HOW TO UNDERSTAND CURRENT MARKET DISTORTIONS ... HINT, IT DOESN'T BEGIN WITH THE 2008 COLLAPSE

I subscribe and contribute to several different forums. The specific forum I'm addressing below invites academics and researchers to comment or ask questions about political economy, global economic trends, and market events. Several regular readers will appreciate the discussion, which is why I'm posting it here. 

The specific question and my response (below) are part of a larger discussion on our current market distortions - especially wealth concentration - and who's benefiting from it all. My comments address how we can better understand these developments ...

QUESTION: Is the current behavior of markets a consequence of the distortions created by the financial crisis?

The 2008 financial crisis has left the financial system flushed with liquidity. Concurrently, wealth is concentrating into fewer and fewer hands. Is there any publication on the effect of the convergence of these 2 factors on market behavior.

There were several responses to this question. I chose to address Jacky from Reyjavik University (Iceland), who wrote that market distortions are a product of market trends that began long before the 2008 market collapse. Anyone who's read my posts, or my book, understands why I would agree with Jacky.

There is, however, more to this story, especially when it comes to understanding who's benefiting from the market distortions that we've been experiencing over the past 30 years (including increased wealth concentration), which I discuss here ...

I agree with Jacky. The causes behind the concentration of wealth didn’t start with the 2008 market collapse. They have been in the making for the past 30+ years. However, I think we can be a little more specific when it comes to determining who’s benefited the most as the money supply expanded (under Alan Greenspan‘s watch).  

But first we need to consider the numbers, and where they've been concentrated. 

Consider this. Between 1972 and 1994 the gap between what Main Street had (holders of M-1) and what the financial institutions and Wall Street played with (holders of M-3) was no greater than 3.5 to 5 times. So, for every dollar Main Street had Wall Street was working with between $3.50 to $5 dollars.  

In fact, as late as 1994 the gap between what Main Street had ($1.15 trillion) and what Wall Street played with ($4.37 trillion) was only about 3.79 times. Then something happened. 

Fast forward to 2006 and we see that Wall Street’s claim on the money supply (M-3) blew past what Main Street had access to (M-1) by a factor of 7. Specifically, Wall Street was now claiming (and playing with) $10.29 trillion while Main Street’s claim on the money supply had only grown to $1.36 trillion.  

This is important because it’s at this time that we begin to see the rise of new debt instruments, secondary markets, and an explosion in hedge fund firms. Throw in America’s shadow banking system - plus the fact that deregulation allowed financial firms to build and trade CDS, CDO, and other debt-driven financial instruments that helped bring everything down in 2008 - and we can begin to see a small group of market players who fed irresponsible market behavior(s) across the board.  

If you really want to dig deep into this mess to assign responsibility, and to better understand what happened in the lead up to 2008, we need to take another look at Hyman Minsky. Why? Because he reminds us what happens to economies when they are dominated by hedged investors (who can back their bets), speculative investors (who can find the money to back their bets), and the Ponzi or Pyramid market players who are just one step ahead of the next market collapse.  

It’s not difficult to see which group of market players we were dealing with in the lead up to 2008 (and, make no mistake, they‘re still out there). 

OK, now for the shameless plug moment … I discuss all of this in chapters 9, 10, and 12 of my book, “The Myth of the Free Market: The Role of the State in a Capitalist Economy” (Kumarian, 2009). 

How do you fix this? I’m not sure you can unless we start with two issues. First, we need to deal with reckless tax cuts and mindless deregulation in America. Without doing this we will continue to bankrupt the state while allowing market players to continue doing what they did before 2008. Second, we need to start addressing the American mind-set, which naively believes that anything market players do is a blessing for everyone. If we do this we can start discussing the Tobin Tax, global labor standards, tax havens, etc.   

Thanks for the discussion.

- Mark