What is Finance For?

The financial collapse of 2008—centred on subprime mortgages—was my first real exposure to the insanity of the “financial sector.” Until then I’d been to young to really pay attention, but suddenly the preposterous games being played with the world’s economy came into sharp focus. When they lost, the world lost, but they didn’t.

So The Future of Finance, which briefly reviews John Kay’s Other People’s Money, gave voice to things I only had vaguely formed thoughts and/or anger about:

Kay goes back to first principles, asking what purposes the financial system is meant to serve, and measuring just how far the modern financial economy has moved from that ideal.

The point of finance, he argues, is to connect savers and borrowers — end-users, that is, not financial intermediaries. The test of a financial system is whether a household with surplus funds, say, and a company or government needing to borrow for investment can be connected at low cost and in a way that makes both parties better off. Correctly understood, all the institutions that lie between such end-users exist to serve this underlying purpose.

In Kay’s view, modern economies have lost sight of this vital point. Finance has come to be seen as an end in itself, as though the global economy exists to serve Wall Street and the City of London rather than the other way round. If you applied that mindset to electricity generation, for instance, the absurdity would be obvious: You don’t generate electricity for its own sake.

2 responses to “What is Finance For?”

  1. Fun fact about power generation: you _can’t_ generate more or less than is being demanded. If that happens, there is a point at which machines will start burning up, twisting apart, or blowing up.

    I think there’s another level of analogy there somewhere.

    It’s really a myth that power companies can push electricity out to their customers in order to charge more because production de facto follows demand, but there’s one sneaky truth in there and that relates to a certain class of machines that suck out power indirectly in proportion to the excess generation on the market. It _is_ possible then for power companies in aggregate to collide and “push” more power for their own benefit, but the range and tolerance of doing this is very small.

    Perhaps when we look at the financials industry we see a much broader tolerance for manipulation, one that’s easier for small players to game and thus one that’s significantly more temping. Is it the cough syrup to the power industry’s cocaine?

    Thanks for the comments – thought-provoking.

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