By Bill Wilson
A recent piece by Bruce Bartlett brings together numerous useful academic studies that suggest “financialization” — the expansion of the credit sector as a percent of the economy — can be beneficial to economic growth to a certain point. But beyond that level, it becomes corrosive.
Towards the end of his piece, Bartlett implies that one siphoning effect of the credit sector from the real economy comes in the form of executive bonuses. Citing research from Jon Bakija, Adam Cole and Bradley T. Heim, he writes “financialization is a principal driver of the rising share of income going to the ultrawealthy — the top 0.1 percent of the income distribution.”
No one questions that financial institutions, with the ability to lend trillions of dollars into existence have become enormously wealthy as a result. But financial sector profits are not what is dragging on the lackluster economy. In truth, it is surprising that Bartlett doesn’t see or understand this point.
In reality, many of the studies Bartlett links to , such as “Reassessing the impact of finance on growth,” from Stepehen Cecchetti and Enisse Kharroubi of the uber-influencial Bank of International Settlements, show very clearly that it is the excessive debt that is created from too much credit, and ensuing defaults, that is the real drag on the economy – not compensation to a mere handful of executives.
As Cecchetti and Kharroubi note, “[A]s with many things in life, with finance you can have too much of a good thing. That is, at low levels, a larger financial system goes hand in hand with higher productivity growth. But there comes a point — one that many advanced economies passed long ago — where more banking and more credit are associated with lower growth.”
They add, “we find that when private credit grows to a point where it exceeds GDP, it becomes a drag on productivity growth.”
In the U.S., private credit — which excludes federal, state, and local government debt, plus Government Sponsored Enterprise and agency debt — stands at $34.5 trillion, more than 215 percent of the Gross Domestic Product.
A primary reason for the failure of credit to boost growth once debt becomes too large is the inability of the credit sector to grow further. Credit has to be given to someone – individual household or businesses who have to at least be able to service the debt. When debt gets too large, there simply aren’t any private entities who can take on any more of it. And that is where we find ourselves today.
After growing an average 8.3 percent every year from 1945 through 2008, the credit sector in the U.S. has only averaged 1.39 percent annual growth since the housing bubble popped. It is starting to pick up some, growing 3.3 percent in 2012, but is nowhere near its former robust expansion. The economy has predictably followed suit.
This is another way of saying the system is a limited fiat system; it can expand rapidly up until the point when individuals and corporations become maxed out on credit and leveraged to the hilt. Banks ran out of new people to lend to. The search for more people to lend to was how we came to such things as “liar loans”, sub-prime loans, mailing credit cards to virtually everyone and the insanity of car loans for 84 to 96 months And when even that was not enough, new credit becomes limited. That is the true culprit.
This observation is nothing new.
A similar phenomenon happened as the gold standard fell apart in the early 1930s as it could not sustain all of the excess credit expansion that occurred at the end of the 1920s.
But one can go back further. The credit-driven economic model of the past few centuries, because it eats a larger and larger share of the economy, resulting in periodic collapses, has always been a failure at delivering sustainable growth.
Today, because populations are much larger, the damage can be even more widespread. In this recession, businesses can no longer expand and unemployment soars, precisely the experience of advanced economies today. The end result is more people going on the welfare rolls and everyone left wondering what hit them.
Governments react by attempting to reflate the credit bubble, taking away more scarce resources from a private sector struggling to recover.
Free markets cannot survive in this environment for long. To the extent that industries become credit-dependent, they ultimately become nationalized. Just look at education, health care, housing, finance, and insurance.
The immediate beneficiaries of financialization might imagine, via the massive profits Bartlett seemingly complains about, that the system is capitalistic. It is not. It is the epitome of corporate fascism, although the actual practice really predates the early 20th Century Italian fascination with the fasces.
The world’s entire economic history has been built on this flawed financialization system. We haven’t seen an alternative for centuries, if ever. Yes, there have been periods of hard currency, but they always allotted credit and were always torn asunder through progressive devaluation. It would appear no society has ever been able to actually live within its means.
History is quite clear. Financial systems tend to evolve into a credit-driven explosion of ever increasing dbet, which leads to too reaching a point of diminishing returns and the inability to take on significantly more debt, which always leads eventually to a decline and fall of the system. Wash, rinse, repeat.
The ultimate question may come down to one of human nature, however.
If man always needs expanding credit because of the need to grow and he is incapable of controlling credit and debt — at least there is no record of it happening over a sustained period of time — then, human nature appears to need to indulge in this orgy of debt.
Unlike predecessor economies that were likely unaware of the corrosive nature of too much debt, the U.S. has been forewarned. If being forewarned is to be forearmed, then our nation has no one to blame but itself if we follow the path of other superpowers that collapsed under the weight of their own self-indulgence.
Bill Wilson is a member of the board of directors of Americans for Limited Government.
