Felix Salmon recently pointed out on his blog that corporate profits earned by the financial sector in the US have recaptured their pre-crisis highs. Irrespective of the measure of corporate profits one uses- with or without adjustment for inventory valuation and depreciation allowance-that conclusion is either foregone or imminent. In any case, the 2008 crisis has already departed from the script of the 1930s, which marked a peak in the dominance of the financial sector for a long time to come. This time, the power of finance to influence policy and market outcomes appears to have rebounded substantially, and quickly, after the crisis. That is bad news for the rest of us, who are more price-takers than price-makers in financial markets.
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That finance dominated non-financial sectors in the US before the crisis was a reflection of excessive risk-taking despite little compensation for risk. This worked for executives in the banking industry until the events of 2008 brought their world to its knees. Yet even as investors and taxpayers took losses, compensation in the financial sector barely flinched. It has since rebounded and exceeded the pre-crisis peak.
Post-crises, central banks keep short-term interest rates low so that banks can finance themselves at cheaper rates, lend to businesses, make profits and turn healthier, while helping the economy recover at the same time. That is theory. In reality, lending activity in the US is showing few signs of life, if any. That could either be due to banks’ risk-averse attitudes to lending, or because demand for loans from small and medium enterprises (the ones who rely the most on bank credit) and other commercial establishments has not recovered yet. Therefore, if the zero interest rate policy has not delivered the desired benefits, it is time to chalk up the costs.
The cost of living has gone up for most of the global poor. The president of the World Bank thinks the global economy is just one shock away from a crisis in food supplies and prices. Fundamental factors are clearly at work, and they do explain a substantial portion of the increase in prices of agricultural commodities. But it is difficult to deny the hand of speculation—keeping the cost of funding low skews the reward-risk ratio towards more, and not less, speculation. In fact, in the case of crude oil, the beginning of the surge in non-commercial (or speculative) contracts coincided uncannily with the Federal Reserve’s announcement in September of the second round of quantitative easing.
For emerging market economies, the costs are not just in terms of higher prices of food and energy. The dollar has weakened against other currencies because holding them yields nothing for investors. Against it, emerging market currencies, including those in Asia, have strengthened considerably. In the long term, this currency strength mitigates the rise in the cost of imported commodities. In the short term, it saps export competitiveness and leads to job losses in the manufacturing sector. Many economists think the Brazilian economy is close to this tipping point.
The US might think that its economy is benefiting from this low-interest rate policy, while the costs are borne by other countries. As we saw earlier, this benefit has to occur in terms of a pick-up in lending activity. That has been elusive. At the same time, the price of gasoline is now almost $4 per gallon in most major US cities, and fast spreading to other areas in the country. Inflation expectations have been creeping up steadily, too. Without incentives to save, the personal savings rate is stuck at below 6%. Further, John Hussman argues convincingly that the poor performance of the US economy in terms of employment generation is inseparable from the Fed’s attempts to make easy monetary policy a substitute for real savings and investment (see http://www.hussmanfunds.com/wmc/wmc110328.htm).
This is the global backdrop to the rise of the financial sector phoenix from the ashes of 2008. Its re-emergence may not portend another 2008-like crisis. But it does indicate lack of healing, which comes only through acknowledgement, reform and restructuring. These attributes form the backbone of character that every economy needs.
The crisis of 2008 was one that showed up severe shortcomings in that character. It originated in the US, and then took wings due to the overweening influence of American monetary policy and currency on the rest of the world.
In 2009, John C. Bogle, founder and former chief executive of The Vanguard Mutual Fund Group, wrote in his book Enough that the question was not whether America had enough money-enough productive wealth-to maintain and enhance its global presence and power, but whether it had enough character, values and virtue to do so. Two years later, the re-emergence of the financial sector has answered that question in the negative.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com