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 http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/1998_2_bpea_papers/1998b_bpea_krugman_dominquez_rogoff.pdf
) 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 http://www.piie.com/publications/chapters_preview/319/7iie289X.pdf
) 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 www.ecb.int/events/conferences/html/cbc6/Session_1_paper_Fahr_Motto_Rostagno_Smets_Tristani.pdf)
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 www.kansascityfed.org/publicat/sympos/1997/pdf/s97mishk.pdf
).
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 ( http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/2001_1_bpea_papers/2001a_bpea_blanchard.pdf
) that Bernanke mentions in the very first paragraph of his address launching
the phrase “the Great Moderation” (here http://www.federalreserve.gov/boarddocs/speeches/2004/20040220/default.htm
):
“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 http://www.eui.eu/RSCAS/WP-Texts/JM96_40.html
)
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 http://www.federalreserve.gov/boarddocs/speeches/2005/20050414/default.htm
) coming from China and other “emerging economies” that were concomitant with
the “globalization” of the capitalist economy (see P Lamy here http://www.ft.com/cms/s/0/4d37374c-27fd-11e0-8abc-00144feab49a.html#axzz1C2IqIb63
) – 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 www.mpettis.com/2010/11/qe2-and-the-titanic/
)
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” http://monthlyreview.org/2010/10/01/the-financialization-of-accumulation
). 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” (http://www.newyorkfed.org/research/staff_reports/sr439.html
- see also J Nocera on “Risk Management” here http://www.nytimes.com/2009/01/04/magazine/04risk-t.html?pagewanted=1&_r=1
). 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 http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf ) 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 http://www.ft.com/cms/s/0/6a9874d6-7023-11e0-bea7-00144feabdc0.html#axzz1KP1dDuqs
)!
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 http://docs.google.com/viewer?a=v&q=cache:w-TR-jguTbkJ:www-personal.umich.edu/~kathrynd/JEP.Contagion.pdf+The+Unholy+Trinity+of+Financial+Contagion&hl=en&gl=au&pid=bl&srcid=ADGEEShL3CjtkRbGzIJLkO2g6VpPwzKUEi5HfFbhoFjLL4q0hgBXTrPm8UWcZFDYj_ohAIs4yaUU8ifMXp4RP02LtOgP0xTHSH3yETdPGThHsYvjDolKCIawZlK3m16ucGcGHi4CWsNc&sig=AHIEtbSLMUTN1iaXY9elevUcaIsoll79sQ
). 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
http://docs.google.com/viewer?a=v&q=cache:UQdyCYokYhoJ:w3.uniroma1.it/cidei/wp-content/uploads/working_papers/cidei49.pdf+marcello+de+cecco&hl=en&gl=au&pid=bl&srcid=ADGEESj4b907TfCwUfVkx2rWhlxHS08kNt_uK6VoDEHckIHCRzvdvc68T3IFfjp8wTt2VpXzPdJcDpTqPUgjMeaCdKpZIOUS2V7j2K9aFq9WAocEMtauIg0ObPoBAnJ83c6TTb3GRvqE&sig=AHIEtbSWV3Qr9egLyO06ZcVQ55jFsGXWRg
)
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: http://docs.google.com/viewer?a=v&q=cache:UQdyCYokYhoJ:w3.uniroma1.it/cidei/wp-content/uploads/working_papers/cidei49.pdf+marcello+de+cecco&hl=en&gl=au&pid=bl&srcid=ADGEESj4b907TfCwUfVkx2rWhlxHS08kNt_uK6VoDEHckIHCRzvdvc68T3IFfjp8wTt2VpXzPdJcDpTqPUgjMeaCdKpZIOUS2V7j2K9aFq9WAocEMtauIg0ObPoBAnJ83c6TTb3GRvqE&sig=AHIEtbSWV3Qr9egLyO06ZcVQ55jFsGXWRg
“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.
3
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: http://www.mrfaught.org/macroecondepression.pdf
(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
effects.
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.
18 : MONEY, CREDIT, AND BANKING
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"!)
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"!)