The colonization of the future: An alternative view of financialization and its portents

ABSTRACT

Financialization is generally interpreted by heterodox economists to be a dysfunctional and thus historically transient outgrowth of contemporary capitalism: dysfunctional because it is seen to be driven by attempts to escape production and profit realization constraints in the real economy, transient because these attempts are seen to be ultimately futile. This article proposes the contrary argument that financialization is a functionally useful feature of contemporary capitalism that is entirely in keeping with the latter’s continuing development as a commodity system. Specifically, it will be argued that just as globalization represents the extension of the commodity principle along the axis of geographical space, financialization represents the extension of this same principle along the axis of time: the future is being colonized so as to make it take the overspill of the pressures on organizations operating in the present.

KEYWORDS:

• Colonization of the future
• financialization

JEL CLASSIFICATIONS:

• G10
• H10

Notes

¹Among the few who reject the term financialization are Michell and Toporowski who argue that “the understanding of finance requires the abandonment of financialisation as a project of intellectual inquiry” (2013–14, p. 80).

²There are several variations of this definition of financialization, but the one that continues to be most frequently cited is that given by Epstein (2005, p. 3): “financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies.”.

³Fine (2011) and Sawyer (2013–14) suggest that there are eight features of financialization but these are essentially variations of the three key features involving size, status, and character of the financial sector.

⁴Van Treeck (2009, p. 909) makes the same argument but from a different perspective. As he states: “the observation that financial profits have increased relative to non-financial profits has led many authors to conclude that there has been some sort of ‘decoupling’ of the financial sphere of the economy from the real sphere,” but as he also goes on to state, this decoupling is not possible because from a formal macroeconomic perspective, “aggregate profits ultimately rely on the production and trade of real goods and services and firms in the aggregate can by no means autonomously choose either between real investment (production) and profits at large or even between non-financial profits and financial profits.”

⁵According to Merton and Brodie, the financial system facilitates resource allocation by providing “(i) ways of clearing and settling payments to facilitate trades, (ii) a mechanism for pooling resources, (iii) a mechanism to transfer resources across time and across borders and amongst industries, (iv) a way of managing risk, (v) price information in decentralised decision making and (iv) a means of dealing with incentive problems that make financial contracts difficult and costly” (1995, p. 4). Heterodox economists accept that the financial sector has to carry out each of these particular functions but, as we say, disagree over the quantitative proportions that the sector needs to acquire in order to execute these functions efficiently. Epstein (2013), for example, presented just such a step-by-step critique in a recent conference presentation.

⁶While most mainstream financial theorists do not consider the continuing growth in size of the financial sector in a negative light, which is one reason that they do not typically use the term financialisation, a minority are beginning to question whether there are in fact limits to that size beyond which the financial sector becomes a “drag” on economic growth and development (see, e.g., Beck et al., 2014 or Cecchetti and Kharroubi, 2012).

⁷Monetary “circuit” theory, as the very name of this branch of heterodox economics implies, makes absolutely explicit the primacy of associative economic relations in general and of the bank-based credit relation in particular. See Lysandrou (2014) for a critique of this theory.

⁸For further discussion of the microfoundations of Marx’s economic theory, see Lysandrou (1996, 2000).

⁹For further discussion of the historical development of the commodity principle along “stretching” and “deepening” lines, see Lysandrou (2005).

¹⁰For data charting the recent growth of institutional asset management on a global level, see, for example, The City UK (2013) or Boston Consulting Group (2014). The U.S. experience illustrates the degree to which institutional investors now dominate the demand side of the capital markets. Where small household investors held 95 percent of U.S. equity in 1945, that ratio had fallen to 23 percent by 2012. As regards U.S. bonds, the ratio held by households is considerably smaller at between 9 percent and 10 percent (Goldman Sachs, 2013).

¹¹For further discussion of firms as “dual commodity providers,” see Lysandrou (2013).

¹²The shift toward more standardized forms of asset management entails not only the tightening of transparency and governance constraints on security-issuing organizations but also a certain parallel tightening of the behavioral constraints on asset managers themselves. There will be always be some scope for fraudulent activities—overcharging of fees, misrepresentation of products, manipulation of accounts, and so on—but this scope will most likely be reduced in line with the ongoing standardization of the asset-managing industry, as has been shown by the experience of other industries. The point is that with the growth and standardization of an industry come benchmarks against which the behavior of the member firms is compared. With these benchmarks it becomes more difficult, if not impossible, to conceal deviant behavior. For further discussion, see Lysandrou and Stoyanova (2007) and Lysandrou and Parker (2012).

¹³In addition to portfolio-balancing trading, there can of course also be trading by institutional investors that may serve no useful purpose in asset management, for example, “churning”—trading simply to appear to be doing something so as to justify fees. For a fuller discussion of churning and other fraudulent activities that institutional investors can engage in, see Grahl and Lysandrou (2006).

¹⁴For more discussion of the growth of trading in the money and FX markets, see Grahl and Lysandrou (2003).

¹⁵For further discussion on the concentrated nature of trading, see Grahl and Lysandrou (2006) and Lysandrou and Stoyanova (2007).

¹⁶For further detail on this point, see Grahl and Lysandrou (2014).

¹⁷For further details on recent trends in household savings and asset allocation, see BIS (2007).

¹⁸While insurance companies tend to concentrate asset holdings on bonds rather than equities because of their greater safety—they pay interest by law as well as having a known maturity date—they also need to hold a substantial proportion of their bond portfolios in the form of government bonds. This is because the latter generally represent the safest and most information-insensitive type of bond, given that they are backed by the power of taxation and because they generally represent the most liquid type of security, given the depth of the government bond market. Proponents of modern monetary theory tend to underestimate the importance of these points. An example of this underestimation is Nersisyan and Wray’s (2010) critique of Reinhart and Rogoff, In that critique they are right to say that “government debt is financial wealth for the private sector,” but in our view wrong to say that for a government of a country that operates on sovereign currency “issuing bonds is a voluntary operation that gives the public the opportunity to substitute their non-interest-earning government liabilities—currency and reserves at the central bank—into interest-earning government liabilities, such as treasury bills and bonds, which are credit balances in securities accounts at the same central bank” (2010, pp 13–15). Who, exactly, are the “public”? The distinction that must be made, but that is not made, is between household and institutional investors. As stated earlier, households that do not market portfolios to the public may be able to switch all of their savings from government fiat money to government bonds and back again according to economic conditions, but institutional investors that do market portfolios have no such choice. They can keep a portion of their assets in cash form, but their very function as financial intermediaries means that they must at all times keep the bulk of their assets in the form of yield-bearing securities.

¹⁹See, for example, Lysandrou (2009) for a discussion of recent changes in the continental European corporate landscape.

²⁰See, for example, Lazonick and O’Sullivan (2000) or Lazonick (2013), for a particularly critical view of the negative impact of these constraints on private corporations.

²¹According to Godley and Lavoie: “market clearing through prices does not usually occur except in financial markets” (2012, p. 18)), and quoting from an earlier publication by the same authors, “with trivial exceptions, there are no equilibria (or disequilibria) outside financial markets” (2006, p. 2).

²²Derivatives are financial instruments that are used by a wide array of financial institutions to either hedge against, or alternatively speculate on, risk. Over-the-counter (OTC) interest rate derivatives such as forward rate agreements (FRAs) and swaps are by far the most important component of the OTC market, a fact that partly ties in with the exigencies of institutional asset management. Long-dated liabilities resulting from pension and annuity products have very large interest rate exposures that can prove costly in the face of even the smallest changes in interest rates, a problem that is compounded by the fact that on the asset side of their balance sheets, insurance companies and pension funds typically hold securities that have a different return–risk profile to their liabilities. In order to reduce this mismatch, interest rate derivatives are used by insurance companies and pension funds to hedge their liabilities by providing them with products whose values move in the opposite direction of those associated with any interest rate changes.

²³The point about a core-satellite framework is that risk is diversified not merely within a single portfolio but across portfolios; core portfolios track market indexes either closely (“core-passive”) or with small departures from indexes (“core-active” and “enhanced index”), whereas satellite portfolios take subsections of market indexes as their benchmarks (e.g., “value” versus “growth” stocks or “small cap” securities versus “large cap” securities).

²⁴To make this argument is not to suggest that the ongoing structuring of the future will be a seamless, conflict-free process. On the contrary, as with any development under capitalism that has unfolded without any blueprint or conscious design, the process will face problems, of which some may cause it to slow down and others may even temporarily force it into reverse gear. The point, rather, is that as with other past developments under capitalism that have eventually overcome the barriers in their way because of their functional usefulness, so will the structuring of the future continue because there will continue to be a need for it to serve as an auxiliary economic space.

²⁵The crisis involved neither the mass of government and corporate securities nor the mass of repos and other money market instruments that used these securities as collateral. Nor did the crisis involve the mass of asset-backed securities issued by special purpose entitites (SPEs) and other shadow bank entities where conforming loans were used as the backing collateral (“prime” asset-backed secuirities). The reasons for this were that all of these securities complied with the standard rules of market exchange (transparency, ease of calculating and pricing risk, etc.). The financial products at the epicenter of the crisis were those that had broken all the rules of market exchange, namely, collateralized debt obligations (CDOs), the money market instruments that used CDOs as collateral, and the derivatives such as credit default swaps that used CDOs as their underlying reference entities. Certainly, the banking sector had the opportunity (the exploitation of weak regulation) and the incentive (the maximization of fee incomes) to create these toxic CDOs. However, the timing of events, the fact that the CDO market, which had been in existence since the early 1980s, only registered a twelvefold increase in size between 2003 and 2007, that is, exactly at the time when yields were falling in all of the major U.S. bond markets due to the global pressure of demand for safe stores of value, would indicate that imbalances outside of the banking sector had more to do with causing the crisis than the failures inside that sector. For further information on these points, see, for example, Caballero (2010), Goda and Lysandrou (2014), Lysandrou (2011) and Lysandrou and Shabani (2015).

Additional information

Notes on contributors

Photis Lysandrou

Photis Lysandrou is a Research Fellow at the Political Economy Research Centre, City University (CITYPERC).