Financialization refers to the transformation of an economy from one focused primarily on production and trade to one dominated by financial markets and transactions. This shift in the U.S. economy has created an environment where financial transactions vastly outsize those of the productive economy, with debt circulating as a primary form of money within financial markets. In this chapter, we will build on concepts introduced in Chapter 7, looking closely at how debt-driven money creation and the circulation of debt as money underpin financialization. We will also quantify the extent of financialization in the U.S., illustrating the disparity between financial transaction volumes and the GDP of the productive economy. By the end of the chapter, readers will have a clearer picture of the financial flows that shape the modern economy and how this level of financialization impacts economic stability and policy.
The Process of Financialization
In a modern economy, money is not created by government issuance or tied to physical assets like gold. Instead, it is created through debt issued by commercial banks, with each loan simultaneously creating a debt and adding new money to the economy. This structure makes the economy highly dependent on debt as the source of circulating money. Debt-based money provides fuel for economic activity, yet it comes with obligations that shape the flow and stability of the entire financial system. The following sections delve into how money as debt provides circulation of that debt as money in financial markets. Multiple uses of that debt creates multiple layers of debt obligations which complicate financial stability.
The process of creating money begins with the borrower’s promise to repay, which becomes a debt asset on the bank’s balance sheet. To balance this loan, the bank simultaneously creates a deposit for the borrower, thereby adding new money to the economy. While the borrower now has funds to spend, there is an obligation to repay the debt with interest, meaning that for every dollar added into circulation through loans, there is a corresponding liability. This liability ensures that money can only circulate temporarily, as it must ultimately return to the lender to repay the loan. Repayment of the loan destroys the created money.
This dependency on lending creates a feedback loop where continuous borrowing is necessary to maintain sufficient money circulation. If loans are repaid without issuing new loans, the money supply shrinks, leading to economic contraction. Thus, to avoid downturns, banks are incentivized to continually issue new loans. This cycle of borrowing and repayment fundamentally shapes the economy, creating an environment where debt itself becomes essential to the economy. Debt, as an asset, can also circulate within financial markets in ways that create a role as a currency.
Public Debt as the Linchpin of Financialization
Among various forms of debt, sovereign or public debt holds a unique place as a cornerstone of the financialized economy. Unlike private debt, government-issued debt is of the highest quality because it is backed by the government’s taxing power and relative stability. Treasury securities, issued by the U.S. government, are often regarded as “risk-free” assets, and they form the backbone of financial portfolios around the world. These high-quality debt instruments are heavily relied upon during periods of economic uncertainty, as they provide a hedge against riskier assets, attracting capital as investors seek safety.
This preference for Treasury securities and other sovereign debt is fundamental to financialization. When economies experience stress or volatility, institutions turn to sovereign debt as a stabilizing force, reallocating funds from riskier or even productive assets to safer government bonds. This shift does more than just secure investments, it ties the economy’s stability to the continual issuance and circulation of government debt, making sovereign debt a crucial component in supporting the financial system. Without it, financial markets would struggle to maintain equilibrium, as many financial products and transactions depend on these high-quality debt instruments to anchor portfolios and manage risk.
The Double Obligation of Debt as Money
A less visible but critical aspect of financialization is the inherent double obligation created when debt is used as collateral in borrowing. In simple terms, each debt used as collateral not only creates a debt between the new borrower and their lender but also still holds the obligations for that money to the original borrower. Money is fungible, meaning any money can theoretically repay any debt. However, collectively, borrowing money against a debt creates a “double obligation,” in which each dollar of borrowed money against debt is obligated to flow through another layer of repayment before it can be retired from the system. If the original borrower defaulted, both layers of created money would be removed from the system if the second borrower were unable to repay his debt.
There is another form of double obligations. Consider a government-issued Treasury security as an example. The government borrows existing money from investors. However, this borrowed money must now serve two purposes: it must be available to repay the Treasury security upon maturity, and, collectively, it must eventually be used to repay the original bank loan that created it. Although money is fungible and individual dollars can settle any debt, this double obligation means that every borrowed (existing) dollar carries layered repayment requirements, amplifying the need for continuous economic circulation and expansion to satisfy all outstanding debts.
Other debt instruments, like corporate bonds, insurance lending, and even personal loans, replicate this double obligation. For example, when a corporation issues a bond, it effectively borrows existing money, and this borrowed money now must serve the dual purpose of eventually satisfying the corporation’s debt obligation while also contributing to the repayment of the original loan that generated that money. This structure ensures that a large portion of money in circulation is bound not by productive investment but by layered debt obligations that prioritize financial transactions over economic goods and services.
The Risks of Rehypothecation
In addition to single layers of double obligations, financial markets have developed methods to amplify debt through collateralization. When a borrower uses an asset as collateral to secure a new loan, they create additional layers of dependency within the system. For instance, if a corporate bond or real estate mortgage is used as collateral to secure further borrowing, a new layer of money is created based on the original debt instrument. Under multilayered obligations, multiples of the original money created can be destroyed on default by the original borrower.
This layered obligation becomes increasingly common in a financialized economy, as institutions routinely use debt-backed assets to secure further lending. Financial products like mortgage-backed securities and collateralized loan obligations (CLOs) represent complex chains of debt that depend on stable collateral value. Each new layer of debt relies on the one before it, creating a structure where a failure at any point in the chain can trigger widespread losses. If a borrower defaults, not only does the most recent loan become impaired, but every subsequent loan also becomes vulnerable. As financial institutions leverage debt in this way, they magnify both their potential returns and the systemic risk of defaults cascading through the system.
Systemic Vulnerabilities in a Debt-Driven Economy
The reliance on debt as money and the creation of layered debt obligations generate a financial economy that is not only vast in scale but also fragile. The extensive circulation of debt-backed assets within financial markets dwarfs the productive economy, with annual financial transactions in the U.S. totaling $7.6 quadrillion in 2023, compared to a GDP of $28 trillion. This disparity reveals the overwhelming extent to which financial markets depend on debt instruments rather than on traditional economic activities. As debt obligations compound through both double obligations and layered collateralization, the system becomes heavily reliant on continuous borrowing to sustain itself.
When economic downturns or crises occur, this structure proves vulnerable. The layers of debt obligations require a constant flow of funds to service outstanding debts, but if liquidity tightens, defaults can trigger a chain reaction. Financial institutions, portfolios, and funds that rely on debt-backed securities may find themselves unable to meet obligations, causing an economic contraction that ripples through the financialized economy. In such situations, the dependency on sovereign debt as a stabilizing force becomes crucial, as Treasury securities and similar high-quality assets are one of the few remaining safe havens.
In a debt-based system, financialization is inevitable, as debt serves as both the currency of economic growth and the fuel for speculative profits. The practice of using debt as money creates incentives for additional debt which collateralize an intricate web of obligations, where debt becomes layered upon debt, circulating within financial markets like a complex network of IOUs. This structure magnifies systemic risk, as the double-bind of each loan and the cascading risks of collateralized debts create a financial economy that is vast in size but increasingly detached from productive value. As more of the economy’s wealth becomes tied to layered debt obligations, the risks of instability grow, raising questions about the sustainability of a debt-driven financialized system.
Economic Money vs Financial Money
In this book, we introduce the concepts of economic money and financial money to distinguish between how money functions in different parts of the economy. Economic money is primarily created by commercial banks through the process of issuing loans, and it includes the money we use in everyday transactions, whether in wallets, bank accounts, or circulating as cash. This money supports what we refer to as the productive economy, where goods and services are bought and sold. Economic money drives transactions that lead to real-world outcomes, such as the creation of products, services, infrastructure, and employment.
By contrast, financial money represents debt circulating as money within financial markets. Unlike economic money, financial money isn’t typically used in ordinary transactions involving goods and services. Instead, it circulates in the financial sector, where debts and financial assets are exchanged. For example, financial instruments like bonds, derivatives, and securities are all forms of financial money that facilitate trades between institutions, often without directly influencing the productive economy. This type of money flows through financial markets rather than contributing to production or consumption, except indirectly.
In addition to these forms of money, we can also categorize transactions based on their interaction with the productive economy. Economic transactions are those that directly involve the exchange of goods or services, transactions like buying groceries, paying for housing, or funding infrastructure projects. These transactions are central to economic growth and the creation of real wealth.
On the other hand, financial transactions involve the movement of financial money within the financial sector. These transactions don’t directly contribute to the production of goods or services but instead involve the shifting of value from one financial instrument to another. They often serve speculative purposes or are intended to manage risk. Such transactions might include trading stocks or bonds, moving securities, or dealing in complex financial products like derivatives. While financial transactions can influence the economy, they do so by moving financial value rather than producing tangible outcomes.
We refer to most financial transactions as “thrashing money“ because they represent the reshuffling of financial instruments without creating new economic output. In other words, financial transactions do not interact with the productive economy in a direct way but instead serve to move financial value in closed loops, often within speculative markets. This distinction between economic and financial transactions highlights the growing divide between money used for real economic activity and money that circulates within the financial sector, often detached from production and consumption.
By introducing these concepts, we aim to clarify how modern economies increasingly rely on financial money and transactions that are divorced from the traditional economic activities that generate real wealth. Financialization, which we discuss in detail in this chapter, is built on this distinction between economic and financial money, and understanding this divide is crucial for analyzing the challenges and risks of today’s financialized economy.
The Scale of Financialization
In Chapter 2, we discussed how money circulates within the economy, outlining various flows that drive both the productive economy and financial markets. Now, in this section, we will quantify these flows by assigning dollar volumes to the types of circulations previously described. The numbers we’ll explore demonstrate the staggering scale of financial transactions in the U.S., which vastly overshadow the size of the productive economy. For example, while U.S. GDP in 2020 stood at around $21 trillion, the total value of all transactions was an astronomical $7.625 quadrillion. These figures highlight the degree to which financial transactions dominate economic activity, illustrating the extent of financialization within modern economies.
Cashless Payments
Cashless payments form a vital part of the modern economy, enabling individuals and businesses to move money digitally and efficiently without the need for physical currency. These transactions play different roles depending on the type of payment method. Here’s a breakdown of the categories of cashless payments and their corresponding dollar volumes:
- Credit Transfers ($49 trillion):
Credit transfers involve moving money from one bank account to another, typically initiated by the payer. These transactions are commonly used for both business-to-business (B2B) payments and personal payments, including payroll, large invoices, and interbank transfers. Credit transfers are critical for the smooth operation of commerce and large financial transactions that keep both businesses and the economy running smoothly.
- Direct Debits ($28 trillion):
Direct debits allow for automatic withdrawals from a payer’s account to the payee’s account, typically used for recurring payments like utility bills, mortgage payments, and subscriptions. This system provides convenience for businesses and consumers alike, ensuring regular payments are processed on time without the need for manual intervention. The significance of direct debits lies in their ability to support steady cash flow for businesses and service providers.
- Checks ($25 trillion):
Although the use of checks has declined in recent years due to the rise of electronic payments, they still represent a significant portion of cashless transactions. Checks are often used for larger payments in industries like real estate, government transactions, and business payments. Despite their slower processing times compared to digital alternatives, checks remain a reliable method for significant financial commitments and for those who prefer traditional payment methods.
- Cards/e-Money ($8 trillion):
Payments made via credit and debit cards, as well as electronic money services (such as digital wallets), account for this category. These methods are prevalent in consumer transactions for goods and services, both online and in-person. They provide the ease and convenience of immediate payment processing and are widely accepted in retail environments. Cards and electronic money services represent the growing shift towards digital commerce and consumer convenience in everyday transactions.
These cashless payment systems contribute to a total of $110 trillion in financial flows within the economy, demonstrating their crucial role in facilitating commerce and streamlining transactions. This segment of financial activity, while substantial, is just one part of the massive $7.625 quadrillion in total U.S. financial transactions for 2020. As we delve into other categories, we will see how financial transactions in other areas dwarf these economic flows even further.
Payment Systems and Service Providers
Here’s a breakdown of payment systems and service providers, including their roles in the economy and their corresponding transaction volumes:
- Fed Check Clearing ($8 trillion):
The Federal Reserve provides check clearing services to financial institutions, ensuring that checks written in one bank are cleared and settled with another. Though check use has declined, this system is crucial for institutions that still rely on paper checks for large-value or business transactions. The Fed’s role ensures security, reliability, and efficient processing.
- Private Check Clearing ($11 trillion):
Private entities also handle check clearing outside the Fed’s systems, processing interbank transfers and managing check settlements between private institutions. While Fed clearing primarily handles government and major institutional checks, private clearing is more commonly used in day-to-day financial activities for businesses and individuals.
- CHIPS (Clearing House Interbank Payments System) ($382 trillion):
CHIPS is one of the largest private-sector systems for clearing and settling U.S. dollar transactions globally. It primarily serves high-value, time-sensitive payments, such as those involving financial institutions, corporations, and governments. CHIPS is central to international banking and finance, handling trillions in daily global settlements.
- EPN (Electronic Payments Network) ($30 trillion):
EPN facilitates automated clearing house (ACH) payments, including direct debits and credits for things like payroll, social security benefits, and consumer bill payments. EPN is essential for the smooth functioning of everyday payments that millions of people rely on, ensuring the efficient movement of funds electronically.
- Fed ACH ($32 trillion):
The Federal Reserve’s ACH network enables batch processing of electronic payments, including payroll, vendor payments, and government transfers like tax refunds. It is a key system for non-urgent, routine transactions, handling a significant portion of the country’s electronic payments with the support of the central bank.
- Fedwire Funds Service ($841 trillion):
Fedwire is a real-time gross settlement system operated by the Federal Reserve. It processes large-value payments for financial institutions, the U.S. Treasury, and other large players in the economy. This system is critical for ensuring the immediate and final transfer of funds in major interbank transactions, providing liquidity and financial stability.
- NSS (National Settlement Service) ($24 trillion):
NSS supports multilateral settlements between financial institutions, facilitating the clearing and settlement of transactions on a net basis. It’s used by private-sector systems like CHIPS and EPN to settle payment obligations efficiently, without requiring real-time gross settlements for every transaction.
These payment systems and service providers account for a total of $1,328 trillion in transactions, underpinning a vast network of financial infrastructure that supports both routine and high-value transactions. Each system plays a specialized role in ensuring the smooth, secure, and reliable functioning of the U.S. financial system, handling everything from everyday payments to international settlements. These systems are integral to maintaining trust in financial institutions and providing liquidity, showing how financial transactions at this scale keep the economy functioning.
Counterparties and Clearinghouses
Counterparties and clearinghouses play essential roles in reducing risk and ensuring smooth settlement in financial markets. These institutions act as intermediaries between buyers and sellers in financial transactions, ensuring that trades are executed reliably and efficiently. Here’s a breakdown of the major players and their transaction volumes:
- FICC-GSD (Fixed Income Clearing Corporation – Government Securities Division) ($1,507 trillion):
FICC-GSD clears and settles trades involving U.S. government securities, such as Treasury bills, bonds, and notes. It ensures that both sides of a trade fulfill their obligations, reducing counterparty risk in one of the world’s largest financial markets. By acting as a central counterparty, FICC-GSD enhances the stability and efficiency of government securities markets, ensuring liquidity and trust.
- FICC-MBSD (Fixed Income Clearing Corporation – Mortgage-Backed Securities Division) ($103 trillion):
FICC-MBSD focuses on the clearing and settlement of mortgage-backed securities (MBS), which are debt instruments backed by home loans. This division provides essential clearing services to facilitate the smooth transfer of these complex financial products, which are crucial for the real estate financing market and broader financial system.
- NSCC (National Securities Clearing Corporation) ($430 trillion):
NSCC clears and settles trades in the U.S. equity and corporate bond markets. It operates as a central counterparty for the clearing of trades, reducing the risk of trade failure and providing net settlement services to simplify the settlement process. By centralizing these operations, NSCC helps ensure the smooth operation of the stock market and other financial markets.
Counterparties and clearinghouses such as FICC and NSCC play a fundamental role in the financial system by reducing risk and ensuring the reliable settlement of securities trades. Together, the systems handled a staggering $2,040 trillion in 2020, with FICC-GSD managing the bulk of these transactions through the government securities market. These institutions are essential for the daily functioning of global financial markets, ensuring that trillions of dollars’ worth of securities transactions are processed smoothly and without disruption. Their role in reducing risk and increasing efficiency is critical in maintaining trust and liquidity in the financial system.
Central Security Depositories
Central Securities Depositories (CSDs) are essential components of the financial market infrastructure, providing a central location for the safekeeping of securities such as stocks, bonds, and other assets. They also handle the settlement of securities transactions, reducing risks and ensuring the integrity of trades. Here’s a breakdown of the major CSDs and their transaction volumes:
- DTC (Depository Trust Company) ($130 trillion):
DTC is the largest securities depository in the United States, responsible for the safekeeping and settlement of billions of securities transactions. It holds securities in electronic form, reducing the need for physical certificates, and facilitates the transfer of ownership between buyers and sellers. DTC’s services are crucial for ensuring the efficiency and security of the financial markets, particularly in handling equities, corporate bonds, and other securities.
- Fedwire Securities Services ($362 trillion):
Fedwire Securities Services is a system operated by the Federal Reserve that processes the electronic settlement of securities transactions, including government securities, mortgage-backed securities, and agency debt. It allows for the real-time, final settlement of securities trades, providing immediate transfer of ownership. This service is critical for ensuring the stability and liquidity of markets involving government and other high-value securities.
Central Securities Depositories, such as DTC and Fedwire Securities Services, are vital in ensuring the smooth and secure transfer of securities ownership in the financial markets. Together, they processed $492 trillion in transactions in 2020, ensuring that securities trades are settled efficiently and safely. These institutions minimize the risks associated with the settlement process and play a crucial role in maintaining trust and stability within financial markets, supporting everything from equity trading to government bond markets.
Other Payments
Other payments in financial markets cover a wide range of high-volume transactions, primarily within derivatives, foreign exchange, futures, and stock exchanges. These transactions often involve substantial amounts of money moving between financial institutions for speculative purposes, hedging, or risk management. Below is a breakdown of the major categories and their associated transaction volumes:
- Stock Exchanges ($142 trillion):
Stock exchanges are marketplaces where stocks, bonds, and other securities are bought and sold. Major U.S. stock exchanges, such as the New York Stock Exchange (NYSE) and NASDAQ, facilitate trading between investors and companies, allowing for the transfer of ownership of shares. Stock exchanges play a central role in capital formation and liquidity within the economy, enabling investors to buy and sell shares of public companies.
- GTC FX and IR Derivatives ($903 trillion):
Global Trade Clearing (GTC) Foreign Exchange (FX) and Interest Rate (IR) derivatives are financial instruments used to hedge or speculate on movements in currency exchange rates and interest rates. These derivatives allow financial institutions and corporations to manage the risks associated with currency fluctuations or interest rate changes, both of which can have significant impacts on their profitability. The sheer volume of these transactions demonstrates the importance of derivatives in global risk management strategies.
- XT Derivatives ($240 trillion):
Cross-Trading (XT) derivatives represent a smaller yet still significant portion of the derivatives market. These contracts often involve more specialized or exotic products and enable firms to hedge against a range of risks not directly tied to more common currency or interest rate risks.
- XT Futures and Options ($1,890 trillion):
Futures and options contracts allow investors to speculate on or hedge against the future prices of various assets, including commodities, indices, and financial instruments. These markets are vast, involving contracts for future delivery of products or financial assets. These high-value transactions are crucial for companies and investors managing future risk or seeking profit from price fluctuations in everything from oil to stocks.
- OTC FX Instruments ($480 trillion):
Over-the-counter (OTC) FX instruments are customized foreign exchange contracts traded directly between two parties rather than on an exchange. The OTC FX market is massive and decentralized, allowing participants to tailor contracts to their specific needs without the standardization required by traditional exchanges. OTC FX instruments play a vital role in the global economy, as corporations, governments, and financial institutions hedge currency exposure and execute international transactions.
“Other payments” in the financial system represent some of the highest transaction volumes, totaling $3,655 trillion in 2020. These transactions, particularly in derivatives, futures, and FX instruments, highlight the scale and complexity of modern financial markets. While these markets are critical for managing risk and providing liquidity, their size also reflects the deep financialization of the economy, where financial transactions vastly outstrip the productive economy. The high value of these transactions illustrates how intertwined financial markets are with the broader global economy, even when many of these transactions do not directly influence the production or consumption of goods and services.
Summary
In Chapter 9, we delved into how financialization has transformed the economy, focusing on the circulation of debt as money. This chapter builds on concepts introduced earlier, exploring how money created through lending forms the backbone of the modern financial system. Commercial banks create money through loans, resulting in an economic cycle where debt circulates not only in the productive economy but also through financial markets.
The chapter emphasizes that public debt, particularly sovereign government debt, plays a crucial role as the linchpin of financialization. During times of economic stress, investors turn to high-quality government bonds as a hedge, further embedding these instruments into the global financial system. The extensive reliance on sovereign debt stabilizes markets but also increases the complexity of financial interactions.
We introduce the concept of double obligations, where borrowing money creates layered repayment responsibilities. For instance, when money is lent through treasury securities or corporate bonds, the same funds are effectively obligated twice, once to the government or corporation, and again to repay the original loan that created the money. The use of collateralized debt adds even more layers to these obligations, increasing risk within the system. This section explores how these multiple layers of debt are a hallmark of financialization, compounding risk as obligations build upon each other.
The chapter also covers the distinction between economic money and financial money. Economic money refers to the funds used in everyday transactions within the productive economy, like money in bank accounts or physical cash. Financial money, on the other hand, circulates within the financial sector, often through speculative or derivative transactions, without directly contributing to the production of goods and services. Similarly, we define economic transactions as those that directly impact the productive economy, while financial transactions involve moving money or debt without creating real-world value, what we term as “thrashing money.”
Finally, we quantify the size of financial flows in the U.S. economy by assigning dollar volumes to the categories discussed in Chapter 2. In 2020, total U.S. financial transactions amounted to $7.625 quadrillion, dwarfing the country’s GDP of $21 trillion. This stark comparison highlights the vast scale of financial transactions relative to the productive economy, illustrating the dominance of financialization.
Through these insights, Chapter 9 demonstrates how the circulation of debt and the sheer volume of financial transactions contribute to a financialized economy increasingly detached from real economic output. In chapter 10, we will show how these vast transaction totals can be harnessed to alleviate the burden of income, property, and sales taxes.