Monetary Policy in the Age of Finance Capital: Inflating Asset Bubbles, Deflating Real Growth
By Ismael Hossein-zadeh
Prior to the rise of big finance to dominance, finance capital was largely at the service of industrial capital; it essentially greased the wheels of production. As the regulatory framework of the New Deal and/or Social-Democratic policies restricted the role of commercial banks to financial intermediation between savers and investors, finance capital moved in tandem with industrial capital. Under those circumstances, where financial institutions served largely as conduits that aggregated and funneled national savings to productive investment, financial bubbles were rare, temporary and small.
Not so in the age of finance capital. In the era of unregulated big finance, where a whole range of speculative financial transactions can garner much higher returns than investment in the real sector, banks and other financial institutions are no longer eager or willing to transmit surplus financial resources, or national savings, to the real sector. Instead, they prefer to invest those resources in the more lucrative financial sector.
Obviously, this means that the traditional capital flow from the financial to the real sector is greatly diminished. Indeed, that long-established flow is nowadays largely reversed as many industrial corporations increasingly tend to invest more and more of their profits in stock buybacks and other financial speculations than in expanding productive capacity.
It also means that, in the age of finance capital, parasitic finance capital, feeding on itself by sucking out economic surplus/profits from the real sector, has effectively torpedoed the neat neoclassical “circular flow” model—where people’s savings and industrialists’ (retained) earnings are supposed to be recycled through financial intermediaries into productive investment.
Contrary to that outdated model, substantial amounts of the real sector’s profits-cum-savings that leak out of the so-called “income-expenditures circular flow” into the financial sector never come back to be reinvested productively, as mainstream economic theory postulates. Instead, those savings are systematically syphoned off the real economy and invested in the unproductive, parasitic financial sector.
What is more, the financial sectors’ draining of economic surplus is not simply an outcome of the blind forces of market mechanism. More importantly, it is accomplished by monetary policy, which has come under effective control of the financial oligarchy—usually through the appointment of its proxies to the heads of central banks and treasury departments.
Creating and/or Protecting Asset Bubbles as Monetary Policy
Starting with the United States and systematically adopted by other core capitalist countries, monetary policy has come in recent years to increasingly mean granting unlimited free or cheap money to major banks and other players of the financial sector in pursuit of creating and/or maintaining asset bubbles.
The formal rationale for the injection of cheap money into the financial system is that such infusions would prompt or induce enhanced lending to the real sector, thereby encouraging productive investment, employment and growth. This justification of excessively cheap money supply to banks and other financial institutions is premised on the implicit assumption that manufacturers face a strong demand for their products and are, therefore, willing or eager to hire and expand but cannot do so because they also face a tight and expensive capital market.
In reality, however, there is no serious shortage of cash in the real sector. In the U.S., for example, the real sector seems to be sitting on a mound of cash but not expanding production because of the austerity-generated weak demand.
While at least 25 million Americans are unemployed or working only part-time when they want and need full-time work, corporate America is sitting on a cash hoard of more than $2 trillion, refusing to invest in new production or hiring new workers, and instead engaging in speculation and stock buybacks that are more profitable for the corporate CEOs. Stock buybacks by non-financial corporations occurred at an annual pace of $427 billion in the first quarter, according to the Fed .
Furthermore, since players in the financial sector are no longer constrained by regulatory restrictions on the types, quantities and spheres of their investment, why would they look or wait for borrowers from the real sector when they can invest in the more rewarding field of speculation. Not surprisingly, as the regulatory constraints have been gradually removed in recent years/decades, financial bubbles and bursts have become a recurring pattern.
Not only do Wall Street banks and other beneficiaries of monetary policy use the nearly interest-free money for speculative investment, but also increasingly real sector corporations divert more and more of their profits to speculation instead of production. They seem to have come to think: why bother with the messy business of production when higher returns can be garnered by simply buying and selling titles.
Capital flight from the real to the financial sector is reflected (among other indicators), in the divergence between corporate profitability and real investment. Prior to 1980s, the two moved in tandem—both about 9% of GDP. Since then, and especially in the very recent years, whereas corporate profits have increased to about 12% of GDP, real investment has declined to about 4% of GDP! .
Financial big wigs at the helm of monetary policy in the U.S. and other major capitalist countries cannot be unaware of these troublesome trends: that most of the generous cash they inject into the financial sector is used for speculative transactions in this sector without any clear positive impact on the real sector. So, the question is: why, then, do they keep pumping more money into the financial sector?
Portraying asset-price inflation as a monetary tool of economic stimulation, policymakers in the United States and other core capitalist countries are no longer averse to creating financial bubbles; as such bubbles are viewed or portrayed as fueling the economy through demand-enhancement effects of asset-price appreciation. Instead of regulating or containing the disruptive speculative activities of the financial sector, economic policy makers, spearheaded by the Federal Reserve Bank since the days of Alan Greenspan as its Chairman, have been actively promoting asset-price bubbles—in effect, also further exacerbating inequality.
Aside from issues of social justice and economic insecurity for the masses of the people, the idea of creating asset bubbles as vehicles of economic stimulation is also unsustainable in the long run. No matter how long or how much they may expand, financial bubbles are ultimately limited by the amount of real values produced in an economy.
Proxies of the financial oligarchy at the helm of monetary/economic policy making, however, do not seem to be bothered by the ominous prospects of the destabilizing effects of the bubbles they help create, as they tend to believe (or hope) that the likely disturbances or losses from the potential bursting of one bubble could be offset by creating another bubble! In other words, they seem to believe that they have discovered an insurance policy for bubbles that burst by blowing new ones. Professor Peter Gowan of London Metropolitan University describes this rather perverse strategy in the following words:
Both the Washington regulators and Wall Street evidently believed that together they could manage bursts. This meant that there was no need to prevent such bubbles from occurring: on the contrary, it is patently obvious that both regulators and operators actively generated them, no doubt believing that one of the ways of managing bursts was to blow another dynamic bubble in another sector: after dot-com, the housing bubble; after that, an energy-price or emerging market bubble, and so on .
It is obvious that this policy of effectively insuring financial bubbles would make financial speculation a win-win proposition, a proposition that is aptly called “moral hazard,” as it encourages risk-taking at the expense of others—in this case of the 99%, since the costs of bailing out the “too-big-to-fail” gamblers are paid by austerity cuts. Knowing that the central bank/monetary policy would bail them out after any bust, they go from one excess to another.
The policy of protecting major financial speculators against bankruptcy shows, among other things, that the neoliberal financial architects of recent years have jettisoned not only the New Deal/Social Democratic policies of demand management but also the free-market policies of non-intervention, as advocated, for example, by the Austrian school of economics. They tend to be interventionists when the corporate-financial oligarchy needs help, but champions of laissez-faire economics when the working class and other grassroots need help.
Prior to the rise of big finance and its control of economic policy, bubble implosions were let to run their course: reckless speculation and mal-investments would go bankrupt, the real economy would be cleansed of the deadweight of the unsustainable debt, and (after a painful but relatively short period of time) the market would reallocate the real capital to productive uses. In the era of finance capital, however, that process of creating a clean slate is blocked because the financial interests that play a critical role in the creation of bubbles and bursts also control policy.
What is to be done?
The fact that profit-driven commercial banks and other financial institutions are major sources of financial instability is hardly disputed. It is equally well-known that, due to their economic and political influence, powerful financial interests easily subvert government regulations, thereby periodically reproducing financial instability and economic turbulence.
By contrast, while better reassuring depositors of the security of their savings, public-sector banks can also help direct those savings toward productive credit allocation and reliable investment opportunities. Ending the recurring crises of financial markets, therefore, requires placing the destabilizing financial intermediaries under public ownership and democratic control.
There is a widespread perception that public-sector banks are inefficient and are, therefore, not conducive to optimum levels of economic growth. Evidence suggests, however, that such concerns are far from warranted. There are, indeed, compelling reasons not only for higher degrees of reliability but also higher levels of efficacy of public-sector banking and credit system when compared with private banking—both on conceptual and empirical grounds .
Contrary to profit-driven private banks that create financial bubbles during expansionary cycles and credit crunch during contractionary ones, government-owned banks can provide steady, reliable financial resources as dictated by a nation’s industrial and/or commercial needs. Despite the purported efficiency of competitive markets, the safety and stability of credit and/or banking system requires that fierce and high-risk competition in pursuit of highest returns in the shortest time possible be restricted. National policies of careful allocation of financial or credit resources to growth- and employment-generating investments are of critical social and economic importance. Thus, public ownership of the credit and banking system is rational and, therefore, necessary—along with democratic control.
The idea of bringing the banking industry, national savings and credit allocation under public control or supervision is not necessarily socialistic or ideological; it makes sense even within the general framework of a capitalist economy. It is only logical that the public, not private, authority should manage people’s money and/or savings.
In the same manner that many infrastructural facilities such as public roads, school systems and health facilities are provided and operated as essential public services, so can the supply of credit and financial services be provide on a basic public utility model for both day-to-day business transactions and long-term industrial projects. Provision of financial services and/or credit facilities after the model of public utilities would allow for lower financial costs to both consumers and producers. By thus freeing consumers and producers from what can properly be called the financial overhead, or rent, similar to land rent under feudalism, the public option credit and/or banking system can revive many stagnant economies that are depressed under the crushing burden of never-ending debt-servicing obligations.
 As cited in Patrick Martin, “Wealth report shows deepening social polarization in US,” <http://www.wsws.org/en/articles/2014/06/07/weal-j07.html>.
 Robin Harding, “Corporate investment: A mysterious divergence,” <http://www.ft.com/intl/cms/s/0/8177af34-eb21-11e2-bfdb-00144feabdc0.html#axzz3spmgvsnJ>.
 Peter Gowan, “The Crisis in the Heartland,” in M. Konings (ed.) The Great Credit Crash, London and New York, Verso 2010: 52.
 Andrianova, S. et al., “There should be no rush to privatise government owned banks,” <http://www.voxeu.org/article/don-t-rush-privatise-government-owned-banks>.