The Finance – State – Society Triangle in Europe

Financialization

*Financialization

1. Financialization is the concept that many students now use to label the socio-economic and political developments since the 1970s. It points precisely at the double fact that the actors in the triangle financial sector – state – society are increasingly interwoven and to the ever more determining role of financial valuation, motives, markets and institutions in their operation, both on the micro level and as an interconnected global system. Financialization is the formation process of a tightly knit global complex system in which finance plays a critical role.

2. Historically, financialization marks the transition from Industrial Age capitalism, that was based on the physical means of production as the primary source of capital and value creation, to an information and services based financial capitalism. Greta Krippner defines financial capitalism as the “pattern of accumulation in which profit-making occurs increasingly through financial channels rather than through trade and commodity production.” In this transition, the financial system ceases to play the role of assisting in the running of the real economy but rather builds on it in order to dominate and to a certain extent displace real economic activity.

3. In a strict sense, financialization is the conversion of real value – any product of labour, asset or service – into exchangeable financial instruments that can be traded, speculated upon and ultimately managed through the financial system (e.g. securitization, i.e. the process of taking illiquid assets, and through financial engineering transform them into a security that can be traded). This affects ever more societal domains, including the public sector, utilities (water, energy, internet etc) and services (education, health, housing, security etc). In a broader sense, a financialised logic is affecting virtually all spheres of social life, re-encoding, disciplining and measuring them to the image of the market.

4. Financialization is financial overdevelopment. A certain level of financial development is needed for economic growth, through making loans, mobilizing savings, promoting information sharing, improving resource allocation, and facilitating diversification and management of risk. But at a certain point, the positive effects on economic growth begin to decline and even turn into its opposite, i.e. impede growth, while costs in terms of economic and financial volatility begin to rise. Debt, especially private debt (of business and households), is vital to powering growth, yet when it gets too high it begins to impede growth because investors shift to riskier undertakings (Minsky’s shift). That is the “paradox of debt”. Financialization then is the spiralling process between excessive or runaway lending on the one hand and greater risk-taking and high leverage in more speculative investments on the other.

5. Over the last decades, private debt growth has steadily outpaced GDP (5 vs 3%) and in advanced economies the private debt to GDP ratio has reached levels of 150-230%. A growing body of research seems to suggest that when private debt enters the range of 100-150% of GDP, it begins to impede economic growth, firstly because businesses and households have to divert an increased portion of their income to paying interest and principal on that debt – and thus spend and invest less. Secondly, as Bezemer has noted, in advanced economies Minsky’s shift shows up as a decline in loans to the ‘real sector’ – the actual production of goods and services, creating new wealth – compared to the funds flowing towards property and financial asset markets. Excessive lending and speculative investing leads to bad loans and asset price bubbles (e.g. housing and office buildings), which in due time will pop, causing a cascade of defaults throughout the economy. Rapid and massive increases in the private debt to GDP ratio and big asset bubbles are supposedly the most expressive signs of a coming crisis.

6. Materially, financialization refers to the burgeoning of what the BIS - Bank for International Settlements – calls the third globalisation layer, which “is characterised by intricate financial links established solely for financial purposes. This layer builds upon the first two to the extent that trade has generated stocks of assets and liabilities that need to be managed financially. [..] However, gross foreign asset and liability positions grow much larger than net positions, underlining the more independent nature of financial linkages.” Since the liberalization of capital markets in the 1980s, the level of financial transactions of all kinds has increased massively, additionally fueled by the massive creation of liquidity by governments over the last 25 years . Much of this money was channelled into financial markets for the trading of derivatives and other new financial products that are only sometimes used for hedging and much more frequently for speculation. The proliferation of derivatives of all form is indeed a key feature of financialization. Thus, for example, in 2016 there were $5.1 trillion in foreign exchange trades (buying and selling of foreign financial assets and liabilities) per day, compared with only $80 billion of trades in goods and services per day.

7. This broader transformation has fed through to the strong effect the financial system has had in reshaping the nature of the corporation, as financialized logics and practices have reshaped performance metrics within the corporation. The behaviour of listed companies is increasingly determined by the financial markets and the behaviour of managers by reward packages that are directly linked to short-term goals pertaining to the stock index. The whole conception of enterprise and business is changing: “ Financialization refers to a shift from managerial capitalism, in which the returns on investments derive from the value created by productive enterprises, to a new form of financial capitalism, where companies are viewed as assets to be bought and sold and as vehicles for maximizing profits through financial strategies” ( Ball and Appelbaum).

8. The nature of the banking industry itself has evolved in the same direction: “In the 1990s leading investment banking houses became public corporations, run by managers rewarded for short-term performance and owned at arms-length by shareholders. The firms could now borrow funds against their equity to finance the buying and selling of securities. The application of leverage fueled exponential expansion of trading markets for shares and other investment contracts. Option contracts to speculate on price movements and derivatives to speculate in price changes in a range of assets were invented and sold in significant amounts. […] Market realities more and more aligned with John Maynard Keynes’ description of them as casinos where money changes hands but little new wealth is created for society” (Young).

9. As Fichtner shows, financial capitalism is clearly dominated by Anglo-America, with New York and London (NY-LON) as its fulcrum. He calculates that in almost all key segments of global finance (over-the-counter (OTC) derivatives trading, OTC foreign exchange trading, currency composition of official foreign exchange reserves, market capitalization of publicly listed domestic corporations and internationally-significant markets for raising capital, external bank deposits, outward direct investment, and international portfolio investment), Anglo-America has market shares between 43% and 75%. The case of the by far largest derivatives market, OTC interest rate derivatives, is particularly illustrative. From 1995 to 2013, daily average turnover increased more than thirteen fold, from USD209 billion to USD2.8 trillion, and Anglo-America’s share rose from 48% to over 75%. Anglo-America’s dominance is so clear that it could be argued that financial derivatives represent a thoroughly Anglo-American phenomenon.

10. With market shares in key segments between 43% and 75%, Anglo-America not only dominates global finance in a quantitative sense; it also dominates global finance in the sense of being able to exert structural power, understood as “ the power to choose and to shape the structures of the global political economy within which other states, their political institutions, their economic enterprises, and their professional people have to operate” (Susan Strange).

11. Not surprisingly, Anglo-America reaps the most benefits of the working of the financial global complex. While Anglo-America’s share in global GDP has stabilised at 31%, its share in global wealth is now 43%. (It declined from a peak of 47% in 2001 to a nadir of 37% in 2008/2009 and since then has risen again to 43% in 2014.). Anglo-America’s share in global financial wealth rose from 46% in 2009 to an astounding 52% in 2014.

12. In Anglo-America’s financial structure, a critical role is played by a small number of banking houses, the top five being American based: JPMorgan, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup. Notably, these five banks together have a t otal exposure to derivatives of USD216 trillion, the total of derivatives contracts globally being USD 500 trillion (Q1, 2017). According to data from the US Office of the Comptroller of the Currency (OCC), as of March 31, 2017, Citigroup held $54.8 trillion; JPMorgan Chase $48.6 trillion; Goldman Sachs Group $45.6 trillion; Bank of America $35.8 trillion and Morgan Stanley $30.8 trillion. Their total assets are worth USD9 trillion, i.e. a mere 4% of the notional amount of the derivatives held. This is relevant, as these features sum up the contagion or spillover risks in case of default: t he larger the bank, the higher its leverage, and the greater its connectivity index, the higher contagion risk that the bank poses for the financial system ( U.S. Treasury’s Office of Financial Research) .

13. At least in the OECD-world, finance has become the ‘super-structure’, increasingly dominating the structures of production and knowledge. Most OECD countries (and increasingly China too), have integrated themselves in the open global financial order dominated by Anglo-America and hence are not inclined to directly challenge it – even though the system is intrinsically fragile and the Anglophone centre reaps most of the benefits. Once countries have integrated themselves into the open international financial order created and dominated by Anglo-America it becomes extremely costly to pull oneself out from it.  

Working hypothesis for the international conference on November 30

The question that will guide the international conference is:

» is it useful (deemed possible, realistic, feasible) to explore the perspectives for a proper European arrangement between the financial sector, state and society?

A proper European arrangement, both referring to its origin and features, and in the sense of distinct and relatively autonomous from the present, financialized and Anglo-America dominated global arrangement.

In the run-up to this conference, two high level seminars were held in The Netherlands, in January and in June this year, with speakers and participants form the financial sector, politics, business, academy and civil society. The seminars were chaired by former Dutch Prime Minister prof. Jan Peter Balkenende and prof. Hans Schenk, Crown member of the Dutch Social and Economic Council. One point of reference for the seminars was the excellent report ‘ Balancing society and the financial sector’ by the Dutch Scientific Council for Government Policy, expounded by its main author, prof. Arnoud Boot.

Both seminars, under Chatham House rule, addressed the following three questions:

- How have we – financial sector, government, academy, companies and households; in short, our society – come to the current situation? i.e. reviewing our history of the present.

- How do we assess our current situation with a view to the future, in its structural, societal, cultural and ethical dimensions?

- Can this ongoing process be reoriented?

The main recommendation that came out of these seminars was that the experience should be repeated at an international level, involving representatives from relevant like-minded countries such as Germany, Belgium, Luxemburg, France and Austria. These countries were selected because supposedly they share a Rhenish legacy – though it should be stressed that this conference is not about restoring it!

Thus, the conference will address the triplet: history of the present - our current situation - possible reorientation with a view to establish the usefulness of exploring the perspectives for a proper European arrangement between the financial sector, state and society. Not less, and not more. It is expressly not the idea to come up with solutions or to design possible new arrangements. Solutions, new arrangements or institutions can only be viable if they are the outcome of a process in which the concerned parties willingly agree to give up part of their autonomy for a collective effort for a shared purpose, i.e. based on trust – and that is precisely where financialization comes in the way.

The outcome of the 30 November conference and the 1 December seminar; follow up

As the nature of the conference is an open conversation on the usefulness of exploring the idea of a proper European financio-societal arrangement, its outcome cannot be predicted.

Ideally, the outcome of the conference is that all (foreign) participants agree that indeed it is useful to further explore this idea, and even agree to engage and to commit themselves to at least two next steps: 1. to further the process in their home-country and 2. to participate in the follow-up international conference, to be held in 2018, in Amsterdam or elsewhere.

In this ideal case, the seminar following the conference (on 1 December, 9.00-13.00 hrs), will be geared towards the preparation of these next steps, establishing themes to be developed, priorities, responsibilities, timelines and so, both at the national and the supra-national level; depending of course on the material that comes out of the conference. Eventually, national working groups may be established and representatives designated.

In the less-than-ideal case, the December 1 seminar will be used to deepen the conversation held on the conference, with a view also to reinforce the academic and policy relevance of the conference report that will be published by Amsterdam University Press.

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