March 2020
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Moving Money to Make Money

In the third year of my economics degree one of the classes was International Finance. This particular class opened up my mind to a world I previously knew nothing about. We were introduced to a whole array of financial instruments and procedures that to me represented little more than moving money to make money, which was anathema to my trusted philosophy of no such thing as a free lunch. How could there be people out there whose whole career is dedicated to moving money around in order to make more money? How can arbitrage be a way of life? In fact I loathed the course content so much this subject resulted in my lowest grade throughout all my academic life. It was not that I did not understand the subject matter, my mind rebelled against it.

This was back in the early 1990s. In terms of finance, this is almost prehistoric. The array of financial instruments have grown ever more exponentially complex since then. However, the same basic principle underlies many of them, moving money to make money. As Bill Bonner points out on his excellent piece from the Daily Reckoning, finance as an industry has exploded in recent decades.

According to Alan Newman, daily trading volume has ballooned more than 25 times since the 1970s. The financial industry has gone from a minor activity representing only 3% of GDP in the ’70s, to a substantial 7.5% of GDP today…and its single major source of profits.

This financial dervish produced plenty of dust but less and less forward motion. Net private investment in the US hit a high in 1978 at about 8% of GDP. It has been declining ever since, recently hitting zero. After WWII, wages and real GDP increased steadily. But without investment in new plants and equipment, hourly wage gains stopped in the 1970s, while real GDP gains declined. People kept up appearances by borrowing heavily. But that only caused another problem.

The private sector is now solving the problem of too much debt by cutting back. Consumer credit is falling. Commercial and industrial loans are falling. The money supply, as measured by M3, is deflating at the fastest rate since the Great Depression – more than 9% annually. And prices – as measured by the US core CPI – are going up at the slowest paces since 1966.

So why should this matter? After all it is just another industry? I’m old fashioned in some ways, growth comes from production, making or servicing something, improving things, making a table, writing a book, changing a tyre. The financial industry in many developed countries has grown at the expense of other industries, crowding them out, rather than supporting them. When you make money by moving money it can seem like magic, but there is no free lunch the magic is not driven by the engenuity of financiers, it is driven by the availability of credit. One thing about credit is, it needs to be paid back, eventually.

There is no free lunch, eventually.

Most of the developed world has been engorging on the biggest free lunch of all time for the last couple of decades. The time has come where the bill finally needs to be paid. Free lunches are addictive though, and like any addict they will ask for more food in order to delay the starvation, but this just adds to the bill. The bill needs to be paid, the only two things that will change from this point forward are how long it will take to pay off and whether it will be enlarged even further before it begins to be paid off.

The sensible option is accept that we have a problem and work to pay off the bill and starve over a shorter time period.

That is not what is happening.

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