Wagging the Dog

Wagging the Dog

Where does finance fit into the economy?

Photo: David Whelan. Source: Morguefile

Time was that the real economy was considered the dog and the financial economy the tail. Except for an occasional bubble, the tail didn’t wag the dog. What people ate and how they dressed was critical; how the saved and where they invested wasn’t. Now it’s not so clear.

The world produced about $80 trillion in goods and services in 2015. At the same time, public and private markets were worth over $250 trillion–more than 3 times global GDP. And this doesn’t even consider the $640 trillion in swap contracts outstanding. Even if you allow for some overlap—levered banks that own public debt, etc.—that’s a lot of money! Without a doubt, what goes on in the market affects the real economy.

This wasn’t always so clear. In 1955 future Nobel laureate Harry Markowitz almost didn’t receive his Ph.D. because his ground-breaking work on portfolio selection wasn’t considered an economic topic. His insight didn’t fit into the categories of the time. How could finance be considered part of economics?

How much the world has changed! Today, if there’s a cash-flow, we securitize it. If someone discovers a new gene, they patent it and go public. We live in a financial age.

It’s another reason that the Fed needs to consider global deflation in their deliberations. Because whether the tail wags the dog or the dog the tail, if the pooch is shaking, someone had better take note.

Douglas R. Tengdin, CFA

Chief Investment Officer

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