The Cantillon Effect and Stock Market Crashes

There’s a mismatch between financial returns and underlying economic activity. This mismatch deforms our society, and there’s only one way out.

Anyone who has paid attention to stocks has noticed a pretty vicious downturn over the last six months. Since its high late last year, the NASDAQ is off by over a quarter, with big tech leading the way down. It’s not just stocks, we’re experiencing a broad-based decline across different sectors, from tech to NFT’s to streaming giants like Netflix, with commodities like oil or diesel that are in short supply holding up or going higher. The bond market is having its worst performance since 1842. Along with the downturn comes pain, from layoffs in Silicon Valley to crypto message boards on Reddit with suicide hotlines affixed to Walmart indicating that broader job cuts are going to come soon. It’s an ugly situation.

And yet, while it’s painful and sad, this collapse, in many ways, can’t come soon enough. The drop in the markets is necessary.

To understand why, it helps to start with the purpose of finance. Financial markets are critical in any free society, because they enable flexibility in production and distribution. Without the ability to borrow money, speculate, and go bankrupt, it is very difficult if not impossible to systemize innovation, kill off old and inefficient firms, or cater to consumer tastes. Yet, finance should be a small part of the economy, because speculation isn’t intrinsically valuable. Banks should serve production, providing capital to ventures that will eventually generate income.

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