In the European Economic Review. Jack and Alex are going to have to use polite words to work out their differences.  I am not a macroeconomist, so I am not going to spend too much time figuring out for myself whether their differences are semantic, empirical, theoretical, or ideological.  But I do feel like I could make a modest contribution in painting an extreme version maybe of what Jack is arguing, namely that “mainstream” economists underestimate the role of financial markets in changing how we should understand macroeconomic theory.

This is what Jack writes:

The new financial structure and the diversion has rendered interest rates and their real determinants increasingly ineffective in generating real investment and growth. Given the new evolved global financial structure of institutions, markets, securities and agents, financial asset investment has proven to be simply more profitable in the short run than real investment. Both risk and uncertainty is less in financial asset investing than in real asset investing. Interest rates may lower to zero, and even negative, but the liquidity that is borrowed those rates will still flow primarily into financial investments.

Financial assets and real assets are in some sense the same.  Each is a claim to some future value.  When I own a financial asset, I have a claim to some other financial asset in the future (e.g. money) and also a claim to be able to sell the financial asset in the future.  When I own a real asset, I have a claim to sell the productive services of that asset and a claim to sell the asset.  Both are vulnerable, in their value, to events.  The value of my real asset might decline precipitously when the forest I own burns up.  The financial asset I own (a bond) may become worthless when the forestry company that issued the bond no longer has a viable forest to harvest.

How can financial assets as a class be less risky and more profitable than real assets, as Jack asserts.  Aren’t financial assets ultimately tied to some real return? (Like the forest company bond is tied to the forest company earnings?)  I think Jack may be arguing, “Not necessarily.”  In a Ponzi scheme, the value of the asset (a place high up the ladder of the scheme) is tied to how many future generations join the Ponzi scheme.  Maybe our current financial markets are like the beginning of a giant, global Ponzi scheme.  Maybe a major set of participants are Central Banks.  (Are they like the proverbial “suckers” born every minute?)  Maybe this can go on for quite some time.  Maybe it will all come crashing down, but for now participants think that is far off, and so joining the scheme is perceived as being safe and profitable, compared with real investment.  That all sounds perfectly plausible.  I don’t know whether mainstream economists necessarily rule this possibility out.

Alex notes (in his earlier review of Jack’s book):

So we lack a clearly worked out story of how an increased volume of financial transactions slows the rate of physical capital accumulation.

If the increased volume makes the Ponzi scheme more attractive to others, then surely diversion of financial funds from real investment to new financial assets might take place.

The question for Jack and the mainstreamers is, how would we tell if this was indeed the case?