Wall Street is bigger than the real economy

The great economist John Maynard Keynes once said:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

via John Maynard Keynes.

The chart shows how the volume of business done on Wall Street vastly exceeds the volume of business done in the real economy.  It is as if a public library had 43 book catalogs for every actual book, and spent more time and attention keeping track of the catalogs than the books.

A well-functioning stock market and a financial services industry are necessary to the functioning of a democratic capitalist economy.  Their job, as somebody once said, is to turn savings into capital.  The financial markets are supposed to provide the means by which existing wealth can be invested to generate new wealth for society.  Even speculators provide a useful service in smoothing out the fluctuations between gluts and shortages, provided they don’t become so big and powerful that they are able to corner the market.

What the chart shows is that the financial markets have become largely disconnected from the real economy.  Instead of putting the savings of individuals and institutions to work in helping business to grow, financiers – many of them – make these savings the chips in a high-stakes poker game among themselves.  There is nothing wrong with high-stakes poker, provided you gamble with your own money. When you gamble with the public’s money, you create the Too Big to Fail Problem – which, if things go on as they are – will become the Too Big to Save Problem.

It will be hard to dial things back so that Wall Street becomes the servant instead of the master of the real economy.  One frequent suggestion is to set a small tax on transactions – say 1/10th of a cent on every dollar traded.  This would be no burden on real investors, but would slow down the gamblers and predators who trade many times a day.  Opposition to this is so strong on Wall Street it is unlikely to pass anytime soon.

Click on Too Big to Fail? for a fuller explanation by Steve Roth, the chart’s creator, crossposted to the Asymptosis and Angry Bear web logs.

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