Finance as an (ever more fragile) ‘perpetual mania’: have they all lost their collective minds? How the new alchemists distorted Kindleberger’s financial-crisis cycle, and how the abundance of easy rents led to lazy elites

Abstract

This paper analyses events in financial markets since the 2008 financial crisis in both the developed and the developing worlds, giving especial attention to the processes of ‘financialisation’. Its main conclusion is that we are paying the price (a huge one) for two related phenomena. The first relates to the failure of economic theory since the 1970s, especially (although not only) of the mainstream type, to really take on board those developments in the world of international finance that ‘did not fit in their models’ (such as the 1970s stagflation; Volker’s subsequent radical monetarist recession; the ‘savings and loan’ debacle following Reagan’s financial liberalisation and deregulation―policies reinforced in the 1990s; the inability of both monetarists, and traditional Keynesian policies to revert Japan’s ‘lost decade’; and the ‘endogenous’ nature of the 2008 financial crisis). Basically, economic theory has failed to reinvent itself when needed as it did after the 1930s crash. The second, in turn, relates to the fact that rocketing the net worth of a few individuals was a rather odd way to reactivate fragile economies after the 2008 crisis and the 2020 pandemic. But when rentier agents were allowed to become ‘too-large-to-be-challenged’, it was likely that these newly (and artificially) created ‘whales’ would capture policy-making and take it in this direction―leaving the politicians and central bankers to tell stories explaining why the very rich should become the biggest welfare recipients of all time. As one group of Native Americans used to say, ‘Those who are better at storytelling will dominate the world’.

Epigraph

At particular times a great many stupid people have a great deal of stupid money

First editor-in-chief of The Economist (on the causes of financial crisis) (Bagehot, 1873)

The last thing we need to reactivate our economies are more ‘silly billys’ [silly billionaires]

Financial Times Columnist (Lee, 2018)

In my darkest moments I have begun to wonder if the monetary accommodation we have already engineered [such as QE] might …be working in the wrong places [in emerging markets rather than in the US].

President of the Federal Reserve Bank of Dallas (Fisher, 2010)

Liberalised finance tends to metastasise, like a cancer.

Martin Wolf (2019)

1. Introduction

This paper analyses events in international financial markets during the 14-year period between the beginning of ‘quantitative easing’ (‘QE’) at the time of the 2008 financial crisis, until the second quarter of 2022, when the FED and the ECB finally began the (long-overdue) switch towards ‘quantitative tightening’ (‘QT’). During this period, the balance sheets of the FED, the ECB and the Bank of Japan increased from less than US$ 5 trillion (tr) to more than US$ 25 tr. In this analysis I will pay especial attention to the impact of ‘QE’ on the processes of ‘financialisation’ in both the developed and the developing worlds; by this I mean the combined effect of the growing size and dominance of the financial sector relative to the non-financial sector, and the diversification towards financial activities in non-financial corporations. My main conclusion is that we are paying the price (a huge one) for two related phenomena: one belongs to the realm of ideology and knowledge, the other to market manipulation (the transformation of financial markets into a rentier’s paradise).

The first relates to the failure of economic theory, especially (although not only) of the mainstream type, to really take on board at least six key developments in the world of finance since the 1970s stagflation that ‘did not fit in their models’. These were the impact of Volker’s subsequent radical monetarism (which, among many other things, led to the 1982 debt crisis in Latin America); the ‘savings and loan’ debacle that followed Reagan and Thatcher’s 1980s neo-liberal agenda of financial liberalisation and deregulation―policies reinforced by further deregulation during the 1990s; the inability of both monetarists, and traditional Keynesian policies to revert Japan’s poor 1990s’ performance; the series of financial crisis in emerging markets following their policies of financial deregulation and opening (such as in 1994 Mexico, 1997 East Asia (especially in Thailand, Malaysia, Korea and Indonesia), 1998 Brazil and 2001 Argentina); and, of course, the ‘endogenous’ nature of the 2018 global financial crisis. To this list, one has to add now the remarkable financial exuberance that took place in the midst of the economic debacle caused by the worst pandemic for a century.

Basically, economic theory has failed to reinvent itself when needed, as it did after the 1930s crash. Long gone are the days when at least some economists had Keynes’ attitude towards events that did not fit in their worldview. After the 1929 crash and subsequent long recession, for example, he simply acknowledged that economists should go back to the drawing board

[W]e have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.¹

We now again face a growingly complicated world out there, where a lot of strange stuff is happening―such as the ever growing decoupling of the financial and real worlds in financialised economies―but one finds little acknowledgment of a lack of understanding. As a result, now in theory and policy-making a surprising lack of imagination rules. Furthermore, a fundamentalist approach to theory and policy has led to a confusion of ‘means’ with ‘ends’―a legacy of the early days of the Washington Consensus, especially in issues of finance.

In other words (like in the 1930s), we have again involved ourselves in a colossal financial muddle of our own making, but in contrast to what happened then, many economists from all walks of life are now so startled by this mess, that instead of trying to rethink economic theory, they have sought refuge in traditional fundamentalist beliefs. It is as if they fear that by allowing new ideas or forms into one’s system of belief they might destroy belief itself.²

Therefore, ideas such as the need for full financial liberalisation and deregulation have become ‘ends’ in themselves, rather than just ‘means’ that (at least according to mainstream theory) could help achieve an efficient allocation of resources in financial markets. Furthermore, in the mainstream theoretical narrative, the key necessary conditions for market efficiency―such as the necessity that all agents should be ‘price’ and ‘rules’ takers (rather than “makers”), and that governments should be able and willing to pass on to relative prices all ‘externalities’ via taxes and transferences―have became redundant.

So, when the above events ‘did not fit in their models’, instead of attempting to rethink their worldview and react in the meantime with the type of policy-pragmatism suggested by their own neo-classical theory of the ‘second best’,³ mainstream actors opted instead for ‘more of the same’, while regurgitating some 1960s theoretical stuff, which had been built (rightly or wrongly) for a completely different world. Meanwhile, they kept delivering a set of ever more unconvincing storylines to embellish whatever they could not explain, trying constantly to generate a positive spin on these events, dressing them up with explanations that were consistently simple, mechanical and invariably ‘optimistic’.

In turn, on the heterodox side of the analytical spectrum, some―but certainly not all―analysts fell into the same ‘neo-phobic’ trap (the fear of the new―in this case, of new ideas). Furthermore, this fear not only kept them stuck in theoretical narratives that also needed an urgent revamp, but sometimes this also led to story-telling―although in this case, instead of being invariably ‘optimistic’ (as those of the other analytical camp), the stories were invariably ‘pessimistic’.

Some of the current heterodox analytical narratives (e.g. financial subordination) are part of a long tradition that tends to switch the main emphasis of the analysis from phenomena ‘within’ the political settlements of developing countries (e.g. the nature of their oligarchies and institutions, and the failure of the left to construct viable alternatives) to those ‘outside’ their sphere of control (such as surplus extraction, unequal exchange, currency hierarchies and financial subordination). The latter are certainly real―and they surely limit the ‘policy space’ of peripheral economies―, but the emphasis on them as opposed to what happens within developing countries is often misplaced (see below, Section 7.1).⁴

The second set of issues (the transformation of financial markets into a rentier’s paradise) refers to the rather odd way in which policy makers tried to ‘save the world economy’ from the 2008 global financial crisis and then from the pandemic. Surely artificially creating a new billionaire practically every day, or helping the richest 10 individuals in the world make US$1.3 billion a day for 20 consecutive months is a rather odd way to counteract the impact of the pandemic on the real economy. But when in financial markets a tiny group of agents are allowed to become price and rules “makers”, able to distort markets at will, it was likely that these newly created ‘whales’ would capture policy-making and take it in this direction―leaving the politicians and central bankers to tell stories explaining why the very rich should become the biggest welfare recipients of all time.⁵

Meanwhile, 160 million more people in the world were pushed into poverty during the pandemic, with about 100 million into extreme poverty, with troubling reversals also in nutrition, health and education.⁶ And the immunisation rates in the world’s poorest countries at the end of 2021 were still below 10%, but pharmaceuticals keep refusing to allow their vaccines to become generic despite all the billions of dollars they got as subsidies from governments for their development.⁷ At the same time, the share of young people in the USA who are now on track to be poorer than their parents has gone up to two thirds!⁸

The intended contribution of this paper is to analyse these issues through the lens of a narrative of the actual events that have taken place in international financial markets since the 2008 crisis. The emphasis will be on the remarkably unimaginative and repetitive response to them by policy-makers, and how this has brought about an increasingly fragile world of artificially created ‘perpetual manias’. Nothing like this had ever happened before!

2. The setting

When I began to write this paper in September 2020, half a year into the worst pandemic in a century, financial markets kept thriving as if living in a different world. We had never seen before such a disconnect between the real and the financial worlds. It was almost as if people at large welcomed some financial pyrotechnics to distract them from the horror of the pandemic and the boredom of isolation―and many even became armchair speculators. In this disconnect, while 230 million people had already been infected by then with Covid-19, 5 million had died, and economies all over were in free fall, a few shareholders and executives of a handful of firms saw their net worth increase beyond their wildest dreams.

At the time I began to write, one speculator had just made US$30 billion (bn) in a single day, while one asset manager pocketed US$16bn from a single bet, and a shareholder of a tiny automaker―that makes minimal earnings and pays no dividend―had just made another US$13bn, lifting his gains since the outbreak of the pandemic to US$88bn (so he was promising to build a city next, on Mars!).⁹

In turn, during the first half a year of the pandemic, the net worth of another individual had risen by US$73bn and another by US$45bn, while the combined fortune of US tech billionaires had increased by US$270bn.¹⁰ In the same short period of time in China, one billionaire made US$30bn, and 257 of its citizens had become billionaires.¹¹ In the meantime, one Asian asset manager was able to make such derivative bets that his ‘Nasdaq whale’ threatened to transform a ‘melt-up’ in tech stocks after their early dip at the start of the pandemic into an avalanche. And, according to one insider, at the time of writing ‘the whale [was] still hungry’.¹²

Meanwhile a quintet of tech-giants, after losing US$1.3 trillion (tr) in March of 2020, gained US$7tr in August―more than the value of the entire Japanese Topix with its 2,170 companies. And Apple, whose best days were meant to be behind it due to a lack of product diversification and concerns about its position in China, saw a whole trillion added to its market valuation in just 21 trading days.¹³ Pandemic, what pandemic?

As two analysts of the Financial Times (FT) rightly remarked, ‘the last time the super-rich had it this good was in 2009, immediately after the great financial crunch’.¹⁴ Nothing like what happened after that crisis had ever happened before, but (given the lack of imagination among policy makers, and their capture by big financial agents) it was bound to happen again after the outbreak of the pandemic. This is precisely the focus of the first part of this paper: the remarkable behaviour of policy makers and central bankers, and of international finance in general, after these two startling events (2008 and 2020); in turn, the second part analyses the impact of the associated process of increased financialisation on emerging markets.

The key issue throughout is how, after the 2008 global financial crisis, policy makers―the “new alchemists”―truncated the traditional Kindlebergian financial crisis cycle of ‘manias, panics and crashes’, so that now any financial panic is likely to be followed by a renewed cycle of mania both in the developed and in the developing worlds alike. In their attempt to do ‘whatever it takes’ to avoid a disorderly crash, they believe that they have invented a new magical formula: all that was needed to avoid them was to keep refilling the punchbowl with ‘high-spirited’ easy money and easy credit. Like that, they could not only avoid a crash, but also keep the ‘party’ going in a perpetual state of mania.

Good old fashioned central bankers acted differently: as they thought that their key role was to avoid a mania from happening in the first place, they took the punchbowl away when the party was threatening to get out of control.¹⁵ And if one began to emerge, what they did was not only to try to bring back some calm, but also some sanity and market discipline―which meant allowing price corrections if some irrational exuberance had distorted prices of financial assets, while governments would severely punish agents that had misbehaved. Not any more―the fines imposed by the Securities and Exchange Commission (SEC) had actually dropped by more than half during the four years preceding 2008; and Bernard Madoff was allowed to keep operating after the SEC was alerted to his misdeeds by Harry Markopolos. In fact, after the 2008 crisis, the USA jailed just one banker, while after the savings and loan crisis more than a thousand got convicted.¹⁶ And things did not get any better after 2008; in fact, according to a recent statement by the US attorney for the southern district of New York, financial crimes, like bribery, ‘have just become part of the corporate culture’―adding that ‘The tone from the top was clear: whatever it takes’.¹⁷ And, again, in the bribery scandal that he is currently investigating, although fines have been imposed, the ‘too-big-to-jail’ meant that no senior executive has been publicly charged (see also below).

2.1 Kindleberger’s financial crisis cycle of ‘manias, panics and crashes’, and Minsky’s concept of the inherent instability of financial markets

When Charles Kindleberger gave me a copy of his famous 2005 book, he wrote on the first page―and in big letters―‘Avoid manias’! In this book, he highlights some important aspects of financial cycles including the tendency of people to forget past shocks and tears when markets are rising. For him, the most surprising feature of a financial bubble is the inability of those trapped inside it to acknowledge the seriousness of the situation. Denial at its worst! In theory, market players know that there is a bubble and that a panic leading to a crash is an almost inevitable outcome of such bubbles bursting. However, when a new bubble begins to take shape, participants invariably believe that either this time will be different,¹⁸ or that they will be able to exit in time. So, they continue to speculate as market manias continue to deliver dizzying rises in prices across all asset classes―until the music inevitably stops.

Even Isaac Newton was enticed by the South Sea bubble! In fact, he got in, made a fortune and (acting rationally) decided that it was time to get out; however, as many of his friends kept making fortunes in the bubble, he could not resist the temptation to get in again―and this time he lost everything.¹⁹ If he could be fooled by the irrational exuberance of a baseless bubble, what could be expected from us, mere mortals? No wonder Kindleberger uses the concept of mania in a psychoanalytic sense: mania as a disconnect, or detachment from reality.

As Freud reminds us, ‘We welcome illusions because they spare us unpleasurable feelings, and enable us to enjoy satisfactions instead. We must not complain, then, if now and again they come into collision with some portion of reality, and are shattered against it’.²⁰

The end of the party is often triggered by what Paul McCulley (referring to the Asian Debt Crisis of 1997) labelled ‘a Minsky Moment’.²¹ This defines the point in time where a sudden decline in market sentiment could lead to a downwards cycle that could easily end up in a market crash. A ‘Minsky Moment’ would follow a prolonged period of bullish speculation, which is also associated with high amounts of debt taken on by all type of agents.

Sometimes, but not always, a ‘Minsky Moment’ happens when some market ‘insiders’ begin to realise that the growing gap between prices and values is becoming unsustainable; then, they close their positions and exit the market. This usually marks the peak of the market cycle. Then, creditors start getting worried about the ability of debtors―who had engaged in excessively aggressive speculation in the rising market and had taken more risks during the bull markets than what would have been privately (let alone socially) efficient―to pay back the loans; and such concerns usually confirm that markets are at a peak. An important part of Kindleberger’s brilliant 2005 book is about how bull markets will always tend to end in epic collapses. In fact, when major central banks adopted ‘QE’ after the 2008 crisis, they were trying to avoid this by constructing an artificial floor under overblown asset prices (as if fighting the law of gravity). To do so, in the decade that followed they pumped over US$16tr into financial markets, creating the biggest policy-induced market distortion in financial history, while engineering on the way a moral hazard of such magnitude that it has transformed finance into an entirely new ball game. One in which the only option now open to central bankers seems to be ‘more of the same’; so, in response to Covid-19, they pumped yet another US$9tr―leaving to politicians the difficult task of explaining why the very rich should become again such huge welfare recipients.

In turn, Minsky’s work also centres on the concept of the inherent instability of financial markets.²² Minsky’s unique contribution is to highlight how a period of steady economic growth is bound to spur a rise in speculative behaviour, which would eventually result in market instability and risk of a collapse. That is, periods of prolonged prosperity can entice financial agents of all sorts to take on riskier assets as lending ‘rationing’ criteria are relaxed, increasing the leverage of the banking system.²³ And riskier assets result in greater market exposure, making the system more vulnerable to defaults. Under these circumstances, issues such as adverse selection are also particularly relevant.²⁴

A key point here is that in emerging markets, plagued with regulatory and market failures, the financial price mechanism is bound to fail even more catastrophically than in advanced economies as regards being able to bring about a system of sustainable finance in an environment with easy access to cheap finance.²⁵

In other words, a capitalist economy with unregulated finance and abundance of liquidity―North and South of the Equator—tends to promote a financial dynamic that is endogenously prone to debt crises. This contradicts the conventional view that financial markets are fundamentally stable, and able to self-adjust. Therefore, for the mainstream, an exogenous shock—like government destabilising interferences—is necessary for crises to occur. The internal dynamics of financial markets would never do that on their own accord. However, Minsky (following Keynes) challenged this perception with his financial instability hypothesis (Minsky, 1992). Essentially, he argues that stability is destabilising, and that the internal dynamics of unregulated markets could be solely responsible for their failures. And he then brilliantly describes the three stages of his financial cycle: the hedge, the speculative and the Ponzi.

The emergence of liquidity issues and bankruptcies is generally the first indication of the beginning of panic mode, as debtors relying on additional loans to cover their cash flows to stay afloat could face bankruptcies, as these cash flows dry up and repayments begin to loom in front of them. In this turn of the tide, there is eventually a sudden and collective move towards the exit, leading to mass panic and a further freefall in asset prices of all kinds. In other words, central bank passivity as a bubble emerges (without consideration of its after-effects), combined with treasury complicity, are usually the underlying cause for market crashes.

In turn, fraudulent behaviour becomes intrinsic to market manias―with Charles Ponzi and Bernie Madoff being paradigmatic examples.

Finally, it is important to emphasise from the start that the work of Kindleberger and Minsky, among others, helps in the understanding of a key point of this paper: if policy makers were to behave as ‘good old fashioned central bankers’ (rather than as ‘rentier-facilitators’ as now; see below), it does not mean that financial markets would behave as those found in mainstream macroeconomic texts. In other words, what this paper is really about is an analysis of distortions and market failures that have taken place over and above those that would ‘normally’ occur in deregulated financial markets. In other words, the counterfactual to what has happened since 2008 is not one of selfish and well-informed agents behaving rationally in competitive and ‘self-adjusting’ financial markets, which are capable of allocating resources in an effective, efficient and sustainable way. It would at least be, however, one in which wishful thinking might not have become delusional.

2.2 We are not in Kansas anymore!

As Carlos Díaz Alejandro brilliantly remarked as early as 1984, ‘we are not in Kansas anymore’. In this post-modern neo-liberal world, policy makers and central bankers do not behave as good old fashioned Keynesian ones: their main aim in life is not to avoid manias (i.e., to avoid a ‘disconnect’ between the financial and the real worlds, leading to insubstantial asset price inflation), but to turn a blind eye to them, and then deal with their inevitable destabilising effects by engineering yet another artificial mania; and the most effective way to do that is by dramatically boosting the net worth of a few individuals.

As suggested above, artificially lifting billionaires’ wealth is surely a rather odd way to ‘save the world’ from the impact of panics—particularly if the (often self-constructed) mania that brought those financial panics should have been avoided, or at least dealt with well before that. But the current obsession in policy-making with sustaining perpetual manias has become so entrenched in financial markets that the combined fortune of the richest 500 individuals in the world has by now been lifted to well above the whole of Latin America’s GDP!

Even before the pandemic, inequality had already reached levels that were simply obscene: had the USA had the same level of GDP, but the share of income of the top 1% were that of 1980 (when Reagan was elected), they would have earned 2 trillion dollars less than what they did―an amount larger than Brazil’s GDP. And for the rest, is the other way round. Furthermore, if the same had happened in wealth distribution, the top 1% would have had only about half their wealth―and the top 0.1% a third, and the top 0.01% just a fifth.²⁶ It was in this scenario that monetary authorities pumped again, as in 2008, a tsunami of liquidity during the pandemic; what they really achieved, as one insider remarked, was to engineer ‘a return to the world of dot.com[edy]’.²⁷

In fact, at the time I started writing the first draft of this paper (end of 2020) the stock of global financial assets had reached an amount five times larger than global GDP (US$422tr).²⁸ In 1980, at the time of the beginning of neoliberal reforms, they had a level similar to global GDP (Palma, 2009a). No wonder that by 2020 there were so many over-liquid and under-imaginative speculators unable to find where to park their money that at the time of writing negative yielding debt pile was fast approaching US$20tr (even the Greek government could eventually sell bonds with negative interest rates!). At the same time, and for the same reason, international finance ‘rediscovered’ emerging markets, and these began to play their usual role of ‘financial markets of last resort’ (see below).²⁹

And the ‘dance of the billions’ (now of trillions) did continue during 2021; so, overall, during the first 20 months of the pandemic, the wealth of just the 10 richest individuals doubled to US$1.5tr³⁰; and that of global billionaires increased by an amount similar to the whole of global public health spending.³¹ To artificially create a new billionaire every 26 hours is surely a rather odd way for dealing with the economic impact of a long pandemic. Instead, as a FT columnist rightly says, the very last thing that was needed to reactivate fragile economies was more ‘silly billys’ (silly billionaires).³²

Meanwhile, the abundance of almost free finance helped create such ownership concentration in financial assets that collectively, the 10 largest institutional investors ended up owning more than a quarter of the US stock market. In fact, mergers and acquisition (M&A) worldwide between the start of ‘QE’ in 2008 and 2020 reached US$46tr, the biggest anti-competition drive ever³³―like Facebook buying Instagram just to stifle competition.

In fact, now just three newly created conglomerates ‘control more than 60% of the seed and agrochemical market, […] almost all GMOs (genetically modified organisms), and the majority of patents on plants in the world’.³⁴ No one seems to have remembered these facts when food prices began to rise well before the pandemic, and now all the talk about their continuous rise is just about weather, disease outbreaks, war and natural disasters. New and growing oligopolistic concentration seems to have become such a fact of life that those in control of key areas of the market taking full advantage of all those events now goes almost unnoticed.

What the new breed of policy makers and central bankers have actually achieved is to engineer a toxic cocktail that not only has kept distorting financial markets, but is also hindering the real economy: according to the chief economist of the Bank of England, the main cause of low levels of corporate investment is that this new financialised environment brought about phenomena such as ‘corporate self-cannibalism’—which he defines in terms of an unholy alliance between a new breed of ‘active’ (bullying) shareholders and self-seeking executives, who dismantle companies, or condemn them to debt, in order to increase immediate returns.³⁵ Part of the problem, of course, is the rise of institutional middlemen: in the 1950, only 6% of stocks in the USA was held by institutions; the rest was owned outright by individuals who voted on matters such as who should sit on a board. Today, institutional middlemen like pension funds, mutual funds, hedge funds and so on own 70% of those shares.³⁶

And emerging Asia and Latin America were not immune to this process of income and wealth concentration, with Asia’s 20 wealthiest families reaching the half a trillion dollars mark towards the end of 2020, and Latin America adding billionaires to the Forbes’ list faster (in relative terms) than other regions in the world.³⁷

No wonder that in the middle of the worst health scare for a century, Ferrari, Lamborghini, Porsche and Rolls-Royce, among many other luxury brands, were registering historic sales records; meanwhile, spending on corporate private jets for personal use was also at record levels. And as reality has become stranger than fiction in this new world of finance, the head of HSBC’s Asian private banking was happy to sign a two-year 10 million dollar deal with a dance instructor to get unlimited Latin dance classes of rumba, samba and cha-cha. In turn, a Malaysian financer was enjoying his newly acquired 4.5 billion dollars yacht, and a Brazilian socialite her 500 million villa on the French Riviera; at the same time, a diamond necklace sold for 55 million, a Ferrari for 52 million, a replica of Degas’ ‘Little Dancer’ fetched 42 million, a cask of Scotch Whisky sold for 21 million, a chess set for 10 million dollars, a bottle of cognac for 2 million, a pen for 1.5 million and a fishing lure for a million. And for those on a lower budget, there were shirts for 250 thousand dollars, a truffle for 100 thousand, a doghouse for 95 thousand, a hotdog for 2 thousand, a Chanel fire extinguisher for 15 hundred, a kilo of coffee for a thousand and a designer paperclip for 185 dollars.³⁸

In short, ‘QE’-led perpetual manias made the remarks of the first editor-in-chief of The Economist (that ‘… at particular times a great many stupid people have a great deal of stupid money’) into something of an understatement (see epigraph).

And since financial markets already live in a world of virtual realities, why not take the next step and join the boom in cryptocurrencies and become (well, at least for a while) another crypto billionaire? Or go one step further and join the metaverse, a collection of shared online worlds, which is already the trendiest tech idea, one that has already attracted millions of people and billions of dollars.³⁹

Thus, if in the real world one cannot afford to buy a house, why not get one in the mirror reality of cyber space, where prices start as low as 100 thousand dollars, or less than half the average cost of a first-time buyer’s house in the UK. The slight catch is that one can’t actually live in it because it only exists in the ‘Sandbox’ virtual world, but you do get a digital receipt in the form of a non-fungible token that is recorded on a shared digital ledger known as a blockchain (similar to how crypto-currency transactions are logged).⁴⁰ One can then open a virtual office, and during spare time visit Sotheby’s virtual art gallery in Decentraland, where there are bargains like a collection of pictures of punks that has already passed 1 billion dollars in sales.⁴¹ And if sport is your thing, why not go to the parallel Australian Open where Novak Djokovic did not need a vaccine passport? There is always, however, an alternative: 'get a life'!

In fact, everything is so fragile in this metaverse world that a quarter of a trillion dollars of the market capitalisation of one of its main earthly backers has recently vaporised in a few hours―again, nothing like that had ever happened before on earth. But now there is nothing new with records falling all the time, like in early February 2018 when in just a few minutes 2 trillion dollars worth of stocks vanished from the Dow Jones in a puff of smoke. Paraphrasing an FT columnist, financial markets now look a lot like a (it’s-not-meant-to-make-sense) gigantic global joke.⁴²

Even the Federal Reserve (FED) has joined in this comical story by doubling the number of hundred-dollar bills in circulation (to US$1.3tr), making it the most widely available dollar-note―even if people hardly ever carry them around to shop with. As the chair of the FT editorial board states, ‘in a supposed ‘digital era’, now there are 13 billion hundred-dollar bills stuffed into wallets, safes and suitcases globally helping hide transactions’.⁴³ The same is happening in the UK, where, according to the National Audit Office, its spending watchdog, 70% of banknotes are ‘missing’―or rather, the criminal activities of gangs and tax evaders have also been ‘quantitative eased’ by the ample availability of large denomination notes. Even the Vatican’s central administration office has joined the casino gaming floor by using donations by its faithful for the poor and needy to speculate in derivatives, like placing a big bet on such holy issues as to whether a US car rental would default on its debts.⁴⁴

3. Have they all lost their collective minds?

It is difficult to think of another period since the glory days of JP Morgan, a century ago, when finance had captured policy to such an extent.⁴⁵ Thus, during the 2008 financial crisis, George W. Bush appointed Henry Paulson (ex-CEO of Goldman Sachs) as Treasury Secretary to sort out the mess for which he had a lot to answer for. Then, as Stiglitz emphasises, Barack Obama, again, ‘inexplicably turned to the same individuals bearing culpability for the under-regulation of the economy in its pre-crisis days to fix what they had helped break’.⁴⁶ And then Donald Trump did the same by appointing an ex-investment banker and hedge manager to the same job.

In 18 March 2020, with coronavirus spreading, stocks tumbling and bond trading seizing up, what Trump did is now typical. The person he summoned to Washington to help sort out the mess was no other than Larry Fink, the CEO of BlackRock, the largest hedge fund in the world. As the Wall Street Journal (WSJ) recounts, Mnuchin (the Treasury Secretary) then organised an Oval office meeting with Fink and the President where they debated what needed to be done and how. The outcome of that meeting is now history:

[T]he government unveiled a roughly $2 trillion package, …[and] the Fed hired a BlackRock unit to help it pump money into corporate bonds—a first for the central bank— … Part of BlackRock’s assignment was helping the Fed buy bond exchange-traded funds, including BlackRock’s own. … The Fed didn’t bid out the job. It simply hired BlackRock.⁴⁷

As Minsky (1986) reminds us, ‘economics … is certainly too important to be left to … [financial] courtiers’.

Does anyone remember, or care, that even according to mainstream economics one absolutely necessary condition for markets to work efficiently is that all agents should not only be ‘price takers’, but also ‘rules takers’ (rather than ‘rules makers’)?

The rescue package was so large that if after the dot.com debacle in 2000 it took the Nasdaq 15 years to return to its previous peak, in 2020, after its one-third collapse in February 2020 it took just two and a half months to do so―only to continue its ascent towards an overall jump of 75% before the end of the year (see Figure 6 below). The fact that financial pyrotechnics as a policy to reactivate the real economy had already been tried―and failed―post-2008 did not stop policy makers from trying them all over again after the start of the pandemic in 2020. During the decade after the start of ‘QE’ in 2008―and despite major central banks pumping over US$16tr into financial markets⁴⁸―the average annual rate of growth of employment and productivity in the high-income OECD reached a meagre 0.7% and 0.6%, respectively (or just one-third and one-half below the levels reached during the previous decade, respectively).⁴⁹ However, the Standard and Poor’s 500 (S&P500) grew 6.6 times faster during the decade that followed the bankruptcy of Lehman Brothers than in the preceding decade. But no-one seems to mind anymore about this growing disconnect between the 'real' and the 'financial' worlds—which is the key failure of ‘QE’ and related measures as ‘recovery’ policies after 2008. This did not stop central bankers from trying exactly the same, all over again in 2020: they pumped another US$9tr in response to Covid-19.⁵⁰ Indeed, policy makers in the UK already knew that (according to Moody) less than 1% of the financial resources generated by ‘QE’ after 2008 had been used to create new productive capacities.⁵¹ As Einstein is quoted as saying, ‘Insanity is doing the same thing over and over again and expecting different results’.

Even the Deputy Director of Fiscal Affairs of the IMF reminded policy makers of some Keynesian fundamentals: ‘You get a bigger bang for your buck from public investment [than from policies such as QE as] … investment by private firms has been extremely low’.⁵²

In other words, what policy makers attempted in 2020 was the same hat-trick they had aimed at in 2008: calming down financial markets after the outbreak of the pandemic by diving in with extraordinary liquidity support; reactivating economies by making sure that the net worth a few individuals went into outer space; and convincing everybody that the more shameless ‘QE’ became as an exchange of cash for trash, the faster the recovery.

There is nothing new in capitalism delivering privileges to a tiny elite; however, those acquired now by Wall Street—including its capacity to capture policy making—have more than a passing resemblance to the power that the British East India Company had in its heyday.

The new ‘financial dealers of last resort’ may well have engineered a return to the world of dot.com[edy], yet, at least the dot.com bubble led to a massive investment boom in the new technology (Pérez, 2002). Now we are just left with the comedy.

4. Some theoretical issues: ‘efficient capital market’ and ‘secular-stagnation’ as story-telling

There are two key theoretical points leading the analysis in this paper: in finance, the real thing to fear is the lack of fear itself; and an over-liquid and under-regulated financial market―in which a few agents acquire the privilege of being ‘price makers’ and ‘rules makers’―becomes a major fetter on the real economy both in advanced and emerging economies alike.

It follows that rescue policies from financial crises of the type implemented since the 2008 crisis and intensified during the pandemic, were likely to be counterproductive. Artificially constructing a floor under already overblown asset prices engineered a moral hazard of such magnitude that it has driven speculators, particularly large ones, even further up on the risk curve―encouraging them to take even more risks than was privately (let alone socially) efficient. This was bound to create a lot of fragilities in financial markets and make them prone to sudden panic attacks, for which even more of the same medicine would be required. In the meantime, the real economy in the West languishes, and emerging Asia cannot believe its luck as this opens up huge productive opportunities for them—and many Asian corporations and governments certainly know how to take advantage of this.⁵³

We are in a scenario in which policy makers and central bankers―the ‘new alchemists’―now believe that their key role in life is not only to keep doing ‘whatever it takes’ in terms of liquidity at times of panics, but also play a ‘therapeutic’ role: that of ‘holding’, ‘containing’ and ‘boundarying’ speculators’ anxieties. In such a scenario, there will be a semblance of a safe and boundaried environment where, no matter how much alarm, confusion, distress and pain can emerge in a panic (particularly in a self-constructed one), the new shrink will always be there with his or her attuned, solid and trustworthy presence and a bottomless wallet.⁵⁴ A lack of new ideas have propelled mere wishful thinking into a delusional state.

4.1 The ‘efficient capital market’ hypothesis

Part of the problem, as always, is ideological. If one comes from an ‘efficient capital market’ perspective―and its worshipping of unregulated and self-adjusting markets―then what would be the problem of injecting large amounts of liquidity into troubled financial markets? After all, this extra liquidity was unlikely to create a gap between market prices and fundamentals―let alone a bubble (ignoring such basic issues as collateral-based credit systems being especially prone to bubbles).

Within this perspective asset prices are always so efficient that they actually deserve a pedestal; it follows that stock options should be the most rational reward for good performance. However, as soon as the latter began to be implemented, agents of the ‘rules making’-type wanted a change in legislation legalising shares buybacks―previously an illegal practice, as they are just a mechanism to distort stock prices. As a result, since 1997, the not very capital market efficient share repurchase programme has surpassed cash dividends, becoming the dominant form of corporate payout in the USA.⁵⁵

Furthermore, since in the efficient capital market utopia, stock prices are supposed to be a ‘random walk’ (i.e. they are supposed to be unpredictable and cannot be modelled or forecasted), under risk neutrality there is no scope for profitable speculation. Therefore, the performance of a rational stock market cannot be beaten on a consistent basis, even by clever agents. Warren Buffett must think that this is a Chicago joke.

The key point of the efficient capital markets hypothesis is that if financial markets get misaligned, they always ‘self-correct’. Smart market players would simply force stock prices to become rational by doing exactly the opposite of what they do in real life: take the other side of trades if prices begin to develop a pattern (as this is supposedly bound to have no substance). In other words, for the efficient market theology, a ‘rational surfer’ is not the one that has fun riding waves, but the one that gets drowned trying to create undertows.⁵⁶

The fact that some people, like Warren Buffet, have been able to beat stock markets in a consistent way for most of their life, or that Larry Fink, among others, is now also doing exactly that (the total returns of his BlackRock fund since its IPO, or ‘initial public offering’, in 1999 has been 22 times higher that that of the S&P500) has made little difference to those fundamentalist beliefs.⁵⁷

The FT Senior Investment Commentator has recently summarised his criticism of the efficient capital market hypothesis rather neatly: ‘Notions that financial markets are perfectly efficient and move seamlessly to incorporate every new piece of information … now seem embarrassing’.⁵⁸

In turn, the Editorial Board of the FT gives a good example of how ‘QE’ has confirmed the Kindlebergian hypothesis that unregulated financial markets under conditions of excess liquidity are bound to run amok:

‘[what] cheap money … [has produced] is just a scramble to invest in nearly everything on offer’. The obvious example of this is the boom in special purpose acquisition vehicles, or Spacs, which list their shares on the premise that the promoters have a great deal lined up in the future that will make their backers a decent return. Seasoned financiers, entrepreneurs and former politicians are all putting their names on Spacs, with tens of billions of dollars raised on little more than the hope that these plans for deals will come to fruition.⁵⁹

This brings to mind South Sea Bubble times, when speculators were successfully lured into putting money into ‘a company for carrying out an undertaking of great advantage, but nobody to know what’.⁶⁰

However, when the purity of belief has to compete with the complexities of the real world, in the efficient capital markets hypothesis there really is no contest.

In a more generic sense, Daniel Kahneman (2011) wonders if anyone has ever really changed his or her mind because of some empirical evidence. He argues that people just replace difficult questions with others which are easy to answer—algebra helps in this if it is economics; after all, ‘WYSIATI’ rules (what you see is all there is). Although efficient capital marketers are not the only ones in the profession to have undue confidence in what their mind believes it knows, they seem to have more undue confidence in that than most. And, as Kahneman writes, ‘Odd as it may seem, I am my remembering self, and the experiencing self, who does my living, is like a stranger to me.’ (ibid. p. 390). (A psychoanalyst would probably place more emphasis on the dynamics of the conflict between these two selves.)

4.2 On irrational exuberances and secular-stagnationist’s ideologies

In an efficient capital markets environment, the immediate reaction of policy makers to the onset of the 2008 crisis was to fall back into Friedman’s famous proposition: financial crises only occur because of monetary authority’s mistakes, and radical monetarism can always offer a way out. The remarks by Governor Ben Bernanke at the conference to honour Milton Friedman’s 90th birthday are telling.

[Milton Friedman and Anna J. Schwartz.] make the case that the economic collapse of 1929–33 was the product of the nation’s monetary mechanism gone wrong. … [A]s an official representative of the Federal Reserve … I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.⁶¹

So, it came as no surprise that the first port of call at the onset of the 2008 crisis was radical monetarism―and interest rates were slashed. Standard monetary theory predicted a relatively quick recovery: given the right monetary policy, the economy was supposed to adjust quickly and efficiently to the ‘new reality’. However, standard models are usually ill-equipped to address some key complexities that tend to slow down the recovery. For example, they ignore issues such as the inevitable fight over who bears losses—and resulting ambiguity in long-term ownership; they also do not take into account that (especially with information imperfections) market adjustments to a perturbation from equilibrium could be (locally) destabilising. In general, markets tend to be neither efficient nor self-correcting because whenever information is imperfect or risk markets incomplete (that is, always), markets are not constrained Pareto efficient.⁶²

When radical monetarism proved ineffective as a mechanism to revert the fortunes of economies in a financial panic (mainly due to Keynesian liquidity traps), received wisdom then moved towards (a particular interpretation of) ‘secular-stagnationists’-style thinking. This became a convenient rationalisation for central bankers, treasury officials and politicians’ belief that only an artificially created perpetual financial mania could deliver some semblance of a recovery.

With the excuse that the (unobservable) ‘natural’ interest rate had supposedly become negative, the new secular-stagnationists argued that the main obstacle for the post-2008 recovery was chronically weak demand (relative to potential output). This proved to be a handy justification for previous financial deregulation and for current systematic injections of liquidity and further relaxation of monetary conditions―no matter how much all this could violate mainstream economic theory. Summers, an early secular-stagnationist, famously stated that:

If [tax-cuts-fuelled] budget deficits had …not grown relative to the economy … [and if] an extra $10tr in wealth had not been created by abnormal stock market returns, it is hard to believe that the US economy would be growing much at all.⁶³

Therefore, and crucially,

Most of what [might be] done under the aegis of preventing a future [financial] crisis would be [now] counterproductive.⁶⁴

What Summers forgot to explain is how his new support for ‘abnormal’ financial returns squares with his previous efficient capital markets belief: ‘[A]sset prices will always reflect fundamental values […]. The logic of efficient markets is compelling’.⁶⁵ Or to explain how could ‘abnormal’ returns in financial markets possibly become an incentive to investment in the real economy if all they do is to increase its opportunity cost?

In short, from the new alchemist’s perspective for a recovery to take hold, the way forward is to engineer a perpetual financial mania. The key fault line in the secular-stagnationists’ thinking is that even if they were right—that is, that the (unobservable) ‘natural’ interest rate had become negative—the other side of the story (their policy proposals) does not necessarily follow. If the key problem is a chronically weak demand relative to potential output, are the artificially generated abnormal stock market returns the best way to deal with that problem (as Summers suggests) rather than, for example, traditional Keynesian reflationary policies?

As the top 10% owns six of every seven stocks held by individuals, and the richest 1% owns half, more stock market bubbles are unlikely to do much to boost actual expenditure (even the unproductive kind), as they will just shift even more resources to those ‘cash-hoarding’ agents who are already responsible for the decoupling of the financial and real economies.

As Krueger remarks, the top 1% of households normally saves about half of the increases in their wealth, while the population at large has a general savings rate of about 10%. This implies that if an extra trillion is earned by the bottom 99% instead of the top 1%, annual consumption would increase by about US$440 billion.⁶⁶ So, if the problem is chronically weak demand, surely there are more effective mechanisms to deal with that than artificially generating abnormal stock market returns.

In other words, since the newly super-rich cannot possibly spend all their money—unlike the rest, who usually do—these abnormal stock market returns would almost certainly have little impact on the natural rate of interest; so, the actions of western central banks were bound to be futile from this perspective. Years of ‘QE’ have basically raised the value of assets held by the rich, thus expanding inequality—and with it, the rich persons’ savings glut.⁶⁷

However, as the problem of the ‘too big to fail’ agent now takes centre stage in a financial panic, policy makers these days believe that the most effective way to avoid a crash are credible assurances of the ‘whatever it takes’ type to allow life to continue in a perpetual financial mania mode. And what about the recovery of the real economy? Well, that would be a great optional extra.

Tobin (1978) was surely right when he said that what is needed for growth is some ‘sand [rather than new lubricants] on the wheels of finance’.⁶⁸ But Krugman, following Summers, disagrees and argues for reckless lending and lax financial regulation:

[Today] even improved financial regulation is not necessarily a good thing … it may discourage irresponsible lending and borrowing at a time when more spending of any kind is good for the economy.⁶⁹

However, as we already know, credit booms weaken (rather than strengthen) output in the medium run.⁷⁰ Furthermore, global debt had already swelled by nearly US$80tr between the 2008 crisis and the start of the pandemic, and poor economic performance, coupled with financial fragility, was evident everywhere.⁷¹

And as no one really expected any significant recovery as a result of perpetual manias, a boost in market shares was the way forward in the search for rents―even if this needed ever more ‘irresponsible’ borrowing to finance ever more overblown prices for existing assets.

Private equity (PE) groups even found a new magical realist niche in the M&A market: on top of their usual gains in terms of ‘longs and shorts’ on either side of mergers, and their role in financing a significant amount of M&A, corporations under PE control began to buy companies from themselves! This type of deal, known as ‘continuation fund’ sales, involves a buyout group selling a company it already owns to a new fund it has more recently raised. That allows it to return cash to earlier investors within the agreed timeframe, while keeping hold of a company that either has potential to grow or is proving difficult to sell―generating handsome payouts to executives.⁷² At the time of writing, these ‘secondaries’ ‘[a]re the asset class that everyone wants’.⁷³

And, as Bloomberg highlights, the merry-go-round circle goes on as it feeds on itself: ‘The more PE firms take over companies, the more they grow, the more cash they can extract from their investments, the more [buyout] opportunities they can take’.⁷⁴ Also, the more they grow, the more they can rise in the form of new capital: between 2017 and 2020 they raised nearly 1 trillion a year! In fact, according to the SEC, hedge funds, PE groups and venture capital funds have amassed more than US$18tr in gross assets.⁷⁵

And with bigger funds come bigger deals, with PE steadily creeping into transactions that were previously the preserve of seriously big businesses or even sovereign wealth funds. However, so far regulators and politicians’ words are louder than action in terms of making it harder for this industry to add leverage on deals, as well as for ending absurd tax breaks for fund managers.⁷⁶ But little action has taken place so far, despite the fact that the SEC has already acknowledged that a lot of PE activities ‘are contrary to the public interest’.⁷⁷

As the FT’s US Managing Editor states, ‘Nobody should underestimate the degree to which those QE experiments have distorted the financial system’.⁷⁸ Now anything goes, except doing something socially useful; as a senior columnist of the same publication states, “... [In] these dysfunctional capital markets, ... I have yet to hear a single business person say: “If only I could borrow at minus 0.05 per cent [the low interest rates associated with ‘QE’] my company would be able to undertake some great projects.”⁷⁹

One obvious problem with this secular-stagnationist ‘irresponsible’ lending fad is that if the financial fragilities it creates went wrong, it could be ugly: already by the end of 2018, ‘If [corporate] default rates were to reach only 10%—a conservative assumption—the corporate debt fiasco will be at least six times larger than the sub-prime losses in 2008’.⁸⁰ Nevertheless, for ‘secular stagnationists’, what was needed was just more of the same.

According to Stiglitz, the real reason why the new breed of secular stagnationists ‘found the idea of secular stagnation attractive, [was] because it explained their failures…’.⁸¹ I would just add that it also became a rather convenient excuse for implementing policies advocated by the most powerful interest groups in modern times. At least Obama should have known better.

Does anyone still remember that the neo-liberal reforms were sold by the Washington Consensus Institutions as necessary for ‘getting the prices right’? Yet, it would be a formidable task to try to find a price that could be said to be ‘right’ (i.e., one that reflects real fundamentals) in today’s financial markets… Paraphrasing Lord Darlington in Oscar Wilde’s play Lady Windemere’s Fan, what they actually delivered was a new Titanic-style speculator that might well know the price of everything, but surely knows the value of nothing.

Secular-stagnationists should know by now that it is one thing is to pump extravagant amounts of liquidity into financial markets, but quite another is that in order to help reactivate growth in the real economy governments should also exercise different forms of agency aiming at ‘disciplining’ the élite into actually spending this extra liquidity―and especially into doing so productively.

The USA provides a great example of how easy access to ever-growing financial rents can coexist―and is bound to coexist―with low levels of investment and productivity growth. On the income side, as already suggested, increased inequality has helped the top 1% to earn 2 trillion more than what it would do otherwise; and on the wealth side, if the USA had the same level of wealth, but wealth inequality was the same that existed when Reagan was elected, the richest 1% would possess only half of their actual current wealth.⁸² But despite these extra 2 trillion in annual income for the top 1%, and this extra doubling of their wealth, overall investment is now 1 trillion lower as a share of GDP than what it would be if this share had remained at the level it was when Reagan was elected.

Ricardo would not be surprised by this asymmetric outcome—in particular because about 70% of the overall extra income appropriated by the top 1% since Reagan, was generated by increased inequality. And (as Ricardo’s analysis predicts) ‘easy rents’—and they don’t come easier than this—was bound to lead to lazy elites, low levels of investment, weak productivity growth and stagnant wages.⁸³

Furthermore, as in Ricardo’s time, governments are now also happy for the lazy rentier elite to not even pay their taxes. The UK government, for example, has now openly admitted ‘that it has no idea how much tax is being evaded through offshore assets’; adding that ‘We have not produced or received any estimates, analysis or statistical information as to what proportion of the foreign financial accounts have been ‘properly disclosed’, nor can this be accurately inferred in the data we hold’.⁸⁴

In the case of wealth, inequality has reached such heights that while the S&P500 was soaring by more than 320% between 2009 and mid-2018―the longest bull market on record, which created more than US$18tr of (virtual) wealth―the median US household wealth was actually falling.⁸⁵ In turn, the retirement assets of just 100 CEOs added up to as much as the entire retirement savings of more than 116 million people at the bottom of the pay scale.⁸⁶ And in terms of income the same happened: while CEO compensation grew by 940% from Reagan’s term to 2018, that of the median worker did so by only 12%.⁸⁷ But, as mentioned above, and as Ricardo would predict, investment is now 1 trillion lower as a share of GDP than at Reagan’s time.

As Figure 1 confirms, rocketing inequality and financial pyrotechnics were actually counterproductive to investment levels. As the top right-hand panel indicates, non-residential private investment as a share of the income of the top 1% fell as if on a roller coaster―from nearly 120% at the time of Reagan’s election to the low 40s.

In turn, overall private investment as a percentage of the income share of the top 10% (top left-hand panel) has also fallen by more than half (from 55% to about 25%)―a level similar to Brazil’s. That is, no matter how ‘abnormal’ (Summer’s) returns are, and how much ‘irresponsible’ (Krugman’s) lending is made, investment levels have collapsed. This is yet another indication of the US―and other high-income OECD countries’―process of (what I have labelled) ‘reverse catching up’ with Latin America: the higher the share of income appropriated by the top, the lower the proportion of that income that is returned to the economy in a productive manner (see also below).

Inevitably, in such a world there will be events of financial panic, but they are now bound to become merely brief interludes from excessive partying as we have reached the bizarre situation in which large speculators can be sure that the new shrink will always be there with his or her attuned, solid and trustworthy presence and a bottomless wallet. So, if they could only remain calm―and solvent―in the face of volatility, a financial distress could become just an excellent opportunity for restructuring portfolios, acquiring assets that might in the past have been lost opportunities. In this totally artificial scenario, speculators can acquire a remarkable ability to navigate shifting markets with bull and bear flexibility.

In other words, financial markets now have the power to ‘stop, rewind, and erase’ and be ready to follow the new mania marching orders coming from a cheering FED and an encouraging Treasury. Thus, what happened for example in early 2018 (to be analysed in the next section) was part of a new post-2008 and ‘QE’ era―and what happened in 2020 had a feeling of déjà vu about it.

At least some members of the FED are finally getting the point: according to the President of the Minneapolis Fed, for example,

[W]e can’t just keep doing what we’ve been doing. As soon as there’s a risk that hits, everybody flees and the Federal Reserve has to step in and bail out that market, and that’s crazy. And we need to take a hard look at that. … For me, monetary policy is a very poor tool to address financial stability risks.⁸⁸

Yes, but mainstream economic theory (although not just this theory) has failed to reinvent itself when faced with the increasingly complicated world discussed above―where a lot of peculiar stuff happens―as it did after the 1930s crash. On the “unfortunate uselessness of most ‘state of the art’ academic monetary economics” see, Willem Buiter (2009). See also Frenkel and Repetti (2009).

5. The 2018 Roller Coaster and the 2020 Déjà Vu: the new financial crisis cycle of ‘manias, panics and renewed manias’

An event that already shows the flavour of things to come during the 2020 pandemic is what happened at the beginning of 2018. In the year before the February 2018 fiasco, global private credit expansion reached US$6tr, and in the USA alone, junk bonds totalled US$4tr, and half of all investment-grade corporate bonds were already at BBB, a rating that indicates that expectations of default risk are just one step from junk status.⁸⁹

Figure 2 shows the sharp swings in the S&P500 during January and February 2018, which was the prelude for the new truncated financial cycle in 2020.

Basically, big agents in financial markets are now able to dismiss panics as if they were mere ‘tail risks’ (risks of rare events), or ‘black swan events’ (unusual events that are hard-to-predict as they are beyond the realm of normal expectations)―even if they are anything but.

And the degree of generalised amnesia following this new-style financial crisis cycle is such that I would not be surprised if many readers of this paper do not even remember what happened in January and February 2018, even though it was certainly no ordinary event as it was characterised by the biggest ever recorded sudden change from exuberance to distress over a period of two weeks since records began more than a century ago. In fact, according to the London’s Longview Economics, the S&P had never fallen so far so fast from a record high⁹⁰; and the Dow suffered its worst fall in absolute terms in its history following the greatest withdrawal from global equity funds on record. It was also the end of one of the longest and strongest bull markets in history (number 1 by some metrics). What followed was the largest percentage jump on record of the ‘Vix’ (Velocity Shares Daily Inverse) index of US stock market volatility, and so on. In other words, under ‘normal’ market conditions all the ingredients needed for a major financial crash were there in abundance. Not anymore.

What happened in February 2018 should go down in financial history for several reasons: first, it was the most vertiginous transition from mania to panic ever. In fact, on February 5, the Dow Jones stock market index plummeted by more than 1,500 points in just a few minutes. Never before in the history of the index had US stocks lost so much in a single day (about 2 trillion dollars). And New York was not alone, as the collapse spread like wildfire to Frankfurt, Sydney and Tokyo. But as there was no apparent discernible real-world economy reason, some blamed it on high-frequency trading going mad (a flash-crash)―many still do.⁹¹ Second, the same happened in terms of a switch from stability to volatility as what preceded it was a year (2017) characterised by having the lowest share volatility in more than half a century, to be followed by a baseless 8% jump in January, only for this to switch to an even greater fall in share prices in just nine trading days (−10% in all). However, third, the swift recovery that followed indicated the ‘V-shape’ of things to come: there was an immediate recovery of the S&P500 in late February (another groundless 8% jump).

As institutional speculators who feed on the mispricing now embedded in asset pricing and on the fuelling of market volatility have learned how to make money on both sides of the cycle, in the panic phase of the following cycle in 2020 (from the market peak in 2020 to its lows in March) short positions notched up paper gains of US$375bn.⁹²

What is new in financial markets is that now in the midst of a panic (as in the first week of February 2018), the chief US equity strategist at Credit Suisse could simply say with complete confidence: ‘Investors … may have been given a gift. … You should be buying into this’.⁹³ And in the next financial panic, at the start of the pandemic, the chief executive at UBS’s boosted the same to the FT: ‘[Our clients] did not [really] panic during the sell-down. Instead they used it to build up positions’.⁹⁴ This is precisely the point: as suggested above, in finance, the real thing to fear is the lack of fear itself.

As already mentioned, events in January and February 2018 took place after a year with the lowest share volatility on record. Shares not only went up at a fast rate―the S&P500 stock market index increased by a fifth, the Dow by a quarter and the Nasdaq not far short of a third―but they did so in a surprisingly stable way. In fact, during 2017, the S&P500 went as far as to rise every month of the year, something which had never before happened in this index’s long history (see Figure 3).

The stable rise of 2017 suddenly switched to a remarkable baseless price surge in January; and then, equally suddenly this bull market turned into a precipitous fall, losing more than their total January gains in just a few trading days.

The remarkable contrast between the stable growth of 2017 and the sharp swings that followed becomes evident in the Vix index of Stock market volatility.⁹⁵ (Figure 4)

Although the Vix is an easy way to make gains in a stable market (as in 2017), the sharp volatility of just one day (5th of February, when index trebled, its greatest percentage jump on record) turned into carnage for holders of the note as by Tuesday it had already fallen by 93% in value. However, as one FT columnist remarked by the middle of February, the recurrent amnesia in financial markets is now such that ‘not even the Vix horror show is deterring new suckers’.⁹⁶

Figure 5 indicates how the 2018-‘V-shaped’ cycle was replicated in 2020. Following a relatively stable 2019 (with many similarities to 2017), the Covid-19 panic led to a sudden one-third drop in the S&P500 index, only for it to turn immediately into a sharp rise; in fact, the upswing was so swift that a bear-market recovery started within one week of the collapse—dismissing all fears of a proper crisis despite individuals such as Warren Buffet reminding us that the world of finance was ‘… not very, very far away from having something that could have been a repeat of 2008 or even worse’.⁹⁷ And by the middle of August, the index was already back to pre-Covid-19 levels, only to continue its ascent despite a persistent unease about the pandemic, the World economy and the US election. In fact, all this was just part of Wall Street stocks’ strongest rebound rally since 1936.⁹⁸

However, this ‘V-shaped’ overall recovery hides its ‘K-shaped’ soul: as everybody bought stocks in the obvious five tech giants, they went through the roof; meanwhile, one fifth of companies ended this period still more than 50% below their all-time highs―with the median stock still 28% below its peak.

As a result, those five tech giants now represent more than a fifth of the S&P500; however, antitrust regulators seem to be unconcerned about this.

Figure 6 shows the top part of the ‘K’, as reflected in the Nasdaq Composite Index―where there wasn’t so much a ‘V-shaped’ recovery as a Nike ‘√’-shaped one.

As suggested above, the sharp rebound renewed fears about the growing disconnect between ‘Wall Street and Main Street’, as a few shareholders and executives of a handful of firms saw their net worth increase beyond their wildest dreams in the midst of a real economy collapse (Figure 7); and short sellers became an endangered species in this US$13tr rebound.⁹⁹ According to Bloomberg, ‘buying surged among professional investors … despite a recession, stagnating profits and the prospect of a messy presidential election’.¹⁰⁰ A falling dollar was providing a further boost.

As Figure 7 indicates, during the second quarter of 2020, the US economy shrank by 9.5% vis-à-vis its previous quarter―at an annualised rate of 33%; however, in a reckless attempt to contradict Archimedes’ principle, while output, employment and investment were sinking like stones (along with the new low in the US–China relations and the prospect of a chaotic US election), the S&P500 was being lifted to a new record high. In fact, despite the massive economic downturn, the S&P500 was trading at some of the highest multiples since the dot-com era.

It is hard to imagine a market more ripe for a major correction―one that policy makers now believe is their duty to make sure never happens. As Carmen Reinhart, the World Bank’s chief economist, notes, ‘If you look at financial sector vulnerabilities, …it is difficult to not be pretty bleak’.¹⁰¹

So, perhaps rather than a growing disconnect between ‘Wall Street and Main Street’, the ‘new alchemists’ seem to have managed to create a new form of ‘connect’ between the two: the faster the fall in stock prices, the higher the incentive for speculators, particularly institutional ones, to start buying stocks again so as not to miss any of the (by now almost) ‘inevitable’ rebound―inevitable because of the ‘whatever it takes’ to force that to happen.

Not surprisingly, when in early August 2020, in the same day that the UK authorities announced that the economy had suffered its greatest recession in three centuries, the London Stock Exchange jumped by more than 2%. Nothing like that had ever happened before!

In the same month, one financial insider was even lamenting that ‘…we have made an awful lot of mistakes, but our biggest mistake may be that we have not been optimistic enough’.¹⁰²

This is not really the world according to the ‘efficient capital market’ theory. As suggested, ‘rational’ surfers are those who enjoy riding waves, not those who drown trying to create undertows. But this theory, against all evidence, has enjoyed such a powerful hegemonic consensus that while Bernie Madoff was laughing all the way to the bank, Alan Greenspan was still arguing against tightening regulation against financial fraud, ‘as rational markets can take care of themselves’.¹⁰³ This statement is reminiscent of Mencken’s remarks: ‘For every complex problem, there is always an answer that is clear, simple and wrong’.¹⁰⁴ As we now know, under his watch, the system already had rampant flows of tainted money (see also below).

The mood in financial markets was so cheerful at the time of the stock market recovery that Citygroup’s Panic/Euphoria Model, a sentiment gauge, was in a blissful mood―likewise one not seen since the dot-com bubble (Figure 8).

At the end of August, the reading of City’s model, at around 1.1, was almost three times the level that denotes euphoria, also showing the longest run of extreme bullishness for three decades. During this fastest bear-market recovery in history,¹⁰⁵ options traders were just piling in on bullish wagers while bears were fast disappearing―precisely at times that were ripe for scepticism! In fact, while some bets on a continuous rise in share prices were so large that these agents behaved as ‘whales’, the economy and corporate operating profits (as opposed to their profits in financial operations) were stuck in a huge recession. Banking on a perpetual fiscal and monetary stimulus, a fear of underperforming the market prompted money managers to chase the gains, despite bleak prospects for the real economy and the World Health Organization’s warnings about the pandemic becoming endemic―they just could not miss out on the next Tesla.

At least, as discussed above, Daniel Kahneman, Amos Tversky, Paul Slovic, Richard Thaler and David Schkade, among others, have made great strides in trying to understand the highly complex nature of human behaviour in economic agents. Long gone are the days when humans were just assumed to be ‘rational’ agents who always aim to perform optimal actions based on given premises and information―where everything was supposed to be just ‘rational behaviour’ on the part of agents reacting reflexively to new information. The same obviously goes for policy makers and central bankers!

6. ‘QE’ as a liquidity-pumping machine―one that gave financialisation a whole new meaning

From the perspective of the ideas of economists like Keynes, Kindleberger and Minsky, within a tradition that also includes intellectuals such as Veblen, Hilferding and Kalecki―although each was stressing somewhat different dynamics―the basic problem with unregulated financial markets is that operational normality can easily start becoming dysfunctional for entirely endogenous reasons, and even turn into manic exuberance, and then to profligacy. Basically, financial markets are more prone to fail than most, and ‘QE’ did indeed help to move things in that direction, as it provided what some (like Kindleberger and many others, including myself) consider to be the usual trigger for this: a sudden jump in liquidity. In fact, in this unusual case ‘QE’ not only provided the extra liquidity, but also did so with the promise of a safety-net for asset prices! This became such a toxic combination that, according to one global investment strategist, “One of the purposes of financial markets is to price risk. We allocate resources accordingly, ... . But [with ‘QE’] we are not pricing risk any more.”¹⁰⁶ As already mentioned, in the decade after the start of ‘QE’ in 2008, Central Banks in the USA, Europe and Japan and other central banks like the Reserve Bank of Australia and the Bank of Canada injected more than US$16tr into financial markets. Then again, in response to Covid-19, they pumped another US$9tr―and this was done so quickly, and included such a range of products, that according to one asset manager, it was a “completely insane” policy-package (Ibid).

The crucial assumption (let’s rather call it wishful thinking) of this policy is that once ‘QE’ had helped to calm financial markets, a continuous wealth-effect in asset holders would work as an engine of growth, setting the economy in motion again. However, first, what the ‘new alchemists’ really did in 2008 was to respond to a crisis caused by excess leverage by inducing the creation of more debt―in fact, much more debt of all kinds. And many forms of banking fragilities actually intensified; for example, most US banks’ derivatives books became even larger than when Bear Stearns had to be rescued.

Furthermore, second, QE’s capacity to reactivate the real economy has been minimal, as distorted market incentives and low propensity to spend by large asset holders led this extra liquidity to be used for anything (including, of course, the financial casino) except for creating more productive capacities―as quoted above, in the UK, this was less than 1%. And lacking shareholders’ support to invest, executives struggled to turn modest economic growth into higher earnings (including their own); so companies started borrowing to spend on buying their own stock and increasing dividends, which provided a boost to the stock prize and to the size of dividends reported per share.¹⁰⁷ According to Dealogic, between 2000 and 2017, equity withdrawn from the market reached US$5tr.¹⁰⁸

Another of the many distortions created by the monetary response to the 2008 crisis is that ‘…pension savers—virtually all of us—may find to our horror that we are the schmucks’.¹⁰⁹

And the wheels of QE financialisation kept turning; PE assets under management doubled after 2008; PE managers borrowed record sums using ever riskier credit facilities; and credit mutual funds tripled in size.¹¹⁰ And as financialisation promises to boost asset prices permanently, by 2017, over a third of those buying homes in the USA made offers without even bothering to see the property in question personally―and in places with greater speculative frenzy, such as Los Angeles, the proportion reached more than half.¹¹¹

Does Summers still believe that ‘asset prices will always reflect fundamental values?’ Or that ‘the logic of efficient [capital] markets is compelling’? Compelling indeed, as sub-prime mortgage bonds came back in fashion¹¹²; and credit default swaps made a big comeback ‘even though it is patently clear that they are not fit for purpose’.¹¹³

According to Minsky (1974, p. 2), ‘A fundamental characteristic of our economy is that the financial system swings between robustness and fragility, and these swings are an integral part of the process that generates business cycles’.¹¹⁴ Except that since the rule of the ‘new alchemists’, they now seem to swing from fragility to fragility.

7. Financialisation in advanced countries and their process of ‘latinoamericanisation’

It is often acknowledged that the only historical legitimacy of capitalism—that is, the legitimacy of a small élite to appropriate such a large proportion of the social product—rests on that élite’s commitment to use it productively. Keynes (1919), for example, discussing the (investment-intensive) ‘Third Technological Revolution’,¹¹⁵ emphasises the contrast between the business elite in ‘emerging’ Germany and the USA vs. that in Britain:

The new rich of the nineteenth century … preferred the power that investment gave them to the pleasures of immediate consumption. … Herein lay, in fact, the main justification of the capitalist system. If the rich had spent their new wealth on their own enjoyments, the world would long ago have found such a régime intolerable.

Intolerable indeed! However, there is not much danger of finding these enlightened characteristics in the current newly rich of the USA or Europe (West or East), where new financial wealth is indeed spent mostly by rentier capitalists on their own ‘enjoyments’―including, of course, at the financial casino. In contrast to what Keynes said about their counterparts from another epoch, the behaviour of most of today’s rich is something akin to the ‘discreet charm’ of the (now globalised) Latin American bourgeoisie.

Meanwhile, the countries of emerging Asia―the eternal heretics of neo-liberalism―have used this opportunity to turn the table on this ‘latinoamericanised’ West:

Germany once saw China as an export market for machinery with which China would develop its industrial base. Today, China is becoming the senior partner in the relationship. [Germany’s] biggest problem is falling behind in the technological race. … [This] is symptomatic of a fundamental European problem. … [Now there] are signs that complacency is about to turn into panic.¹¹⁷

It has surely not helped that Germany’s now latinoamericanised market inequality (i.e. before taxes and transferences) has become even higher than China’s (Ginis of 52.1 and 46.9).¹¹⁸ In fact, its market inequality has been in a phase of ‘reverse catch-up’ with Latin America since the 1970s (Figure 9), and by this metric, the USA is also already more unequal than Mexico. So now we see countries in Europe and the USA (with Japan not far behind) with a market income distribution characteristic of countries south of the Rio Grande.

In turn, and perhaps not surprisingly, as Figure 10 conveys, while its market Gini went up by 14 points, Germany’s share of investment in GDP and its rate of productivity growth collapsed, becoming now similar to the Latin American respective averages since 1980 as well. Figure 1 indicated that the same had happened in the USA.

Part of the problem of lack of investment in financialised advanced economies is due to the process of corporate ‘self-cannibalism’, as highlighted by the chief economist of the Bank of England (see Section 2.2 above). He also points out that where shareholders in the UK used to demand about 10% of corporate profits, they now want it all (and more); and where they once kept shares for six years, they now keep them for less than six months, implying far less concern for the firm’s long-term health. For Keynes (1936), in contrast, the health of the corporate sector depends on building a relationship between shareholders and firms like a marriage. Instead, as Warren Buffett remarked (speaking in Omaha to thousands of shareholders gathered for the company’s annual meeting, often referred to as Woodstock for Capitalists), ‘Wall Street encouraged traders to treat shares like poker chips, … [transforming financial markets] almost totally [into] a casino’.¹¹⁹

In turn, as financialisation has been associated with low levels of corporate investment and rising corporate saving, it has ended up being a major contributor to the growing mismatch between abundant liquidity and a relative shortage of solid financial assets, making the ease of performing a transaction in a hollow security or instrument the trademark of the current process of financialisation.

There were, of course, many other things happening in high-income OECD countries than just financialisation and increased inequality; however, most point in the same direction of a ‘reverse catching-up’ with features of middle-income countries such as those in Latin America. As Figure 10 indicates, in Germany, investment as a share of GDP fell from 30% to 20% (becoming in the process similar to the average Latin American ratio since 1980), which led productivity growth to do the same, from an average of nearly 5% p.a. to close to zero (again, similar to the Latin American average since 1980).¹²⁰

Meanwhile, as ‘light-touch’ regulation relaxed operating standards, corruption in the North became ever more common—this is how the ‘too big to fail’ join up with the ‘too big to jail’. We now know, for example, how five global banks—Deutsche Bank, JPMorgan, HSBC, Standard Chartered and Bank of New York Mellon—were helping shadowy characters and criminals to move staggering sums of illicit cash around the world, in a scam that totalled US$2tr.¹²¹ And HSBC’s subsidiaries were also transporting billions of dollars of cash in armoured vehicles for Mexican drug lords, clearing suspicious travellers’ cheques worth billions, helping drug-related mass murderers to buy planes with money laundered through Cayman Islands accounts, and moving at least US$7bn of drug cartel’s money from Mexico into its own US operations. Other subsidiaries were moving money from countries on US sanctions lists, and also helping a Saudi bank linked to Al-Qaida to shift money to the USA.¹²² In turn, the Danske Bank €200bn money-laundering scandal, the world’s biggest, exposed the extent of Europe’s tax evasion and avoidance—with UK entities (largely ‘limited liability partnerships’, or LLPs) being the second largest non-resident client at Danske Estonian’s offending branch.¹²³

At the same time, when Purdue Pharma and other drug makers encouraged over-prescription of opioids, leading to overdoses and addiction that according to US government data resulted in at least 450,000 overdose deaths between 1999 and 2018, and millions to opioid addiction, there was just a fine and no one went to prison.

As a law professor states (commenting on how the Trump Administration spared corporate wrongdoers billions in penalties), ‘There’s no reason anymore to fear prosecution for committing serious corporate crimes’.¹²⁴ And if anyone is unlucky enough to be prosecuted, why fear the consequences? If convicted for a huge tax fraud, for example, instead of going to prison one may be just sent back to university! A Chilean judge recently punished two corporate executives convicted of a major tax fraud to take a single one semester course on business ethics (with the condition that they had to get a passing grade!).

But declaring that corruption is intrinsic in over-liquid and poorly regulated ‘too-big-to-jail’ financial markets is a bit like going to the circus to watch a magician sawing a person in half and then complaining that it’s only a trick.

As Martin Wolf emphasises,

Rigged capitalism is damaging liberal democracy. … Economies are not delivering for most citizens because of weak competition, feeble productivity growth and tax loopholes … [and all this] because of the rise of rentier capitalism.

And he defines this as ‘economies in which market and political power allow privileged individuals and businesses to extract a great deal of rents from everybody else’.¹²⁵Mariana Mazzucato (2018) also defines rentier capitalism in terms of a system in which the few live from extracting the value created by others. And in Palma (2019a), I emphasise a similar phenomenon for the Latin American elite (financial or otherwise): and that its preference is now for getting rich by extracting value, in ever more ingenious ways, from those who actually create it.

In other words, rather than bringing to Latin America some new and more civilised advanced Western practices, globalisation and financialisation―including their emphasis on market deregulation and the emasculation of the state―has instead brought to the developed world a great deal of ‘latinoamericanisation’.

It is remarkable to see how neo-liberal reforms triggered the high-income OECD to embark upon this process of ‘reverse catching-up’ with the tropics. As is well known, one key Washington Consensus promise was that if their package of policies and structural transformations were implemented, what would follow for developing and emerging economies (DEEs) would be a process of rapid catching-up with the production frontier, leading to a ‘convergence’ across the world. In other words, if everyone behaved themselves, there would be a rapid process of closing the productivity gap between countries. And this convergence would occur not only in income per capita terms, but also in institutions, in inequality and so on.

In fact, market deregulation with subsidiary States, ‘rentier globalisation’ and financialisation have indeed achieved a process of convergence across the world—but in the opposite direction!¹²⁶ Instead of encouraging Latin America to ‘Europeanise’, this new environment has led the high-income OECD to ‘bananise’―with QE providing a great helping hand.

In the introduction to one of his best-known works, Marx (1933, p. 13) claimed that ‘The country that is more developed industrially only shows, to the less developed, the image of its own future’. For him, therefore, albeit for different reasons, the direction of the convergence would be of the kind also predicted by the Washington Consensus. If ever it was like this, it is certainly no more. Now, in this neo-liberal era, convergence takes place in the opposite direction: towards features that are characteristic of some highly unequal middle-income countries, such as mobile élites creaming off the rewards of economic growth (in a scenario not that dissimilar from a winner-takes-all one), and of ‘magic realist’ politics that although lacking any self-respect, have plenty of originality.

I never expected to live to see the USA being recently led by a president who only lacks dark glasses and a military uniform to look like the leader of some banana republic. No wonder Pope Francis has called unfettered free markets the ‘dung of the devil’.¹²⁷

Indeed, life in high-income OECD countries is no longer as easy as their income per capita might suggest, as one now has not only a family but also a plutocracy to support. One is actually tempted to say: Welcome to the Third World!

8. Financialisation in emerging markets

In understanding ‘financialisation’ as defined in the introduction, it’s important to consider that there are two related phenomena involved, one which relates to the growing size and dominance of the financial sector relative to the non-financial sector; and the other to the diversification towards financial activities in non-financial corporations. The first relates to phenomenon such as the mounting power of the financial sector and its growing ability to capture policy, its ever-greater capacity to generate ‘easy rents’ and its increasing capacity to extract value generated by others. The second, meanwhile, relates to the switch of the composition of earnings in non-financial corporations from operating profits to financial rents, which―as Ricardo emphasised―is bound to have a negative impact on investment, technological absorption and productivity growth.¹²⁸ Both developments lead to the productive sector becoming ever more subservient to the logic of financial markets, part of a process of subordination of the real economy to the financial sector that takes place in advanced and emerging economies alike.

In emerging countries, of course, there are two dynamics of subordination involved: the one already mentioned, in which the real sector becomes ever more compliant to the whims of the financial one (a process that includes the diversification towards financial activities in non-financial corporations); and the other, between domestic finance and the cycles of international financial markets (as highlighted by narratives such as that of the ‘international financial subordination hypothesis’, or IFS).¹²⁹ This second is especially detrimental to countries with a troubled financial history, such as Argentina.

However, when it comes to financialisation in DEEs, at least in most emerging markets, the main driver of the transformations that led to this new scenario can be found at least as much at home as abroad. In Latin America and South Africa (Africa’s honorary Latin American country), for example, no one pushed more for financial deregulation and the full opening of the capital accounts than their rentier domestic elites seeking to generate a whole new class of ‘easy rents’―including acquiring the property right to capital flights (a crucial component of their ‘exit strategy’ in case domestic politics turned unfriendly). In fact, this was a key component of South Africa’s political settlement ending apartheid, even though the white elite did not have this right before. And they have surely used it after the start of democracy! In fact, the whole package of economic policies implemented by Mandela’s government was anchored on this: as they needed foreign exchange to finance this capital flight, and as their reserves were practically non-existent, interest rates had to be set sufficiently high so as to attract short term speculative flows to finance it—and as a result the real economy practically stagnated throughout (with investment as a share of GDP reaching just 17% on average during his term in office, and average annual productivity growth managing just 1%).¹³⁰

The same happened in Chile after the 1973 coup: for the ‘Chicago Boys’ (a group of Chilean economists who studied at the University of Chicago under Milton Friedman and Arnold Harberger), financial deregulation and the full opening of the capital account became an ‘end’ in itself. And again, it did not matter at what cost (the average investment rate during the first decade of their reign stood at less than 16% of GDP, and productivity growth actually declined). In other words, in their fundamentalist vision of policy making, financial deregulation and the opening of the capital account were a sacrosanct right of the elite—no matter what, and no matter at what cost.

This is not to say that the Washington Institutions and Wall Street were not seeking similar policies, or that ‘help’ during the difficult 1980s did not come with tough ‘conditionalities’ in this direction; however, to argue that somehow this happened only (or even mainly) because these were helpless nations trapped in a hierarchical world economy that coerced them to do all this is to miss the point entirely. In fact, in the whole world, no domestic elite was happier to trigger a process of financialisation—and benefited most from it—than the rentier ones in DEEs themselves, especially those in emerging countries with complex domestic politics (as the ones mentioned above).

Oddly enough, in emerging markets, financial deregulation and the opening of the capital account to international financial markets of the type analysed above—and the process of financialisation that followed—have at least brought one crucial positive externality for the rest of society (e.g. in Latin America). As suggested above, since financialisation has provided domestic elites with an expedient ‘exit strategy’, they are now willing to become a bit more democratic. As Boix (2003) emphasises, in a financialised environment, it is easier for them to take this risk because they are no longer geographically tied by ‘fixed’ investments, such as land and machinery, as they were in the past.

In turn, Palma and Pincus (2022) have argued that what happened in middle-income emerging Asia in this respect (e.g., Malaysia, Thailand and Indonesia) is not that different, except that change took place in slow motion―but this accelerated after the 1997 financial crisis. Important segments of their domestic elites were nearly as eager for these transformations as their more perennially rentier-oriented counterparts in Latin America.¹³¹

Therefore, some of the more established forms of heterodox analysis of development—such as those of ‘Dependency’, ‘Structuralism’ and some early ideas in ‘Post-Keynesianism’, as well as some new related narratives such as that of IFS (with their emphasis on core-periphery relationships, uneven development, the ‘development of underdevelopment’, international currency hierarchies, and so on)—now have a significant analytical challenge ahead. Their traditional emphasis on peripheral ‘nation states’ struggling to gain some development space in a world economic scenario somehow artificially constructed so as to keep them in their place is now no longer appropriate in finance.

Rather, the key agent that should be taking centre stage in the analysis of the economics and politics of financialisation in emerging markets has now largely switched from ‘nations’ trapped in a hierarchical world economy that coerces them to integrate passively into the world market, to domestic elites—who are anything but 'victims' in this story as they share the interests and values of key external agents—and are able to deliver the new financialised scenario by their capacity to capture domestic politics and shape new institutions. They are the ones leading the process of financialisation at home, engineering the domestic reforms that led to this new reality; and they are also the ones that have also benefited most from it (see Section 8.1 below). At the same time, the abject failure of the left in DEEs to construct viable alternatives should also be a crucial component of a new, more appropriate narrative of financialisation.

The fact that Latin America has been adding millionaires, centa-millionaires and billionaires to the Forbes’ list (as defined by them) faster (in relative terms) than any other region in the world (at times, China apart) is not an unrelated phenomenon! And none faster than in countries that have been led by the ‘new-left’, such as Brazil and Chile. In fact, during President Lula da Silva’s period in office, the numbers of millionaires, centa-millionaires and billionaires trebled. In 2013, for example, while the real economy lagged behind, according to the 2021 Forbes report, one additional Brazilian became a Forbes-type millionaire every 27 minutes. Today, there are more billionaires in Brazil than in Korea, and more in Chile than in Saudi Arabia.¹³²

Key agents of international finance and international institutions, of course, had the same rampant deregulation aims in mind, and large international financial corporations have surely benefited from them, but it was their domestic allies who were the real ‘whales’ capable of manipulating politics and markets at home so as to make these transformations possible.

These key domestic agents, as well as their local allies―including a remarkably corrupt political one―also played a crucial role in transforming the neo-liberal ideology at the basis of all this into an hegemonic one. Let’s not forget the ‘Magnificent Seven’, those visionary leaders who selflessly pioneered these transformations in Latin America: Pinochet, Salinas, Menem, Fujimori, Collor, Pérez and Bucaram—what a collection of thugs!

From this perspective, it is even tempting to question Foucault’s proposition that ‘in order to develop more sophisticated technologies of power one needs more sophisticated forms of knowledge’.¹³³ As discussed in detail below, although financialisation has been transformed into a powerful type of the former, it seems to indicate that this can also be done with pretty unsophisticated forms of knowledge.

8.1 Some theoretical issues regarding financialisation in emerging markets

In the heterodox tradition of development theory, it was often argued that being ‘in the wrong place’ in a hierarchical world economy was supposed to be responsible for the weak economic structures and poor performance of developing countries, as well as their exposure to recurrent crisis and vulnerabilities. The emphasis was placed in factors such as surplus extraction, unequal exchange, currency hierarchies, imposed fiscal austerities, and so on. Lately, however, the emphasis of the analysis has been switching to how emerging markets, although facing a relatively similar external scenario, end up living in a world of multiple equilibria. Some of the (external) pieces of the puzzle may well be the same, but the way they fit together does differ—sometimes significantly.

There are, of course, common factors affecting all emerging markets, and none more than the continuous predominance of the dollar in this financialised world; but, over the last two decades, at least some emerging markets have built up their domestic-currency-denominated debt markets in a variety of ways—so now about 90% of the sovereign bond market is in local-currency bonds.¹³⁴ In turn, while yields in the North remained low, even negative, such bonds became an attractive asset class for foreign speculators, who held about one-fifth of them at the beginning of 2022.

However, own-currency bond issuance did not absolve emerging markets from their ‘original sin’, as domestic bond markets remained highly sensitive to the global dollar cycle. This became evident during the ‘dash for cash’ at the beginning of the pandemic, when the appreciation of the dollar and the loss of confidence in emerging markets capacity to deal with the economic impact of the pandemic led to a massive local-currency-bond market sell-off. The same happened all over again in March 2022, when the Fed raised interest rates for the first time since slashing them to zero due to soaring inflation. In turn, the Russian invasion of Ukraine exposed growing geopolitical risk in the world economy. The rate of growth of many DEEs also began to slowdown. All this triggered a stampede for safety among international speculators, and emerging market bonds suffered their worst losses in almost three decades.¹³⁵ Although for different reasons, at the time of writing Lebanon, Sri Lanka, Russia, Suriname and Zambia are already in default, while Belarus is on the brink of one; and at least another dozen are in the danger zone (such as Argentina, Ukraine, Tunisia, Egypt, Kenya, El Salvador, Pakistan and Ecuador). Overall, there are more than US$ 400 billion at stake.

At the same time, bond prices in the North began to tumble as central banks started to reduce their large-scale asset purchases; this made bond yields increase to their highest levels in years—a move that shrank the global tally of bonds with sub-zero yields by US$11tr.¹³⁶ This has impacted local-currency bond markets in emerging markets as they have become less of an attractive asset class for foreign speculators.

However, there was something different in this new dollar cycle: now the FED could not ignore the impact that this new cycle had on emerging markets anymore—as Volker did during his radical monetarism at the end of the 1970s, which led to the 1982 debt crisis.¹³⁷ So, the FED was forced to relaunch its dollar swap lines with central banks of some key emerging countries, while providing them with a brand new type of repurchase agreement facility, which allowed them to exchange their US Treasury securities for dollars at their pleasure (so as to dissuade them from dumping the securities for cash in the open market).

The dollar may continue to be the dominant factor transmitting financial volatility to the South, but now the (somehow also a bit ‘subordinate’) FED has little option but to take emerging markets’ volatility seriously into account.¹³⁸ Also, the emergence of China, and to a lesser extent that of India, as key players in international finance has opened new options for emerging countries’ finances. However, this has also given them new constraints; for example, China—now the main trading partner of almost all countries in Latin America—tends to use trade and finance as a form of pressure to dissuade countries in the region from industrialising their commodity at home.¹³⁹ So, this new obstacle to the industrialisation of commodities in home countries has become another common factor (like the continuous predominance of the dollar) affecting the economies of the entire region.

However, as I have emphasised in previous works (e.g. Palma, 2016a), for emerging markets ‘being in the wrong place’ in a hierarchical world economy is only a part of their story. It may well be obvious that capitalism tends towards a growing process of rentier globalisation and financialisation, that societies in DEEs are divided into antagonistic classes, and that the particular is to a certain extent conditioned by the general, but by just highlighting all this we have not gone beyond the partial—and therefore abstract as well as indeterminate—characterisation of the historical process of emerging markets.

Basically, “if the internal dynamics of emerging countries are one aspect of the general dynamic of global capitalism, this does not imply that the latter produces concrete effects in the former, but only that it finds concrete expression in them. The system of external domination reappears as an internal phenomenon through the social practices of local groups and classes, who share some of the interests and values of their external counterparts. In turn, other internal groups and forces oppose this domination, and in the concrete development of these conflicts, the specific dynamic of these societies is thus generated” (Cardoso and Faletto, 1977; emphasis added). See also Palma (1978 and 2016a).

In other words, it does not really help our understanding of the internal dynamics of developing countries to continue seeing the world capitalist system as one in which the development of one part somehow necessarily requires the underdevelopment of the other—and that subordinates part of the system can do very little about it because they have been reduced to a relative passive role determined by the other. Nor is to continue believing that the success of emerging Asia is just a one off special case because realpolitik led the West to lift traditional development constraints on them (and only on them).

The main story of financialisation in emerging markets is not really about somehow automatic consequences of processes of structural national subordination, but about how domestic agencies, conflicts and choices have led to a world of growing multiple equilibria. Again, here one has only to think about the remarkably different routes taken by emerging countries in Latin America and Asia, even though both have little choice but to engage with the same (and ever more weird) global capitalist system. While in the former—all the way from the 1982 debt crisis and the neo-liberal reforms that followed to their current processes of financialisation—it has been all about sinking slowly into the quicksand of a ‘middle-income trap’, in the latter (paraphrasing George Bernard Shaw) it has been about ‘dreaming things that never were, and saying “Why not?”’

If Latin America is the basket case that it is, politically, institutionally and economically, we have no one else but ourselves to blame! No one forced nearly 60 million Brazilians (over 55% of those who voted) to vote for Bolsonaro. Since he had been a Federal Deputy for Rio de Janeiro for nearly three decades, they knew exactly what they were getting. And no one has forced the region to have a stagnant level of average productivity for more than four decades either (Palma, 2019b and 2022c). Also, the inability to upgrade its already exhausted dual-extractive model is basically a home product—true, China doesn’t help, but this country doesn’t send its marines as another bully did so often in Latin America’s not so distant past.

One should not underestimate the role that ‘external’ common elements play in all developing countries either, but it is precisely the diversity within this unity that characterises their historical processes.¹⁴⁰ Thus, as the authors quoted above have emphasized, the analytical focus should be oriented towards the elaboration of concepts that can explain how the general trends within world capitalism turn into specific relationships between individuals, classes and states, how this in turn reflects back upon the global capitalist system, how internal and external processes of political domination reflect one another, both in their compatibilities and their contradictions, how the economies and polities of emerging markets are articulated with those of the core countries of the system and how their specific dynamics are thus generated.

Oligarchies in the South have always sought easy sources of income derived mainly from the ownership, possession or control of scarce rent-bearing assets—in what North et al. (2007) has labelled ‘limited access orders’, where political elites seeking to maintain cohesion divide up the control of those rents and block the access of others. What is new is how the rentier orientation of these key new agents (the domestic though internationalised conglomerates) has now gone well beyond traditional rent-bearing assets, such as minerals and land. Now they include many other forms of physical assets, legal entities (such as intellectual property rights), rents that come from their remarkable capacity to capture policy making, and rents that come from the overt utilisation of their power to control finance and other sectors of the economy due to an almost unrestricted market concentration.¹⁴¹

Therefore, key domestic struggles in most emerging markets, such as those in Latin America, are now mainly about elites trying to control access to an ever increasing variety of easy income sources from a much more diverse range of rent-bearing scarce resources—whose scarcity is often as much self-constructed as real.¹⁴² The process of privatisation of natural resources and state corporations at the beginning of the neo-liberal reforms, for example, let alone their remarkable levels of corruption, was very much part of this ‘rent-diversifying’ drive. In turn, the process of financialisation—which required full domestic financial deregulation and external financial liberalisation, as well as increased liquidity (and an accommodating Central Bank)—was also an ingenious construction that opened up a whole new world of ‘easy rents’ not just for international finance, but also for these rent-seeking domestic conglomerates when other forms of rents were facing some inevitable diminishing returns. And the fact that these ‘easy rents’ are being used for almost anything but productive purposes (a local tradition), is as much part of the dynamics that have led to the sinking into the ‘middle income trap’ as financialisation itself. In both processes—that of growing financialisation and the unproductive use of all forms of ‘easy rents’, including those of finance and natural resources—some domestic actors have been at least just as involved as international ones.

In turn, financialisation has also provided an extra advantage for domestic (though internationalised) corporations: becoming ‘too big to fail’. This artificially created ‘externality’ has become an effective form of blackmail—if they collapse, everything else goes with them—so the rest of society can now be held to ransom if their property rights over their ever growing variety of rent-bearing assets (no matter how corrupt was the form in which they acquired them, or the degree of market distortion needed to sustain them) were to be challenged. In other words, the ‘too big to fail’ comes within a package that also includes the ‘too big to be challenged’, and the ‘too big to jail’. Large domestic conglomerates of this kind, North and South of the Equator, have also acquired the right to claim all kinds of subsidies to secure their privileged position at times of financial distress—even if the trouble is entirely of their own making.

In short, one should also look at financialisation from Walter Benjamin’s (1966) perspective: as in all class societies rulers are always under threat, they live in a permanent state of emergency.¹⁴³ From this perspective, one can think of neo-liberalism as an ideology aimed at building a consensus and a praxis—and a ‘common sense’—that would help to create a class society in which rulers escape this threat by their ability to debilitate the rest of society enough by imposing on them a continuously insecure life. In this scenario, to be a financially mobile and malleable agent helps achieve an unrivalled dominance. In the jungle, big capital—especially of a rentier financialised type—is king!

And then the temptation for the (rather ideologically clueless) ‘new left’ to acquiesce was too hard to resist because, in a context like this, any progressive nationalist development agenda attempting to challenge this growing process of financialisation and its poor economic performance could run the risk of becoming a collective suicide pact.

What the history of the global South teaches us is that for this type of progressive agenda to succeed requires a sufficiently large and strong domestic constituency behind it to be able simultaneously to take on all the ‘usual suspects’ (in the form of international and domestic forces) that would fiercely oppose it. This constituency is required, for example, for the State to be able to impose East Asian-style ‘discipline’ on capitalists (and sometimes on workers) to be able both to build up an economic scenario in which rents have to be used productively, and low levels of inequality are anchored in the sphere of production (like that found in countries such as Korea and Taiwan) (Palma, 2019a).

When Pope Francis, speaking about financial markets, said that ‘A new, invisible and at times virtual, tyranny [has been] established, one which unilaterally and irremediably imposes its own laws and rules’, surely he was not just referring to international actors, but to domestic ones as well!¹⁴⁴ (He knows, he comes from Argentina…)

9. On the ‘natural’ state of capitalism with deregulated markets and emasculated governments: how ‘easy rents’ give rise to lazy elites

As I understand it, the key lesson from all this is that the ‘natural’ state of deregulated markets with (so-called) subsidiary States seems no longer to be a dynamic process of capitalism, in which competitive markets are capable of developing the productive forces of society, as envisaged by Marx and Schumpeter, among many others. Instead, they are only able to deliver a feeble process of capitalism à la Latin America, where markets are dominated and distorted almost at will by large rentier agents who ceased to be price-takers and rule-takers a long time ago—two key necessary conditions for markets to be able to deliver growth and well-being in an efficient and effective way.

Thus, financialisation in advanced countries should also be understood as another step in the building-up of this new kind of rentier capitalism in which ‘easy rents’ (in this case financial ones), of the ‘low-hanging-fruits’ variety, rule—à la Latin America. This process of ‘reverse catching-up’ of the economics, politics and institutions in the high-income OECD is one of the most significant (and ignored) developments since Reagan and Thatcher—and especially since the fall of that infamous wall.

Meanwhile, in the European high-income OECD, average productivity growth from the 2008 crisis until the start of the pandemic in 2019 only reached an average of 0.4% p.a., similar to Latin America, where there was no productivity growth at all, and also similar to South Africa’s just 0.3%. Asian DEEs cannot believe their luck, since all of the above has given them a clear run on most of manufacturing production.

Ricardo would probably not be surprised by what is happening in the rentier west, north and south of the equator, as for him ‘easy rents’ lead to lazy elites, weak productivity growth and stagnant wages.¹⁴⁵ One of his key contributions was to emphasise that the distinction between rents and operating profits was fundamental for both the analysis of distribution, and growth. In fact, he insisted that the main problem with economic theory at the time [with the partial exception of Malthus] was that “…Adam Smith, and the other able writers to whom I have alluded [Turgot, Stuart, Say and Sismondi], not having viewed correctly the principles of rent, have, it appears to me, overlooked many important truths, which can only be discovered after the subject of rent is thoroughly understood” (Ricardo, 1817, p. 5).

The nature of economic activities has surely changed since Ricardo, but economic underperformance (especially in terms of productivity growth) arising from shifts in distribution from operating profits to unproductive rents has not. And let’s not forget that in Ricardo’s model the ‘steady state’ is one in which real wages become stagnant, capitalists make no profits and rentiers get the lion-share of national income—and the more unproductive and inefficient the use of those rents, the merrier. We may be in a totally different technological paradigm as well as financial markets and institutional settings from those at Ricardo’s time, but the current ‘steady state’ already resembles a similar scenario—one in which Ricardo’s distributional trilogy predominates (where the key is the shift in distribution within capital from operating profits to unproductive rents), which is as toxic for inequality and productivity growth as it is for our democracy.¹⁴⁶

10. How did emerging markets become ‘the wrong place’?

By some estimates, after the FED began buying bonds in 2008, up to US$7tr of ‘QE’ funds flooded emerging markets in no time (Wheatley and Kynge, 2015). The irony of this tsunami of funds towards the South is that it was fuelled by funds released by the FED, followed later by the Bank of England, the European Central Bank and the Bank of Japan, to help reduce their systemic risks, and to reactivate their domestic economies. However, a significant amount of those funds ended up as emerging markets’ corporate debt—often after being leveraged into many multiples of their original value (see McCauley et al., 2015 and Lavigne et al., 2014). This unintended redirection of funds towards emerging markets is best summarised by the president of the Dallas FED:

In my darkest moments I have begun to wonder if the monetary accommodation we have already engineered might … be working in the wrong places. Far too many of the large corporations I survey … report that the most effective way to deploy cheap money raised in the current bond markets or in the form of loans from banks, beyond buying in stock or expanding dividends, is to invest it abroad.¹⁴⁷

Emerging markets were more than happy to play again what I have labelled their traditional role of financial markets of ‘last resort’¹⁴⁸; the difference is that this time the tsunami of hot-money flows to the higher-yields South was transforming their own financial markets beyond recognition—and domestic speculators were having as much of a field day as international ones. ‘QE’ was not only distorting the financial markets and the underlying performance of advanced economies, but was also doing the same in the South—and rentiers had never had it so good.¹⁴⁹

According to the Bank for International Settlements (BIS), the 7 trillion dollars of ‘QE’ money that ‘reverse-emigrated’ to emerging markets helped lift overall credit provided overseas in dollars through bank loans and bonds to nearly US$10tr.¹⁵⁰ In fact—and also according to BIS data—at end of 2019 non-financial corporations in 16 emerging economies had outstanding debts of US$29tr, more than two and half times that of 10 years earlier—and this was not just a China phenomenon, as this debt had also grown by 61% in the other 15 countries.¹⁵¹

In Chile, for example, the foreign currency component of overall debt by non-financial corporations reached one-third of GDP, with the figure for Turkey at nearly 30% and for Mexico 21%. In 2019, this overall debt had reached well over US200bn in Brazil and in Mexico, and about US$100bn in Chile.

Also during the 2020 pandemic, the IPO market in Brazil had its biggest year since the early Lula mania (2007).¹⁵² And all sorts of asset prices joined the fast-track. And in Chile, while GDP was down by 14% (second quarter), unemployment up at 3 million, and investment and domestic demand down by 20%, many asset prices were rising at record pace and mortgage rates soon returned to pre-pandemic record lows. In the meantime, Chile’s non-financial corporate debt, already the highest as a share of GDP among all emerging markets in the world (except for China), continued to grow as in best of times—but with little or no productive use of those funds to show for it at home.¹⁵³

At least there was a substantial increase of venture capital (or ‘angel investors’), and of finance through banks available for start-ups—with the former being more sought-after as its members do not expect to be repaid until and unless the new company becomes profitable.

There were several routes by which ‘QE’ did this ‘reverse-emigration’ to the South; one involved the FED buying US Treasury bonds from financial corporations such as pension funds, institutions that hold them as long-term assets with low but dependable yields. By doing this, the FED raised bond prices and lowered yields, sending restless asset managers in search of higher yields to the South. Another was that ‘QE’-liquidity also found its way to funds that use their leverage capabilities to increase the (often highly destabilising) ability of speculators to navigate shifting emerging markets with bull and bear flexibility. Funds with highly leveraged cash also sought high returns by scalping emerging markets with activities such as the carry trade¹⁵⁴―and since instruments such as credit cards in rentier paradises like Brazil had reached an average interest rate of 240% p.a. (up to 490% p.a. at HSBC), returns were astronomical.¹⁵⁵ All this, of course, could only remain one-way bets so long as exchange rates in emerging markets and other ‘automatic destabilisers’ acquiesced.

In terms of domestic absorption, Central Banks in developing countries, by taking these foreign assets on to their balance sheets, also had to create liabilities. So, they printed money and sometimes sold bonds to sterilise. But when fresh cash made its way into the local banking system, they could then lend more—multiples of those amounts, actually (about four times in Brazil, eight times in Malaysia and 10 times in Chile).¹⁵⁶

Another irony is that even when those funds ended up creating new productive capacities, it also tended to be in the ‘wrong places’. In Chile, for example, as its extractive model had long become exhausted (Palma, 2019b and 2022c), and extra ‘easy rents’ à-la low-hanging fruits were becoming scarce, a significant amount of the extra funds were used to finance all forms of capital flight, including shifting new productive capacities to neighbouring countries (i.e. the ‘wrong place’ from the point of view of Chile’s domestic economy), where there were still some ‘easy rents’ niches available. So the assets emerged abroad while liabilities were kept at home, as it was cheaper to raise funds from Chile—with policy-makers and the Central bank cheering it all on.

In Chile, once the purely extractive model had become exhausted, domestic corporations faced a choice: take on the challenge of an upwards diversification of their extractive model via the industrialisation of commodities and the local production of more technologically sophisticated inputs, or keep doing more of the same merely extractive activities but in neighbouring countries.¹⁵⁷ Almost unlimited access to cheap finance provided a unique opportunity to take on the challenge of the former. However, the ‘more of the same’ easy extractive rents in neighbouring countries prevailed—as a key component of Chile’s middle-income trap is what I have called its ‘neo-phobia’, or fear of the new.¹⁵⁸

Foreign direct investment (FDI) was another route for ‘QE’ to find its way into emerging markets; with often up to half of it being just intra-company loans.¹⁵⁹ In Asia, as opposed to Latin America and South Africa, some of it did end up helping to increase productive capacities, but in Latin America the ‘QE’-related surge of FDI seems to be having little or no impact on overall investment (Figure 11).

Despite FDI inflows since the 1989 ‘Brady Bonds’ of no less than US$3.6tr—US$2.2tr of which since the beginning of QE (all in 2019 dollars)—Latin America’s investment rates have remained stuck at their low historical rates. Part of the problem, of course, is the nature of that FDI: researchers at the IMF and the University of Copenhagen have shown that the purpose of a large share of FDI is simply to minimise multinationals’ global tax bill, ending up in empty corporate shells with no real business activities in the host nation. As the report concludes, ‘Globally, phantom [foreign direct] investments amount to an astonishing $15 trillion, or the combined annual GDP of economic powerhouses China and Germany’.¹⁶⁰

In fact, even in ‘FDI-intensive’ Brazil and Mexico, investment per worker has remained stagnant in real terms since the 1982 crisis—that is, for 40 years! The same is true for Argentina and almost all countries of the region.¹⁶¹ Meanwhile in emerging Asia, Korea increased its investment per worker by a factor of 5, India by 8 and China by more than 20 (and according to some sources by nearly 30)―perhaps one can have too much of a good thing!

Thus, while in Latin America, investment has struggled to reach even 20% of GDP since the neo-liberal reforms—less than half China’s levels—its GDP share of household consumption is currently twice that of China. Needless to say, both China and Latin America now urgently need to rebalance their growth, but in opposite directions!

With such poor investment performance, it is no surprise that according to the economic complexity index (ECI), some Latin American countries—given their levels of income per capita—are among the least diversified economies in the World (and none worse than Chile relative to its GDP).¹⁶²

Even though these huge FDI inflows, as well as foreign bank loans and portfolio inflows, have had a negligible impact on investment rates, they certainly have had a major negative effect on the current account of the balance of payments (Figure 12). Considering only those associated with FDI since 2002, when commodity prices began their meteoric rise, nearly US$2tr has left the region in the form of profit repatriation—with those of portfolio investment and ‘other’ reaching almost US$1.5tr.

In the case of Chile, for example, during the 12-year period of the post-2002 ‘super-cycle’ of commodity prices, profit repatriation by FDI alone became larger than the stock of the entire retirement account savings of all Chilean workers (more than 10 million people, who have no choice but be affiliated to the draconian private pension fund system, or ‘AFPs’)—that is, about US$190bn versus about US$160bn, respectively.¹⁶³ In fact, in US dollar of the same value, profit repatriation by FDI alone during this short period of time became larger than the entire cost of the Marshall Plan! Lack of a proper royalty on natural resources is the main culprit of this farce.¹⁶⁴

In turn, huge volatilities in portfolio inflows brought in a remarkable degree of macroeconomic instability and damaging uncertainty (Figure 13).

These highly destabilising inflows into Latin America (their coefficient of variation was 0.86 per year) reached US$1.8tr between the beginning of the Brady bonds (1989) and 2019—and over US$1tr since the beginning of ‘QE’ (2019 dollars). In Chile, at least its 1990s-style capital controls on portfolio inflows—those that can only be applied now if huge compensations are paid to disgruntled speculators due to its 2003 ‘trade’ agreement with the USA—helped to control their volume and significantly reduced their volatility during the seven years in which they were implemented.¹⁶⁵

In sum, emerging markets already owe a total of US$71tr¹⁶⁶; and their non-financial corporate debt (at nearly 100% of GDP) is greater than in developed markets in the build-up to the 2008 financial crisis. In fact, since many of the commodity producing economies simply assumed that the ‘super-cycle’ would last forever (‘this time it’s different’), they adjusted their permanent income expectations accordingly. In Chile, for example, consumption jumped from 65% of GDP in 2006 to no less than 76% in 2014 (towards the end of the commodities’ ‘super-cycle’)—with consumption of durable goods more than doubling in just 7 years, and household debt increasing from 28% to 40% of GDP.¹⁶⁷ In such a scenario, a consumption binge can easily be mistaken for prosperity.

According to the Institute of International Finance (IIF), pre-pandemic overall emerging market debt reached 220% of GDP—and in mature economies, debt-to-GDP reached 380%, with global debt soaring to a record high of US$258tr at the end of 2019.¹⁶⁸ From this perspective, the paradox is that ‘QE’ was designed to help reduce systemic risks in mature economies; however, the US$25tr of ‘QE’ funds injected since then has enable the build-up of a huge debt-bubble in them and in emerging markets via cross-border lending and bank lending—with the former now at serious risk of currency mismatches, and the latter of liquidity mismatches. Accordingly, a credit crunch could mean a major corporate dollar-debt crisis due to the former, and/or a large domestic banking one to the latter. The already mentioned current ‘stampede for safety’ among international speculators will not help.

In fact, we should not expect a proper demand-led recovery in emerging markets such as Latin America or South Africa unless a robust set of linkages between financial markets and the real economy is re-established (à la Franklin Delano Roosevelt). As Keynes (1930, p. 133–34) said after the crash:

[T]here cannot be a real recovery, in my judgment, until the idea of lenders and the idea of productive borrowers are brought together again.

The stakes for emerging markets’ corporations, their real economies and financial markets, and their wider society could scarcely be higher, and these challenges are happening at the worst possible time, as our social imagination has seldom been so barren.¹⁶⁹

Add the pandemic to this, and (quoting the great poet Camões on the Portuguese sailors of the 1500s) surely we are now ‘em mares nunca dantes navegados’.¹⁷⁰

11. Conclusions

When Paul Samuelson wrote a blurb on the cover of the fourth edition of Kindleberger’s (2005) book, little did he know how right he would be! He states: ‘Sometime in the next years you may kick yourself for not reading and re-reading Kindleberger’s Manias, Panics and Crashes’.

In an excess liquidity environment—let alone in one with credible assurances of the ‘whatever it takes’ type that speculators in distress will always be saved—discerning agents (North and South of the equator) will inevitably be in very short supply, as everyone would have the incentive to join what the FT has called the ‘everything rally’.¹⁷¹ As the investment strategist quoted above stated, in ‘QE’ financial markets there was little need to price risk before allocating resources.

In turn, the impact of this on the real economy of advanced and emerging markets alike can best be summarised by paraphrasing Oscar Wilde (in a passage from The Picture of Dorian Gray): distorted financial markets can now offer such levels of returns that anyone who now wants to make money doing something socially useful must be suffering from a lack of imagination.

What financial ‘liberalisation’ and excess liquidity have really achieved is to transform financial markets in the advanced and emerging worlds alike into an (it’s-not-meant-to-make-sense) ‘gigantic global joke’—which is beginning to unravel since ‘QT’ began to take away ‘QE’s safety net’. This also applies to inequality, as ‘all told, the primary effect of monetary policy since 2008 has been to transfer wealth to those who already hold long-term assets—both real and financial—from those who never will’.¹⁷²

This recalls Foucault’s (2004) proposition that neo-liberalism is not really a set of economic policies but a new, and highly effective, technology of power.¹⁷³ This has come at a huge price as it has also proved to be one of the most inefficient forms of economic organisation possible from the point of view of growth and well-being—but rentier elites had never had it so good.

Financialisation, particularly in emerging countries, reminds one of Theodore Roosevelt’s (1913) statement: ‘Of all forms of tyranny, the most vulgar is the tyranny of mere wealth, the tyranny of a plutocracy’. It also seems to be the least conducive to unleashing our social imagination, particularly in politics and economics.

Perhaps what has been going on in financial markets of advanced and emerging markets alike since the 1980s, something that has intensified since 2008 and even further during the pandemic, is best summarised by the first editor-in-chief of The Economist (see epigraph): ‘A great deal has been written and is being written on panics and manias … but one thing seems certain, that at particular times a great many stupid people have a great deal of stupid money’.

As I am writing about insubstantial asset price inflation, I must declare an interest: since graduating, I have always owned a comfortable flat or a house, and I have made more money via (tax-free) capital gains on them than from my whole long working life (something hard to square with the ‘efficient capital markets’ narrative of finance). I would like to thank Jonathan DiJohn, Daniel Hahn, Richard Kozul-Wright, Cristóbal Palma, Jonathan Pincus and Ignês Sodré for their comments on an earlier draft. Stephanie Blankenburg, Ha-Joon Chang, Jorge Fiori, José Antonio Ocampo, Carlota Pérez and Robert Wade have also made valuable contributions to my work in this area. Two anonymous referees and participants at a seminar at Girton College, Cambridge, also made valuable comments. Charles Kindleberger, a constant inspiration in matters of finance. When writing this paper, I had a health scare, but with Ignês, and as always (borrowing from Neruda), ‘una palabra entonces, una sonrisa bastan’ (Just one word, one smile are enough). Also, my lifelong friend and colleague Geoff Harcourt died when I was writing this paper. One of the pleasures of my life was to have had the opportunity to be his friend and the editor of his Festschrift. I dedicate this paper to him.

Bibliography

Footnotes