Reverse Money Flow Suppresses Productivity and Economic Growth as Revealed by Money Flow Paradigm

Several economists such as George Cooper, Ray Dalio, and Hyman Minsky, among others, have pointed out that the financial markets operate in a fundamentally different manner than the markets for ordinary goods and services. In ordinary markets, demand retreats as prices rise.  In financial markets, particularly in the stock market, rising prices induce people to buy more stock, not less. Conversely, when stock prices drop dramatically, people pull their money out of the market, making prices drop even more dramatically. While most markets exhibit a negative feedback loop where higher prices curb demand, the financial markets tend display a positive feedback loop with irrational exuberance as prices rise and a downward spiral as prices fall.

However, the Money Flow Paradigm has now revealed the full picture of how the separation of the financial markets from the real economy can reverse the flow of money, which normally flows from the financial markets into the real economy, and instead cause a backward flow from the real economy into the financial markets in a manner that can be self-enforcing, especially when assisted by major national and international movements of money into the financial markets.

This regurgitation of money from the real economy back into the financial economy is a product of the maximization of shareholder value as in maximizing short-term share stock price, often using money for stock buybacks instead of for investments in the real economy.  The GDP in the real economy has been growing at an average of three percent per year for several decades while stock market prices have averaged ten percent per year.  This has caused many non-financial businesses to invest money that would otherwise go for improving productivity and product offerings and instead invest that money in the stock market.

Before 1982 the Securities and Exchange Commission (SEC) treated stock buybacks as insider trading and forbid them. Starting in 1982 the SEC allowed stock buybacks, a change in regulations that has significantly and substantially undermined productivity and economic growth in the real economy. In the past banks made loans locally and stayed with those loans until they were paid back. More recently banks have been making riskier loans because they know they can sell off or securitize the loan in the financial markets. This has increased the instability of the financial markets and our economy overall. 

Bed, Bath & Beyond under CEO Mark Tritton is only one of many U.S. firms that have engaged in “financialization” where the focus is on saving money and investing it in stock buybacks to boost the firm’s short=term stock share price instead of in offering better products at lower prices through improvements in productivity and customer satisfaction. Tritton swapped cheaper in-house brands for the quality national brands in his financialization efforts.

Silicon Valley Bank is another example where the company invested too much money into bonds in the New York financial markets and failed to invest adequately in developing exciting new products for consumers. There is an inverse relationship between bond prices and interest rates. This occurs because bonds fix the coupon value at some initial interest rate. This coupon value does not change after the bond is issued. When interest rates rise on new bonds, the old bonds lose value so that the coupon value relative to the bond prices reflects the proper interest rate relative to price as established by the new higher-interest rate bonds. Silicon Valley Bank had overinvested in bonds in the financial markets and as interest rates rose the value of its bond portfolio fell dramatically triggering its financial crisis. 

Back in the day, our economic system rewarded customer-focused entrepreneurs such as Steve Jobs of Apple, Inc. who came up with new and innovative products.  But then John Sculley came along and told Steve that he needed a professional manager, someone who could increase profit margins and more quickly raise Apple’s short-term share price. By diverting money from product development and innovation to share buybacks and cost cutting, Sculley undermined Apple’s competitive position. When Microsoft and others began to surpass Apple in creativity and innovation, Apple’s board realized their mistake, removed Sculley and brought back Steve Jobs. Companies that forget about their customers and emphasize cost cutting over product development jeopardize their competitive advantage and future profitability.

The U.S. Federal Reserve has also played a role in the suppression of productivity and economic growth in the U.S. economy.  Back in 1996 Fed Chair Alan Greenspan complained of irrational exuberance in the New York financial markets but did little or nothing to counter it and instead contributed to the problem by having the Fed purchase more U.S. Treasury securities. Later under Ben Bernanke and subsequent Fed Chairs the pumping of money into the financial markets continued under the rubric of quantitative easing. This pumping of money into the financial markets increased the wealth gap by driving up prices in the financial markets at the expense of productivity and economic growth in the real economy as revealed by Christopher Leonard in his book “The Lords of Easy Money” and by Karen Petrou in her book “The Engine of Inequality.”

China has played a role in this suppression of U.S. productivity and economic growth along with the U.S. Federal Reserve Bank. For several decades the Chinese has taken their resources and worked hard to produce good quality products sold at low prices in the U.S.  However, instead of sending our products back in return to China, we have seen sending them pieces of paper with George Washington’s picture on it (U.S. dollars).  Ordinarily, these U.S. dollars would flow into the foreign exchange markets and drive down the value of the U.S. dollar, making our products cheaper for the Chinese to purchase and Chinese products more expensive in the U.S.  However, the Chinese government does not allow this to happen. Instead, they require that Chinese businesses turn in those U.S. dollars to the Chinese government in return for Chinese currency (yuan, aka renminbi).  China then has its sovereign wealth fund invest those dollars in U.S. Treasury securities in the New York financial markets. The Chinese government now owns trillions of dollars of U.S. Treasury securities. In effect, we gave China a lot of money in purchasing their products, but instead of using that money to buy our products, China has loaned us our money back again by purchasing U.S. Treasury securities. This has contributed to the suppression of productivity and economic growth in the U.S.  Other nations have followed China’s lead in this regard and also have trillions of dollars invested in U.S. financial markets.