Mariana Mazzucato - The Value of Everything - Making and Taking in the Global Economy

According to theories that view the financial sector as productive, ever-expanding finance does not harm the economy; indeed, it actually facilitates the circulation of goods and services. Yet all too often investment funds and banks act to increase their profits rather than channel the proceeds into other forms of investment, such as green technology. Macquarie, the Australian bank which used post-privatization acquisitions to become one of the world’s largest infrastructure investors, quickly became known for securing additional debts against these assets so that more of their revenues were channelled into interest payments, alongside distributions to shareholders. After acquiring Thames Water in 2006, it used securitization to raise the company’s debt from £3.2 billion to £7.8 billion by 2012, while avoiding major infrastructure investment, 12The strategy raised alarm among environmentalists when, in 2017, Macquarie acquired the Green Investment Bank, a major financer of renewable energy and conservation projects set up by the UK government five years earlier. Moreover, once financiers realize that very little value stands behind their liabilities, they try to issue even more debt to refinance themselves. When they cannot continue to do so, a debt deflation occurs, such as the one that began in the US and Europe in 2007–8 and was still depressing global growth rates ten years later. Society at large then bears the costs of the speculative mania: unemployment rises and wages are held down, especially for those left behind during the previous economic expansion. In other words, value is extracted from labour’s share of earnings in order to restore corporate profits.

It is, then, difficult to think about the financial sector as anything but a rentier : a value extractor. This, indeed, was the economic verdict on finance before the 1970s, incorporated into national accounts, until a decision was taken to ascribe ‘value added’ to banks and their financial-market activities. That decision redesignated, as results of productive activity, financial profits that economists previously had little problem ascribing to banks’ monopoly power, associated with economies of scale and governments’ recognition that the biggest were ‘too big to fail’. The redrawing of the production boundary to include finance was in part a response to banks’ lobbying, which was itself a feature of their market power and influence. By showing finance as a large and growing source of national output, it overthrew the logic of previous financial regulation. Where beforehand such regulation had been seen as a safeguard against reckless and rent-seeking behaviour, it was now portrayed as a shackle suppressing a valuable trade in money and risk.

DEREGULATION AND THE SEEDS OF THE CRASH

Financial sectors were heavily regulated in the early 1970s, even in countries with large international financial centres such as the US and UK. Governments viewed regulation as essential, because a long international history of bank crashes and failed or fraudulent investment schemes showed how, left to themselves, financial firms could easily lose depositors’ money and, in so doing, disrupt real economic activity and even cause social unrest. When banks competed, they tended to offer ever more improbably high returns to savers by funding ever more risky investment projects, until disaster (and bankruptcy) struck. But while such competitive instability was averted by restricting entry, and giving banks some monopoly power, they still inflicted damage on the rest of the economy in other ways – by artificially inflating the price of loans, and co-ordinating their buying and selling to cause artificial boom and bust in the prices of key commodities. Small banks were especially vulnerable because their (and clients’) activities were insufficiently spread across different industries and geographical regions. But big banks quickly became ‘too big to fail’, assured of expensive government rescue when overextended because their collapse would do too much economic damage. Such assurances only led them to behave even more recklessly.

Governments’ appetite for financial regulation increased after the global depression of the 1930s, heralded by the collapse of insufficiently regulated stock markets and banks, and the world war to which this indirectly contributed. In 1933, following the Wall Street Crash, the US had separated commercial banks (financial institutions which took deposits) from investment banks (financial firms raising money for companies through debt and equity issues, corporate mergers and acquisitions, and trading in securities for their own account) under the Glass–Steagall Act. The Act’s regulations were in some respects strengthened by the Bretton Woods Agreement of 1944. In line with the so-called ‘Keynes Plan’, the Bretton Woods system imposed tight curbs on international capital movements in order to preserve a system of fixed exchange rates – thereby ruling out most of the cross-border investments and currency trades which had previously been major sources of instability and speculative profits. The Bretton Woods Agreement also required governments to maintain tight restrictions on their domestic financial sectors – including high minimum ratios of capital to assets and liquid reserves to total bank assets, interest rate caps and, in the US, strict legal separation of commercial and investment banking. The cornerstone of the Bretton Woods currency system was the gold standard, under which the dollar was convertible into gold at $35 an ounce.

Such measures made it hard for financial institutions to shift their business to low-tax or low-regulation jurisdictions. The rules reflected policymakers’ consensus that financial institutions acted at best like a lubricant for the ‘real’ motors of the economy – agriculture, manufacturing and business services – and were not significantly productive in themselves. It was feared that a deregulated financial sector could become excessively speculative, causing disruption domestically and to the external value of currencies. But in the 1960s, as the idea of ‘light-touch’ regulation became increasingly attractive, such measures were increasingly viewed on both sides of the Atlantic as an obstacle to circumvent.

During this time, banks never ceased to lobby against the regulations that deprived them of significant markets, and others (like the Glass–Steagall Act) which restricted their scope to combine operations in different markets. As well as pushing for an end to regulations, banks proved adept at persuading politicians that restrictive regulations were unworkable, by finding ways to work around them. Bans on speculative derivatives trading, enacted in the US in the 1930s because of its role in magnifying the 1929 Crash and Great Depression, were effectively sidestepped by the growth of unregulated over-the-counter derivatives trading, which grew explosively in the 1980s and defied subsequent efforts at re-regulation. 13Banks’ invention of ‘offshore’ currencies, to sidestep cross-border capital controls, was especially effective. In 1944, the Bretton Woods system had pegged the value of the dollar to gold. But when the post-war boom, based on manufacturing, tailed off around 1970, ‘light-touch’ financial regulation increasingly appealed to policymakers on both sides of the Atlantic. The financial sector reacted to this interest by developing a new currency, the Eurodollar.

As non-US companies, mainly in Europe, accumulated dollars from exports to the US and from oil sales, financiers realized they could borrow and lend in these dollars, which would be outside the control of European governments because they had not issued the currency. UK banks were keen as early as 1957 to mobilize their dollar-denominated deposits, as the chronic balance-of-payments deficit forced the government to impose controls on their use of sterling for foreign transactions. 14Russian banks stepped up their use of Eurodollars in fear of financial sanctions from the US, and were joined by US banks as they correctly anticipated the suspension of convertibility by the US in response to its worsening US external deficit. London became the centre of the Eurodollar market, which grew into a global one. Rather than being reinvested in the US economy to build new factories or research laboratories, Eurodollars were siphoned off to developing countries in search of a higher yield than was available in developed economies at the time. The result was what has been called the ‘dollar shortage’, meaning that the currency was insufficient even for the country that issued it – the US. 15In 1971, faced also with the cost of the Vietnam War and mounting inflation, President Richard M. Nixon stepped in to avert a vacuum in the vaults of the US Bullion Depository at Fort Knox by suspending the dollar’s convertibility into gold. It was a dramatic move which signalled the end of the Bretton Woods system and the start of a search for a new way to manage international trade and payments, which was far more market-driven. There followed a period of zero growth and high inflation (‘stagflation’), exacerbated by OPEC quadrupling the oil price in the 1970s. By 1980, the gold price had reached $850 an ounce.