How The Finance Industry Destroys Economies

Mr Zaidi

#GrowthSchool #GlobalEconomy #EconomicsExplained  ❤️ Reshare this with your friends who will need this 😇  Does the finance industry add value, or just chaos? From crashing economies to turning homes into gambling chips, it’s made billions while leaving us questioning its worth. We unpack its core role—connecting capital to land, labor, and ideas—and how it fueled the Industrial Revolution and consumer credit. But today’s mega-banks, high-frequency trades, and info gaps are sucking value dry, boosting inequality instead. Featuring insights from Rana Foroohar (Financial Times) and Warren Buffett’s casino warning—watch if finance is a tool or a trap!   Watch the full documentary now: https://curiosity.tv/mijelrl Special Offer for EE Fans! Use code EE30 for 30% off an annual Curiosity Stream subscription. Every redemption directly supports future projects like this!  This video was made possible by our Patreon community! See new videos early, participate in exclusive Q&As, and more!   / economicsexplained    ▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀ Writing credits: Hugh O'Reilly Check out our other channels Context Matters @BaqGamers  #EconomicsExplained #GlobalEconomy #GrowthSchool   ▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀▀  THANK YOU TO OUR PATREON COMMUNITY 👊🙏

Transcript

00:00Finance is one of the easiest industries to be inherently distrustful of and for good

00:04reason too. The finance industry has been responsible for creating many major economic

00:08downturns, they have lost people their life savings and turned essential goods into speculative

00:12assets to be profited on. Throughout this all they have made billions of dollars and never

00:16clearly demonstrated the value that they have provided to society at large.

00:19But finance is a useful tool in any economic system that can genuinely do a lot of good.

00:25It can allocate resources effectively, it can facilitate easy trade,

00:28and it can help people trade intangible future value for something that they need right now.

00:33Finance is not exclusive to capitalism either. A good financial system is a crucial tool in

00:38basically any economic system and bad financial systems have been responsible for undoing a lot

00:43of alternatives. But it is just that, a tool. Something that can be extremely useful or do a lot

00:49of damage, especially when it's allowed to grow beyond its usefulness. Today the financial industry

00:53is one of the largest and arguably most influential systems in the world and between mega banks,

00:58hedge funds, private equity firms, sovereign wealth funds and just regular people investing their

01:02money, we have arguably lost track of the role that this theoretically simple industry was supposed

01:06to play in our economies. It actually is surprisingly simple, but the manufactured complexity lumped on

01:11top of this whole system is a big part of the problem and the only way to see that is to zoom out

01:16and properly understand what this whole thing is supposed to do and what it's not supposed to do.

01:21So, what is the function of finance in an economy supposed to be? Is it still performing that role? And if not,

01:27what are the consequences of a finance industry that gets too large?

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02:41Finance is a broad term and it's difficult to define what sits within the finance industry and

02:49what doesn't in the modern economy. So before continuing any further, it makes sense for us

02:53to establish the basic idea of finance. At its most fundamental level, the financial industry has

02:59forever been the intermediary between capital and the other factors of production, land, labour and

03:04entrepreneurship. The finance industry takes money or wealth that's not being used and allocates it to

03:09productive economic activities to generate a return on investment. In the case of land,

03:13the finance industry is, in theory, there to direct those investments of capital to where they could

03:17add the most value by taking savings deposits and using it to invest in property development for

03:22example. Then there's labour, where the financial industry provides capital to workers so they can

03:26own assets through a mortgage and consume through things like credit cards. Here the finance industry

03:31is trading present capital to workers in order to receive a share of the value of the worker's future labour.

03:36And then there is the fourth factor of production, entrepreneurship, which dictates what is made

03:40with the limited resources of an economy. The finance industry, in theory, is supposed to

03:44regulate this factor of production by only providing capital to the ideas and businesses with the

03:49most potential to add value to the resources given to them. Say for example there are two entrepreneurs

03:54who have an idea to cure cancer. One is a trained oncologist with decades of experience and one is a

03:58high school dropout with no medical training. It's the finance industry's job to decide who gets

04:03allocated the limited resource of capital. When successful, entrepreneurialism is a source of

04:07invention that leads to the production of new goods and services which, if successful, can improve

04:12living standards for consumers, benefit society, and generate profits for the entrepreneurs themselves

04:17who will share the returns with the financial intermediary who connected them with the capital

04:21to make these ideas a reality in the first place. Now in practice, any capital investment usually

04:26funds some mixture of all three factors of production. And whilst entrepreneurialism offers good returns,

04:31it also tends to be the riskiest investment, so the financial intermediary obviously needs to

04:35perform due diligence. Perhaps one of the most illustrative and organic examples of finance

04:40driving economic growth would be the industrial revolution in Britain from the late 18th century

04:44to the early 19th century where technological innovation and the shift to more efficient

04:48means of production radically increased economic output. New large-scale enterprises required large

04:52capital inputs up front to fund the construction of textile mills, steam engines, and mechanized

04:56equipment which, when put to use by an abundant labor force, would still take years to see

05:01any return on investment. This was only possible through access to financial capital in the first

05:06place which made it critical to industrial expansion. But even at this stage the financial

05:10industry was still pretty small and undeveloped with funding usually being sourced from wealthy

05:14individuals directly without a bank or investment fund acting as a middleman. As the finance industry

05:19grew larger institutions formed and new markets emerged. Fast forward to the 20th century and financial

05:24intermediaries began to expand from investment in production to investment into consumption, which in a

05:30way was a logical move for them. Why mass produce all of these goods if the vast majority of society

05:35can't afford to pay you for it? And so began the rise of consumer credit which for the first time

05:39enabled consumers to live beyond the unnecessary constraints of their immediate income and savings.

05:44Credit for big ticket items such as cars, appliances, and furniture quickly became accessible in most

05:48capitalist nations during the roaring twenties. Mortgages steadily became commonplace and as data

05:53technology evolved finance for consumption became epitomized by credit cards during the 1980s.

05:57From 1950 to 2008 the US household debt which measures how much credit consumers are taking on

06:02grew from 24% of GDP in 1950 to 73% of GDP in the modern day. Now not only is the finance industry

06:08allocating capital to the supply side of the economy, it's allocating capital to the demand side of the

06:13economy. Now this dual effect has driven real economic growth and improvements in living standards

06:17but it's clear to see that the finance industry has evolved way beyond this historical account.

06:22And as the financial industry has grown in complexity it's become difficult to see the value that many

06:26aspects of it actually provide for the real economy. This concern is further driven by the sheer size

06:31and therefore power some of the largest financial institutions have grown to possess.

06:34Just take a look at the annual revenue of some of the largest finance companies.

06:38Some are generating totals that compare to the GDP of entire nations such as New Zealand or Portugal.

06:42And whilst size may not matter in and of itself and so I'm told, it's safe to say that private

06:46interests of people in finance do not necessarily align with wider economic interests which begs the

06:51question as to whether the financial industry has outgrown the net contribution role it's primarily

06:55played in the economy. This is a huge question to unpack and luckily we're able to sit down with

07:00Rana Faruha to get her thoughts. Rana is the business columnist and associate editor of the Financial

07:04Times as well as the global economic analyst for CNN. She had some concerning insights on the matter.

07:09So if you think about the traditional role of the financial industry I kind of think of it like an

07:15hourglass right and you know here are the savers up here and here are the borrowers down here so people

07:23that need mortgages people that want to start businesses we've got all the savings up here and

07:28finance is supposed to be this kind of tiny part of the hourglass that is a help meet you know helping

07:33those two sides to reach each other productively. When I did my first book Makers and Takers in 2016

07:40and I looked at the financial industry in depth and if anything things have gotten worse since then

07:45only about 15 percent of the money that was sloshing around the financial system in America was going to

07:54that kind of productive investment into new businesses into helping someone to buy a home those sorts of

08:00things that really grow Main Street. Most of the the money 85 of it was just in this kind of closed loop

08:08of buying and selling of existing assets which again raises the price of things it raises the price

08:13of housing it raises the price of stock markets but it doesn't create anything new on Main Street.

08:19What Rana is talking about here is the transition that the finance industry has made away from long-term

08:23productive investments such as small business loans which are extremely rare nowadays and towards

08:28shorter term trading and interest seeking from consumption. All over the world there are people

08:32in finance analyzing price movements and market data to execute trades that last as long as months

08:36and as short as a few nanoseconds. For foreign exchange markets, stock markets, cryptocurrency markets

08:41and even commodity markets, short term trading makes up a huge proportion of the total volume of trades.

08:46While this provides liquidity to the markets, this level of short term trading contributes little

08:50if anything to the real economy because it creates unreliable price fluctuations and it doesn't

08:55actually give publicly traded companies on the stock market any real capital to work with.

08:59Unlike long term investing where both parties in a hypothetical transaction can win,

09:03speculative short term trading is a zero sum game. Total profits have to be matched by total losses

09:09and the only change that has occurred is the redistribution of value amongst the players.

09:12And since it's a game built on an unequal playing field, it's actually driving inequality as

09:17untrained uneducated happy go lucky novel traders get financially skimmed by professional analysts

09:21and larger players who have more knowledge, experience and informative tools at their disposal.

09:26This is especially the case since the COVID-19 pandemic where millions of new traders enter

09:30the markets for the first time. It is well known that trading can be addictive and leads to negative

09:34outcomes for most inexperienced people who are drawn by the flashy adverts and the allure of quick

09:38cash by financial trading platforms whose only incentive is to maximize trading activities so that

09:42they profit from the fees. Have you seen the 80% of traders lose money disclaimer that greets you when

09:46you're setting up a trading account? That's the financial industry's equivalent of the smoke and kills

09:50warning found on a cigarette packet. Both are grim, legally imposed reminders of the inherent risks

09:54yet too often ignored in the pursuit of short-term satisfaction. Now you might say a game is a game,

10:00survival of the fittest right? But at the end of the day nothing is made on the back of this type

10:03of speculative financial activity. No fiscal goods created, no services provided and therefore value

10:08is not produced for the economy. Investment legend Warren Buffett said it himself at the Berkshire Hathaway

10:12annual meeting in 2022 when he declared that financial markets became almost totally a casino.

10:17The late Charlie Munger, Warren's right-hand man went even further to say that civilization would

10:21have been a lot better without it when referencing speculative trading.

10:24There are certain parts of the financial industry where you can tell that same story times 10 or

10:30times 20. I would look at something like the commodities market for example and say

10:34okay yeah you can go way back in history you can go back to the Greeks and their olive presses and say

10:39if you're an olive farmer you might need some financial instruments to help you hedge the possibility of a

10:45drought or a poor harvest. Okay that's that's a productive use of financial capital but is it a

10:51productive thing when 60 times of the trading in the commodities markets and certain kinds of minerals

11:00and energy resources are being done just for the sake of financial trading versus say real hedging by

11:07farmers and I would have to say no. Now if you're thinking speculative short-term trading does not represent the

11:13financial industry as a whole you'd be correct it's only one part of a wider system but the core

11:18factor that enables institutional traders to profit without adding value also applies to essentially

11:23every other finance market in existence and that is information asymmetry when one entity in a

11:28transaction has better information than the other which means that they have a better understanding of

11:31the true value being exchanged. For example if a corporate executive knows about an upcoming deal

11:36that's going to increase a company's stock price they can buy stocks before the information becomes public

11:40and before the higher price equilibrium is established. This information asymmetry between

11:44the corporate executive who is buying the stock and the seller who is blind to the near future value

11:47of the stock gives one party an advantage which they can exploit to take profit from the market.

11:52Now this example is the definition of illegal insider trading but elsewhere in the financial markets

11:56information asymmetry is a perfectly fine way to make profits. Take high frequency trading where algorithms

12:01with super fast connections are accessing information before anyone else. This is all done in the space of

12:06microseconds but it adds up. Research in the quarterly journal of economics found that high frequency

12:10trading costs the equities market alone 5 billion us dollars a year. This represents a tax for all

12:16other market participants and is literally automated rent extraction. In the case of consumers information

12:21asymmetry could be in the form of insurance products that you overpay for because there are subtle details

12:25in the terms and conditions that reduce the size or chance of a payout and ultimately what these examples

12:29show us is that as the finance industry becomes increasingly complex the information gap between the

12:33industry and the average Joe grows whether that's trading, insurance, credit or any other financial

12:38market. This creates more room for the finance industry to extract value from transactions instead

12:42of assisting in the creation of new value. Consequently the financial industry has increased its dominant

12:47position in the global economy and its concentrated profitability is extracting value in other less

12:52obvious ways as well. The latest global graduate survey shows finance to be the leading prospective

12:58industry for graduates having become more preferable compared to the last year whilst education,

13:02healthcare and government has become less preferable. As a result human capital is diverting away from

13:06occupations that produce high marginal benefits to society such as medical research, construction,

13:11teaching or civil service causing talent gaps and less effective governance and lower efficiency.

13:16These graduates could work on the development of solutions to energy storage, medical research and

13:20space exploration or the development of bots that can buy stock for $213.72 on one exchange and sell it for

13:26$213.73 on another. Of course an oversized financial system is not just a problem simply because much

13:32of it is pointless. Problems are further compounded by the disproportionate benefit it has for people who

13:37already have wealth. Most of the equities, the stocks, the bonds, even the housing market in America is owned by

13:45the top 10% of the population. So about 85% for example of the entire stock market is owned by the top 10%

13:52of the population. That gets even more concentrated when you go into the 1%, the 0.1%. So the Carl Icons of

14:00the world are benefiting tremendously. I'm benefiting because I have a large stock portfolio, but the average

14:08American still gets most of their money from a paycheck. It's about income. It's not about asset

14:14wealth. And yet over the last 40 years, the entire nature of our economy has changed in ways that

14:22encourage asset wealth at the expense of income growth. A recent report by McKinsey and Company

14:28found that asset price inflation has created $160 trillion US dollars of paper wealth globally, which

14:34is mostly benefiting the wealthy by definition. Just take a look at the house price to income

14:38ratio in most developed countries. In most places, it's been rising for at least the last 10 years,

14:43most notably in Portugal, which we've explored in a recent video. If you'd rather look at more

14:47liquid financial assets, it's the same story. Since 2010, US stock markets have grown 3.5 times

14:52quicker than median wage growth. This is great for the owners of financial assets, but for the majority

14:56of people in the economy who source their income from labour and have low levels of investable savings,

15:00there's been little benefit. Now finance is an easy scapegoat for all of our economic

15:05problems because, well, even finance bros don't like finance bros. The reality is that the industry

15:10does have a function. It's there in theory to be the lubricant that makes investing, transacting,

15:14saving and conducting business easier. It moves risks from people who don't want it to people

15:18that are happy to accept it for the potential of a reward, and even for consumers using credit,

15:23within reason, it can help to ease out budgeting and make the consumption of the goods and services

15:27we enjoy a little bit more seamless. The poison, as with most things, is in the dosage. A good engine

15:32needs oil to run. Submerge the whole thing in it though, and it's gonna seize up.

15:36Unfortunately, there's no natural stop on the finance industry, and if it can't make money by

15:40providing value, it will make money from extracting value. Now of course, this can be addressed with

15:45regulations, but to do that we need to first acknowledge that it has clearly gone too far to

15:49begin with. Now our full interview with Rana, as well as several other world-leaning economists and

15:54industry insiders is available on curiosity stream as part of our new feature-length documentary.

15:58There will be a link in the description to sign up and watch that, as well as an extensive library

16:01of other world-class documentaries. Thanks for watching mate, bye.

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