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Is the Financial Economy Holding Us Back?

In “Economic Possibilities for Our Grandchildren”, the famed British economist John Maynard Keynes predicted that near about 2030, we would be living in an economic utopia, or at least well within sight of it. We would work perhaps four hours a week only to stave off boredom and society would be structured around how to best enjoy our endless wealth. This was not a daydream, but a sincere hope in the power of modern economic forces to create unprecedented wealth. 

So where did it all go wrong? How did we lose sight of this utopia?

A crucial part of Keynes’ logic is capital accumulation to the point of eliminating capital scarcity. In other words, he believed that investment and investment returns would compound and snowball to the point that capital would cease to be scarce. Interest rates, which are the price of capital, would be essentially zero, because the supply of capital would be boundless. Like someone tapping into their retirement savings, we would be free to begin fully enjoying all the wealth we carefully saved up.

Among other reasons, the rise of the financial economy has made it more difficult to achieve this Keynesian utopia. The financial economy is the economy of financial instruments, like stocks or bonds and is contrasted with the real economy, which is the rest of the economy. The real economy has a natural limit to how much can be invested, because there are only so many profitable investments made and assets created.  In contrast, the financial economy is insatiable. The real economy is about asset creation and the financial economy is about asset transfers. The real economy has a natural limit to how much can be invested, because there are only so many assets it would be profitable to create. Building one hundred thousand toy factories would simply be unprofitable.  In contrast, the financial economy is insatiable,

because it is always possible to pass around a financial instrument more times. A toy factory’s stock can be bid upwards and bought and sold endlessly. A financial bubble can reach limitless heights, as long as there is a constant flow of money inwards. We may be producing limitless wealth through capital accumulation, but the financial economy’s appetite is equally insatiable. Therefore, we are unable to eliminate capital scarcity. 

In “Economic Possibilities for Our Grandchildren,” Keynes quotes the story of a man who never paid his tailor, by promising the tailor that if they would only wait one more year, he would double his payment. Even as his assets compounded year after year, the tailor never got to spend and enjoy a cent of it. By this story, Keynes applauded the lust for money that would drive the capital accumulation to the point of his utopia, but also cautioned against doing so endlessly, forever multiplying imagined future revenues and never enjoying their fruits. So do the financial markets promise us endless growth, if only we continually starve ourselves to feed its bottomless hunger. 

The subprime mortgage crisis of 2008 was a vivid and painful demonstration of the dangers of our ballooning financial economy, which estimates synthesized by Investopedia place at about 20% of the global economy. The financial economy is more inherently unstable than the real economy and as it gorges itself on our capital accumulation, we can look forward to rising economic instability, rather than a Keynesian utopia.

In sum, we have sleepwalked away from Keynes’ utopia and into a new era of instability. To reverse this awful reality, we need bold regulation of the financial sector. The financial sector can have real economic benefits, because it can provide capital for investment in the real economy. However, it very quickly spirals into a loosely controlled realm of speculation that poses serious danger to the economy.

For example, while mortgages make home ownership more accessible, the transformation of mortgages into a financial instrument via mortgage securitization without adequate controls was one of the precipitating causes of the 2008 financial crisis. The financial sector should not be allowed to endanger the economy and needs to be focused on socially beneficial activities, not blindly multiplying financial instruments.

We need to tame the financial economy, returning and restricting it to its origins in providing capital for real economic activity and pruning away the mess of activities that only expand the personal wealth of a few while actively raising risk in the whole economy. Without aggressive action, Keynes’ utopia will slip away forever.

The opinions expressed in this article are those of the individual author.

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