Financialization
Financialization is a term sometimes used to describe the development of financial capitalism during the period from 1980 to the present, in which debt-to-equity ratios increased and financial services accounted for an increasing share of national income relative to other sectors.
Financialization describes an economic process by which exchange is facilitated through the intermediation of financial instruments. Financialization may permit real goods, services, and risks to be readily exchangeable for currency and thus make it easier for people to rationalize their assets and income flows.
Financialization is tied to the transition from an industrial economy to a service economy in that financial services belong to the tertiary sector of the economy.
Specific academic approaches
Various definitions, focusing on specific aspects and interpretations, have been used:- Greta Krippner of the University of Michigan writes that financialization refers to a "pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production." In the introduction to the 2005 book Financialization and the World Economy, editor Gerald A. Epstein wrote that some scholars have insisted on a much narrower use of the term: the ascendancy of shareholder value as a mode of corporate governance, or the growing dominance of capital market financial systems over bank-based financial systems. Pierre-Yves Gomez and Harry Korine, in their 2008 book Entrepreneurs and Democracy: A Political Theory of Corporate Governance, have identified a long-term trend in the evolution of corporate governance of large corporations and have shown that financialization is one step in this process.
- Thomas Marois, looking at the big emerging markets, defines "emerging finance capitalism" as the current phase of accumulation, characterized by "the fusion of the interests of domestic and foreign financial capital in the state apparatus as the institutionalized priorities and overarching social logic guiding the actions of state managers and government elites, often to the detriment of labor."
- According to Gerald A. Epstein, financialization refers to "the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy and its governing institutions, both at the national and international levels."
- Financialization may be defined as "the increasing dominance of the finance industry in the sum total of economic activity, of financial controllers in the management of corporations, of financial assets among total assets, of marketized securities and particularly equities among financial assets, of the stock market as a market for corporate control in determining corporate strategies, and of fluctuations in the stock market as a determinant of business cycles".
- More popularly, however, financialization is understood to mean the vastly expanded role of financial motives, financial markets, financial actors, and financial institutions in the operation of domestic and international economies.
- Sociological and political interpretations have also been made. In his 2006 book, American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century, American writer and commentator Kevin Phillips presents financialization as "a process whereby financial services, broadly construed, take over the dominant economic, cultural, and political role in a national economy". Phillips considers that the financialization of the US economy follows the same pattern that marked the beginning of the decline of Habsburg Spain in the 16th century, the Dutch trading empire in the 18th century, and the British Empire in the 19th century :
Roots
In the American experience, increased financialization occurred concomitant with the rise of neoliberalism and the free-market doctrines of Milton Friedman and the Chicago School of Economics in the late twentieth century. Various academic economists of that period worked out ideological and theoretical rationalizations and analytical approaches to facilitate the increased deregulation of financial systems and banking.In a 1998 article, Michael Hudson discussed previous economists who saw the problems that resulted from financialization. Problems were identified by John A. Hobson, Thorstein Veblen, Herbert Somerton Foxwell, and Rudolf Hilferding.
At the same 1998 conference in Oslo, Erik S. Reinert and Arno Mong Daastøl in "Production Capitalism vs. Financial Capitalism" provided an extensive bibliography on past writings, and prophetically asked
In the United States, probably more money has been made through the appreciation of real estate than in any other way. What are the long-term consequences if an increasing percentage of savings and wealth, as it now seems, is used to inflate the prices of already existing assets - real estate and stocks - instead of creating new production and innovation?
Financial turnover compared to gross domestic product
Other financial markets exhibited similarly explosive growth. Trading in US equity markets grew from $136.0 billion in 1970 to $1.671 trillion in 1990. In 2000, trading in US equity markets was $14.222 trillion. Most of the growth in stock trading has been directly attributed to the introduction and spread of program trading.According to the , page 24:
Trading on the international derivatives exchanges slowed in the fourth quarter of 2006. The combined turnover of interest rate, currency, and stock index derivatives fell by 7% to $431 trillion between October and December 2006.
Thus, derivatives trading—mostly futures contracts on interest rates, foreign currencies, Treasury bonds, and the like—had reached a level of $1,200 trillion, or $1.2 quadrillion, a year. By comparison, the US GDP in 2006 was $12.456 trillion.
Futures markets
The data for turnover in the futures markets in 1970, 1980, and 1990 is based on the number of contracts traded, which is reported by the organized exchanges, such as the Chicago Board of Trade, the Chicago Mercantile Exchange, and the New York Commodity Exchange, and compiled in data appendices of the Annual Reports of the U.S. Commodity Futures Trading Commission. The pie charts below show the dramatic shift in the types of futures contracts traded from 1970 to 2004.For a century after organized futures exchanges were founded in the mid-19th century, all futures trading was solely based on agricultural commodities. However, after the end of the gold-backed fixed-exchange-rate system in 1971, contracts based on foreign currencies began to be traded. After the deregulation of interest rates by the Bank of England and then the US Federal Reserve in the late 1970s, futures contracts based on various bonds and interest rates began to be traded. The result was that financial futures contracts—based on such things as interest rates, currencies, or equity indices—came to dominate the futures markets.
The dollar value of turnover in the futures markets is found by multiplying the number of contracts traded by the average value per contract for 1978 to 1980, which was calculated in research by the American Council of Life Insurers in 1981. The figures for earlier years were estimated on the computer-generated exponential fit of data from 1960 to 1970, with 1960 set at $165 billion, half the 1970 figure, based on a graph accompanying the ACLI data, which showed that the number of futures contracts traded in 1961 and earlier years was about half the number traded in 1970.
According to the ALCI data, the average value of interest-rate contracts is around ten times that of agricultural and other commodities, while the average value of currency contracts is twice that of agricultural and other commodities.
Futures contracts are "contracts to buy or sell a very common homogeneous item at a future date for a specific price." The nominal value of a futures contract is wildly different from the risk involved in engaging in that contract. Consider two parties who engage in a contract to exchange 5,000 bushels of wheat at $8.89 per bushel on December 17, 2012. The nominal value of the contract would be $44,450. But what is the risk? For the buyer, the risk is that the seller will not be able to deliver the wheat on the stated date. This means the buyer must purchase the wheat from someone else; this is known as the "spot market." Assume that the spot price for wheat on December 17, 2012, is $10 per bushel. This means the cost of purchasing the wheat is $50,000. So, the buyer would have lost $5,550, or the difference in the cost between the contract price and the spot price. Furthermore, futures are traded via exchanges, which guarantee that if one party reneges on its end of the bargain, that party is blacklisted from entering into such contracts in the future, and the injured party is insured against the loss by the exchange. If the loss is so large that the exchange cannot cover it, then the members of the exchange make up the loss. Another mitigating factor to consider is that a commonly traded liquid asset, such as gold, wheat, or the S&P 500 stock index, is extremely unlikely to have a future value of $0; thus, the counter-party risk is limited to something substantially less than the nominal value.