8 Economists' Investment Tips
Liu Yuhui: “A Perspective on Macro Chess Games” -- The Mysteries of Financial Cycles and Wealth Distribution (1)
Summary of this issue
1. What is the essential difference between the current globalized world and the 1870s?
2. What is the core of today's economic cycle research?
3. What far-reaching impact will the endogenous financial world economy have?
Financial cycle:
The next point of knowledge is the financial cycle. You can see the difference between the world before the 1970s and the world today through the picture below.
Before the 1970s, the real economy was 10 times larger than the virtual economy; today it is completely reversed. In today's virtual economy, all kinds of assets and derivatives contracts can reach 50 trillion US dollars or more in a year. However, the global real economy is only 77.3 trillion US dollars, and the gap between the two is more than 10 times. What is the reason for this upside down? Or what has changed in the macro?
In the past 40 years, from theory to practice, the biggest change in the macroeconomic framework is finance, so we must mention finance. Finance is no longer like in the 1970s, only acting as an intermediary for converting savings into capital formation, or investment, in a very classic and complete Western macroeconomic framework. Simply put, in the 1970s and 80s, finance that everyone learned in textbooks can essentially be summed up as financial neutrality and currency neutrality. What works in the short term doesn't work in the long term. Why?
Because at that time, finance was just an intermediary; it did not enter the production function; it was an exogenous variable. But in the past four or five decades, we've seen that finance is no longer an exogenous variable; what has it become? It becomes an endogenous variable and goes directly into the production function.
Even today, financial capital has become a dominant force in wealth distribution. Today in the US, we see that in science and innovation capital like Zuckerberg, 0.1% of top minds allocate as much revenue as 90% of people in this system. How was this achieved? It is achieved through a finance that is no longer exogenous and is highly endogenous.
When was this change completed? In fact, it is very close to today, in the past 40 to 50 years. One very important thing that has happened in macroeconomics is that finance is highly endogenous, and it has directly changed the content of the economic cycle we see. The content of economic fluctuations has changed, so the high degree of endogenesis of finance has been a clear study in the economics community in the past four to fifty years. How to transform the original framework composed of three macroeconomic research questions, insert finance as an endogenous variable, and rebuild a model is the jewel in the crown of the Nobel Prize in Economics that all researchers want to win. It is the highest dream of any aspiring young person to enter this field.
In such a financially highly endogenous economy, what is one state we are seeing? From a practical point of view, the basis for monetary credit creation today has changed. It should be said that before the 1970s, in the entity-based economic world, credit creation was based on income flows generated in the real economy. At that time, we were concerned about the performance of the enterprise's efficiency, income statement, and asset cash flow statement.
Today, real-world revenue streams are less important, or even a marginal factor. What is the core basis for credit today? It is the price of an asset collateral.
So we see that a large amount of credit creation does not directly correspond to the formation of commercial capital, or the expenditure of commercial capital, but to what? It is an inventory of assets and financial transactions. Therefore, the virtual economy has become the main consumer of money, and very little money is actually invested in the real economy. So we're seeing changes in the content of the economic cycle described in textbooks.
Today, the core of economic cycle research has changed to the credit cycle. The correlation between the credit cycle and the business cycle has begun to weaken, and the inventory cycle has become less important. We often encounter a lot of confusion in the practical application of the knowledge we have learned in classic books. Why did these confusions arise?
This is my personal understanding of the internalization of finance. Because the correlation between today's credit cycle, business cycle, and normal business cycle has begun to weaken, it is almost one with the asset price cycle. The credit cycle we are seeing today can basically be equivalent to the asset price cycle, and can basically be the same as the real estate cycle. why? Because the basis for creating and providing credit is the price of asset collateral. So we saw this real world, and it's been running like this for four and a half decades.
What's one problem with it? It is the free financial market that provides strong private incentives for trading activities within the financial system, so that the scale of such financial transactions far exceeds the actual social value it can create. There is a huge difference in strength between the two. The real economy is only 77 trillion US dollars, while the virtual economy has created a transaction scale of 50 trillion US dollars. Therefore, as financial intensity increases, the financial and economic system will become more and more unstable, and fiscal crises and currency crises will be frequent.
We have seen that since the 1980s, the frequency of various crises, such as financial crises, has occurred far more frequently than in the entity-dominated economic world of the 1970s. This is our problem. Including the 2008 US subprime mortgage crisis, which we recently faced, eventually became a crisis of globalization. So I want to introduce this knowledge point to everyone in advance.
That is the content of this course, thank you all.
This issue's guests
Liu Yuhui is a professor of economics at the Chinese Academy of Social Sciences, doctoral supervisor, and chief economist at Tianfeng Securities.
Research interests: macroeconomics, international economics, financial markets and commercial banking.