Wednesday, May 24, 2017

Reader Response - The Achilles' Heel of Capitalism

Recently we featured this article in The Wall Street Journal that quoted Johns Hopkins professor Steve Hanke as saying that financial volatility in currency exchange rates is "the Achilles' heel of capitalism."  

A blog reader here had a different take on that and provided me the input posted below by email. This reader prefers to remain anonymous, but gave permission to publish his comments. 

"I have a comment on Professor’s Hanke’s observation re: financial volatility ( as the Achilles heel of capitalism )

Using rough figures, global annual GDP is around $70 trillion, of which international trade comprises around 15%,
call it $10 trillion.  Using 250 financial trading days per year, that trade per trading day amounts to $40 billion per
day of real flows of trade in goods and services.

Meanwhile, daily FX trading volume is currently about $5.2  TRILLION per day (note: see here), with the dollar accounting for as much as 80% of one side of all forex trades.  That is A 130 MULTIPLE  of the “trade flows” that, presumably, forex trades are entered into for the purpose of “hedging” currency risk.  Clearly, something else is going on.

In the late 70’s, when hard pegs, crawling pegs, and all the other attempts at currency stability failed, the “free
float” was introduced, for lack of an alternative.  As Paul Volcker remarked later, the largest money center banks
found that this need to hedge volatility produced all sorts of means to profit, both as providers of currency insurance as well as trading for their own account, as they were "closest to the source” of the hedging needs of their large muli-national corporate customers.  These banks will be, until the next crisis, the loudest opponents of any change that would impair this source of profit.

So, we have “industrial capitalism” and “financial capitalism” but they don’t necessarily always correspond.  Further,
as the BIS’s Hyun Song Shin has repeatedly pointed out recently, in a series of papers, international financial flows dwarf trade flows, and have perverse spill over effects both on the way in, and the way out. Convertibility between currencies, combined with the desired “liquidity” (large trades possible with small price movements) while at the same time hoping for “stability” are an impossible trilemma.

Getting back to Professor Hanke’s observation, permit me to disagree.  The Achilles heel of (financial) capitalism
is the growth of DEBT, both public AND private, where the debt fails to produce a corresponding increase in the
net stock of real capital, bet it tangible ( goods and enabling infrastructure ) or intangible (education, scientific
progress).  Any system which lacks a brake on this non productive debt will eventually default on it, when the
holders of it desert, and leave only the central bank as the buyer of last resort."


My added comment: We always appreciate reader emails and comments such as this one. It turns out that this article by George Gilder appeared in The Dallas Morning News made somewhat the same point about "currency choas" as our reader did in his comments above. The reader forwarded me the link to that article and pointed me to the paragraph below in particular:

"According to the Bank of International Settlements, this market (currency trading) has swelled to some $5.1 trillion a day, 25 times global GDP and 73 times all trade in goods and services. Yet all the vast shuffle of money fails to achieve the crucial function of money and markets: to yield a reliable guide for international transactions."

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