Commentary on Political Economy

Tuesday 17 December 2013

Capitalism, Conflict and Deflation

There has been much talk recently about the notion of "secular stagnation" as applying to the current state of capitalist economies globally. Here I am paraphrasing the title of Bob Rowthorn's seminal early studies to summarise theoretically the real sources of this condition. Whereas when Rowthorn wrote in the 1970s conflict in capitalist societies could be measured by inflation, now it can be measured by overleveraged finance and deflation.

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"!)

In this paper on “Financial Fragility and Economic Performance” ( ) , Bernanke and Gertler identify the "ultimate source" of asymmetries in the "borrowers' net worth position" - the lower the net worth, the higher the risk of implosion. Again, this fails to isolate "the virus" responsible for the disease, but it offers some hints. The first hint is that "high net worth firms" will be "ensconced" from debt-deflation initially by their "oligopolistic" and hence "systemic" importance (too big to fail). And the second is that each successive "crisis" brings about a series of "mergers and acquisitions" whether voluntary or "shot-gun marriages" that increases further the degree of "oligopoly" of capitalist enterprise and therefore its future "fragility" - the "systemic riskiness" of the system. (See this FT story on M&A activity following GFC ) And finally, the growing "systemic riskiness" of the structure of capitalist enterprise, together with the parallel "centrality" of State authorities in "crisis management", mean that central banks become "lenders of first (not last) resort".


Indeed, Bernanke and Gertler zoom into this specific “chasm” or “lacuna” (Keynes’s “slip ‘twixt the cup and the lip”) seeking to determine what “factor” would trigger a debt-deflation implosion of the credit pyramid (remember: a pyramid of term contracts enabled by low inflation for prolonged periods). This is what they come up with at p88:


“In this paper we take a step toward an operational definition of

financial stability. We argue that financial stability is best under-

stood as depending on the net worth positions of potential borrow-

ers. Our basic reasoning is as follows: generally, the less of his own

wealth a borrower can contribute to the funding of his investment

"project," the more his interests will diverge from those of the

people who have lent to him. When the borrower has superior

information about his project, or the ability to take unobserved

actions that affect the distribution of project returns, a greater

incompatibility of interests increases the agency costs associated

with the investment process. We define a financially fragile situa-

tion to be one in which potential borrowers (those with the greatest

access to productive investment projects, or with the greatest

entrepreneurial skills) have low wealth relative to the sizes of their

projects. Such a situation (which might occur, e.g., in the early

stages of economic development, in a prolonged recession, or

subsequent to a "debt-deflation"') leads to high agency costs and

thus to poor performance in the investment sector and the economy


We illustrate this general point in the context of a specific

model of the process of investment finance. In this model individual

entrepreneurs perform costly evaluations of potential investment

projects and then undertake those projects that seem sufficiently

worthwhile. The evaluation process gives the entrepreneurs (who

must borrow in order to finance projects) better information about

the quality of their projects than is available to potential lenders. As

in Myers and Majluf [I9841 and others, this informational asymme-

try creates an agency problem between lenders and the entrepre-

neurs-borrowers. This agency problem (which is more severe, the

lower is borrower net worth) raises the prospective costs of invest-

ment finance and thus affects the willingness of entrepreneurs to

evaluate projects in the first place. We show that,, in general

equilibrium, both the quantity of investment spending and its


1. The term is due to Irving Fisher [1933]. See Bernanke and Gertler [I9891 for

an analysis.




expected return will be sensitive to the "creditworthiness" of

borrowers (as reflected in their net worth positions). Indeed, if

borrower net worth is low enough, there can be a complete collapse

of investment.


Now, the thing to be noticed instantly is that, unlike Mishkin who leaves the question of the precise “operation” of “asymmetric information” in the actual structure and function of capitalist enterprise might give rise to these “asymmetries”, preferring to attribute them to “exogenous factors” (listed above), B&G concentrate here on the structural “endogenous” factors that might “pre-dispose” the system to debt-deflation and find (or hypothesize) that it is “the net worth position” of the borrower that is determinant. This would seem to support our initial hypothesis that the “functional” predisposition of the “lending” aspect of capitalist investment is to reduce risk, even at the cost of sacrificing profit maximization. This stands to reason because maximizing profit is never the real goal of capital – it is merely the pursuit of safe profit above what is called “the risk-free rate of interest” which merely represents the interests of “social capital”.


Note (!) that B&G look at “fragility” from an “ex post” position, that is, “after” a debt-deflation” has occurred and therefore what they mean by “fragility” is the inability of the investment cycle “to re-start” owing to the low net worth of entrepreneur-borrowers. But in fact it can be argued that this situation can arise even “ex ante”, that is, that instability increases “before” debt-deflation. A surfeit of capital in the sense of either excessive liquidity vis-a-vis actual “productive activity” (note that B&G themselves refer to “productive [!] investment projects” and fail to specify what they  m e a n  by this!) and therefore the ability to find “productive investment projects” except those of entrepreneurs lacking the requisite skills… - either of these possibilities reduce the “net worth”, the “skin in the game” of the entrepreneurs selected by lenders for loans. – Hence the “fragility”  b e f o r e  debt-deflation occurs once the volume of investments reaches a “critical” stage. Again, Fisher’s “debt-deflation”, or Minsky’s “hypothesis”, only tackle the “implosion” of Ponzi finance – but not its “generation”!


They do this desultorily in the Conclusion:

“Putting aside the reasons for the increase in leverage, it still

may be asked whether the higher level of debt implies greater

financial fragility. Our answer is, "It depends." We believe that the

focus on debt versus equity ignores the primary determinant of [p111]

financial stability-the net worth of borrowers, or, as we may call it

for the purposes of this discussion, the "insiders' stake."z3 If the

insiders' stake is high, debt need not be harmful. For example, as

has been frequently pointed out, Japanese corporations have tradi-

tionally relied much more on debt than have U. S. firms. This has

not posed a problem for the Japanese, however, because managerial

decisions are tightly monitored by financial backers-banks or

parent corporations. Effectively, insider stakes in Japan are high;

among other things, this means that firms' finances can efficiently

be restructured when circumstances change. Thus, whether the

U. S. economy is in a financially fragile condition depends funda-

mentally more on the magnitude of insiders' stakes in the United

States than on the composition of firms' external liabilities.

There have been factors pushing insiders' stakes in both

directions in the United States during this decade. For example, to

the extent that the wave of takeovers and buyouts has represented

the seizure of corporate control by well-financed management

teams, there may have been an effective increase in insiders' stakes;

likewise, increased monitoring of management by takeover special-

ists and investment banks may have had a salutary effect. Working

in the other direction, increasing securitization (for example, the

greater reliance on junk bond financing a t the expense of commer-

cial bank loans4)has typically reduced the overlap between the

providers of financial capital and the insiders in the corporation;

greater use of "arm's length" financing trends to increase financial

fragility. Measurement of the effects of these countervailing forces

on the stability of the U. S. financial system is a difficult, but not

impossible, empirical challenge.”


So here we have an evident “divide” between “social capital” (capital as a whole represented by finance capital) and individual capitals. And when B&G remind us that the “creditworthiness” of borrowers is a function of their “net worth position”, then we know we are on to something extremely important. – Because this “net worth” will depend in large part not merely on the individual position of the borrower, but above all on the specific weight (weight!) that this individual capitalist plays in the capitalist economy, in terms of how “pivotal” it is to social reproduction overall and its specific role in a certain “sector” (or “market”, if you like) – in other words, on the degree of “oligopoly” (recall Sylos-Labini’s point on how “lollies differ from steel”!). B&G touch briefly on this at Part V on “debtor bail-outs”.


Indeed, the ultimate significance of State intervention in a “crisis” to restore the “flow” of capitalist activity threatened by the “disintermediation” of financial institutions and the emergence of the central bank as “lender of first resort” have to do with the impossibility at a certain level of debt-deflation of the monetary authorities to distinguish between liquidity and solvency and between “idiosyncratic” and “systemic shocks” or crises (p108), that is , to tell apart the “real” and the “fictitious” parts of capitalist activity or investment in terms of “use value” and of arms-length allocation of social resources between individual capitalists. (Note also Rajan's point about the better creditworthiness of "illiquid" firms because of the greater immobility of their assets used to secure loans!) In the end, it is the “systemically important” capitalist firms that simply must survive – they become “too big to fail” once a relevant degree of “oligopoly” is achieved. Mishkin, to be fair, had already insisted on the ability of large firms (oligopolies) to issue securities to finance themselves – an evident adoption of the B&G thesis on the importance of net worth for surviving debt-deflation. Worse still, each “crisis” simply tolls the death-knell for smaller capitalist firms (financial and industrial) that are then acquired and merge with bigger ones in a growing spiral of capitalist “concentration”. – Until, that is, the collective capitalist has to intervene “in first person”, through financial intermediation, tighter regulation and supervision, and (in extremis) outright “nationalization” (anathema but nearly a reality in the latest US crisis!).


We find here a curious but undeniable and significant inversion or contra-diction of Schumpeter’s “entrepreneurial spirit”, in that the “trustification” of capital either saps and suppresses or at least “internalizes” the “Innovationsprozess” that he had singled out as the differentia specifica of capitalism. It is in this perspective or dimension that one must read Schumpeter’s late doubts about the very survival of capitalism as a form of social organization. Thus, here not only the process of innovation but also that of concentration – that is to say, the “internalization” of “information” within individual firms or “units of command” which the NIE had attributed (foolishly) to the reduction of “transaction costs” - become critically “subordinate” to that of wage-relation antagonism. It is the capitalist imperative to preserve the “private” character of the allocation of resources, the artificial “separation” of the social division of labour – the need of capital to avoid at all costs the “democratization” of the process of production in the face of its “re-composition” by workers (by “society”! even by “social capital”!) that leads inevitably to the “crisis”. And, in an apparent paradox, it is the higher level of social interdependence or integration of production – the very process of capitalist concentration – that provokes crises and necessitates ever-higher levels of State intervention to restore the broken “co-ordination”, to abolish the “asymmetries” that had emerged as a result of the peculiar “private” character (or Trennung) operated by capitalist private ownership of the means of production and their “separation” of workers from them and from one another.


Bernanke and Gertler have not ceased to surprise us with their insights, however. This one is at p89:


This paper also contains some novel policy results, not dis-

cussed in our earlier work. The most striking of these is that, if

"legitimate" entrepreneurs are to some degree identifiable, then a

policy of transfers to these entrepreneurs will increase welfare. We

show that a number of standard policies for fighting financial

fragility can be interpreted along these lines.”


We will look closer at what “legitimacy” means here. The central problem is that from being purely “friction” and relegated to “externalities” such as “transaction costs”, which together were bundled up in the “unification” of micro- and macroeconomic theory – just the embarrassing “fact” that money is central to a capitalist economy (Patinkin’s “you can’t buy goods with goods”; see also Wicksell on Walras in ‘IandP’, p22) -, now these “frictions” (impossibly “generalized” by Williamson’s “NIE” to the point of destroying any and all “economic theory”) come to the fore of the entire bourgeois “science” to the point that they “replace” the maximization of “welfare” as the sine qua non of economic activity and regulation. In other words, truly with Hayek we have shifted from an “economics of price” to an “economics of information”. (On all this, see the wonderful review by Klaes here,+Martin+(1993):+'The+Challenge+of+Monetary+Theory',&hl=en&gl=au&pid=bl&srcid=ADGEESgQ84n9NomIQw14Ug8Rkxu0sDSuFw9SUiYKoj0CgiYSERM8xHLn-LCZtZPUgYWcASB20qA0jqwh0QoWehjc8k9pN4HM3ldAPmbSJirs2zojNbr_0xgy-TLXp1JXBHjNijfvK-MA&sig=AHIEtbQ8j6otJa5aXBgnMBFw71SqMZ25Zg


In his sweepingly devastating conclusion,


“While the folk history of transaction costs is often told as a story of

remarkable success, the historical sketch presented here, which focuses on the

transaction cost notion itself, suggests a rather different picture. The study of

the use of transaction costs in the literature of modern economics turns out to be

the history of the quixotic struggle of the discipline to endogenize one of the

most pervasive residual categories of the neoclassical heritage—the category of

institutional friction.” )


Now two problems arise in this respect. The first lies with the “meaning” of “information”. And the second is with establishing why this “information” is subject to “asymmetries”! Bourgeois economists steadfastly refuse to face these two questions that go to the heart of “economic science”, preferring instead (quite wisely) to hide “within” the bounds of their meanings and simply seeking “to squeeze” the status quo (capitalist relations of production) safely within these categories – what they call “endogenising” all these “frictions” or what I call “internalizing” the “externalities”! As long as this grex venalium (this venal herd) steers very clear of the “ultimate” questions – those questions that undermine its very “rationale”, its very “basis and foundation” – they can play on very safe ground. But the problem is that “the reality” of capitalist “antagonism” never ceases to intrude! And it intrudes most – lo and behold! – in the monetary sphere, the root of all evil, not just in popular lore, but in bourgeois economic theory as well! Go figure!



“Recently, interest has grown in exploring the possible links between the finan-

cial system and aggregate economic behavior. This interest partly reflects the

ongoing beliefs of applied economists and policymakers that financial markets

and institutions deserve serious attention - that they play important roles in the

growth and fluctuation of output.”


The reluctance to tie the two questions together – financial structure and growth of output – is too evident. The cancer at the core of economic theory was and remains “money”, because money is the one “institution” that bourgeois theory cannot digest, cannot assimilate. But that such “externalization” of money is an abject admission of defeat – a further proof of the insolent scorn that bourgeois economists have not just for truth but even for intellectual coherence – is shown not only by the frantic and desperate attempt “to endogenise” money, but above all by the prepotent emergence of the reality of capitalist practice – the utter inveterate yelp for help of the bourgeoisie for the State to rescue it form its theoretical-ideological blindness! The crushingly inconfutable reality of late capitalism is that, in Fisher’s words (quoted by Gertler at p561) "they (debts) [are] great enough to not only 'rock the boat' but to start it capsizing." Thus, not only is “the monetary question” central for bourgeois economic theory; it is also increasingly “critical” for the survival of capitalism itself!


(Interestingly, Gertler relates how later conventional Keynesian theories, including the monetarist perversion, tended to divorce monetary from “real” factors and then again credit from monetary factors:

“Considerable debate arose over the empirical significance of the mechanism

linking money to real activity. Indeed the early Keynesians emphasized the im-

portance of "real factors" such as the multiplier/accelerator mechanism and fis-

cal policy. The monetarists, with an intellectual foundation tied closest to classi-

cal theory but nonetheless influenced by Keynesian thinking, provided the main

support for the importance of the monetary mechanism,” (p562).)


We should stress here that whilst borrowers’ and lenders’ risk are only internal functions of capitalist command, this is not to say that therefore the “valourisation and realisation hiatus” ceases to bind or that money and finance are secondary to “real” considerations in the production process. On the contrary, the hiatus binds even more because now the distinction between “real” and “monetary” becomes superfluous in the sense that the two are aspects of a single unitary process in the circulation of capital. That bourgeois “science” seeks to conceal the reality of social relations that gives rise to “fictitious capital” with equally fictitious “asymmetries”, “transaction costs” and other “externalities” or “frictions” is yet another sign of its perennial attempt to mystify those relations.


Paradoxically, money is precisely what living labour imposes on capitalists; for, not only does the capitalist wish to pay as little as possible, but also he seeks to pay “in kind”! Money is the “uncertainty” that gnaws at the bourgeoisie, that mortal loss of “Sekuritat” (the refuge of Individualitat), the “slip ‘twixt the cup and the lip”. Money is what stands between “investment” and “profit” – that P in the formula M-C…P…C’-M’ that stands for “process of production” that symbolizes the chasm, the hiatus, the insuperable antagonism of the wage relation. “Money dissolves” the feudal link at the dawn of the capitalist era. But it also dissolves every “bond”, every “bridge” that capital may wish to project to tie living labour to its own fate and destiny, to its goals. Here is Gertler on AI:


“Another current limitation is that these frameworks have very ambiguous pol-

icy implications. In analogy to the intermediation literature, the basic issue in-

volves whether the government can improve on the types of contractual ar-

rangements that would arise in an unfettered private economy. The results are

highly sensitive to the postulated information structure…

Finally, the analyses are not well integrated with monetary theory. The major

obstacle is probably the general difficulty of incorporating money into general

equilibrium frameworks. As a result, it is difficult to sharply evaluate the effects

of monetary policy,” (p582).


As Klaes (at p111) quotes Hellwig,


“In the words of Martin F. Hellwig’s 1992 Presidential Address to the European Economic Association:

[T]he problem is to find appropriate conceptual foundations for monetary

economics. I believe that we do not, as yet, have a suitable theoretical

framework for studying the functioning of a monetary system. The main

obstacle to the development of such a framework is our habit of thinking in

terms of frictionless, organized, i.e. Walrasian markets (Hellwig 1993, p. 215).”

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