How are financial markets supposed to work? Per Adam Smith

Financial Markets" A picture of the book cover "Makers and Takers" and it's author Rana Foroohar.

The video below is an interview with Rana Foroohar, being interviewed by Bob Herbert on Op-Ed TV.

She makes an incredibly clear statement starting at 3:02, and lasting until 4:18 about how financial markets used to work, how they work today, and how the way they work today encourages asset bubbles and discourages more production in the economy.

When you click into the video below, it starts at the right point, but you’ll need to stop it after 4:18.

When she makes mention of her book, it’s Makers and Takers: The Rise of Finance and the Fall of American Business.


Rana Foroohar

How are the financial markets supposed to work?

Which by the way is something we didn’t really do all that well post 2008.

The way that Adam Smith, you know, the father of modern capitalism, set them up to work is that banks are supposed to take all of our savings, all of the deposits we’ve put into financial institutions, and they’re supposed to lend those out to new businesses.

To productive enterprises that then create jobs, and employ all of us, and hopefully raise wages, and grow prosperity.

But over the last forty years that model has changed.

So back in the early 70s that’s roughly what banks did.

Since then it’s changed, and the killer stat really in my book is that only 15% of all the money washing around Americas financial institutions actually gets lent to new businesses.

The rest of it is existing in this sort of closed loop of speculation, of trading, the creation of asset bubbles, and so it’s no wonder that you’ve got the markets here [she gestures “high level” with her right hand] and Main St here she gestures “low level” with her left hand].

Bob Herbert

So there’s no real productive capacity coming out of most of that money.

Rana Foroohar

Not nearly as much as there was.

So if you look at that 15%, that money that banks spent lending, that was about double in the 1970s and it was the majority of their business in the earlier part of the 20th century.

Today, banks don’t lend out deposits

That commercial banks loan out deposits was apparently true in the past, but it is not true any longer.

Today, banks create new money every time they make a loan.

Here is a link to a video of the Cowboy Economist (John T Harvey PhD) explaining this commercial bank money creation process.

This statement, that banks create money from nothing, is neither hyperbolic, nor is it a metaphor.

It is literally true.

When you go to a bank and take out a loan, the money they put into the checking account they create for you doesn’t “come from” anywhere.

It simly appears in the account, as if by magic, but in reality per the rules of how banks make loans. Literally. Seriously.

This is poorly understood by most people, and this misunderstanding is made worse by the fact that some Universities still teach that banks loan out deposits, even though everyone who understands banking knows that’s not true.

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