Even as rabble rousers rail against financiers, the powers that be prize the breadth and liquidity of financial markets. Flash traders are investigated for unsettling stock markets and violators of securities laws receive jail sentences on par with violent criminals. The Federal Reserve has spent trillions with the avowed aim of pumping up the prices of traded securities, while expressing little more than the pious hope that this largesse might spill over into old-fashioned, illiquid loans.
In my article, The Hidden Costs and Underpinnings of Debt Market Liquidity, I offer a skeptical view of pro-liquidity policies. A good financial system may be vital for a thriving economy, but what warrants favoring liquid over illiquid claims? Yes, the United States—the world’s leading economic power since 1914—has exceptionally broad and liquid financial markets. But, “industry led and finance followed.” The transformation of the US from agrarian society to industrial powerhouse occurred before the smoothly functioning stock and bond markets became indispensable stars of American capitalism. The NYSE even shut down for nearly six months in 1914 without paralyzing the economy. Britain, the birthplace of the Industrial Revolution, actually lost its economic leadership, even as financial markets flourished in the City of London. Meanwhile, in spite of defeats in two World Wars, Germany’s economy and industry surpassed Britain’s, powered by businesses with illiquid stocks and banks making illiquid loans.