Putting an end to the reign of financial illusion : for real growth , livre ebook

Odile Jacob - Jacques De Larosière

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“We all know that our world has become very indebted over the past decades and that its ‘financialization’ has reached proportions never observed before, at least in peacetime. But how serious is this phenomenon? What are its consequences on the solidity of our financial system, on the functioning of our economy and on the future of our society? Above all, we must understand how our world has surreptitiously changed its model for the past two decades. It has slipped to a strange paradigm, one in which the bulk of economic activity is now reflected in the rise in the value of financial assets at the expense of growth, wage income and productive investment. It is time to put an end to the reign of illusion and to reinstate the fundamental economic springs without which there can be no real growth.” J. de L. “No one alive today combines Jacques de Larosière’s experience with an acuity about global finance. His sharp and cogent expression of alarm in this timely volume deserves and even demands the attention of the global financial community.” Lawrence Summers, Former Secretary of the United States Treasury and President Emeritus of Harvard “This is a must-read for those who want to understand the ‘economic illusions’ hiding in plain sight. And for those who are prepared to step-up to the benefit of a new generation.” Kevin Warsh, member of the Federal Reserve Board (2006-2018), and professor at Stanford “The book is a harsh criticism of the fairy tales that have guided monetary theory and the actions of central bankers in recent decades.” Vito Tanzi, Honorary President of the International Institute of Public Finance Jacques de Larosière spent his entire career at the head of financial institutions: he was first Managing Director of the International Monetary Fund (1978-1987) before becoming Governor of the Banque de France (1987-1993), then president of the European Bank of Reconstruction and Development (1993-1998). He is currently Advisor to the president of BNP-Parisbas.

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Business

Economics

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Publié par	Odile Jacob
Date de parution	07 septembre 2022
Nombre de lectures	2
EAN13	9782415003791
Langue	Français

Informations légales : prix de location à la page 0,0750€. Cette information est donnée uniquement à titre indicatif conformément à la législation en vigueur.

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Originally published in French as En finir avec le règne de l’illusion financière by Jacques de Larosière. © Editions Odile Jacob, 2022.
The present English-language edition is published by Editions Odile Jacob.
© Odile Jacob, September 2022.
All rights reserved. No part of this book may be used or reproduced in any matter whatsoever without written permission of the publisher. No part of this book may be stored in a retrieval system or transmitted in any form or by any means including electronic, magnetic tape, mechanical, photocopying, recording, or otherwise without the prior permission in writing of the publisher.
www.odilejacob.com www.odilejacobpublishing.com
ISBN : 978-2-4150-0379-1
Ce document numérique a été réalisé par Nord Compo .
Introduction

This book was born out of a nagging question.
We all know that our world has been heavily indebted for decades and that its “financialization 1 ” has reached proportions never before reached, at least in peacetime.
But how serious is this phenomenon? What are the consequences for the solidity of our financial system, for the functioning of our economy and for the very future of our society? Given the speed of the current developments, the return of high inflation and the seriousness of the situation in Ukraine, it is essential to ask these questions, especially since our leaders do not seem to care too much.
To answer these questions, it is necessary to study the extent of the drift and to analyze the vulnerabilities that have resulted from it.
Above all, we need to understand how our world has surreptitiously changed its model: it has slipped, over the last two decades, towards a strange paradigm, one in which the bulk of economic activity is now translated into the rise in the value of financial assets to the detriment of the growth of wage income and productive investment. If we allow these drifts to continue, without changing the very foundations of the system, we will continue to lose competitiveness and productivity, to increase social inequalities and to jeopardize the future of our grandchildren.
The ambition of this essay is twofold:
– to understand and describe the processes that have led us to the current disruptions; this implies an in-depth analysis of the evolution of the system as it functions today. This analysis must be comprehensive and show the link between, on the one hand, financing methods and, on the other hand, the future of our society. It must be based on global statistical data in order to deal with the subject in an objective way at the international level;
– to formulate simple recommendations in order to get out of the trap of financialization and to free the forces of savings and investment that condition our future.
But since interest rates have been very low for a long time, some are tempted to say, or even to think, that the problem is not urgent since “money doesn’t cost anything anymore”: but nothing could be further from the truth, as this essay will attempt to show.

We have reached a point where what should be a supplement – that is, borrowing beyond self-financing – has become the norm, and where financial fiction dominates economic reality.

It is time to put an end to the reign of illusion and to restore the fundamental economic forces without which there can be no real growth.
*
Since we have resorted – “whatever it takes” – to borrowing to solve all our problems, we have the right – I would say the duty – to ask the following questions:

What were the effects of this massive indebtedness on:
– the evolution of balance sheet values,
– economic growth,
– productivity gains
– the risks of financial instability and inflation?
Not asking these questions would be comparable to hiring an engineer to supervise a dam who would not be concerned about rising water levels or the risks to the populations of the surrounding valleys.
*
To answer these fundamental questions seriously, one must first be able to evaluate and understand the evolution and components of the global balance sheet over the last twenty years.
We must then ask ourselves the question of the economic and social consequences of the explosion of this balance sheet and of the monetary policy that underlies it.
Finally, an attempt will be made to draw conclusions and recommendations from the findings.
*
The art of governing has always resorted to illusion.

As reality is often painful and difficult to deal with, one seeks, by demagogy, to improve it by disguising it.
– An example: when the freedom of the markets allows us to buy without limits abroad products of better quality and cheaper than those we can produce, the illusion consists in pretending that these imports are “normal” and that, moreover, the fact of easily finding means of payment to acquire them does not present any disadvantage: we can, indeed, go into debt to finance the trade deficit by borrowing the necessary currencies.
– Or again in a closely related matter: when our de-industrialization – which has been growing for 30 years – puts whole cohorts of workers out of work. . . (while foreign producers of the goods we now import can recruit), the illusion consists in thinking that we can always increase the number of civil servants and that, for those who do not find a job, unemployment benefits will be made more generous.
– A third example: when the interest burden of the debt becomes high and risks threatening the capacity of governments to borrow more and more, a subterfuge is used: interest rates are lowered by having Central Banks buy government securities for practically unlimited amounts. The result of these purchases is that the value of the securities increases while their interest rates decrease.

The monetary policy of the last few years has thus allowed the interest rates on European government bond issues to tend towards zero, and even reach negative figures: savings were no longer remunerated but taxed. This is the reign of illusion.
*
These three examples – unfortunately taken from French reality – have one thing in common: the structural nature of the problems to be addressed. It is not a question of financing momentary “hollows” by borrowing, but of settling permanent deficits by resorting to indebtedness.
– In the first example, it is the competitiveness of companies that is at issue (because of the excessive costs they incur, the lack of research and development, etc.). It is a problem that is only getting worse.
– In the second, it is deindustrialization (reflecting the weakness of our companies in the face of international competition) that creates unemployment; and this phenomenon, increasingly serious, has been undermining our economy for decades.
– In the third, it is the size of the accumulated public deficits that is at the heart of the interest rate problem.

All three of these structural problems have received the same answer: “More borrowing”, whether to cover the trade deficit, or to mitigate the effects of structural unemployment through deficit-generating budgetary spending (through bloated government or generous benefits), or to facilitate further public indebtedness by artificially lowering interest rates.
It is therefore important to understand the impasse into which these forms of indebtedness lock us.
In principle, we should only go into debt if the new activity made possible by the borrowing is likely to generate additional resources which, in turn, will make it possible to repay the loans in question.
But if the debt has only been used to finance deficits – and not productive investments – no new activity generating future income will have been created. The debt and its servicing will therefore accumulate without allowing the loan to be repaid (unless taxes are increased or public spending is reduced, which is precisely what one is trying to avoid).

We are therefore trying to answer fundamental questions by resorting to credit or monetary creation, while we are only postponing the real solution, which we prefer to leave to future generations.
If these were only three isolated examples, we could relativize the gravity of the problems created by the systematic use of credit.
But this is not the case. The reality – which this essay will attempt to describe – is quite different.

It leads to this observation: for the past twenty years, our societies have tended to systematically deal with economic and social problems by intensifying the use of credit and money creation.
*
Some will say:

“In an aging world, it is normal for savings to exceed investment needs and therefore for the ‘natural’ interest rate to decline. Refinancing maturities with new low-rate loans makes a lot of sense.”

The answer is that debt stimulation cannot be infinite: beyond certain limits, it creates more problems than it solves, and inflation, as we are seeing today, eventually reappears.
What is surprising in the current situation is the almost total absence of concern among our ruling elites about the limits of indebtedness, and the vulnerabilities it creates.

This essay aims to respond to this lack of concern, to show the dangers it causes, and to suggest ways out.
*
I would like to thank in particular the McKinsey Global Institute, whose latest report “The rise and rise of the Global balance sheet” is essential to the understanding of the subject and from which I drew much inspiration. I am grateful to Mr. Eckhart Windghagen for personally sending me this report.

I am also grateful to Didier Cahen, the Secretary General of EUROFI, whose advice, meticulous proofreading of the manuscript and the Score Boards – economic and monetary – were invaluable.

I would also like to thank Ivo Maes, from the National Bank of Belgium, for his judicious remarks and careful reading.

Finally, I would like to thank Madame Odile Jacob who, once again, helped me with her wise remarks and encouragement.
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