The big question in the current global economy relates to the horse-and-cart relationship between the speculative economy and the real economy. Often it seems that the speculative economy drives the real economy, and not the other way round. Central banks and governments act to ensure the speculative economy remains healthy, in the expectation that a healthy speculative economy results in a healthy real economy. This may seem natural, as financial markets run more on sentiments going forward than on recorded present or past outcomes; the problem starts because sentiments often translate into â€˜irrational exuberanceâ€™, mostly with an upward bias.
The role of the 24/7 globally integrated financial markets, which are essentially speculative in nature, on the real economy has been a much-debated issue. The excesses of the financial markets, in spite of talks of increased regulation, have become greater over time and with the globalisation of easy liquidity in financial markets. With increasedÂ â€˜financialisationâ€™, what we increasingly see is, as Toporowski puts it, â€˜finance mostly financing financeâ€™. This leads to a self-sustaining, cyclical speculative economy, decoupled from the real economy and at best coupled with hypothetical projections of the real economy. It essentially works like this: bad projections of the real economy force central banks and governments to act, which drives the speculative economy. Consequently, more expectations are built into the speculative economy which, when not fulfilled by more commensurate actions, drive its own downturn. Most of these actions have no bearing on the real economy, other than creating economic shock or euphoria.
Recently, the efficient-market hypothesis, which made us believe financial markets act rationally, hasÂ come under attack. The historically unprecedented economic boom from 2001â€¢2008 resulted in a huge group of followers of the efficient-market hypothesis.Â Defenders of the hypothesisÂ have argued that markets can be inaccurate for significant periods, but will tend to self-correct. Regulators like central banks have often resisted intervention because timing any financial-market intervention, or for that matter any policy regulation, is an impossible task.
The more frequent boom-and-bust cycles of the speculative financial economy have become a reality, and this adversely affects the recovery of the real economy.Â The words and sentimentsÂ of central bankers drive the market more than real-economic activities or projections.
Reaching out to the poorest of the poor has always been the biggest challenge for policy makers, whether from developed or developing countries. This is true in the banking sector, where easy liquidity created by central banks to foster an atmosphere conducive to growth, or the fiscal incentives initiated by any government, rarely reaches out to the segments who need to feel the effects of growth the most. The supply chain to reach the poorest of the poor is long, whereas speculative-economy valuations can skyrocket in minutes. So, by the time the easy liquidity hits the small-scale manufacturer or the struggling mortgage holder, market operators usually take speculative paper-asset prices to much higher levels. In the developing economies, the sections of populace that mostly remain beyond the reach of the financial and monetary supply chains are those without the basic financial inclusion.
The success of the Federal Reserveâ€™s mainly Keynesian solutions has been mixed. Policy makers have often tried to yield to speculative market expectations, whereby central banks have done what speculative markets demanded as if they had lost their influence over the real economic players. But, all of that has shown that the more policy makers try to appease the speculative economy through intended actions to address the real economy, the more the bullwhip effect is observed.
The bullwhip effect is larger and larger swings in demand fluctuations down the supply chain, starting from retailing to primary economic activities. It is usually due to differences between actual demand and forecast demand, and is observed across different industries. The longer the supply chain is, the greater is the observed swing down the chain. As an example, if actual car sales is lower than 5% of forecast one, the tire manufacturers are likely to observe a higher % change in actual sales than forecast sales, and even a further increase of same would be observed among manufacturers of Carbon Black. Another example with which B-Schools are quite familiar with are how slowing down economy affects placements in B-Schools at a much higher rate than the difference of the projected versus the actual slowdown.
It is not that markets have become dependent of the central banks; rather, central-bank policies have become ineffective to drive the real economy as they have apparently built an ineffective supply chain, where the chain tends to feed itself before feeding the intended end recipient of the supply chain. The problem may not lie with the way the animal spirits of the freewheeling capitalistic markets operate; the problem may well lie with the way our banking systems work. And therefore, the unthinkable solution probably demands disintermediation of the existing supply chain. It may sound impossible, butÂ disintermediation of fragmented intermediariesÂ by large intermediate players such as Google and Amazon has been a key characteristic of the digital age. Maybe we are nearing a time when the central banks will consider playing the role of a single large intermediate themselves catering to all end customers of the banking sector. The present intermediaries have inevitably and increasingly failed in channeling credit to important stakeholders of productive segment of business and society as they tend to serve their own interests more.
However, the â€˜too bog to failâ€™ category of banks, that have been emerging Â pre-2008 and subsequently have become bigger post-2008, have not fundamentally corrected that inefficient and ineffective supply chain of banking â€“ be it through market forces or through policy-intervention. These â€˜too big to failâ€™ banks, based in the developed nations with strong currencies and easy liquidity, affect global financial markets and sentiments significantly, as these â€˜too big to failâ€™ banks have significant global presence, unlike the banks from the developing nations. It effectively also makes monetary and fiscal policy making difficult for developing nations, on a standalone basis, in a globalized economy, where money seamlessly flows across borders. These big banks effectively transfer the monetary and fiscal policies, and the sentiments of developed nations to the developing nations, although one size may not fit these different economies. Policy-makers in developing nations need to consider the monetary policies of developed nations on top of other internal existing constraints, whereas developed economies can solely work for their self-interests. Essentially it translates into an even longer supply chain of financial inclusion in the developing economies for those who deserve it the most.
In any supply chain, the interests of the supply chain members should not replace the interests of the intended end customers in that supply chain. Contrarily and sadly, in present age, and in the all important banking area, the interests of the banks and the financial-market intermediaries work against the interests of the real economic players.
Prof. Ranjit Goswami works as theÂ Director of School of Management of RK University. Opinion expressed in this article is personal. HeÂ invites you to visit his blog,Â Wondering ManÂ (or take a look at his book,Â Wondering Man, Money & Go(l)d). You are also invited to join him onÂ Twitter