Commentary on Political Economy

Thursday 28 March 2013

Theories of Underconsumption and Overproduction 2

This is Part Two of the 'Notes On Minsky' that we promised to post earlier for those friends who are more inclined to the study of political economy.

On a walk through Princeton's verdant grounds and lawns, amidst pleasant replicas of European architectural styles, from English Gothic to Italian Renaissance to Greek neo-classic, the great Italian monetary economist and historian Marcello De Cecco once explained to me how the cultural milieu at this academic establishment in New England had been shaped by the German Jewish "refugees" who had fled the horrors of Nazism - until we passed, on our way to lunch at Graduate College, the house where Albert Einstein resided "in this friendly country and this liberal atmosphere". As a graduate student from Cambridge, England, I was welcomed with astounding hospitality by members of the Economics Department (Peter Kenen even found time to read and comment on my Ph.D. thesis early draft!) in what seemed an Arcadian citadel of enlightenment. Aufklarung.
It seems no coincidence to me that, apart from Kenen, illustrious economists like Paul Krugman, Michael Woodford and now Professor Shin (formerly at the NY Fed) have joined the departmental staff. One such member, until promoted to the Chair of the Federal Reserve, was Professor Ben Bernanke, of course. And it is in this Princetonian context that we need "to situate" him. It is a context that we may describe as "Princeton Enlightenment" - right there in the heart of New England, a short distance from Manhattan and Wall Street, at the nerve centre of the capitalist world.
I make this introduction because it is vital to understanding what I call "the fracture" in the American ruling elite between "Progressives" who have a new vision of how a modern society should function and evolve from its capitalist origins, and those "Conservatives" who (in the words of FD Roosevelt) would have us return "to the days of horse and buggy". One of the chief "ailments" (Freud would call them "neuroses") of capitalism is "fear" - not least "fear of stagnation", of that "liquidity trap" that Keynes theorised and Krugman reviewed (here ) in relation to Japanese deflation and which is brought about by the existence of "money", which Keynes described as "the bridge between the present and the future". It is this "fear" that paralyses capitalist society - the fear of the future, the fear that the present (the capitalist established order) is in conflict with the future (the need of capital to allocate social resources only if they yield a "profit" when this outcome is obstructed by the antagonism of us "workers", that is, by all those who produce social wealth but have next to no say in "how", "what" and "how much" is produced).
Once again, it is in the context of this capitalist "fear" and the "Rooseveltian Resolve" (Bernanke's phrase coined here ) that is needed to overcome it that we must begin to analyse the conduct of monetary policy under the current leadership at the Fed.
Keynes introduced "uncertainty" to economics, just as Freud introduced "neurosis" to psychology and civilisation. Uncertainty is what separates the capitalist present from its future: and "money" is the means of "bridging" these two. Just as Schumpeter was initially wrong to believe that "entrepreneur" and "capitalist" were two "separate" persons, so were Keynes and Kalecki wrong to believe that borrower's risk and lender's risk are two "separate" entities: - they are merely "functions" of capital. It is false and meaningless to say that "risk is the engine of capitalist growth". Capital does not seek "risk" - if that were so the entire earth would have been laid waste by now! Capital seeks "safety" - "safe profits", to be exact. The "lending function" is that "aspect" (Bild) of capital that seeks at least the return "of" capital; the "borrowing function" is the one that knows that for capital even "to preserve itself" it must go through the mortal danger of "investment". No "profit" without "investment". The "lender" is the present, and the borrower represents the future. By the process of lending "money-as-capital" to the borrower, the lender "invests" in the future - because without "investment", without being perennially "in circulation", capital cannot even "preserve" itself, let alone "grow" and "be profitable" ("Accumulate! Accumulate! That is Moses and the prophets!").
So there can be no "information asymmetries" between borrowers and lenders - because both are "internal functions" of capital. Therefore, "risk" (both borrowers' risk and lenders' risk) can determine only (through higher interest rates) the internal "distribution of profit" between capitalists - but it cannot determine "profit" itself! "Risk" is the capitalist "projection" into the future - the "expectation" of the likelihood of "profit". When this "expectation" is beset with and devoured by "uncertainty", we have a "liquidity trap", we have... "the zero bound" (see M Woodford and Eggertsson, "Monetary Policy at the Zero Bound" here http://www.scribd....licy-at-Zero-Bound ). When the "expected" profit is minimal, capital prefers to bide its time and remain "liquid", "ready-at-hand".
But what is the "ultimate source" of this "uncertainty"? (Fahr et alii, "Lessons for monetary policy strategy" at page 6, here Few, if any, monetary economists will answer the question properly: they will point to "higher interest rates", "higher uncertainty", or "information asymmetries" (see F Mishkin, "Spread of Financial Instability" here ).

But in reality, the antagonistic reality of capitalist society, is that in order "to valorise" itself and emerge from the crucible of the production process in the shape of "products" that can be sold to yield a "profit", capital must first contend with "us" - the workers, in the workplace and, increasingly, in "the society of capital" at large.
So we know that capital seeks “to valourise” itself as “safely” as possible – indeed, if this circle could be squared, capital would “wish” to be “profitable” as “naturally” as trees bear fruit! (- Whence comes the notion of “fructiferous capital” and of that more ignominious one, the Wicksellian “natural rate of interest”! – or finally that most infamous of bourgeois phantoms, “the natural rate of unemployment”!)
And when, in one fell swoop, two decades ago, one of the most bestial dictatorships this world has ever seen, the Chinese Politburo, decided to make “the great leap forward”, all the prayers of capital seemed to be answered – it was Christmas all year round! Here were a billion potential “workers” that could produce consumption goods to keep workers in advanced capitalist countries “pacified” and maintain nominal wages stable whilst the cost of wage goods for capitalists declined dramatically! This was the basis of the Great Moderation. Again, Fahr at alii fail to mention this, and list the “effects” rather than “the ultimate source”: “The period before the financial crisis, known as the great moderation, was the result of a number of factors that can be grouped into: a) structural change, e.g. better inventory management (McConnel and Perez-Quiros, 2000) or financial innovation and better risk sharing (Blanchard and Simon, 2001), b) improved macro-economic policies, such as the establishment of stability-oriented monetary policies, and c) good luck, i.e. the absence of large shocks such as the oil price crises of 1974 and 1979.11 The relative importance of those factors has been hotly debated, but all three factors are likely to have contributed to a reduction of volatility.12”

It is this paper by Blanchard and Simon ( ) that Bernanke mentions in the very first paragraph of his address launching the phrase “the Great Moderation” (here ):

“One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. In a recent article, Olivier Blanchard and John Simon (2001) documented that the variability of quarterly growth in real output (as measured by its standard deviation) has declined by half since the mid-1980s, while the variability of quarterly inflation has declined by about two thirds.1 Several writers on the topic have dubbed this remarkable decline in the variability of both output and inflation ‘the Great Moderation’”.
A remarkable decline, indeed! So remarkable that finally it seemed as if central banks could be given a “technical mandate” to target inflation simply by means of small “corrections” to the interest rates they set – and this could be “set in stone” even in bourgeois constitutions as part of “economic management” without the need to bother about anything else. “The Jackson Hole Consensus” (the last mantra spun out of “the Greenspan put”) was that “asset prices” are not and cannot be the concern of central banks – “price stability” alone will suffice, and “the market” will take care of the allocation of capital to various investments. The entire wave of “financial deregulation and liberalisation” that culminated with the repeal of the Glass-Steagall Act by the US Congress in 1999 gathered its tsunami-like strength from this “Great Moderation”.  (The tide of capitalist opinion toward “privatization” from the ‘80s is wonderfully summarized by the doyen of Italian central bankers, T Padoa-Schioppa in this, “The Genesis of EMU”, here )

Because, just as in the 1920s under Fordism, the sudden reduction in the cost of wage goods for capital made possible by the opening of “the Chinese frontier” could allow capital “to undo”, to demolish and reverse what had been the unstoppable and ominous expansion of the role of the State in the US economy and worldwide. The industrial analogue of “financial liberalization” was the “re-privatisation” of entire areas of social productive activity that had fallen under the direct management of the State since the New Deal. The unprecedented profits and “global savings glut” (again the title of a Bernanke speech, here ) coming from China and other “emerging economies” that were concomitant with the “globalization” of the capitalist economy (see P Lamy here )  – all this had “silenced” the real “motor”, the true “engine” of capitalist accumulation, just as Fordism did in the 1920s – the working class, the antagonism of workers in the workplace and in society, the one and only true “test” of the real “value” and “profitability” of capitalist “investment”!
Without its continuous “conflict and confrontation” with living labour (with workers) in the workplace and in society, capital is deaf and blind, it has “no senses” because it cannot “gauge” the actual political command it can exercise over workers and over society at large without encountering their “resistance” in its stage of “valourisation” (the productive process) and “realization” (the sale of products). The real life of capital is precisely this: - command over living labour in the process of production – a “process” that through workers’ antagonism then becomes “extended” to the whole of “society” and that causes “the State” to intervene (and “interfere”!) in the notionally “private” capitalist “market” economy. To the extent that capital fails to engineer “growth”, the State needs “to control growth”, and this leads inevitably to the “growth of its control” over the economy and the society of capital as a whole.

The “retreat” from the New Deal “expansion” of State activities is what “the Great Moderation” allowed. Capital seized the opportunity with both hands. Previously, as Hyman Minsky had perspicaciously shown, the State had been called upon to play an ever-growing role as “the collective capitalist” to rescue the capitalist economy from its frequent crises, its booms and busts, but each time at a higher level of social antagonism, culminating in the social struggles and high inflation of the 1960s and 1970s. Now, commencing with Arthur Burns and Paul Volcker at the Fed in the late ‘70s and through the ‘80s – now was the opportunity “to re-launch” the capitalist dream of a “self-regulating market economy”. And this is what happened through the Reagan years up until 2007.

We were saying – “the global savings glut”. The breathtaking growth of the Chinese economy as the “assemblage hall” of consumer goods for export to developed economies generated massive amounts of capital (savings) that the Chinese dictatorship could not “re-invest” in domestic consumption for the simple reason that this would hasten the rate of politico-economic “emancipation” of its own workers. All dictatorships integrated in the capitalist world “market” have this good reason to privilege “exports” by (a) suppressing domestic wages and (b) siphoning off capital from domestic consumption, providing in effect “export subsidies” to their leading firms which are owned exclusively by members of the elite (from China to India to “you name it”, and this includes the German elite which, with its Junker and Nazi past has a brutal track record of mercantilism [cf. Schumpeter’s classic study on ‘Imperialism and Social Classes’]). (On China, its mercantilist policies and the Fed’s reaction, there is no greater authority than Michael Pettis at )

Too many Marxist and left-wing critics of the capitalist economy preach the mantra that what causes capitalist crises is the “underconsumption” of goods produced due to excessive “oligopolistic accumulation”. (Keynes and Kalecki started this neo-Ricardian fable, aping Rudolf Hilferding’s ‘Imperialism’ thesis, and were then embraced by Piero Sraffa and Paul Sweezy and several strands of “post-Keynesians”. Cf this review by JB Foster on “The Financialisation of Capitalism” ). It is quite ludicrous to argue that workers are unable to consume what they produce or simply that capital cannot be invested “profitably” because there are no “opportunities” for investment. This leads to a certain “defeatism” and, more important, fails to explain why indeed, given the more “skewed” distribution of income and capital ownership, actual social “tensions” rise both within nation-states and between them.

In reality, the problem arises for capital when the “savings” generated by “profits” cannot be invested any longer “profitably” because the growth in employment and consumption or wages ends up “emancipating” workers. This leads to “wage-push” and “demand-pull” inflation, with all the attendant problems that that causes in terms of “price stability” and the normal functioning of debt contracts (which become short-term and impossible to fix predictably). (The link between “Capitalism, Conflict and Inflation” is traced admirably by my Cambridge supervisor Bob Rowthorn in his homonymous book). The “crisis” then becomes “real” and is not just a creature of “excess” or of “casino capitalism”. The “conflict” is real, not engineered artificially (by Finanzkapital) or wholly “internal” to the dynamics of capitalist accumulation. We will focus on these matters very shortly.
But the essential characteristic of “the Great Moderation” was the absence of inflation in developed economies, and the “global savings glut” represented by the regurgitation or re-cycling of Chinese dictatorship profits into “parked savings” in US treasuries and other “financial investments”. Combined with the “absence” of the working class from wage and industrial disputes, this greater availability of social resources in the form of “capital” could only be “invested” by exasperating the “financial” side of capital – through “credit creation” and “leveraging” that resulted in “asset-price speculation”. As Minsky and then Mishkin explained, low inflation encourages the “lending” of capital at low rates of interest and the “borrowing” for longer contract terms in the “expectation” of higher future income streams from investment in financial assets. As the market price of assets on balance sheets of firms rises, the “Value at Risk” of debt-financed investment falls inducing capital into what Adrian and Shin have called “the risk-taking channel” ( - see also J Nocera on “Risk Management” here ). From there to the collapse of what becomes eventually “Ponzi finance” (Minsky) once the “expected” income stream from over-valued assets fails to be “realized” – in other words, once capital can no longer be “valourised” in the production process -, the road is very short indeed.

Once again, it is the “absence” of the working class, the “absence” of the real “motor or engine of capitalist growth”, the real “acid test” of antagonism and conflict in the production process that allows “the rising tide that lifts all boats” (asset bubbles) which, once it recedes, exposes “those who have been swimming naked” (Warren Buffett). But the problem is precisely this! That by that stage it becomes impossible to tell which “investments” are “real” and which are “fictitious” (the infamous “mark to market”)!

Worse still, in the financial sphere, the implosion of asset prices and contracts and the consequent “debt-deflation” (correctly theorized by Irving Fisher here  ) threaten to destroy not just “value” but indeed “markets” themselves – chief among them the “inter-bank loan market” which allows the vital “metabolism” of capitalist “equiparation” of loans across disparate branches of capitalist investment and social production – necessitating the use of exceptional “unconventional” measures by monetary authorities that in some cases may lie well beyond their legal mandate (see FT article here )!

As Lahr et alii linked above put it: “Malfunctioning interbank and other financial markets called upon central banks to take on a more active financial [p.2] intermediation role. They also highlighted the fact that there was no longer a single market rate due to the collapse of normal arbitrage activities. Second, because monetary policy had to be eased beyond what is possible by reducing short-term interest rates close to their lower bound at zero, a number of central banks had to pursue alternative policies of quantitative and credit easing. The notion that the policy-controlled short-term interest rate is the sole tool of monetary policy has therefore been questioned.”

So now we come closer to the heart of the rationale of capitalism: - the efficient allocation of social resources (what they call “capital”) under the control of capitalists (now [!] it becomes “capital”!). (This point is intended to enlighten all those who wish to have capital… without “the capitalist”! Because capital is not a “thing” – it is a social relation of subordination and exploitation of workers by capitalists.) The question here is that, given that it is real social antagonism and conflict over the wage relation that occasions the “asymmetric information problems” (moral hazard, free-rider and principal-agent) and not rather these “asymmetries” themselves (as Mishkin on behalf of all bourgeois economists suggests) – given this reality, what has been and is “the present strategy” of capital (both “private” and “social capital” acting through the State, or “the collective capitalist”)?

As mentioned above, underconsumptionist theses tend to overlook entirely the “conflict” of which financial crises are clear evidence – precisely because they are seen “only” as “financial” and therefore “fictitious” in nature given that they seem to arise “outside” the sphere of production. JB Foster, for instance (see link above), dismisses De Brunoff’s statement in ‘Marx on Money’ that financial crises are tied to “real relations of production”, wrongly suggesting that she fails to understand the “reality” of credit crises. Now, to the degree that financial crises are “real” and not as “fictitious” as the capital created, it is only because they arise directly from the “conflict” that capital experiences in the process of “valourisation”. The problem with this misapprehension starts perhaps with the very notion of “surplus value” which, whilst it denotes a higher “rate of exploitation”, also seems to suggest that capitalists accumulate a “surplus” that gives them a “margin of manoeuvre” in dealing with living labour. But this is clearly wrong because, regardless of how large this alleged “surplus” is supposed to be, its “value” quickly “collapses” as soon as a “crisis” occurs – often in just a matter of hours! (The point is made powerfully by Kaminsky et al. on “Fin. Contagion” here ). In this regard, whilst it is true that Marx considered capital’s “velleity” for a miraculous leap to profit (M to M’), it must be stressed that he regarded this purely as “ideology”, whereas he considered financial crises to be not only “real”, but indeed “critical” to the analysis of capitalism itself! It is the growing opposition or “conflict” between the need “to socialize social resources” and the need to socialize “the losses” that capital’s attempt “to elude” this conflict engenders – it is this “conflict” that is “real”! Small wonder Foster, and post-Keynesians from Kalecki and Steindl to Sweezy and Minsky, dreamily find many similarities between Marx and Keynes where very few indeed exist!

It is possible to gain a strong insight into the nature of the “ailment” (almost a Freudian “Unbehang”) of late capitalism by returning to the conclusions reached from our review of Mishkin. We saw there the contrast that has developed, to the point where it induces chronic “crises”, between the need of capital to retain its independence from social control – because in that case it would lose its essential characteristic as “command over living labour” -, which occurs through deregulation and liberalization of “markets”; and then, on the opposing side, the fact that each time such “deregulation” ends up in catastrophic “crises” that require the massive “systemic intervention” of the State to rescue the capitalist economy, with consequent “expansion” of the role of the State which “deregulation” was supposed to curtail! Thus, each time that an attempt is made by the collective capitalist (the State) to allow “private capitalists” to run the economy, the end-result is the re-assertion and aggravation of the “control of growth” by the State. The problem is that “private capital” is incapable of achieving anything like balanced growth of the economy and that each time the State is forced to intervene the level of intervention required is aggravated and its “effectiveness” constrained by the amount of “public debt” accumulated in the preceding “rescue operation”. The result is a “fiscal crisis of the State” whereby “taxpayers” end up paying for what, in the period of “deregulation”, were “private profits”. (De Cecco describes this process “encomiably” well here )

At this stage, however, a new “fault-line” appears in the system, because now the ability of the State to operate a return to “growth” within the parameters of a “capitalist” economy – that is, if it is to respect its legal, proprietary and contractual rules, with a modicum of “privacy”, or indeed simply to maintain the “market price mechanism” (we already see suggestions, like REA Farmer’s, of direct intervention in asset markets) – in order for the State to do so, its “room for manoeuvre” becomes exceedingly small and restricted, so that essentially we reach an impasse, an “insuperable” limit where the only way forward is… to abolish the “barriers” to social activity – which are ever more “visibly” the legal categories of capitalist ownership and control over production and society.

The first dilemma lies between “regulation/supervision” and “deregulation/liberalization” to allow “market allocation” of social resources. This results in “moral hazard” because the “public/State insurance” of the “private economy” leads the latter (the capitalists) “to game” the rest of society in the knowledge that the “social insurance” of private investment will secure their “ownership and control” of social resources. Economic authorities therefore have to engage in a game of “cat and mouse” with private capitalists in order to induce them to invest “as private owners” by utilizing ever more “public” means, methods and resources in order to preserve the reproduction of society itself! Price stability is one target, but “leaning against the wind” and all manner of “unconventional” or “non-standard” measures are required (from QE to “announcement effects” to guide “expectations” – or ultimately direct investment by the State to maintain aggregate demand!).

The second dilemma then takes hold, of “State supervision” being insufficient or “collusive” with “private capital” and therefore not representing “democratically” the interests of “society” which are antagonistic to those of “capital”. De Cecco speaks here of “credit channels” that increasingly seem to be “informal” and channeled into “too big to fail” institutions. And, most important of all, of the fact that the State itself must fail (because of the fiscal and legal constraints) in its task “to revive” the capitalist economy – which is what leads to the paralysis and “fracture” of the “Crisis-State” (and, perhaps, even of the bourgeoisie itself!). In a nutshell, it seems, this is the manifestation of the Marxian notion of “capital becomes a barrier, a limit, to itself” (Grundrisse).

De Cecco makes another point, with characteristic acumen, on which we will need to reflect very hard. First, he traces the change of economic paradigm, from the Modigliani-Miller model of perfect knowledge and rational expectations (reconducible to Hayek’s ‘economics as co-ordination’) to the existence of “information asymmetries” which now “explain” the existence of central banking itself (!) formerly “exonerated” by neoclassical theory. Here is De Cecco:

“Neo-classical theory has its natural complement in the Modigliani-Miller theorem which
demonstrates the irrelevance of the financial structure and in so doing extends the concept of
monetary veil to the whole financial structure. Thus the system’s determination depends on
exogenous variables such as consumer choice, factor availability and technology levels and no
value can be assigned to an institution, like the lender of last resort, which can acquire legitimacy
only if we believe that the financial structure is relevant. In particular, we must believe that the
banking system, as provider of a public good as an efficient payments system can be seen to be, is
relevant to the efficient functioning of the whole economic system. This is why the most consistent
among neo-classical economists, F.Hayek and G.Stigler being the best known among them, have
flatly denied any institutional relevance to central banks especially as lenders of last resort. Their
faithful disciples have, moreover, striven to demonstrate the free banking and currency competition
are indispensable to the well functioning of the economic system. They have reproduced, without of
course having any notion of it, the heated debated on free banking and currency competition which
raged in Italy in the second half of the XIXth century.
Less radical neo-classical economists, however, have tried to rationalise the existence of institutions
like central banks, which are, by their very nature, the negation of laissez faire, within the
theoretical context of decentralised decision-making, by using ad-hoc arguments such as the need to
protect the payments system which is a public good. They did not realise, or realised with some
embarrassment, that, once a limitation is introduced to decentralised decision-making, we get into a
dark night of sub-optimal choices where all cows are black and unique solutions evaporate or at
least become extremely unlikely.
As is well known, economists are ill at ease when they think without a precise theoretical
framework. This is why they have welcomed the arrival of a new theoretical paradigm, which has
been constructed in the last two decades, the theory of asymmetric information and of decision-
making under uncertainty. Within the new paradigm, the central bank and the lender of last resort
function in particular, can be found a comfortable and legitimate ubi consistam. With the speed of
diffusion which characterises mass societies the new information theories have replaced theories of
the real cycle and rational expectations as the winning paradigm, as scholars previously wed to it
rapidly repudiated their old beliefs.
On the basis of asymmetric information theory, with its important complements, adverse selection
and moral hazard, the non-relevance of the Modigliani-Miller theorem can be easily established
outside a world of perfect information. The relevance of the financial structure for the dynamics of
an economic system can be then inferred. From that it is only a short step to proving that banks are
unique or at least peculiar credit intermediaries and organisers of the payments system which makes
a decentralised decision-making system a working proposition. At this point, it is not difficult to
introduce central banks, as institutions necessary to safeguard the payments network. If attention is
paid to an important feature of a fractional reserve banking system, namely its capacity to multiply
and demultiply credit, it is easy to notice that such a system will be inherently unstable, and that an
economic system based on fractional reserve banks, and therefore unstable, will require an
institution which will play the role of lender of last resort in the lamentable but frequent cases when
the banking system will demultiply its credit creation powers.”

It is now appropriate to introduce the concept of moral hazard. In an asymmetric information
context, the well known formula known as the Bagehot Rule for the activation of the lender of last
resort function will be vitiated by a difficulty: it is practically impossible for a central bank to know
whether banks requiring loans of last resort are illiquid or insolvent. As is known the Bagehot rule
mandates that only illiquid banks be admitted to last resort lending. But if the lender of last resort
faces an insolvent bank, if it refuses to bail it out it will by this action most probably determine a
serious demultiplication to occur to credit available. The payments system will be accordingly
weakened and since the latter can be considered a public good, it is clear that the Bagehot Rule is
not easily applicable and that last resort loans must be provided every time the payments network is
in danger and severe demultiplication can occur in the country’s credit system.

It follows, of course, that if the Bagehot Rule is modified to include insolvency, all banks which,
because of the state of their balance sheets, represent a potential threat to the stability of the credit
system are perfectly aware of their being indispensable and therefore virtually immortal as
institutions .From this awareness they can derive a cavalier attitude toward risk, in the quest for
higher profits. The banking system can accordingly develop an excessive propensity to expansions
followed by equally excessive interventions by the monetary authorities. The latter, aiming to
reduce the volume of reserves which they have themselves created to bail out the risk-prone banks,
may end up destroying the smaller banks, which are too small to influence the trust of the public in
the credit system, while the real culprits, the banks that are too big to fail, manage to escape
unscathed and can start, after a short period of quiet, all over again on too bold a path of expansion.”

Now, this is a point of inestimable importance: - because now, if we admit that central banks are no longer capable of determining who is illiquid from who is insolvent… the entire game is well and truly up! Bernanke makes the same point when discussing Fisher’s debt-deflation (in the “Macroecons of GD”, where he also reviews “sticky wages”). And, like De Cecco, notes the “switch” in economic approach to the “monetary channels” leading to instability that Mishkin operated, applying the game-theoretic notions of information asymmetry. Here is Bernanke: (p17)

Fisher's idea was less influential in academic
circles, though, because of the counterargument that debt-deflation represented
no more than a redistribution from one group (debtors) to another (creditors).
Absent implausibly large differences in marginal spending propensities among the
groups, it was suggested, pure redistributions should have no significant macroeconomic
However, the debt-deflation idea has recently experienced a revival, which has
drawn its inspiration from the burgeoning literature on imperfect information and
agency costs in capital markets.14 According to the agency approach, which has
come to dominate modem corporate finance, the structure of balance sheets provides
an important mechanism for aligning the incentives of the borrower (the
agent) and the lender (the principal). One central feature of the balance sheet is the
borrower's net worth, defined to be the borrower's own ("internal") funds plus
the collateral value of his illiquid assets. Many simple principal-agent models imply
that a decline in the borrower's net worth increases the deadweight agency costs of
lending, and thus the net cost of financing the borrower's proposed investments.
Intuitively, if a borrower can contribute relatively little to his or her own project and
hence must rely primarily on external finance, then the borrower's incentives to take
actions that are not in the lender's interest may be relatively high; the result is both
deadweight losses (for example, inefficiently high risk-taking or low effort) and the
necessity of costly information provision and monitoring. If the borrower's net
worth falls below a threshold level, he or she may not be able to obtain funds at all.
13. Kiyotaki and Moore (1993) provide a formal analysis that captures some of Fisher's intuition.
14. An important early paper that applied this approach to consumer spending in the Depression is
Mishkin (1978). Bemanke and Gertler (1990) provide a theoretical analysis of debt-deflation. See Calorniris
(1993) for a recent survey of the role of financial factors in the Depression.
From the agency perspective, a debt-deflation that unexpectedly redistributes
wealth away from borrowers is not a macroeconomically neutral event: To the extent
that potential borrowers have unique or lower-cost access to particular investment
projects or spending opportunities, the loss of borrower net worth effectively cuts
off these opportunities from the economy. Thus, for example, a financially distressed
firm may not be able to obtain working capital necessary to expand production,
or to fund a project that would be viable under better financial conditions.
Similarly, a household whose current nominal income has fallen relative to its debts
may be barred from purchasing a new home, even though purchase is justified in a
permanent-income sense. By inducing financial distress in borrower firms and
households, debt-deflation can have real effects on the economy.
If the extent of debt-deflation is sufficiently severe, it can also threaten the health
of banks and other financial intermediaries (the second channel). Banks typically
have both nominal assets and nominal liabilities and so over a certain range are
hedged against deflation. However, as the distress of banks' borrowers increases,
the banks' nominal claims are replaced by claims on real assets (for example, collateral);
from that point, deflation squeezes the banks as well.'' Actual and potential
loan losses arising from debt-deflation impair bank capital and hurt banks' economic
efficiency in several ways: First, particularly in a system without deposit insurance,
depositor runs and withdrawals deprive banks of funds for lending; to the extent that
bank lending is specialized or information-intensive, these loans are not easily replaced
by nonbank forms of credit. Second, the threat of runs also induces banks to
increase the liquidity and safety of their assets, further reducing normal lending activity.
(The most severely decapitalized banks, however, may have incentives to
make very risky loans, in a gambling strategy.) Finally, bank and branch closures
may destroy local information capital and reduce the provision of financial services.

What Bernanke and Mishkin forget is that “the capitalist economy” has little to do with “use values” in terms of what is socially useful allocation of resources, and even less to do with (Hayekian) “co-ordination” in the sense of “exchange and pricing of ‘information’” on anything resembling “democratic” principles! This last is a crucial point, and it is our central point of attack!  – Because what Mishkin would have us believe is that “debt-deflation” occurs when there are simple “asymmetries” in the exchange of “information”. But we know all too well…. that these “asymmetries” (free-rider, principal-agent, moral hazard) arise because of….the very real “antagonism” of capitalist social relations of production, with the wage relation at the centre! Indeed, it this antagonism that explains the “ultimate source” of financial instability that Mishkin relegates to the never-never or to “shocks” or “black swans” or “unexpected disinflation” or “uncertainty” or “sudden rise in interest rates” or other “exogenous factors”!!

Perhaps before we leave "Bernanke" (save to return to him - so "central" is his contribution, if read critically, to the theorisation of the present "crisis"), could I rapidly "situate" the discussion in a "theoretical" context - an essential task if we are to rise above the "noise" of the quotidian "random walk". Indeed, it will be recalled that in neoclassical theory, it is the very assumption of "perfect information" (Modigliani-Miller), of "common knowledge" (game theory), and Walrasian "tatonnement" (in equilibrium analysis) that make the exchange of information "symmetrical" and that reduce the entire field of "economic science" to "the problem of co-ordination" (see Hayek's "Individualism and Economic Order", discussed in Loasby's "Equilibrium and Evolution" for an attempt to "historicise" the problem).

It is evident that there can be no space in all of these "theories" for central banks, nor indeed for "financial intermediation" (hence Hayek's virulent opposition to central banks and fractional reserves as a "negation" of the market pricing mechanism). The "separation" of borrower's risk and lender's risk first raised by Kalecki and Keynes - and the consequent recognition that "money is not neutral" - remains "internal" to the function of capital: it is, as it were, a "division of labour". But an understanding of why, how and where "information asymmetries" arise in the "channel" that links investment decisions with financial structure is absolutely essential. To leave the entire matter to "asymmetric information" arising "after" some "exogenous shock" (see any of Mishkin's papers on the subject) is quite simply inadequate. (Similarly, the "New Institutional Economics" of Coase, Williamson and Demsetz, explain away the "internalisation" of these "asymmetries" as the need to minimise "transaction costs" - which then raises the conundrum of why the capitalist economy is not constituted by one "mega-firm"!)

Sunday 10 March 2013

Theories of Overproduction and Underconsumption 1

In this brief intervention I wish to discuss cursorily, without source or data references, the most popular and frequent type of theories advanced by orthodox and even radical economists about capitalist economic crises. These tend to be cognate or contiguous in the sense that the one, the overproduction theory, is really the obverse of the other, the underconsumptionist. Typically, these theories regard capitalist production as a simple production of “goods”: in other words, the capitalist economy is simply a historical variant of many other preceding forms of production in that it differs merely in the way in which the social product is “distributed”. The underlying assumption is that expounded in the 1930s (before Keynes) by Michal Kalecki: capitalism is a system of production divided into capitalists and workers. The workers spend what they earn and the capitalists earn what they spend. In other words, the difference between the “classes” of capitalists, on one side, and workers on the other has nothing to do with social antagonism – with the political control over what is produced, when and how and to whom it is distributed – but rather it has to do entirely with the “distribution” of what is taken to be a “technologically-determined” process of production where technology and labour processes are entirely “external” to the capitalist system of production!

Now, we know very well that this is quite simply false. But for these so-called “radical” economists (from Kalecki to Minsky to Krugman even) what matters is not “what is produced and how”, but rather how the “product” (understood, once again, to be a “technically-given” output of production) is distributed between the social classes. It stands to reason, therefore, that for these theoreticians the entire problem of capitalist economies – all the crises, recessions and depressions – have nothing to do with the antagonism of the wage relation – with the command of dead labour over living labour – but have all to do with how the product of labour and technology is distributed.

If capitalists “earn” too much because wages fall too low, they will be unwilling to consume the surplus earned and therefore aggregate demand will be too low to employ all workers, resulting in higher unemployment. This is called “underconsumption”. But at the same time it is also “overproduction” because workers’ wages are insufficient to consume the whole “product”.  In the alternative case, if capitalists reinvest their “excess earnings” there will be “overproduction” as a result of excessive “competition” between capitalists which workers will not be able to consume because their wages will be too low to absorb the (excess) production at a given “required”  rate of profit. The resulting lower rate of profit will further remove capitalist incentives to invest unless a political entity like the State intervenes to provide the requisite aggregate demand, with a return to “equilibrium” between investment and savings and employment.
Alternatively, if workers are paid “too much” in wages due to excessive demand for “labour” or because of State labour policies, the resulting fall in the rate of profit will again cause a decline in the rate of investment with a consequent rise in unemployment. If the capitalists “save” or retain their excess profits, there will be “underconsumption” or deficient aggregate demand which will again result in a crisis that will require State intervention to restore “equilibrium” conditions.
In both these situations, it is the politically-determined or “acceptable” rate of profit and wage rates that will determine whether the capitalist economy is at equilibrium or not, and therefore whether or not there is a “crisis”. It can be seen quite readily from this very simple presentation that these widely-held opinions or “theories” of what constitutes a capitalist economy leave out the most crucial and essential element of capitalism: the social antagonism of the wage relation, of the fact that workers are not “free” to decide democratically what is produced and when and how, and then in turn what is to be done with the “pro-duct”!

We can see that in both instances the “radical” theories of capitalism presented here can oppose only a “moralistic” objection to capitalist production in terms of the “distribution” of what is uncritically and unquestioningly accepted to be “the process of production” – as if this were a “technically-given”, “scientific” process wholly devoid of political antagonism! That is why bourgeois economists are able to present “economics” as a “science” that deals merely with “quantities” or with “optimal distribution” of the “output” of production given basic “political” assumptions, choices and constraints that are “external” to economic “science” itself! Once again, we know that this is entirely false and grievously and perfidiously misrepresents and mystifies the operation of this most odious social system – the society of capital.


Theories of over-production and under-consumption have this in common then: - that both postulate the existence of a “neutral process of production” over which the only antagonism possible is over the “distribution” of the “product” understood as homogeneous “output” either (in the Marxist version) of “socially necessary labour time” or (in the neoclassical version) of the marginal utility of the totality of “endowments” available for exchange on the “free self-regulating market” through the “price mechanism”. We have already considered the “apories” (or practical contra-dictions) involved in these notions and will not reiterate them here.
The important point to understand is that “over-production” and “under-consumption” theories both postulate an “equilibrium level” of profits and wages that (in the neoclassical version) is determined by the original marginal utility of the “endowments” of individual market participants and (in the “Marxist” version – which is partly a distortion of Marx’s position) by the politically-determined “share” of wages and profits over the distribution of the “output”.

One thing to notice immediately here is that this theory does not explain why, given that “output” is a homogeneous set of “pro-ducts” produced with “neutral and exogenously given” technologies, there should be a “class division” between workers and capitalists. Put otherwise, if all that is wrong with capitalism is that capitalists may re-invest too much (overproduction) or that workers may consume too little (underconsumption) –why, then the answer is all too easy! Simply ensure that capitalists and workers work out (mathematically!) the “equilibrium” level of wages to profits so that the economy may operate at maximum efficiency with full employment of resources! The whole of economics would then boil down to a simple “engineering problem”! Because obviously it could never be the case that workers would consume too little unless their wages were too low, or that capitalists would produce too much unless their profits were too high! In other words, in such an economy there would be no distinction, aside from a “technical” one perhaps (the capitalists would be simple engineers or managers “conducting” the production process), between workers and capitalists! Everyone could then aspire to become – as in the company capitalism utopia – a “shareholder” with a share in the economy commensurate with some “labour input” or politically-agreed level of income!

This is precisely the kind of nonsense that comes out of people like Kalecki and Keynes or Minsky and Krugman! All of these “theoreticians” deny that capitalist problems and crises have to do with the antagonism of the wage relation because…. that would amount to placing the blame on workers! (See Krugman link below. Minsky says as much in “Can ‘It’ Happen Again?”) As if, that is, workers should be blamed for an antagonistic relationship in which they are necessarily the “exploited” party that is forced and coerced “to sell” its “living activity” or living labour… in exchange for dead labour in the form of “goods and services” from the capitalist!

Wednesday 6 March 2013

"Notes on Minsky" to be posted soon

I intend to post soon a series of reflections on the current state of the capitalist economy and its ideological mystique called "economic science". Here is a preview of the problematic in a recent post to Gavyn Davies's blog in the Financial Times:

Gavyn Davies at his most engaging, stimulating, perceptive and, dare I say, even provocative best. This is the kind of analysis that leads straight into more "existential" matters (our friend Marcus Rongunui would surely concur) in the sense that although it starts from seemingly mundane technical issues and pragmatic solutions, it quickly directs our attention to what is the "essence" of so-called economic "science" or theory. The theoretical divide or "gap" that exists in economics between the "real" economy and its "monetary" aspect (the "monetary veil") is something that invests (pun intended) "the output gap", which refers to that level of productive activity consistent with low inflation, to the "transmission mechanism" linking that real activity to monetary policy.

The conclusions to which this sort of analysis leads may well be "explosive" where the survival of what I call "the society of capital" is concerned. In essence, my point is that we are fast approaching the point at which the wage relation or capital becomes the ultimate "barrier to production" - and therefore capital meets its own "internal" or intrinsic limit. The Greenspan and Bernanke "puts" illustrate the manner in which the wage relation can continue to subsist (the subsistence wage?) only on entirely "fictitious" grounds (what Soros has called "fictitious capital"). High time, is it not, that we began searching for alternatives, particularly in view of the alarming developments in Europe and China.

Gavyn may be aware that for a long time, even but not solely on his blog, I was warning about the existence of asset-price "inflation" (speculative bubbles) even in the absence of "measurable" inflation. I have cobbled together some analytical thoughts (in the tradition of the "critique of political economy" that dates from Marx to Minsky) that I will seek to publish sporadically and spasmodically on in the near future under the collective title of "Notes on Minsky".