From Servant to Master and Back Again:  Finance for a Sustainable World

When talking about finance’s role with respect to sustainability, it is important to make clear the distinction between flows and stocks for investing. During industrial capitalism, between 1945 and 1971, most financing went into „real investment“ (a flow), i.e. plant, machinery, buildings, creating additional value added. With the onset of neoliberalism came financial capitalism, and most finance went (and still goes) into trading of existing assets, of stocks – not creating additional value added and of limited social value. Driver of these „investments“ were different assessments of the price (value) of assets, leading to massive trading to exploit these differences. Since every financial transaction generates fees, there is a strong incentive for traders to maximize the volume of trades. Powerful vestged interests arise.

FROM SERVANT TO MASTER

The framework for industrial capitalism had been set up during the Bretton Woods Conference of 1944, delineating the design of global economy cooperation (and founding the International Monetary Fund and the World Bank as the prime institutions delivering global cooperation) – in memory of the devastating experience of the former inter-war years with Great Depression and its contribution to the horrors of fascism in Europa.

Its anchor was to be the U.S. Dollar as lead currency, pegged to gold at the price of 35 $ per ounce. The U.S. promised to exchange everybody’s dollars for this much gold, when desired. All (Western) currencies were pegged to the US Dollar, thus creating stability and stable foresight of future investments: high global GDP rates (over 5% p.a.), low unemployment (around 2%), low inflation led to a „Golden Age“ of word economic developments. Fixed exchanged rates also meant stable raw materials prices, helping industrial countries „economic miracles“ after rebuilding after WWII. State intervention, argued by Keynesian economics (later denounced by Keynes himself as „Bastard Keynesianism“, a term coined by Joan Robinson) stabilized business cycles and improved countries’ infrastructure. Finance was mainly used to enable a veritable investment boom, it was seen as an immaterial input into the economic process, a servant to the real economy.

All that changed abruptly in 1971 when the dual costs of financing Lyndon Johnson’s Great Society and the horrendously expensive Vietnam War led the USA to abandon their promise to exchange dollars for gold. Immediately, the Dollar`s value (relative to other currencies) fell by 25%, exchange rates were no longer fixed, but floating according to supply and demand for the respective currency. This introduced a degree of uncertainty into future economic developments – anathema for investing into the real economy; raw materials prices fluctuated, best seen in the increase of oil prices by OPEC countries in 1973 and again in 1981, in order to compensate for the fall in the dollar which remained the currency of exchange. In 1981 world oil prices were higher by a factor of 10 relative to 1972, the adjustments of the economies were severe.

Already before 1971 a concerted (?) attack on Keynesian economics as the guiding light for economic policy was waged by free-market proponents. Flexible exchange rates, „market before state“ and especially deregulation of financial activities became the rule. The insecurity delivered by flexible exchange rates and the ups and downs of market-driven developments damaged the incentives to invest into the real economy; increases in interest rates (above GDP growth) led to ever-higher indebtedness of governments (today many governments fact debt levels of close to 100% of GDP) and firms: GDP growth fell, unemployment went up, inflation rates went up and were brutally brought down. Trading volumes increased the global turnover of financial activities from estimated 540 bill $/day in 1989 to 3.6 trill $/day in 2019, to 7.l5 trill $/day in 2022 . In 2024 total financial flows amounted (estimates) to 1 quadrillion (10 to the 15th) $ a year. Simultaneously, the political influence of the financial sector increased in a way that today financial papers assess each and every economic policy measure of economic occurrence with respect to the financial market („how will the financial markets react?“). Financial markets have become the „masters“ of economic developments: this is corroborated by a seemingly insignificant re-classification in the UN System of National Accounts (the blueprint of GDP accounting world-wide) of financial activities from an input into the economic process into an output (value added) in 1992/3. No longer are financial activities lowly inputs (like raw materials) enabling growth, but they supposedly contribute to societal wellbeing, i.e. GDP.

Induced high volatility enabled a number of devastating crises (from the Asian crisis before the millennium , to the dotcom buble, the financial crisis of 2008 ff. – which nearly brought the world economy down, the inflation crisis, the energy crisis and the more general „affordibility“ crisis, endangering the livelihood of millions). The concomitant insecurity brought into the economy led to real investment being curtailed, booming financial „investment“, and since private markets do not invest in public goods (no profit), a significant fall in public sector investment, with devastating effects on the climate/environment and social cohesion.

BACK FROM MASTER TO SERVANT

If financialization is the root of the present economic evil, the path towards sustainability, both environmentally and socio-politically, requires to „put the genie back into the bottle“. But as well as we know that toothpáste once pushed out cannot be put back into the tube, the same is true with financialization: re-establishment of the old order is not possible. The financial sector has acquired too much lobbying power and a number of financial instruments is useful also to a future economy. Very significant political pressure would need to be applied (by civil society) to promote global cooperation and harness the power of the financial industry.

But: it is possible to throw sand into the all too smooth workings of today’s financial sector. Public opinion needs to sway away from the financial sector’s propaganda machine – and with it the mindset of economic and monetary policy makers.

The major direction must be to reduce the number of financial trades: to this effect, continuous algorithmic trading must be prohibited, and the necessary „equalization“ of demand and supply for assets be effected through twice or three-times-a-day auctions at the major stock exchanges. This can reduce trading volumes dramatically, since only at fixed times supply and demand offers are permitted.

Another well-discussed way would be to levy a global financial transactions tax on each trade, making trading more expensive and eliminating automatically low-profit speculative trades.

Another strand would be to increase stability by re-introducing fixed or semi-fixed exchange rates, where conversion rates are fixed, but can be aligned in case of major asymmetries. An institution like the IMF or BIS could be tasked.

Reversion of the burden of proof of „social value“ for the introduction of new financial instruments could reduce the proliferation of FinTech firms, many of which of zero or even negative social value (e.g. crypto).

The global regulatory regime for finance (epitomized in the „Basle Committee’s“ standard setting power) needs to have economic, environmental and socio-political stability as its lode star. This requires, among others, to include „shadow banking“ institutions into the realm of regulation; to increase capital buffers for financial institutions; to include environmental and socio-political risk considerations into risk management; to increase the burden of proof for the social desirability of mergers and acquisitions.

The overriding task to change finance’s role to once again (?) serve the real economy and society, instead of its own interests which frequently go against the interest of the above, requires not only a reversal of the dominant neo-liberal economic doctrine, but also immense political c ounter-pressure.