The new Wall Street and the high cost of manipulating money.

• Author: Gilder, George
• Position: REFLECTIONS - Essay

Wall Street's Triumph over Main Street

The current world monetary and economic system favors Wall Street's currency regime over both Main Street and Silicon Valley. Once offering a wide range of research, analysis, and support for the independent enterprises of America, the new Wall Street simply means giant banks informally nationalized by Washington, D.C., in behalf of a system of manipulable currencies trading at a rate of $5.1 trillion per day that stultify and retard international commerce. Some seventy-three times larger than all trade in real goods and services, this chaos of floating currencies inflicts arbitrary damage on real businesses around the globe.

Capriciously defined and traded by banks, this ocean of fluctuating monies has even rendered international trade a political liability and resulted in a worldwide outbreak of economic nationalism, as changes in currency values dwarf all real differentials of comparative advantage. A case in point is the opposition to the North American Free Trade Association (NAFTA), which is chiefly an effect not of free trade but of an 87 percent drop in the value of the Mexican peso, from 34 cents to less than a nickel, even though the Mexican economy has actually improved since the pact was enacted in 1994.

In the midst of this global turmoil, Goldman Sachs, Morgan Stanley, UBS, Deutsche Bank, Citibank, JP Morgan Chase, and their ilk--eminent institutions all--are full of dazzling financial prestidigitators. But they are too big to fail and too dependent on government to succeed. Their horizons are too short to enable the falsifiable knowledge that alone constitutes entrepreneurial wealth and growth. They now make profits chiefly through what they call "proprietary trading," with a time horizon measured in minutes and weeks rather than in years and decades. They impart liquidity but not learning. They are profitable because of a vast transfer of wealth away from workers and savers toward bankers.

These institutions have accepted an insidious bargain where they thrive by serving government rather than entrepreneurs. Under the current zero-interest-rate policy, the dollar has thrived as a haven in a tempestuous world. But Washington has vitiated savings as a source of income, and it has rewarded financial manipulation over entrepreneurial investment and learning. Government policy now favors the short-term arbitrage and rapid trading of the big banks and multinationals over the long-term commitments that create employment and growth. Shrinking the horizons of economic activity, the result of currency chaos is a predatory zero-sum economy that destroys the jobs and depletes the incomes that sustain Main Street and the middle class.

For most of us, wildly changing prices and currency values are a menace. They confuse enterprise and learning and thwart the enduring commitments and investments that shape our lives and prospects. But the new Wall Street and its computer-driven trading benefit massively from volatility. Gyrating currency values and stock movements, whether up or down, mean opportunities for arbitrage, hedges, and fast trading. The new Wall Street harvests these gains through cheap borrowing from the Federal Reserve and accelerated cyberbuying and shorting of currencies and securities.

The new Wall Street wants volatility, with the downsides protected by government. Main Street and Silicon Valley want stable currencies for the benefit of work, savings, and long-term investment, with the upsides protected by the rule of law.

The new Wall Street mostly welcomes Luddite environmental regulations that thwart manufacturing and promote litigation. But regulatory overreach and litigation paralyze Main Street and all but the lawyered leviathans of Silicon Valley.

The new Wall Street revels in the spiral of guaranteed loans to college students that expand the ledgers of banks and the investible endowments of universities. Main Street and Silicon Valley suffer from the debt-driven flight from marriage and entrepreneurship of entire generations of debt-burdened college graduates (or, worse, nongraduates) (Konczal 2014).

Favoring financial power over entrepreneurial knowledge, these government policies have crippled the U.S. job machine that led the world in the 1980s and 1990s and sustained income growth for nearly all Americans (Eberstadt 2016, figs. 1.3 and 4.2, showing international comparisons).

Over the past twenty years, initial public offerings (IPOs) that create new jobs and prosperity have sharply declined compared to mergers and acquisitions that by comparison tend to shrink employment growth. In the 1990s, there were twenty IPOs for every merger and acquisition; since the turn of the century, there have been eight merger-and-acquisition events for every IPO (Gao, Ritter, and Zhu 2013). Not only are large companies buying up their own shares, but they are also buying up the shares of their potential competitors. With the number of shares shrinking by some 50 percent since 2008 and the number of rivals dropping, the value of the surviving companies moves up--hence the stock-market "boom" amid economic doldrums. But the benefit to elite-company stock values comes at the cost of a stagnant economy, without new company competition and learning, jobs, and growth.

By favoring a volatile environment of rapid trading, shorting, indexing, and arbitrage, current monetary and economic policies cultivate a hypertrophy of finance. Since 2008, the United States has seen a 30 percent rise in the financial share of gross domestic product (GDP), with as much as 40 percent of profits going to the financial sector (Greenwood and Scharfstein 2013; see also "The 5 Percent Solution" 2012But falsifying the yields of all this bloated banking is a maze of government guarantees and subsidies, regulations and privileges. If government guarantees an investment, it is not falsifiable and cannot yield learning or economic growth. Helping at once to disguise and enforce this covert nationalization have been fines and fees for alleged offenses that mount to a total of some $300 billion since 2008.

The most prestigious vessels in the finance industry now shun any serious attempt to fund the real economy's industries and learning curves. Apart from providing liquidity, the short-term trading activities that prevail in the financial world yield virtually no new knowledge and thus are exploitative of wealth rather than creative of it.

Part of the problem is what should be called the "outsider trading scandal." Hounded by government insider-trading witch hunts and "fair-disclosure laws," investors must follow the government rule "Don't invest in anything you know about." For the public, the only investment idea that governments devoutly support is "Invest in the state lottery, where no one knows more than you do."

Outside traders use market statistics and quarterly earnings correlations to guide ever more evanescent transactions. Because entrepreneurial learning comes from deep inside companies and requires intimate special knowledge, bans on insider trading or knowledge impel investors away from close company analysis and productive finance. In the face of the mazes of protean Securities and Exchange Commission (SEC) rules and computerized investigations, it is simply foolhardy for a bank or hedge fund to base its public investments on real unique inside knowledge. Nearly anyone who understands a company is barred from investing in it. Basically prohibited from buying shares in the companies they know best, for example, are members of company boards of directors, who can always be judged to possess some incriminating inside insight. They are safe only if they lose money.

The SEC astoundingly favors boards that know nothing about the companies they rule and have no stake in them. Lawyers and accountants proliferate. In an economy increasingly governed by information flows, the SEC thus suppresses learning and knowledge and...