The neglect of credit and debt in economic theory continues to produce muddled policy thinking. Take the tendency to protect banks lock, stock and barrel, at huge costs. The mantra is that if we let banks go bankrupt, that will ruin the economy. This is a nifty inversion of the truth: it is precisely the support for banks’ balance sheets that will prolong our economic woes. But to see this, you need to think about balance sheets – which macroeconomics almost forbids one to do.
Nothing more intricate is involved than the accounting equality that the financial sector’s assets are the real sector’s liabilities. But here comes the important bit: most of that debt growth has NOT been due to lending to the real sector – to nonfinancial firms, supporting growth in wages and profit. Almost all of it was due to mortgage lending and to credit to the nonbank financial sector credit, to inflate stocks and property prices and to create and trade options, futures, and other derivative instruments. These credit flows, and the activities they fuelled – share buybacks, leveraged buyouts, securitization – create no wage or profits for the many, but capital gains for the few, and a huge net debt burden on the economy.
Property and asset prices may be falling, but the debts that jacked them up are not. The threat to growth today is not a shrinking of the financial sector, but it enormous size. The accumulated claims by the nonbank financial sector cause a daily drain of purchasing power out of the economy in debt service. This is money that could be effective demand for goods and services, and stimulate economic growth. Nowadays, finance is stifling, not stimulating growth…
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