Misesian Insight: Cantillon Effects and Financialization
[This article is Part 5 of a series. See Part 1 and Part 2 and Part 3 and Part 4.]
A final important analysis to be made with regard to wealth redistribution, alongside those presented in previous articles, is also related to the case of firms, domestic and international, and the impact of fiat money inflation and subsequent Cantillon effects on their overall financial behaviour and financing decisions. As Lin and Tomaskovic-Devey (2013) argue, one important tendency of the last decades has been the increased participation of both financial and non-financial firms in financial markets.
The two authors analyze the ratio between the financial income (sum of interest, dividends, and capital gains) and profits for manufacturing as well as all non-financial firms in the United States—as depicted below in Figure A below. They discover that between 1970 and 2007, US firms have become more and more financially driven, obtaining an increasingly smaller share of their income from the sale of goods and services, and about four times as much revenues from financial activities compared to 1970.
The evolution of this ratio is also correlated with the development of global financial booms, and as the figure above shows, it collapsed rapidly during financial crises (such as early 1990s, 2001). The larger the share of financial revenue in a company’s total earnings, the more favorable the impact of monetary expansion will be on the value of a company’s assets and total worth. At the same time, companies that continue to rely on revenues from product markets are, in these circumstances, the later receivers of the new money among companies, and thus they tend to earn less or even lose wealth in the process. More importantly, the ratio of financial income to profits for exporting and importing firms is at higher than average levels for domestic companies—because firms that trade on global markets often have to hedge against commercial, sovereign, and currency risk using financial market instruments such as derivatives, futures or foreign exchange market instruments. This makes global companies more and more likely to push for expansionist monetary policies that will disproportionately benefit them in the short-run.
In the longer run, scholars argue that not only financial corporations, but also firms from the non-financial sector will respond to a greater extent to changes in financial markets rather than product markets. This tendency of “financialization” is gradually reinforced with the passing of time and recurring inflationary episodes, which supports the argument that financial market development makes firms (who trade on global markets in particular) dependent on monetary expansion, and more likely to grow rapidly and malinvest their resources during booms.
This means, however, as Hülsmann (2014, 13) points out, that “…a fiat-money system destroys the two major limitations of fiat finance… [First] it undermines the role that objective factors play in the individual decision-making process. It thereby destroys the reality check of success and failure, while the economic system as a whole is still subject to objective limitations. Furthermore, the permanent price-inflation that typically results from fiat-money production destroys one major alternative to financial investments, namely, cash hoarding and thus discourages savings. In short, savings diminish below the level they would otherwise have reached, and the savings that remain tend to be wasted to a greater extent. “
Internationally, this means that companies from developed countries—such as the United States—are more likely to diversify their income sources sooner into financial markets, thereby outpacing companies from developing or transition countries, where financial markets are less developed. This is done at the expense of careful financial planning and to the continued discouragement of business savings, and reflects once again the uneven and gradual effects of monetary expansion on the distribution of income and wealth among individuals and firms on a global scale.
At the same time, however, companies from developing countries have gradually increased their presence on financial markets, and the tendency is also for them to rely less and less on business savings. As Correa et al. (2013, 263) argue, this “has been a peculiar process of domestic accommodation to the dominant tendencies in the global economy”, transmitted to developing countries through global supply chains, international trade relations, as well as inter-governmental and central bank cooperation.
In sum, an overarching effect of expansionary monetary policies on international trade is the promotion of a certain business climate in global markets, one in which entrepreneurs believe they can thrive only with large amounts of debt and state support. Internationally, the tendency is for entire industries and countries, as financial sectors develop, to cut savings and retained earnings, and reorient toward borrowing from both domestic and foreign banks. With booms and busts, international movements of capital become more erratic, as do trade flows of goods and services. Commercial relations between traders are short-lived, and fewer firms (generally only large corporations) establish long-term partnerships. The world economy responds more to the changes in government policies, and is less and less connected to consumer preferences. As a matter of fact, the exacerbated growth of debt, and the reckless financial behavior are ingrained in the institution of fiat money, which is maintained only by the power of legal tender conferred to it by national governments. Governments impose and maintain the monetary and banking system that allows for monetary expansion, and that is the root cause of all these modifications in the pattern of international trade.
Last but not least, we can note also that external financial support is easy to lose in the long-run: the uncertain evolution of stock markets makes many investors find a short-term investment or a short-term extended loan quicker to provide a return, and less risky that longer-term commitments. Thus, the time horizon of stock market investors becomes shorter than otherwise. Deprived of long-term equity in this way, small firms which cannot access credit markets (at least not to the same extent as their competition) find their growth unnecessarily stifled, and their capacity to penetrate global markets greatly limited.