, because they have bought the system and created an ideology that says it is unfair to take money away from people who are given a systemic advantage by being allowed to create money from thin air and/or borrow it at prime when no one else can; or that the people allowed to control oil production should be allowed to keep all its benefits because they created the oil, or some such, then those people WILL come to control your society and they will create it in their image.
I will discuss at a later day happiness and meaning (and even eudomania), which should be the sane goal of any political economy. I will discuss how to design an economy which works for everyone. But the first thing to realize is that you must want that, and you must believe it is Just that your society be run that way.
If you do not believe that it is moral and right and just to tax people who have a structural advantage in your economy (and that structural advantage can and will exist if you remove the State entirely), if you do not believe you are allowed to redistribute, if you do not understand what the economy is for (creating the good life), if you do not believe in not allowing concentrations of private power based on position, then you will not keep whatever prosperity and good life you have, because those who win the game (and someone always will) will buy up the game and change the rules to ensure their continued wealth and power. They will do so in a way that will cost you your liberty, your health and your prosperity.
There will always be winners and we don’t want to change that. Let them win, let them enjoy winning in their time, but do not allow them to buy the system, to destroy the actual productive capacity of the system, or to try and make money the sole determinant of how decisions are made. Doing so, letting market mechanisms work until they don’t, then continuing to use them anyway: refusing to enforce competitive markets and keep markets doing what they do well and only what they do well, is why we had a financial collapse, why we’re in a depression, and why we have a catastrophic climate change episode coming our way which will kill a billion people or more. It is why we are seeing a long term decline in happiness in market democracies, why we have soaring rates of depression and chronic disease, rising chronic unemployment, and a host of other social ills.
An economy exists to fill the needs of the people in it, material and non-material. It has no other purpose.