The financial markets are always on the edge. Should an alien, with an exceptional grasp of English, come onto earth and read the financial papers for a week, it would feel that the collapse of the world was imminent. Words such as “fall”, “crisis”, “struggle”, “worries”, “fears” litter articles daily. Perhaps this is a result of the financial crisis that has prevailed since 2007. But I would disagree. This has been an ongoing state. The underlying philosophy of the financial and commercial markets is apprehension. Agents are required to be risk takers, and being a risk taker means constantly asking “will it?” or “wont it”.
Economists and financial analysis forecast the possible repercussions of decisions on the financial markets utilising complex statistical processes and financial models. Models can be quite accurate on a micro level, and relatively accurate on a macro level. But predictions of anything dependent on human behaviour are wrought with uncertainty. In an interconnected financial market, considering each and every cog of the machine is difficult, if not impossible. Even big data will not give 100% definitive answers.
Yet the financial markets works on the idea that certainty is possible although in many respects the markets create their own reality, especially in the financial markets. As one commentator dismayingly describes the pricing of financial assets “what happened at Enron, and in the banks, was that trading assets were marked to values that had been established not by people who knew about the contracts or the loans, but by the biased and ill-informed assessments of the traders.” The financial markets, with $600 trillion flowing through different channels in some guise or another, is by and large controlled by avaricious individuals keen to push the boundaries of what is acceptable.
This has large scale ramifications for the rest of the economy and for the swathes of people that have very little understanding of the financial markets. The perdurance of the current financial malaise is often ascribed to a lack of demand. People are not buying as they wish to save; companies are not receiving money so they have to let go of workers. Workers no longer have that much money so they cannot buy ergo lack of demand. The government decides that they need to stimulate the economy, so they inject money into the economy via quantitative easing. Quantitative easing is the government creating electronic money to buy debt instruments, usually government bonds. The money goes to banks, which can now protect their capital and they can now lend. By lending, people have more money to spend. However, Banks have failed to actively lend, and loans have not been given out as freely as expected. The result has been that an optimal number of companies cannot expand, meaning individuals have problems receiving money meaning they cannot buy.
So the issue does not seem to be a lack of demand, but rather a lack of money. One argument for the failure of channelling new money to individuals was the worry of hyperinflation. Germany in 1923 and Zimbabwe are notable examples. Hyperinflation in Germany petered out by 1926, not because there was some brilliant monetary solution, but because the oppressive conditions of the Treaty of Versailles were relaxed. More goods were allowed to come into the country, meaning that money was not chasing fewer goods.
As mentioned the largesse of banks has been less than forthcoming. It has been suggested that the government give out “helicopter money” (government prints money, gives it to people) although the ultimate difference between the objectives of this and quantitative easing are negligible. There is the fear of inflation, but this, I believe, is misplaced. If people demand more, inflation is likely to increase, but only in the short run. Established companies, as well new companies seeking to break into the market, will eventually supply, leading to increased competition and an eventual decrease in inflation in the long run. Many economists are encouraging central banks to focus on targeting nominal GDP (NGDP) rather inflation as increase in inflation would be offset by better growth.
(Speaking of growth, China appears to losing steam but maybe this is a good thing considering China’s proclivity for wasteful spending). NGDP is probably not going to be adopted by central banks leaving one policy aim: hope to God quantitative easing has the desired effects in the long run. The problem is when most of the money is in the hands of the banks then the spillover effects will be dependant on the choices they, the banks, make. The Fed has announced that it will be tapering its $85 billion Quantitative Easing programme in 2014 meaning an eventual increase in interest rates. The bond markets have reacted negatively with bond yields increasing. However, nothing definitive has happened. The market agents have reacted to possibility and created a self-defeating situation. They have simply formulated a worry, and perpetuated it. In the end, this worry affects us all, but one wonders if there is anything to worry about in the first place. Instead, concern should be on how to stimulate consumer commercial activity. A good place to start would be to ensure the flow of new money eventually goes to them. But this is unlikely to happen. So the financial markets keeps us in fear whereas they hold the power to alleviate many of our problems.