Cycle of financialization or financial deleveraging?

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By FERNANDO NOGUEIRA DA COSTA*

Considerations about the economy of debt

In economic science, too, we have to stand against scientific denialism. Its method – observation, questioning, hypotheses, experimentation, analysis of test results and conclusion – has to be practiced even against what was said even by fellow leftists, in this case, authors and/or supporters of the so-called “financialization” literature.

Scientists follow the scientific method when trying to approach the truth (transitory or configured) and, for that, starting from empirical observation. A convincing logical-causal narrative can tell a convincing story at first sight, but false in the face of other theoretical concepts or historical stretching of the vision.

For example, wouldn't the phenomenon of “financialization” just describe a transitory cycle or a periodic configuration to be soon overcome, when this phase of financial deleveraging passes, where “monetary policy pushes the rope”? The interest rate remained low, in view of inflation under control in all advanced countries, despite the long “monetary easing” and… no recovery or resumption of sustained economic growth in the long term!

Then, when the economy passes the normalization phase, there will be new financial leverage, bubble, boom, depression until another phase of financial deleveraging. In finance, leverage designates the increase in equity return on equity through indebtedness. It results in greater economies of scale (and profit) with the participation of third-party capital in the company's capital structure.

It is enough for operating profit to be higher than interest (and other financial expenses) to be more profitable, for example, a bet on a firm upward trend in the price of an asset, a way of maintaining wealth such as stocks, real estate or any other. This practice is common, in the capitalist evolution, since when the “fundamental stone” of the banking system appeared in Genoa, through the Bank of San Giorgio, in 1406, only ending its activities 400 years later, in 1805.

In the same Pre-Renaissance era, to avoid confiscation, during wars between City-States, wealthy citizens opted to borrow “soldo” – or “solido”, an ancient gold coin of the Roman Empire, created by Constantine in 309 – to pay mercenary “soldiers”. After all, the government was dominated by themselves and they were guaranteed to receive interest on the public debt instead of tax collection.

Since then, in order to compensate wealthy citizens, liquidity has been provided in addition to interest payments. Such public debt securities could be sold, in a secondary market, if the rentier needed immediate cash.

Then, the indebtedness economy (public and private or banking) emerged with this sovereign risk ballast, for financial wealth, and remains so until today. The beginnings of a Capital Market Economy occurred when the purchase and sale of currencies, bills of exchange and precious metals ceased to be carried out outdoors, in the streets and sidewalks, and started to be carried out in a property of the family of nobles. belgians, the van der burse, whose coat of arms were three purses. As the residences in Bruges did not have numbers, it became known as the House of Bags.

Created in 1531, the Antwerp Stock Exchange, in Belgium, is considered the first official exchange, based on the negotiation of loans. However, the first shares traded on a stock exchange were those of the Dutch East India Company, in 1602, on the Amsterdam Stock Exchange. They represented associations to share risks and profits.

This financial revolution, 200 years before the industrial revolution, occurred with the use of other people's money for their own benefit: getting associates, maintaining management and shareholding with profit or loss sharing. The IPO is an IPO (Initial Public Offering) of a minority share with quotation assigned by shareholders.

Since the beginning of the evolution of this capitalist system, the “business secret” has been to borrow money for mergers or acquisitions of competitors. This concentration of capital causes an increase in the market value of the shares and personal enrichment of the founding partners.

In capitalization, via issue of shares, the controller shares expected profits or unexpected losses without the risk of being a debtor. In turn, when taking loans, in order to increase the scale of the business and the profitability of equity capital with the use of third-party capital, the borrower assumes the risk that the expected operating profit is not confirmed, and the new revenue is below of interest on loans. When this occurs, in general, it enters into a “financial deleveraging phase”.

Authors and readers adept at the “financialization” literature confuse this phase with a stage of structural change in capitalism, almost a New Age. Worse, they denounce it as an artificiality in the face of the beloved industrial capitalism that generates better jobs, although it exploits the workforce, to obtain greater productivity, either via relative surplus value (today digital economy), or via absolute surplus value. (today extracted by the extension of working hours in home-office).

According to the Theories of blocking productive investments, due to the growing financial activity of non-financial companies, profits would not be reinvested due to monopolies creating excess productive capacity. Profits would then be channeled to financial capitalization and would cause an increase in the prices of financial assets, causing speculative bubbles.

With neoliberalism, according to this inventive but unrealistic narrative, the trade union and/or salary barrier to the profitability of capital would have been replaced by the barrier of underconsumption. The deficiency in demand would have been compensated for by fictitious capital, created by the demonized banks on the malevolent indebtedness of families.

The increase in the rate of exploitation of the workforce would have led to a recovery in the rate of profit, but without a corresponding increase in the rate of investment (or accumulation in Marxist jargon) in the production process. Faced with the lack of profitable opportunities for this productive investment, profits would have been distributed as dividends, a measure of the degree of financialization.

This “financial dominance” (another fashionable magic word) would have occurred because the managers' interest in the company's growth in the long term was overcome by the shareholders' interest in the greater distribution of dividends in the short term. Decreased demand, due to increased globalized competition and the reduction in the wage share and underconsumption, added to the pressure for dividend payments.

The management of non-financial companies has adapted to this pressure by aligning the interests of managers, in increasing the stock options (Option to purchase shares of the business for its executives to acquire them for a predetermined amount after a certain period), in the interest of shareholder investors. Financial hegemony would have led to an increase in interest and dividend payments and, despite the recovery of the profit rate in productive activity, its retention in reserves decreased, causing a drop in the economic growth of jobs and income.

Worse, a sizable proportion of profits would be channeled into share buybacks and a smaller proportion into productive investments. Hence, there was a process of replacing share capitalization with financing through corporate debentures.

The issuance of these direct debt securities by non-financial corporations served to finance the repurchase of shares, changing the capital structure, that is, replacing equity capital with corporate debt. Is this evidence of “financialization”?

Financing share buybacks through corporate debt issuance evidently gives rise to increased interest payments on debentures. This share repurchase reduces the amount outstanding and helps to increase earnings per share, being an alternative to dividends to “return capital” to shareholders.

The self-financing of non-financial companies to make investments could imply a sharp reduction in the dividend distribution rate. In this case, a new issue of shares with the possibility of subscription, to avoid the dilution of shareholdings, would be less harmful to the interests of its shareholders.

Which of the two phenomena occurred first? Increase in financial investments or fall in productive investments?

In this “chicken-egg dilemma”, for authors of the “financialization” literature, the increase in financial activity precedes and causes a reduction in productive accumulation. For the critics of this literature, there is no strong reason for this reorientation of activity, except the temporary paralysis of the capital accumulation process, because financial profitability is empirically lower compared to productive profitability - and, when it is not, it triggers the phase of financial deleveraging with a cut in all expenses, including investments, until the level of indebtedness is reduced.

As the catchphrase of a sports announcer says, commenting on the bad phase of a club or a player, “what a phase!”. But, console yourself, it's fleeting. Life, including financial life, is difficult, the authors of this literature must learn to deal with it…

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Economic analysis methods (Context).

 

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