3.3.4 Financial Markets
Lenders in financial markets supply borrowers with money at a price – an interest rate – that both are prepared to accept.
Financial markets are an example of supply and demand: the demand for loans competes for the supply of credit. People and governments tend to borrow more if interest rates are low, and lenders can charge a higher rate of interest if the money supply is tight.
As described later, the behaviour of financial markets also play a big part in management of the economy (3.3.8). The power of currency markets was vividly illustrated in 1992, for example, when Britain crashed out of the ERM: “Chancellor Norman Lamont raised interest rates from 10% to 12%, then to 15%, and authorised the spending of billions of pounds to buy up the sterling being frantically sold on the currency markets.”
There are several differences between financial markets and the supply and demand for labour or for goods and services:
● There is a link between investment risk and interest rates (3.3.4.1). Lenders charge a higher interest rate to borrowers who are deemed to be more of a credit risk.
● Some financial intermediaries between lenders and borrowers have become large and exploitative (3.3.4.2). They make profit out of the advice that they have given to their investors, leading to a conflict of interest.
● Financial crises have occurred in under-regulated financial markets (3.3.4.3), which can be destabilised by price bubbles – such as that in the American housing market in 2007.
● Financial regulation is essential, to prevent the need for taxpayers to ‘bail-out’ banks (3.3.4.4). Banks need to be compelled to have strong balance sheets, and restrictions are necessary on how they speculate.
● Lenders have more power than borrowers (3.3.4.5). The loan remains the property of the lenders, and they can apply continuing restrictions to the activities of borrowers.
● The value of currency can very (3.3.4.6). It is a commodity that can be bought and sold. Its value is significant because of its direct link to inflation, and because it affects the value of loan repayments.
This page is intended to form part of Edition 4 of the Patterns of Power series of books. An archived copy of it is held at https://www.patternsofpower.org/edition04/334.htm.