Stiglitz Asks, Does Excessive Financial Activity Undermine the Economy? Transcript

2014 Financial Markets Conference

April 2014

An interview with Joseph Stiglitz, University Professor, Columbia University

Dave Altig: Hi, I'm Dave Altig. I'm here at the Atlanta Fed's Financial Markets Conference with Joseph Stiglitz, University Professor at Columbia University, and among many other awards, the 2001 recipient of the Nobel Prize in economics. Professor Stiglitz, welcome.

Joseph Stiglitz: Nice to be here.

Altig: You're going to present a paper titled "Are [Less] Active Markets Safer and Better for the Economy?" So, what's the answer?

Stiglitz: The answer is that financial markets can be hyperactive. They can be too active. You have to remember, financial markets are supposed to be the servant of the rest of the economy. They're supposed to make the rest of the real sector work better. You don't enjoy—at least, most people don't—financial services, they are a means to an end, not an end in themselves. But, too often in our economy, they become an end in themselves. The share of GDP has grown and the question is, as a result of all this activity, is the economy working better? What I'm going to try to argue is that some of what is going on actually is undermining the way our economy is, it undermines stability, efficiency. And therefore, as the title says, tapping on the brakes, somehow slowing it down, would actually improve our economy's performance.

Altig: Well, speaking of slowing things down, there's a particular example I know you've been thinking a lot about, and that's high-frequency trading. So what are the arguments of the proponents of high-frequency trading, and why do you think they might not quite have it right?

Stiglitz: They always make an appeal to the notion of price discovery and liquidity. It's sort of a magical concept; they never show that these notions—price discovery and liquidity, as they are reflected in markets in which they play an important role—actually lead to a more efficient economy. Let me give you an example.

High-frequency trading might have the effect of making prices work a little bit better in the nanosecond. Faster than anybody's going to at making a real decision about whether to build a steel mill or not. You're not going to make your decision on the fluctuations of the stock market going on in the nanosecond. What we really care about is the informativeness of the prices for guiding the important decisions in our economy. The rest of this is a zero-sum game; "You win, I lose."

The problem is that what they are doing—pointed out by a lot of people—is, for instance, sophisticated versions of front running. Basically, they're taking rents out of those who have more information because they've done research. They've studied where the economy's going. "Should we have more steel, invest more in aluminum." They are taking the rents that otherwise would accrue to those real investors and information, which are really important for the real sector of our economy. They take that away and the net result of that is the stock market is actually less informative, in the relevant sense. So while they talk about this mystique of prices, they're actually undermining the effectiveness of a price system in our economy.

The same thing on the notion of liquidity. What does liquidity mean? It means that if you have a thick enough market, that if I decide I want to sell a large number of shares, I can place an order and the market won't move against me, or it won't move very much against me. If you have a thick market, you can do that. If you wanted to buy a T bill, you can do that. But what they've done is create a lot of market activity, so it looks like it's a thick market. But what they've done is the liquidity isn't there when you need it. So you place an order, they detect that you're placing an order, they figure out what's going on, and the price moves against you. They've picked up these words that seem to be good things, price discovery and liquidity, and they've perverted them.

Altig: There's another example where the liquidity issue comes up often and that has to do with the global economy, the international flow of capital and funds. What's your thinking about the "tapping on the brakes" issue in that context?

Stiglitz: One of the reasons I begin my paper with a discussion of that is that now we understand that market and there's a global consensus. That the flows of money...we're not talking about real investment, we're talking about the flows of unstable, hot money can be very destabilizing for the real economies. They can make exchange rates go up and down, put enormous pressures on exporters, on people who are really concerned with the real sector of the economy. And so, even the IMF [International Monetary Fund], which is viewed as a bastion of free markets, even the IMF says today you need to have some forms of capital control at certain critical times. We have to "tap on the brakes." We actually have to do more than that at certain critical times because these short-term financial flows can be very, very destabilizing.

Altig: Let me ask a question about a country that seems to be stepping on the accelerator, rather than "tapping on the brakes," and that's China, which seems very committed to opening up its markets. How are they going to know when they hit the sweet spot?

Stiglitz: That is a question that is being constantly discussed in China. I go there often, I was just there a couple of weeks ago, and quite honestly, there's a battle going on. Not surprisingly, there are people who make money from instability. There are people who make money from doing deals. There are people who make money from money sloshing in and sloshing out and they want liberalization.

America's financial markets, who also make money out of that, have been putting pressure on them to open up. There are a lot of people in China, though, who are not so sure. They look back to, say, 1997 or 2008 and say, "Boy, are we glad that we didn't have fully open capital markets, because we would have been devastated." There's a broad consensus among senior policymakers that they are thankful that they hadn't fully opened up their markets back in '97 and 2008.

Now, as your economy gets bigger and bigger, there're new numbers...how do you compare different economies? With some of the new numbers coming out now, China has become the world's largest economy. It doesn't want to talk about it because it wants to stay below the radar screen, but when you're the largest economy and doing so much savings, it's much harder to impose some of the controls. As the economy develops, it will have to change the regulatory structure, that is clear; but I think it would be premature for them at this juncture to simply strip away the regulations. We in the United States learned that deregulation has its problems, so every country has to try to find its "sweet spot." We know we went over the line before 2008, and China will have to struggle to find that right place.

Altig: Professor Stiglitz, thank you very much.