agcapita july 26 2012 briefing - the retreat of financialisation

7/31/2019 Agcapita July 26 2012 Briefing - The Retreat of Financialisation

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Agcapita Update

July 26, 2012


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THE RETREAT OF FINANCIALISATION

Let me start by saying that I do not adhere to the mistaken

belie that banking is intrinsically bad. Banking and

fnance serve a productive purpose in the economy by

intermediating savings and investments. However I believethat what passes or much o modern banking, or more

accurately post 1971 banking with its dysunctional central

bank/private bank nexus and its anti-competitive nature

courtesy o regulatory barriers to entry, is not productive

and is actually acting as an impediment to the underlying

economy by destroying vast amounts o real capital - aka

bailouts.

So with that context in mind, I believe it is putting it mildly

indeed to say that we have arrived at a point where the

vast majority o fnancial institutions are simply regulatory

oligopolies with asset-harvesting business models moreconcerned with ees and proprietary speculative activities

than with providing any useul services to savers and retail

investors.

The mainstream fnancial sector has indoctrinated an entire

generation to buy and hold because it suits their business

model that is asset-driven rather than perormance-driven.

Large fnancial frms have an intrinsic institutional bias to be

bullish on everything - they have no incentive to tell you not

to invest in something as they will usually be operating a und

in that area. Hence such sophistry as being underweightunattractive asset classes rather than encouraging outright

selling. Ultimately they have little investment insight other

than everything will go up in the long-run. O course in the

long-run it has been quipped that we are all dead. To add

insult to injury they seldom outperorm their benchmarks

over long periods and charge management ees or what is

eectively closet indexing.

Agcapita Update


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Agcapita Update (continued)

Once again, I am not a knee-jerk critic o the fnancial

sector but I do believe that it has become too large.

Corporate profts attributable to the US fnance sector

were eectively stable rom the 1950s to the early

1980s rom 5% to 15%, then as the growth in the

money supply turned sharply higher on a sustainedbasis in the 1980s they peaked at 40% in the early

2000s and still remain around 30% - substantially

higher than long term averages.

On an asset basis the numbers tell a similar story. The

20 largest banks in the US have combined assets o

approximately 90% o GDP. The fve largest banks -

JPMorgan Chase, Bank o America, Citigroup, Wells

Fargo, and Goldman Sachs - have combined assets

o approximately 60% o GDP. These numbers are

roughly 3 times what they were in the 1990s.

Given the fnance sectors intimate relationship with

government and central banks it is not surprising that

it grows aster than the underlying economy. Newly

printed money ows into and through the fnance

sector acting as a wholesale subsidy that drives

corporate profts, compensation and speculation.

Despite widespread belie to the contrary,

government intervention into broad swathes o the

fnancial sector to support too big to ail banks

or, more accurately, to prevent capital destroying

business activity rom being eliminated to the beneft

o the entire economy is not a positive or uture

growth. When it is unded via expansionary monetary

policy it seems to me that at best it is laying the

groundwork or stagation.

There is an economic truism that whatever you

subsidize you get more o - hence by subsidizing

ailure we are ensuring bigger ailures in the uture

and worst o all penalizing well-run businesses. The

frms that were prudently managed leading up to the

crisis should have benefted rom the demise o their

poorly-run competitors - in a ree economy capital

would have owed to the proftable businesses rather

than the loss making ones. The act that this didnt

happen creates a perverse if you cant beatem,joinem mentality with respect to risky and imprudent

business practices.

Lets be clear on one thing, the primary purpose o

low interest rates is not to save the economy, it is

to save the banks and allow them to continue all

this risky, bonus-generating behavior. Low interest

rates are simply a case o robbing Peter to pay Paul

as capital is being strip-mined rom savers via low

interest rates and in eect donated to the fnancial

sector. I would argue that the enormous size o the

fnancial sector coupled with its current insolvency,which the constant bail-outs are attempting to

disguise, will be a drag on growth or years unless

losses are allowed to take place via ree market

mechanisms.

Perhaps another interesting indicator o the

fnancialisation o western economies is the ratio o

the Commodities Research Bureau Index versus the

S&P 500. The long-term average is around 1.5 times.

Simplistically, this ratio indicates how much S&P 500

stock you can buy with a fxed basket o commodities

a rough indicator o the growth o fnancial assets in

relation to real assets so to speak:

During the commodity bull market o the 1970s,

the ratio was consistently higher than 2 times or

over 10 years - it peaked at around 4 times.

The ratio is currently at around 0.2 times - ar

below the 1.5 times long-term average and

ar below the 4 times peak seen in the last


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Agcapita Update (continued)

commodity bull market. We still appear to be at

an all time low relative valuation between hard

assets versus fnancial assets.

I history is a guide, the ratio o real assets to

fnancial assets will return something closer to its

historic average. How? Stocks will all and/or commodities will

climb most likely a combination o both as

investors seek saety outside o the insolvent

fnancial system and fnancial assets.

I would not suggest that this ratio is perectly

predictive, but it is certainly ood or thought and

perhaps another data point supporting the premisethat the process o fnancialisation will tend to retreat

rather than grow rom here.


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agcapita july 26 2012 briefing - the retreat of financialisation

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