Financialization
This recognized success brought also some negative reactions. In the Introduction to the 2006 book Financialization and the World Economy, editor Gerald A. Epstein wrote that
in the mid- to late 1970s or early 1980s, structural shifts of dramatic proportions took place in a number of countries that led to significant increases in financial transactions, real interest rates, the profitability of financial firms, and the shares of national income accruing to the holders of financial assets. This set of phenomena reflects the processes of financialization in the world economy . . .
. . . finance benefits handsomely from the same processes that create economic crises and injure so many others. Hence the costs of financial crises are paid by the bulk of the population, while large benefits accrue to finance. Duménil and Lévy provide new and valuable data documenting these trends in the case of France and the USA . . .
Using the case of the US economy, Crotty argues that financialization has had a profound and largely negative impact on the operations of US nonfinancial corporations. This is partly reflected in the increasing incomes extracted by financial markets from these corporations; trends identified also by Duménil and Lévy and Epstein and Jayadev. For example, Crotty shows that the payments US NFCs paid out to financial markets more than doubled as a share of their cash flow between the 1960s and the 1970s, on one hand, and the 1980s and 1990s on the other . . .
Financial markets’ demands for more income and more rapidly growing stock prices occurred at the same time as stagnant economic growth and increased product market competition made it increasingly difficult to earn profits. Crotty calls this the ‘neoliberal’ paradox. Non-financial corporations responded to this pressure in three ways, none of them healthy for the average citizen: 1) they cut wages and benefits to workers; 2) they engaged in fraud and deception to increase apparent profits and 3) they moved into financial operations to increase profits. Hence, Crotty argues that financialization in conjunction with neoliberalism and globalization has had a significantly negative impact on the prospects for economic prosperity.
The graph below shows profits of the U.S. financial sector and of the U.S. manufacturing sector, as a percent of GDP
Source for graph above: Economic Report of the President: 2007 Report Spreadsheet Tables, Tables B-1 and B-91.
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The development of financial derivatives
One of the most notable features of financialization has been the development of financial derivatives – financial instruments, the price or value of which is derived from the price or value of another, underlying financial instrument. The most common types of derivatives are futures contracts, swaps, and options. In the early 1990s, a number of central banks around the world began to survey the amount of derivative market activity, and report the results to the Bank for International Settlements.
In the past few years, the number and types of financial derivatives have grown enormously. In November 2007, commenting on the financial crisis sparked by the sub-prime mortgage collapse in the United States, Doug Noland’s CREDIT BUBBLE BULLETIN, on Asia Times Online, noted,
The scale of the Credit "insurance" problem is astounding. According to the Bank of International Settlements, the OTC market for Credit default swaps (CDS) jumped from $4.7 TN at the end of 2004 to $22.6 TN to end 2006. From the International Swaps and Derivatives Association we know that the total notional volume of credit derivatives jumped about 30% during the first half to $45.5 TN. And from the Comptroller of the Currency, total U.S. commercial bank Credit derivative positions ballooned from $492bn to begin 2003 to $11.8 TN as of this past June. . . .
A major unknown regarding derivatives is the actual amount of cash behind a transaction. A derivatives contract with a notional value of millions of dollars may actually only cost a few thousand dollars. For example, an interest rate swap might be based on exchanging the interest payments on $100 million in U.S. Treasury bonds at a fixed interest of 4.5 percent, for the floating interest rate of $100 million in credit card receivables. This contract would involve at least $4.5 million in interest payments, though the notional value may be reported as $100 million. However, the actual “cost” of the swap contract would be some small fraction of the minimal $4.5 million in interest payments. The difficulty of determining exactly how much this swap contract is worth when accounted for on a financial institution’s books, is typical of the worries many experts and regulators have over the explosive growth of these types of instruments.
Contrary to common belief in the United States, the largest financial center for derivatives - and also for forex - is London. According to MarketWatch on December 7, 2006,
The global foreign exchange market, easily the largest financial market, is dominated by London. More than half of the trades in the derivatives market are handled in London, which straddles the time zones between Asia and the U.S. And the trading rooms in the Square Mile, as the City of London financial district is known, are responsible for almost three-quarters of the trades in the secondary fixed-income markets.
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External links
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The references in this article would be clearer with a different or consistent style of citation, footnoting, or external linking. |
- John Bogle, founder and retired CEO of The Vanguard Group of mutual funds, discusses how the financial system has overwhelmed the productive system, on Bill Moyers Journal
- Gerald A. Epstein’s Introduction to Financialization and the World Economy
- Thomas I. Palley's November 2007 paper, Financialization: What it is and Why it Matters
- The Financialization of Capital and the Crisis, Monthly Review, April 2008
- The Financialization of Capitalism, Monthly Review, April 2007
- Monopoly-Finance Capital, Monthly Review, December 2006
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