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Finance, Trick or Treat

Finance, Trick or Treat - Finance trick or treat Oct 21st...

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Finance: trick or treat? Oct 21st 1999 From The Economist print edition During the past two decades, financial transactions have grown much faster than global output. This article, the first in a series of schools briefs about the world of finance, looks at the role that the financial system plays in a modern economy THEODORE ROOSEVELT, an American president, once claimed that there was no moral difference between gambling on cards or horses and gambling on the stockmarket. Jacques Chirac, the current president of France, has denounced currency speculators as “the AIDS of the world economy”. Bankers are widely condemned either as greedy usurers or as incompetent fools. At best, the financial system is seen as a wasteful sideshow that relies on churning money earned in “real” businesses and adds no economic value. At worst, it is portrayed as an irrational casino, in which 22-year-old traders are able to bankrupt economies. Might we be better off without all the financiers? A stockmarket crash or a run of bank failures can clearly do serious economic harm. The worst recessions in history, including the Great Depression in the 1930s and, more recently, Japan’s stagnation during the 1990s and East Asia’s slump in 1997-98, all followed financial crises. Yet this brief will explain that, for all its failings, the financial system provides services that are vital for long-term economic growth. Finance has existed in some form since the dawn of recorded history. Credit was used in agriculture in Mesopotamia in 3000BC. Banks existed in Egypt in 200BC. Even derivatives are not new: futures contracts were traded on the Amsterdam exchange in the 17th century. There is nothing inherently new about borrowing, lending and investing.
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Even so, in “Hamlet”, Polonius advised his son “neither a borrower nor a lender be”. If everybody followed that advice the financial system would not exist. Most people, however, need to borrow or save at some time in their life—from taking out a student loan or home mortgage to paying into a savings account or a pension fund. Even share ownership is no longer the preserve of a rich few. America will enter the 21st century with half of all households owning shares directly or through mutual funds, compared with 25% in the mid- 1980s and only 5% in the 1950s.
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The past two decades have, indeed, seen something of a financial revolution. Advances in computing and telecoms, financial innovation and liberalisation of capital controls have combined to reduce the costs of financial transactions. There has been a corresponding explosion in the volume of transactions. Since 1980 the global stock of financial assets (shares, bonds, bank deposits and cash) has increased more than twice as fast as the GDP of rich economies, from $12 trillion in 1980 to almost $80 trillion today. The volume of trading in financial securities has increased even faster (see chart 1). Note that the markets for bonds and foreign exchange have far higher turnover (ie, are more “liquid”) than does the equity market.
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