one - A Short Story of Finance
Published online by Cambridge University Press: 14 April 2023
Summary
Money is in every facet of our lives and any activity involving money is possible only through the services of the financial industry with all its markets and institutions. Finance serves the purposes of:
1. Payments system to match payers with payees;
2. Market mechanisms to match savers with businesses;
3. Financial planning for old age and wealth transfer between generations; and
4. Managing monetary risks in business and personal lives.
The basic function of finance is intermediation between people and businesses with surplus income and those who need capital for investment or consumption. Financial markets and institutions are expected to intermediate through efficient mechanisms with optimized transaction costs and proper governance. The more efficient a financial system is, the faster the turnover rate of capital will be for more production to better serve social and economic well-being. It is a platform of allocating capital to its best uses, both spatially and intertemporarily. A sketchy chart of the finance industry is given in Figure 1.1.
This is an oversimplistic picture of the finance industry today and the actual ecosystem has become much more complex in recent decades. From the figure, there are two takeaways from the book:
• Without a finance industry, lenders (savers) cannot match with borrowers (businesses) that need money for investment in real productive assets, a costly impediment to economic growth. Therefore, the financial industry is probably one of the most vital infrastructures of societies, maybe second in importance after energy.
• Finance is a “contingent industry” in that, without a real economy producing goods and services, there cannot be any value to its existence. Without a link to the real economy, it can exist only as a casino of bets and games played by casino owners and gamblers.
People save now to consume more later, or to have satisfactory income levels in old age. Similarly, people invest now to have a greater economic value later. The rate of profits from the real economy (where companies invest and produce) must therefore be greater than the total costs of capital and intermediation. Otherwise, businesses and borrowers would not use the available funds. People could not save through the system, or they would not lend except for charitable purposes.
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- Good FinanceWhy We Need a New Concept of Finance, pp. 1 - 14Publisher: Bristol University PressPrint publication year: 2019