David Murray's FSI report under fire

By Tim Stewart
 — 1 minute read

The Financial System Inquiry (FSI) report has a misguided emphasis on liquidity and price discovery, argues British economist John Kay.

Speaking in Sydney at an event hosted by Regnan and the Responsible Investments Association of Australia, British economist John Kay questioned the idea that financial markets must be extremely liquid.

Mr Kay rejected the premise of Mr Murray's recent Financial System Inquiry (FSI) final report, which states in its opening pages: 


"The financial system plays a vital role in supporting sustainable economic growth and meeting the financial needs of Australians.

"It does this by facilitating funding, liquidity and price discovery, while also providing effective risk management, payment and some monitoring services."

Mr Kay remarked that the primary activity of the finance sector is now to "trade with itself".

"What we have now is a finance sector in which the primary activity is actually trading in secondary markets," Mr Kay said.

He pointed out that the volume of trading in foreign exchange is 100 times greater than the trading in goods and services.

"The value of exposures under derivative contracts is under the order of $700 trillion, which is something like three times the value of all the assets in the world," Mr Kay said.

When it comes to the FSI, Mr Kay said he is struck by its focus on liquidity and price discovery in the efficient functioning of markets.

"I stand back and ask myself – why do we need a great deal of liquidity? And what is price discovery and its relevance?" Mr Kay said.

"The majority of people are long-term savers for whom markets provide more than enough liquidity.

"If [markets] opened once a week or once a month, or perhaps once a year [that would be enough] – the notion that markets need to trade every millisecond in order to do that [is absurd]," he said.

When it comes to price discovery, he was quick to differentiate it from 'value discovery' for people who work in long-term asset allocation.

"Price discovery is about trying to assess the opinions of other people in markets about things that are being traded in markets," Mr Kay said.

"It’s not very clear what it adds to the function of the real economy. And to the extent that it impedes value discovery, it actually gets in the way."

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David Murray's FSI report under fire
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