Finance, Money and Cow Clicking

Finance and its derivatives like financialization, are like many political economy categories: they’re a widely used term but lack an agreed-upon definition. One often encounters formulations like “financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions.” That isn’t very helpful!

Let me offer a simple definition of finance, which I think corresponds to its sense both for Marx and in everyday business settings. Finance is the treatment of a payment itself  as a commodity, independent of the transaction or relationship that initially gave rise to it. 

The most straightforward and, I think, oldest, form of finance in this sense is the invoice. Very few commercial transactions are in cash; much more common is an invoice payable in 30 or 60 or 90 days. This is financing; the payment obligation now appears as a distinct asset, recorded on the books of the seller as accounts receivable, and on the books of the buyer as accounts payable.

The distinct accounting existence of the payment itself, apart from the sale it was one side of, is a fundamental feature, it seems to me, of both day-to-day accounting and capitalism in a larger sense. In any case, it develops naturally into a distinct existence of payments, apart from the underlying transaction, in a substantive economic sense. Accounts payable can be sold to a third party, or (perhaps more often) borrowed against, or otherwise treated just like any other asset.

So far we’re talking about dealer finance; the next step is a third party who manages payments. Rather than A receiving a commodity from C in return for a promise of payment in 30 or 60 or 90 days, A receives the commodity and makes that promise to B, who makes immediate payment to C. Until the point of settlement, A has a debt to B, which is recorded on a balance sheet and therefore is an asset (for B) and a liability (for A.) During thins time the payment has a concrete reality as an asset that not only has a notional existence on a balance sheet, but can be traded, has a market price, etc.

If the same intermediary stands between the two sides of enough transactions, another step happens. The liabilities of the third party, B, can become generally accepted as payment by others. As Minsky famously put it, the fundamental function of a bank is acceptance — accepting the promises of various payors to the various payees. Yes, the B stands for Bank.

Arriving at banks by this route has two advantages. First, it puts credit ahead of money. The initial situation is a disparate set of promises, which come to take the form of a uniform asset only insofar as some trusted counterparts comes to stand between the various parties. Second, it puts payments ahead of intermediation in thinking about banks 

But now we must pause for a moment, and signal a turn in the argument. What we’ve described so far implicitly leans on a reality outside money world. 

As money payments, A —> C and A —> B —> C are exactly equivalent. The outcomes, described in money, are the same. The only reason the second one exists, is because they are not in reality equivalent. They are not in reality only money payments. There is always the question of, why should you pay? Why do you expect a promise to be fulfilled? There are norms, there are expectations, there are authorities who stand outside of the system of money payments and therefore are capable of enforcing them. There is an organization of concrete human activity that money payments may alter or constrain or structure, but that always remain distinct from them. When I show up to clean your house, it’s on one level because you are paying me to do it; but it’s also because I as a human person have made a promise to you as another person.

This, it seems to me, is the rational core of chartalism. The world, we’re told, is not the totality of things, but of facts. The economic world similarly is not the totality of things, but of payments and balance sheets. The economic world however is not the world. Something has to exist outside of and prior to the network of money payments.

This could, ok, be the state, as we imagine it today. This is arguably the situation in a colonial setting. The problem is that chartalism thinks the state, specifically in the form of its tax authority, is uniquely able to play this role of validating money commitments. Whereas from my point of view there are many kind of social relationships that have an existence independent of the network of money payments and might potentially be able to validate them.

Within the perspective of law, everything is law; just as within the perspective of finance, everything is finance. If you start from the law, then how can money be anything but a creature of the state? But if we start instead from concrete historical reality, we find that tax authority is just one of various kinds of social relations that have underwritten the promises of finance. 

Stefano Ugolino’s Evolution of Central Banking describes a fascinating variety of routes by which generalized payments systems evolved in Western Europe. The overwhelming impression one takes away from the book is that there is no general rule for what kinds of social relationships give rise to a centralized system of payments. Any commitment that can be commuted to cash can, in principle, backstop a currency.

In the medieval Kingdom of Naples payments were ultimately based on the transfer of claims tokens at the network pawnbrokers operated by the Catholic Church. The Kingdom of Naples, writes Ugolino, “is the only country with a central bank that was founded by a saint.” 

A somewhat parallel example is found in Knibbe and Borghaerts’ “Capital market without banks.”  There they describe an early modern setting in the Low Countries where the central entity that monetizes private debt contracts is not the tax-collecting state, but the local pastor. 

The general point is made with characteristic eloquence by Perry Mehrling in “Modern Money:Credit of Fiat”:

For monetary theory, so it seems to me, the significant point about the modern state is not its coercive power but the fact that it is the one entity with which every one of us does ongoing business.We all buy from it a variety of services, and the price we pay for those services is our taxes. … It is the universality of our dealings with the government that gives government credit its currency. The point is that the public “pay community” …  is larger than most any private pay community, not that the state s more powerful than any other private entity.

There are different kinds of recipients of money payments and the social consequences they can call on if the payments aren’t made vary widely both in severity and in kind. The logic of the system in which payments are automatically made is the same in any case. But all the interesting parts of the system are the places where it doesn’t work like that. 

Let me end with a little parable that I wrote many years ago and stuck in a drawer, but which now seems somehow relevant in this new age of NFTs.

Once upon a time there was a game called cow clicker. In this game, you click on a cow. Then you can’t click it again for a certain period of time. That’s it. That is the game.

How much is a cow click? Asked in isolation, the question is meaningless. You can’t compare it to anything. It is just an action in a game that has no other significance or effect.  How much is a soccer goal, in terms of baseball runs?

On one level, you cannot answer the question. They exist in different games. You could add up the average score per game as a conversion factor … but then should you also take into account the number of games in a season… ? But you can’t even do that with cow clicker, there is no outcome in the game that corresponds to winning or losing. There is no point to it at all — the game was created as a joke, and that is the point of the joke.

Nonetheless, and to the surprise of the guy who created it, people did play cow clicker. They liked clicking cows. They wanted more cows. They wanted to know if there was any way to shorten the timeline before they could click their cow again. 

Now suppose it was possible to get extra cow clicks by getting other people to also click a cow. These people, who wanted to click their cows more, now could persuade their friends to click cows for them. Any relationship now is a potential source of cow clicks.

For example, if you exercise any kind of coercive power over someone — a subordinate, a student, a child — you might use it to compel them to click cows for you. Or if you have anything of value, you might offer it in return for clicking cows. Clicking cows is still inherently valueless. And your relationship with your friends, kids, spouse, are valuable but not quantifiable in themselves. But now they can be expressed in terms of cow clicks.

Imagine this went further. If enough cow-clicker obsessives are willing to make real-life sacrifices — or use real-life authority — to get other people to click cows, then a capacity to click cows (some token in the game) becomes worth having for its own sake. Since you can offer it to the obsessives in return for something they have that you want. Even people who think the game is pointless and stupid now have an interest in figuring out exactly how many cows they can click in a day, and if there is any way to click more.

As more and more of social life became organized around enticing or coercing people into clicking cows, more and more relationships would take on a quantitative character, and be expressible in as a certain number of cow-clicks. These quantities would be real — they would arise impersonally, unintentionally, based on the number of clicks people were making. For instance, if a husband or wife can be convinced to click 10 times a day, while a work friend can only be convinced to click once a day on average, then a spouse really is worth 10 co-workers. No one participating in the system set the value, it is an objective fact from the point of view of participants. And, in this case, it doe express a qualitative relationship that exists outside of the game — marriage involves a stronger social bond than the workplace. But the specific quantitative ratio did not exist until now, it does not point to anything outside the game.

In this world, the original  contentless motivation of the obsessives becomes less and less important. The answer to “why are you clicking cows” becomes less anything to do with the cows, and more because someone asked me to. Or someone will reward me if I do, or someone will punish me if I don’t. And — once cow-clicks are transferable — this motivation applies just as much to the askers, rewarders and publishers. The original reason for clicking was trivially feeble but now it can even disappear entirely. Once a click can reliably be traded for real social activity, that is sufficient reason for trading one’s own social existence for clicks.

EDIT: The idea of finance as intermediation as an object in itself comes, like everything interesting in economics, from Marx. Here’s one of my favorite passages from the Grundrisse:

Bourgeois wealth, is always expressed to the highest power as exchange value, where it is posited as mediator, as the mediation of the extremes of exchange value and use value themselves. This intermediary situation always appears as the economic relation in its completeness… 

Thus, in the religious sphere, Christ, the mediator between God and humanity – a mere instrument of circulation between the two – becomes their unity, God-man, and, as such, becomes more important than God; the saints more important than Christ; the popes more important than the saints.

Where it is posited as middle link, exchange value is always the total economic expression… Within capital itself, one form of it in turn takes up the position of use value against the other as exchange value. Thus e.g. does industrial capital appear as producer as against the merchant, who appears as circulation. … At the same time, mercantile capital is itself in turn the mediator between production (industrial capital) and circulation (the consuming public) or between exchange value and use value… Similarly within commerce itself: the wholesaler as mediator between manufacturer and retailer, or between manufacturer and agriculturalist…

Then the banker as against the industrialists and merchants; the joint-stock company as against simple production; the financier as mediator between the state and bourgeois society, on the highest level. Wealth as such presents itself more distinctly and broadly the further it is removed from direct production and is itself mediated between poles, each of which, considered for itself, is already posited as economic form. Money becomes an end rather than a means; and the higher form of mediation, as capital, everywhere posits the lower as itself, in turn, labour, as merely a source of surplus value. For example, the bill-broker, banker etc. as against the manufacturers and farmers, which are posited in relation to him in the role of labour (of use value); while he posits himself toward them as capital, extraction of surplus value; the wildest form of this, the financier.

You read this stuff and you think — how can you not? — that Marx was a smart guy,

“Has Finance Capitalism Destroyed Industrial Capitalism?”

(At the big economics conference earlier in January, I spoke on a virtual panel in response to Michael Hudon’s talk on the this topic. HIs paper isn’t yet available, but he has made similar arguments here and here. My comments were in part addressed to his specific paper, but were also a response to the broader discussion around financialization. A version of this post will appear in a forthcoming issue of the Review of Radical Political Economics.)

Michael Hudson argues that the industrial capitalism of a previous era has given way to a new form of financial capitalism. Unlike capitalists in Marx’s day, he argues, today’s financial capitalists claim their share of the surplus by passively extracting interest or economic rents broadly. They resemble landlords and other non-capitalist elites, whose pursuit of private wealth does not do anything to develop the forces of production, broaden the social division of labor, or prepare the ground for socialism.

Historically, the progressive character of capitalism comes from three dimensions on which capitalists differ from most elites. First, they do not merely claim the surplus from production, but control the production process itself; second, they do not use the surplus directly but must realize it by selling it on a market; and third, unlike most elites who acquire their status by inheritance or some similar political process, a capitalist’s continued existence as a capitalist depends on their ability to generate a large enough money income to acquire new means of production. This means that capitalists are under constant pressure to reduce the costs through technical improvements to the production process. In some cases the pressure to reduce costs may also lead to support for measures to socialize the reproduction costs of labor power via programs like public education, or for public provision of infrastructure and other public services.

In Hudson’s telling, financial claims on the surplus are essentially extractive; the pursuit of profit by finance generates pressure neither for technical improvements in the production process, nor for cost-reducing public investment. The transition from one to the other as the dominant form of surplus appropriation is associated with a great many negative social and political developments — lower wages, privatization of public goods, anti-democratic political reforms, tax favoritism and so on. (The timing of this transition is not entirely clear.)

Other writers have told versions of this story, but Hudson’s is one of the more compelling I have seen. I am impressed by the breadth of his analysis, and agree with him on almost everything he finds objectionable in contemporary capitalism.  

I am not, however, convinced. I do not think that “financial” and “industrial” capital can be separated in the way he proposes. I think it is better to consider them two moments of a single process. Connected with this, I am skeptical of the simple before and after periodization he proposes. Looking at the relationship between finance and production historically, we can see movements in both directions, with different rhythms in different places and sectors. Often, the growth of industrial capitalism in one industry or area has gone hand in hand with a move toward more financial or extractive capitalism somewhere else. I also think the paper gives a somewhat one-sided account of developments in the contemporary United States. Finally, I have concerns about the political program the analysis points to.

1.

Let’s start with idea that industrial capitalists support public investments in areas like education, health care or transportation because they lower the reproduction costs of labor. This is less important for owners of land, natural resources or money, whose claim on the social surplus doesn’t mainly come through employing labor. 

I wouldn’t say this argument is wrong, exactly, but I was struck by the absence of any discussion of the other ways in which industrial capitalists can reduce the costs of labor — by lowering the subsistence level of workers, or reducing their bargaining power, or extracting more work effort, or shifting employment to lower-wage regions or populations. The idea that the normal or usual result of industrial capitalists’ pursuit of lower labor costs is public investment seems rather optimistic.

Conversely, public spending on social reproduction only reduces costs for capitalist class insofar as the subsistence level is fixed. As soon as we allow for some degree of conflict or bargaining over workers share of the social product, we introduce possibility that socializing reproduction costs does not lower the price of labor, but instead raises the living standards of the human beings who embody that labor. Indeed, that’s why many people support such public spending in the first place!

On the flip side, the case against landlords as a force for capitalist progress is not as straightforward as the paper suggests. 

Ellen Meiksins Wood argues, convincingly, that the origins of what Hudson calls industrial capitalism should really be placed in the British countryside, where competition among tenants spurred productivity-boosting improvements in agricultural land. It may be true that these gains were mostly captured by landlords in the form of higher rents, but that does not mean they did not take place. Similarly, Gavin Wright argues that one of the key reasons for greater public investment in the ante-bellum North compared with the South was precisely the fact that the main form of wealth in the North was urban land. Land speculators had a strong interest in promoting canals, roads and other forms of public investment, because they could expect to capture gains from them in the form of land value appreciation. 

In New York City, the first subways were built by a company controlled by August Belmont, who was also a major land speculator. In a number of cases, Belmont — and later the builders of the competing BMT system — would extend transit service into areas where they or their partners had assembled large landholdings, to be able to develop or sell off the land at a premium after transit made it more valuable. The possibility of these gains was probably a big factor in spurring private investment in transit service early in the 20th century.

Belmont can stand as synecdoche for the relationship of industrial and financial capital in general. As the organizer of the labor engaged in subway construction, as the one who used the authority acquired through control of money to direct social resources to the creation of new means of transportation, he appears as an industrial capitalist, contributing to the development of the forces of production as well as reducing reproduction costs by giving workers access to better, lower-cost housing in outlying areas. As the real estate speculator profiting by selling off land in those areas at inflated prices, he appears as a parasitic financial capitalist. But it’s the same person sitting in both chairs. And he only engaged in the first activity in the expectation of the second one.

None of this is to defend landlords. But it is to make the point that the private capture of the gains from the development of the forces of production is, under capitalism, a condition of that development occurring in the first place, as is the coercive control over labor in the production process. If we can acknowledge the contributions of a representative industrial capitalist like Henry Frick, author of the Homestead massacre, to the development of society’s productive forces, I think we can do the same for a swindler like August Belmont.

More broadly, it seems to me that the two modes of profit-seeking that Hudson calls industrial and financial are not the distinct activities they appear as at first glance. 

It might seem obvious that profiting from a new, more efficient production process is very different from profiting by using the power of the state to get some legal monopoly or just compel people to pay you. It is true that the first involves real gains for society while the second does not. But how do those social gains come to be claimed as profit by the capitalist? First, by the exclusive access they have to the means of production that allows them to claim the product, to the exclusion of everyone else who helped produce it. And second, by their ability to sell it at a price above its cost of production that allows them to profit, rather than everyone who consumes the product. In that sense, the features that Hudson points to as defining financial capitalism are just as fundamental to industrial capitalism. Under capitalism, making a product is not a distinct goal from extracting a rent. Capturing rents is the whole point.

The development of industry may be socially progressive in a way that the development of finance is not. But that doesn’t mean that the income and authority of the industrial capitalist is different from that of the financial capitalist, or even that they are distinct people.

Hudson is aware of this, of course, and mentions that from a Marxist standpoint the capitalist is also a rentier. If he followed this thought further I think he would find it creates problems for the dichotomy he is arguing for.

Let’s take a step back.

Capital is a process, a circuit: M – C – P – C’ – M’. Money is laid out to gain control of commodities and labor power, which are the combined in a production process. The results of this process are then converted back into money through sale on the market.

At some points in this circuit, capital is embodied in money, at other points in labor power and means of production. We often think of this circuit as happening at the level of an individual commodity, but it applies just as much at larger scales. We can think of the growth of an industrial firm as the earlier part of the circuit where value comes to be embodied in a concrete production process, and payouts to shareholders as the last part where value returns to the money form. 

This return to money form just as essential to the circuit of capital as production is. It’s true that payouts to shareholders absorb large fraction of profits, much larger than what they put in. We might see this as a sign that finance is a kind of parasite. But we could also see shareholder payouts as where the M movement is happening. Industrial production doesn’t require that its results be eventually realized as money. But industrial capitalism does. From that point of view, the financial engineers who optimize the movement of profits out of the firm are as integral a part of industrial capital as the engineer-engineers who optimize the production process. 

2.

My second concern is with the historical dimension of the story. The sense one gets from the paper is that there used to be industrial capitalism, and now there is financial capitalism. But I don’t think history works like that.

It is certainly true that the forms in which a surplus is realized as money have changed over time. And it is also true that while capital is a single process, there are often different human beings and institutions embodying it at different points in the circuit.

In a small business, the same person may have legal ownership of the enterprise, directly manage the production process, and receive the profits it generates. Hudson is certainly right that this form of enterprise was more common in the 19th century, which among other things allowed Marx to write in Volume One about “the capitalist” without having to worry too much about exactly where this person was located within the circuit. In a modern corporation, by contrast, production is normally in the hands of professional managers, while the surplus flows out to owners of stock or other financial claims. This creates the possibility for the contradiction between the conditions of generating a surplus and of realizing it, which always exists under capitalism, to now appear as a conflict between distinct social actors.

The conversion of most large enterprises to publicly traded corporations took place in the US in a relatively short period starting in the 1890s. The exact timing is of course different elsewhere, but this separation of ownership and control is a fairly universal phenomenon. Even at the time this was perceived as a momentous change, and if we are looking for a historical break that I think this is where to locate it. Already by the early 20th century, the majority of great fortunes took the form of financial assets, rather than direct ownership of businesses. And we can find contemporary observers like Veblen describing “sabotage” of productive enterprises by finance (in The Price System and the Engineers) in terms very similar to the ones that someone like Michael Hudson uses today.

It’s not unreasonable to describe this change as financialization. But important to realize it’s not a one-way or uniform transition.

In 1930s, Keynes famously described American capital development as byproduct of a casino, again in terms similar to Hudson’s. In The General Theory, an important part of the argument is that stock markets have a decisive influence on real investment decisions. But the funny thing is that at that moment the trend was clearly in the opposite direction. The influence of financial markets on corporate managers diminished after the 1920s, and reached its low point a generation or so after Keynes wrote.  

If we think of financialization as the influence of financial markets over the organization of production, what we see historically is an oscillation, a back and forth or push and pull, rather than a well-defined before and after. Again, the timing differs, but the general phenomenon of a back and forth movement between more and less financialized capitalism seems to be a general phenomenon. Postwar Japan is often pointed to, with reason, as an example of a capitalist economy with a greatly reduced role for financial markets. But this was not a survival from some earlier era of industrial capitalism, but rather the result of wartime economic management, which displaced financial markets from their earlier central role.

Historically, we also find that moves in one direction in one place can coexist with or even reinforce moves the other way elsewhere. For example, the paper talks about the 19th-century alliance of English bankers and proto-industrialists against landlords in the fight to overturn the corn laws. Marx of course agreed that this was an example of the progressive side of capitalist development. But we should add that the flip side of Britain specializing in industry within the global division of labor was that other places came to specialize more in primary production, with a concomitant increase in the power of landlords and reliance on bound labor. Something we should all have learned from the new historians of capitalism like Sven Beckert is how intimately linked were the development of wage labor and industry in Britain and the US North with he development of slavery and cotton production in the US South; indeed they were two sides of the same process. Similar arguments have been made linking the development of English industry to slave-produced sugar (Williams), and to the second serfdom and de-urbanization in Eastern Europe (Braudel). 

Meanwhile, as theorists of underdevelopment like Raul Prebisch have pointed out, it’s precisely the greater market power enjoyed by industry relative to primary products that allows productivity gains in industry to be captured by the producers, while productivity gains in primary production are largely captured by the consumers. We could point to the same thing within the US, where tremendous productivity advances in agriculture have led to cheap food, not rich farmers. Here again, the relationship between the land-industry binary and the monopoly-competition binary is the opposite as Hudson’s story. This doesn’t mean that they always line up that way, either, but it does suggest that the relationship is at least historically contingent.

3.

Let’s turn now to the present. As we all know, since 1980 the holders of financial assets have reasserted their claims against productive enterprises, in the US and in much of the rest of the world. But I do not think this implies, as Hudson suggests, that today’s leading capitalists are the equivalent of feudal landowners. While pure rentiers do exist, the greatest accumulations of capital remain tied to control over the production process. 

Even within the financial sector, extraction is only part of the story. A major development in finance over the past generation has been the growth of specialized venture capital and private equity funds. Though quite different in some ways — private equity specializing in acquisition of existing firms, venture capital in financing new ones — both can be seen as a kind of de-financialization, in the sense that both function to re-unite management and ownership. It is true of course, that private equity ownership is often quite destructive to the concrete production activities and social existence of a firm. But private equity looting happens not through the sort of arm’s length tribute collection of al landlord, but through direct control over the firm’s activity. The need for specialized venture capital funds to invest in money-losing startups, on the other hand, is certainly consistent with the view that strict imposition of financial criteria is inconsistent with development of production. But it runs against a simple story in which industry has been replaced by finance. (Instead, the growth of these sectors looks like an example of the way the capital looks different at different moments in its circuit. Venture capitalists willing to throw money at even far-fetched money-losing enterprises, are specialists in the M-C moment, while the vampires of private equity are specialists in C-M.)

It is true, of course, that finance as an industry has grown relative to the economy over the past 50 years, as have the payments made by corporations to shareholders.   Hudson describes these trends as a “relapse back toward feudalism and debt peonage”, but I don’t think that’s right. The creditor and the landlord stand outside the production process. A debt peon has direct access to means of production, but is forced to hand over part of the product to the creditor or landlord. Capitalists by contrast get their authority and claim on surplus from control over the production process. This is as true today as when Marx wrote. 

There is a widespread view that gains from ownership of financial assets have displaced profits from production even more many nonfinancial corporations, and that household debt service is a form of exploitation that now rivals the work place as a source of surplus, as households are forced to take on more debt to meet their subsistence needs. But these claims are mistaken — they confuse the temporary rise in interest rates after 1980 for a deeper structural shift.

As Joel Rabinovich convincingly shows, the increased financial holdings of nonfinancial corporations mostly represent goodwill from mergers and stakes in subsidiaries, not financial assets in the usual sense, while the apparent rise in their financial income of in the 1980s is explained by the higher interest on their cash holdings. With respect to household debt, it continues to overwhelmingly finance home ownership, not consumption; is concentrated in the upper part of the income distribution; and rose as a result of the high interest rates after 1980, not any increase in household borrowing. (See my discussion here.) With the more recent decline in interest rates, much of this supposed finacialization has reversed. Contrary to Hudson’s picture of an ever-rising share of income going to debt service, interest payments in the US now total about 17 percent of GDP, the same as in 1975.

On the other side, the transformation of the production process remains the source of the biggest concentrations of wealth. Looking at the Forbes 400 list of richest Americans, it is striking how rare generalized financial wealth is, as opposed to claims on particular firms. Jeff Bezos (#1), Bill Gates (#2) and Mark Zuckerberg (#3) all gained their wealth through control over newly created production processes, not via financial claims on existing ones. Indeed, of the top 20 names on the list, all but one are founders and active managers of companies or their immediate families. (The lone exception is Warren Buffet.) Finance and real estate are the source of a somewhat greater share of the fortunes found further down the list, but nowhere near a majority.

Companies like Wal Mart and Google and Amazon are clearly examples of industrial capitalism. They sell products, they lower prices, they put strong downward pressure on costs. Cheap consumer goods at Wal Mart lower the costs of subsistence for workers today just as cheap imported food did for British workers in the 19th century.

Does this mean Amazon and Wal Mart are good? No, of course not. (Tho we shouldn’t deny that their logistical systems are genuine technological accomplishments that a socialist society could build on.) My point is that the greatest concentrations of wealth today still arise from the competition to sell more desirable goods at lower prices. This runs against the idea of dominance by rentiers or passive rent-extractors. 

Finally, I have some concerns about the political implications of this analysis. If we take Hudson’s story seriously, we may see a political divide between industrial capital and finance capital, and the possibility of a popular movement seeking alliance with the former. I am doubtful about this. While finance is a distinct social actor, I do not think it is useful to think of it as a distinct type of capital, one that is antagonistic to productive capital. As I’ve written elsewhere, it’s better to see finance as weapon by which the claims of wealth holders are asserted against the rest of society.

Certainly I don’t think the human embodiments of industrial capital would agree that they are victims of finance. Many of the features of contemporary capitalism he objects would appear to them as positive developments. Low wages, weak labor and light taxes are desired by capitalists in general, not just landlords and bankers. The examples Hudson points to of industrial capitalists and their political representatives supporting measures to socialize the costs of reproduction are real and worth learning from, but as products of specific historical circumstances rather than as generic features of industrial capitalism. We would need a better account of the specific conditions under which capital turns to programs for reducing labor costs in this way — rather than, for example, simply forcing down wages — to assess to what extent, and in which areas, they exist today. 

Even if it were feasible, I am not sure this kind of program does much to support a more transformative political project. Hudson quotes Simon Patten’s turn-of-the-last-century description of public services like education as a “fourth factor of production” that is necessary to boost industrial competitiveness, with the implication that similar arguments might be successful today. Frankly, this kind of language strikes me as more characteristic of our neoliberal era than a basis for an alternative to it. As a public university teacher, I reject the idea that my job is to raise the productive capacity of workers, or reduce the overhead costs of American capital. Nor do I think we will be successful in defending education and other public goods from defunding and austerity using this language. And of course, it is not the only language available to us. As Mike Konczal notes in his new book Freedom from the Market, historically the case for public provision has often been made in terms of removing certain areas of life from the market, as well as the kinds of arguments Hudson describes.

More fundamentally, the framing here suggests that the objectionable features of capitalism stem from it not being capitalist enough. The focus on monopolies and rents suggests that what is wanted is more vigorous market competition. It is a strikingly Proudhonian position to say that the injustice and waste of existing capitalism stem from the failure of prices to track costs of production. Surely from a Marxist perspective it is precisely the pressure to compete on the basis of lower costs that is the source of that injustice and waste.

There is a great deal that is interesting and insightful in this paper, as there always is in Michael Hudson’s work. But I remain unconvinced that financial and industrial capitalism can be usefully thought of as two opposed systems, or that we can tell a meaningful historical story about a transition between them. Industry and finance are better thought of, in my view, as two different sides of the same system, or two moments in the same circuit of capital.  Capitalism is a system in which human creative activity is subordinated to the endless accumulation of money. In this sense, finance is as integral to it as production. A focus on on the industrial-financial divide risks attributing the objectionable effects of accumulation to someone else — a rentier or landlord — leaving a one-sided and idealized picture of productive capital as the residual.

This being URPE, many people here will have at one time or another sung “is there aught we have in common with the greedy parasites?” Do we think those words refer to the banker only, or to the boss?

 

UPDATE: My colleague Julio Huato made similar arguments in response to an earlier version of Hudson’s paper a few years ago, here.

 

On Negative Rates

Negative interest rates – weird, right?

In the five thousand years that interest rates have been recorded, they’ve never hit zero before.  Today, there’s some $15 trillion in negative-yielding bonds — admittedly down from $17 trillion last year, but still a very substantial fraction of the global bond market outside the US. At first it was only shorter bonds that were negative, but today German bunds are negative all the way out to 30 years. What’s going on? Does this mean it would be profitable to bulldoze the Rockies for farmland? Will it cause the extinction of the banking system? And more fundamentally, if the interest rate reflects the cost of a good today in terms of the same good next year, why would it ever be negative? Why would people place a higher value on stuff in the future than on stuff today?

Personally, I don’t think they’re so weird. And the reason I think that is that interest rates are not, in fact, the price of goods today in terms of goods tomorrow. It is, rather, the price of a financial asset that promises a certain schedule of money payments. Negative rates are only a puzzle in the real-exchange perspective that dominates economics, where we can safely abstract from money when discussing interest rates. In the money view, where interest transactions are swap of assets, or of a stream of money payments, nothing particularly strange about them. 

(I should say up front that this post is an attempt to clarify my own thinking. I think what I’m writing here is right, but I’m open to hearing why it’s wrong, or incomplete. It’s not a finished or settled position, and it’s not backed up by any larger body of work. At best, like most of what I wrote, it is informed by reading a lot of Keynes.)

The starting point for thinking about negative rates is to remember that these are market prices. Government is not setting a negative yield by decree, someone is voluntarily holding all those negative-yielding bonds. Or more precisely, someone is buying a bond at a price high enough, relative to the payments it promises, to imply a negative yield. 

Take the simplest example — a government bond that promises a payment of $100 at some date in the future, with no other payments in between. (A zero-coupon bond, in other words.) If the bond sells today for less than $100, the interest rate on it is positive. If the bond sells today for more than $100, the interest rate is negative. Negative yields exist insofar market participants value such a bond at greater than $100. 

So now we have to ask, what are the sources of demand for government bonds?

A lot of confusion is created, I think, by asking this question the wrong way. People think about saving, and about trading off spending today against spending tomorrow. This after all is the way an economics training encourages you to think about interest rates — as a shorthand for any exchange between present and future. Any transaction that involves getting less today in return for more tomorrow incorporates the interest rate as part of the price — at a high enough level of abstraction, they’re all the same thing. The college wage premium, say, is just as much an interest rate from this perspective as the yield on the bond. 

If we insist on thinking of interest rates this way, we would have to explain negative yields in terms of a society-wide desire to defer spending, and/or the absence of any store of wealth that even maintains its value, let alone increases it. Either of those would indeed be pretty weird!

(Or, it would be the equivalent of people paying more for a college education than the total additional wages they could expect to earn from it, or people paying more for a house than the total cost of renting an identical one for the rest of their lives. Which are both things that might happen! But also, that would be generally seen as something going wrong in the economic system.)

Since economists (and economics-influenced people) are so used to thinking of interest as reflecting a tradeoff between present and future, a kind of inter-temporal exchange rate, it’s worth an example to clarify why it isn’t. Imagine a typical household credit transaction, a car loan. The household acquires means to pay for the acquisition of a car, and commits to a schedule of payments to the bank; the bank gets the opposite positions. Is the household giving up future consumption in order to consume now? No. At every period, the value the household gets from the use of the car will exceed the payments the household is making for it — otherwise, they wouldn’t be doing it. If anything, since the typical term of a car loan is six or seven years while a new car should remain in service for a decade or more, the increased consumption comes in the future, when the car is paid off and still delivering transport services. Credit, in general, finances assets, not consumption. The reason car loans are needed is not to shift consumption from the future to the present, but because use of the transportation services provided by the car are tightly bound up with ownership of the car itself.

Nor, of course, is the lender shifting present consumption to the future. The lender itself, being a bank, does not consume. And no one else needs to forego or defer consumption for the banks to make the auto loan either. No one needs to deposit savings in a bank before it makes a loan; the lent money is endogenous, created by banks in the course of lending it. Whatever factors limit the willingness of the bank to extend additional auto loans — risk; liquidity; capital; regulation; transaction costs — a preference for current consumption is not among them. 

The intertemporal-exchange way of looking at government bonds would make sense if the only way to acquire one was to forego an equal amount of consumption, so that bond purchases were equivalent to saving in an economic sense. Then understanding the demand for government bonds, would be the same as understanding the desire to save, or defer consumption. But of course government bonds are not part of some kind of economy-wide savings equilibrium like that. First of all, the purchasers of bonds are not households, but banks and other financial actors. Second, the purchase of the bond does not entail a reduction in current spending, but a swap of assets. And third, the owners of bonds do not hold them in order to finance some intended real expenditure in the future, but rather for some combination of benefits from owning them (liquidity, safety, regulation) and an expectation of monetary profit. 

From the real-exchange perspective, there is one intertemporal price — the interest rate —  just as there is one exchange rate between any given pair of countries. From the money view perspective, there are many different interest rates, corresponding to the different prices of different assets promising future payments. Many of the strong paradoxes people describe from negative rates only exist if rates are negative across the board. But in reality, rates do not move in lockstep. We will set aside for now the question of how strong the arbitrage link between different assets actually is.

We can pass over these questions because, again, government bonds are not held for income. They are not held by households or the generic private sector. They are overwhelmingly held by banks and bank-like entities for some combination of risk, liquidity and regulatory motives, or by a broader set of financial institutions for return. Note for later: Return is not the same as income!

Let’s take the first set of motivations first. 

If you are a bank, you may want to hold some fraction of your assets as government bonds in order to reduce the chance your income will be very different from what you expected; reduce the chance that you will find yourself unable to make payments that you need or want to make (since it’s easy to sell the bonds as needed); and/or to reduce the chance that you’ll fall afoul of regulation  (which presumably is there because you otherwise might neglect the previous two goals).

The key point here is that these are benefits of holding bonds that are in addition to whatever return those bonds may offer. And if the ownership of government bonds provides substantial benefits for financial institutions, it’s not surprising they would be willing to pay for those services.

This may be clearer if we think about checking accounts. Scare stories about negative rates often ask what happens when households have to pay for the privilege of lending money to the bank. Will they withdraw it all as cash and keep it under the mattress? But of course, paying the bank to lend it money is the situation most people have always been in. Even before the era of negative rates, lots of people held money in checking accounts that carried substantial fees (explicit and otherwise) and paid no interest, or less than the cost of the fees. And of course unbanked people have long paid exorbitant amounts to be able to make electronic payments. In general, banks have no problem getting people to hold negative-yield assets. And why would they? The payments services offered by banks are valuable. The negative yield just reflects people’s willingness to pay for them.

In the national accounts, the difference between the interest that bank depositors actually receive and a benchmark rate that they in some sense should receive is added to their income as “imputed interest”, which reflects the value of the services they are getting from their low- or no- or negative-interest bank accounts. In 2019, this imputed interest came to about $250 billion for households and another $300 billion for non financial corporations. These nonexistent interest payments are, to be honest, an odd and somewhat misleading thing to include in the national accounts. But their presence reflects the genuine fact that people hold negative and more broadly below-market yield assets in large quantities because of other benefits they provide. 

Turned around this way, the puzzle is why government debt ever has a positive yield. The fundamental form of a bond sale is the creating of pair of offsetting assets and liabilities. The government acquires an asset in the form of a deposit, which is the liability of the bank; and the bank acquires an asset in the form of a bond, which is the liability of the government. Holding the bond has substantial benefits for the bank, while holding the deposit has negligible benefits for the government. So why shouldn’t the bank be the one that pays to make the transaction happen?

One possible answer is the cost of financing the holding. But, it is normally assumed that the interest rate paid by banks follows the policy rate. There’s no obvious reason for the downward shift in rates to affect spread between bank deposits and government bonds.  Of course some bank liabilities will carry higher rates, but again, that was true In the past too.

Another possible answer is the opportunity cost of not holding positive-yield asset. Again, this assumes that other yields don’t move down too. More fundamentally, it assumes a fixed size of bank balance sheets, so that holding more of one asset means less of another. In a world with with a fixed or exogenous money stock, or where regulations and monetary policy create the simulacrum of one, there is a cost to the bank of holding government debt, namely the income from whatever other asset it might have held instead. Many people still have this kind of mental model in thinking about government debt. (It’s implicit in any analysis of interest rates in terms of saving.) But in a world of endogenous credit money, holding more government debt doesn’t reduce a bank’s ability to acquire other assets. Banks’ ability to expand their balance sheets isn’t unlimited, but what limits it is concerns about risk or liquidity, or regulatory constraints. All of these may be relaxed by government debt holdings, so holding more government bonds may increase the amount of other assets banks can hold, not reduce it. In this case the opportunity cost would be negative. 

So why aren’t interest rates on government debt usually negative? As a historical matter, I suppose the reasons we haven’t seen negative yields in the past are, first, that under the gold standard, government bonds were not at the top of the hierarchy of money and credit, and governments had to pay to access higher-level money; in some contexts government debt may have been lower in the hierarchy than bank money as well. Second, in the postwar era the use of the interest rate for demand control has required central banks to ensure positive rates on public  as well as private debt. And third, the safety, liquidity and regulatory benefits of government debt holdings for the financial system weren’t as large or as salient before the great financial crisis of 2007-2009. 

Even if negative yields aren’t such a puzzle when we think about the sources of bank demand for government debt, we still have the question of how low they can go. Analytically, we would have to ask, how much demand is there for the liquidity, safety and regulatory-compliance services provided by sovereign debt holdings, and to what extent are there substitute sources for them?

But wait, you may be saying, this isn’t the whole story. Bonds are held as assets, not just as reserves for banks and bank-like entities. Are there no bond funds, are there no bond traders?

These investors are the second source of demand for government bonds. For them, return does matter. The goal of making a profit from holding the bond is the second motivation mentioned earlier.

The key point to recognize here is that return and yield are two different things. Yield is one component of return. The other is capital gains. The market price of a bond changes if interest rates change during the life of the bond, which means that the overall return on a negative-yielding bond can be positive. This would be irrelevant if bonds were held to maturity for income, but of course that is not bond investment works. 

For foreign holders, return also includes gains or losses from exchange rate changes, but we can ignore that here. Most foreign holders presumably hold government bonds as foreign exchange reserves, which is a subset of the safety/liquidity/regularity benefits discussed above. 

To understand how negative yielding bonds could offer positive returns, we have to keep in mind what is actually going on with bond prices, including negative rates. The borrower promises one or more payments of specified amounts at specified dates in the future. The purchaser then offers a payment today in exchange for that stream of future payments. What we call an interest rate is a description of the relationship between the promised payments and the immediate payment. We normally think of interest as something paid over a period of time, but strictly speaking the interest rate is a price today for a contract today. So unlike in the checking account case, the normal negative-rates situation is not the lender paying the borrower. 

Here’s an example. Suppose I offer to pay you $100 30 years from now. This is, formally, a zero-coupon 30-year bond. How much will you pay for this promse today? 

If you will pay me $41 for the promise, that is the same as saying the interest rate on the loan is 3 percent. (41 * 1.03 ^ 30 = 100). So an interest rate of 3 percent is just another way of saying that the current market price of a promise of $100 30 years from now is $41. 

If you will pay me $55 for the promise, that’s the same as an interest rate of 2 percent. If you’ll pay me $74, that’s the same as an interest rate of 1 percent.

If you’ll pay me $100 for the promise, that is of course equivalent to an interest rate of 0. And if you’ll pay me $135 for the promise of $100 30 years from now, that’s the equivalent of an interest of -1 percent. 

When we look at things this way, there is nothing special about negative rates. There is just continuous range of prices for an asset. Negative rates refer to the upper part of the range but nothing in particular changes at the boundary between them. Nothing magical or even noticeable happens when the price of an asset (in this case that promise of $100) goes from $99 to $101, any different from when it went from $97 to $99. The creditor is still paying the borrower today, the borrower is still paying the creditor in the future.

Now the next step: Think about what happens when interest rates change. 

Suppose I paid $135 for a promise of $100 thirty years from now, as in the example above. Again, this equivalent to an interest rate of -1 percent. Now it’s a year later, so I have a promise of $100 29 years from now. At an interest rate of -1 percent, that is worth $133.50. (The fact that the value of the bond declines over time is another way of seeing that it’s a negative interest rate.) But now suppose that, in the meantime, market interest rates have fallen to -2 percent. That means a promise of $100 29 years from now is now worth $178. (178 * 0.98 ^ 29 = 100.) So my bond has increased in value from $135 to $178, a capital gain of one-third! So if I think it is even modestly more likely that interest rates will fall than that they’ll rise over the next year, the expected return on that negative-yield bond is actually positive.

Suppose that it comes to be accepted that the normal, usual yield on say, German 10-year bunds is -1 percent. (Maybe people come to agree that the liquidity, risk and regulatory benefits of holding them are worth the payment of 1 percent of their value a year. That seems reasonable!) Now, suppose that the yield starts to move toward positive territory – for concreteness, say the current yield reaches 0, while people still expect the normal yield to be -1 percent. This implies that the rise to 0 is probably transitory. And if the ten-year bund returns to a yield of -1 percent, that implies a capital gain on the order of 10 percent for anyone who bought them at zero. This means that as soon as the price begins to rise toward zero, demand will rise rapidly. And the bidding-up of the price of the bund that happens in response to the expected capital gains, will ensure that the yield never in fact reaches zero, but stops rising before gets much above -1 percent. 

Bond pricing is a technical field, which I have absolutely no expertise in. But this fundamental logic has to be an important factor in decisions by investors (as opposed to financial institutions) who hold negative-yielding bonds in their portfolios. The lower you expect bond yields to be in the future, the higher the expected return on a bond with a given yield today. If a given yield gets accepted as usual or normal, then expected capital gains will rise rapidly when the yield rises above that — a dynamic that will ensure that the actual yield does not in fact depart far from the normal one. Capital gains are a bigger part of the return the lower the current yield is. So while high-yielding bonds can see price moves in response to fundamentals (or at least beliefs about them), these self-confirming expectations (or conventions) are likely to dominate once yields fall to near zero. 

These dynamics disappear when you think in terms of an intertemporal equilibrium where future yields are known and assets are held to maturity. When we think of trading off consumption today for consumption tomorrow, we are implicitly imagining something equivalent to holding bond to maturity. And of course if you have a model with interest rates determined by some kind of fundamentals by a process known to the agents in the model — what is called model-consistent or rational expectations — than it makes to sense to say that people could believe the normal or “correct” level of interest rates is anything other than what it is. So speculation is excluded by assumption.

Keynes understand all this clearly, and the fact that the long-term interest rate is conventionally determined in this way is quite important to his theory. But he seems never to have considered the possibility of negative yields. As a result he saw the possibility of capital gains as disappearing as interest rates got close to zero. This meant that for him, the conventional valuation was not symmetrical, but operated mainly as a floor. But once we allow the possibility of negative rates, conventional expectations can prevent a rise in interest rates just as easily as a fall. 

In short, negative yields are a puzzle and a problem in the real exchange paradigm that dominates economic conversation, in which the “interest rate” is the terms on which goods today exchange for goods in the future. But from the money view, where the interest rate is the (inverse of) the price of an asset yielding a flow of money payments, there is nothing especially puzzling about negative rates. It just implies greater demand for the relevant assets. A corollary is that while there should be a single exchange rate between now and later, the prices of different assets may behave quite differently. So while many of the paradoxes people pose around negative rates assume that all rates go negative together, in the real world the average rate on US credit cards, for example, is still about 15 percent — the same as it was 20 years ago. 

In the future, the question people may ask is not how interest rates could be negative, but why was it that the government for so long paid the banks for the valuable services its bonds offered them? 

Money and Cryptocurrencies


(This is an edited and expanded version of a talk I gave in Trento, Italy in June 2018, on a panel with Sheila Dow.)

The topic today is “Digital currencies: threat or opportunity?”

I’d like to offer a third alternative: New digital currencies like bitcoin are neither a threat or an opportunity. They do not raise any interesting economic questions and do not pose any significant policy problems. They do not represent any kind of technological advance on existing payment systems, which are of course already digital. They are just another asset bubble, based on the usual mix of fraud and fantasy. By historical standards, they are not a very large or threatening bubble. There is nothing important about them at all.

Why might you conclude that the new digital currencies don’t matter?

– Aggregate size – the total value of all bitcoin is on the order of $200 billion, other digital currencies are much smaller. On the scale of modern financial markets that’s not much more than a rounding error.

– No articulation with the rest of the financial system. No banks or other important institutions rely on cryptocurrencies to settle transactions, or have substantial holdings on their balance sheets. They’re not used as collateral for loans.

– Not used to structure real activity. No significant part of collective productive or reproductive activity is organized by making payments or taking positions in cryptocurrencies.

Besides that, these currencies don’t even do what they claim to do. In practice, digital currencies do depend on intermediaries. Payment is inconvenient and expensive — as much as $14 per transaction, and accepted by only 3 of top 500 online retailers. And markets in these currencies are not decentralized, but dominated by a few big players. All this is documented in Mike Beggs’ wonderful Jacobin article on cryptocurrencies, which I highly recommend.

Compare this to the mortgage market. Total residential mortgages in the US are over $13 trillion, not far short of GDP. The scale is similar in many other countries. Mortgages are a key asset for the financial system, even when not securitized. And of course they play a central role in organizing the provision of housing (and commercial space), an absolutely essential function to social reproduction.

And yet here we are talking about cryptocurrencies. Why?

Partly it’s just hard money crankery and libertarianism, which have a outsized voice in economics discussions. And partly it’s testimony to the success of their marketing machine. One might say that the only thing that stands behind that $200 billion value, is the existence of conversations like this one.

But it’s not just cranks and libertarians who care about cryptocurrencies. Central bank research departments are earnestly exploring the development of digital currencies. This disproportionate attention reflects, I think, some deeper problems with how we think of money and central banking. The divide over whether crypto-currencies represent anything new or important reflects a larger divide over how we conceive of the monetary system.

In the language of Schumpeter — whose discussion in his History of Economic Thought remains perhaps the best starting point for thinking about these things — it comes down to whether we “start from the coin.” If we start from the coin, if we think of money as a distinct tangible thing, a special kind of asset, then bitcoin may look important. We could call this the quantity view of money. But if we follow Schumpeter — and in different ways Hyman Minsky, Perry Mehrling and David Graeber — and start from balance sheets, then it won’t. Call this the ledger view of money.

In the quantity view, “money” is something special. The legal monopoly of governments on printing currency is very important, because that is money in a way that other assets aren’t. Credit created by banks is something different. Digital currencies are a threat or opportunity, as the case may be, because they seem to also go in this exclusive “outside money” box.

But from the Minsky-Mehrling-Graeber point of view, there’s nothing special about outside money. It’s just another set of tokens for recording changes in the social ledger. What matters isn’t the way that changes are recorded, but the accounts themselves. From this perspective, “money” isn’t an asset, a thing, it is simply the arbitrary units in which ledgers are kept and contracts denominated.

The starting point, from this point of view, is a network of money payments and commitments. Some of these commitments structure real activity (I show up for work because I expect to receive a wage). Others are free-standing. (I pay you interest because I owe you a debt.) In either case money is simply a unit of account. I have made a promise to you, you have a made a promise to someone else; these promises are in some cases commitments to specific concrete activities (to show up for work and do what you’re told), but in other cases they are quantitative, measured as a certain quantity of “money.”

What does money mean here? Simply whatever will be accepted as fulfilment of the promise, as specified in whatever legal or quasi-legal provisions govern it. It is entirely possible for the unit of account to have no concrete existence at all. And in any case the concrete assets that will be accepted are never identical; their equivalence is to some extent a fiction enshrined in the terms of the contract, and to some extent the result of active interventions by whatever authorities are responsible for the payments system.

In short, the fact that some particular asset that serves as money in this or that case is not very interesting. What matters is the balance sheets. Money is just a means of recording changes on balance sheets, of making transfers between ledgers. If we take the ledger view, then there’s no difference between physical currency and an instrument like a check. In either case the social ledger maintained by the banking system has a certain credit to you. You want to transfer a part of that to someone else, for whatever reason. So you give that person a piece of paper with the amount written on it, and they take it to their bank, which adjusts the social ledger accordingly. It makes no difference whether the piece of paper is a dollar or euro bill or a check or a money order, any more than it matters what its physical dimensions are or whether it is one sheet of paper or two.

And of course the majority of transactions are made, the majority of obligations, are settled without using pieces of paper at all. In fact the range of transactions you can carry out using the pieces of paper we call “money” is rather limited.

To put it another way: At the train station there are various machines, which will give you a piece of paper while debiting your bank account. Some of those pieces of paper can be used in exchange for a train ride, others for various other purposes. We call one a ticket machine and one an ATM. But conceptually we should think of them as the same kind of machine. Both debit your social ledger and then give you a claim on something concrete — a paper from the newsstand, say, or a train ride, as the case may be.

In the quantity view of money, there is some special asset called money which the rest of the payments system builds off. So the fact that something else could “be” money seems important. It matters that the government has a legal monopoly on printing currency, so it also matters that something like cryptocurrency seems to evade that monopoly. In the ledger view, on the other hand, that legal monopoly doesn’t matter at all. There are lots of systems for making transfers between bank accounts, including many purely electronic ones. And there are social ledgers maintained by institutions that we don’t officially recognize as banks. New digital currencies introduce a few more of each. So what?

In the quantity view, money and credit are two distinct things. We start with money, which might then be lent. This is how we learn it as children. In the ledger view, money is just anything that settles an obligation. And that is constantly done by promises or IOUs. The fact that “banks create money” in our modern economy isn’t some kind of innovation out of an original situation of cash-on-the-barrelhead exchange. Rather, it is a restriction of money-creation from the historical situation where third-party IOUs of all kinds circulated as payment.

Related to this are two different views of central banks. In the quantity view, the fundamental role of the central bank is in some sense setting or managing the money supply. In the ledger view, where money is just an arbitrary subset of payments media, which is constantly being created and destroyed in the course of making payments, “the money supply” is a nonsense term. What central banks are doing in this view is controlling the elasticity of the credit system. In other words, they are managing the willingness and ability of economic units to make promises to each other.

There are a variety of objectives in this; two important ones today are to control the pace of real activity via the elasticity of money commitments (e.g. to keep the wage share within certain bounds by controlling the level of aggregate employment) and to maintain the integrity of the payments system in a crisis where a wave of self-perpetuating defaults is possible.

In either case the thing which the central bank seeks to make more scarce or abundant is not the quantity of some asset labeled as “money”, but the capacity to make promises. To reduce the level of real activity, for example, the central bank needs to make it more difficult for economic units to make claims on real resources on the basis of promises of future payments. To avoid or resolve a crisis the central bank needs to increase the trustworthiness of units so they can settle outstanding obligations by making new promises; alternatively it can substitute its own commitments for those of units unable to fulfill their own.

Now obviously I think the ledger view is the correct one. But many intelligent people continue to work with a quantity view, some explicitly and some implicitly. Why? I think one reason is the historical fact that during the 20th century, the regulatory system was set up to create a superficial resemblance to the quantity theory. The basic tool of monetary policy was restrictions on the volume of credit creation by banks, plus limits on ability of other institutions to perform bank function. But for various reasons these restrictions were formalized as reserve requirements , and policy was described as changing quantity of reserves. This created the illusion we were living in world of outside money where things like seignorage are important.

Axel Leijonhufvud has given a brilliant description of how regulation created this pseudo quantity of money world in several essays, such as “So Far from Ricardo, So Close to Wicksell.”

Now this structure has been obsolete for several decades but our textbooks and our thinking have not caught up. We still have an idea of the money multiplier in our head, where bank deposits are somehow claims on money or backed by money. Whereas in reality they simply are money.

The fact that money as an analytic category is obsolete and irrelevant, doesn’t mean that central banks don’t face challenges in achieving their goals. They certainly do. But they have nothing to do with any particular settlement asset.

I would frame them the problems like this:

First, the central bank’s established instruments don’t reliably affect even the financial markets most directly linked to them. This weak articulation between the policy rates and other rates has existed for a while. If you look back to 2000-2001, in those two years the Federal Reserve reduced the overnight rate by 5 points. But corporate bond rates fell only one point, and not until two years later. Then in 2003-2006, when the Fed raised its rate by 4 points, the bond rates did not rise at all.

Second, neither real economic behavior nor financial markets respond reliably to interest rate changes. It’s a fiction of the last 25 years — though no longer than that — that this one instrument is sufficient. The smugness about the sufficiency of this tool is really amazing in retrospect. But it’s obvious today — or it should be — that even large changes in interest rates don’t reliably affect either the sclae of concrete activity or the prices of other assets.

Third, there is no single right amount of elasticity. A credit system elastic enough to allow the real economy to grow may be too elastic for stable asset prices. Enough elasticity to ensure that contracts are fulfilled, may be too much to avoid bidding up price of real goods/factors.

People who acknowledge these tensions tend to assume that one goal has to be prioritized over the others. People at the Bank for International Settlements are constantly telling us that financial stability may require accepting persistent semi-depression in real activity. Larry Summers made a splash a few years ago by claiming that an acceptable level of real activity might require accepting asset bubbles. From where I am sitting, there are just competing goals, which means this is a political question.

Fourth, the direction as well as volume of credit matters. In discussion like this, we often hear invocations of “stability” as if that were only goal of policy. But it’s not, or even the most important. The importance of crises, in my opinion, is greatly overrated. A few assets lose their values, a few financial institutions go bust, a few bankers may go to jail or leap out of windows — and this time we didn’t even get that. The real problems of inequality, alienation, ecology exist whether there is a financial crisis or not. The real problem with the financial system is not that it sometimes blows up but that, in good times and bad, it fails to direct our collective capabilities in the direction that would meet human needs. Which today is an urgent problem of survival, if we can’t finance transition away from carbon fast enough.

For none of these problems does some new digital currency offer any kind solution. The existing system of bank deposits is already fully digital. If you want set up a postal banking system — and there’s a lot to recommend it — or to recreate the old system of narrow commercial banking, great. But blockchain technology is entirely irrelevant.

The real solution, as I have argued elsewhere (and as many people have argued, back to Keynes at least) is for central banks to intervene at many more points in financial system. They have to set prices of many assets, not just one overnight interest rate, and they have to direct credit to specific classes of borrowers. They have to accept their role as central planner. It is the need for much more conscious planning of finance, and not crypto currencies, that, I think, is the great challenge and opportunity for central banks today.

“Monetary Policy in a Changing World”

While looking for something else, I came across this 1956 article on monetary policy by Erwin Miller. It’s a fascinating read, especially in light of current discussions about, well, monetary policy in a changing world. Reading the article was yet another reminder that, in many ways, debates about central banking were more sophisticated and far-reaching in the 1950s than they are today.

The recent discussions have been focused mainly on what the goals or targets of monetary policy should be. While the rethinking there is welcome — higher wages are not a reliable sign of rising inflation; there are good reasons to accept above-target inflation, if it developed — the tool the Fed is supposed to be using to hit these targets is the overnight interest rate faced by banks, just as it’s been for decades. The mechanism by which this tool works is basically taken for granted — economy-wide interest rates move with the rate set by the Fed, and economic activity reliably responds to changes in these interest rates. If this tool has been ineffective recently, that’s just about the special conditions of the zero lower bound. Still largely off limits are the ideas that, when effective, monetary policy affects income distribution and the composition of output and not just its level, and that, to be effective, monetary policy must actively direct the flow of credit within the economy and not just control the overall level of liquidity.

Miller is asking a more fundamental question: What are the institutional requirements for monetary policy to be effective at all? His answer is that conventional monetary policy makes sense in a world of competitive small businesses and small government, but that different tools are called for in a world of large corporations and where the public sector accounts for a substantial part of economic activity. It’s striking that the assumptions he already thought were outmoded in the 1950s still guide most discussions of macroeconomic policy today.1

From his point of view, relying on the interest rate as the main tool of macroeconomic management is just an unthinking holdover from the past — the “normal” world of the 1920s — without regard for the changed environment that would favor other approaches. It’s just the same today — with the one difference that you’ll no longer find these arguments in the Quarterly Journal of Economics.2

Rather than resort unimaginatively to traditional devices whose heyday was one with a far different institutional environment, authorities should seek newer solutions better in harmony with the current economic ‘facts of life.’ These newer solutions include, among others, real estate credit control, consumer credit control, and security reserve requirements…, all of which … restrain the volume of credit available in the private sector of the economy.

Miller has several criticisms of conventional monetary policy, or as he calls it, “flexible interest rate policies” — the implicit alternative being the wartime policy of holding key rates fixed. One straightforward criticism is that changing interest rates is itself a form of macroeconomic instability. Indeed, insofar as both interest rates and inflation describe the terms on which present goods trade for future goods, it’s not obvious why stable inflation should be a higher priority than stable interest rates.

A second, more practical problem is that to the extent that a large part of outstanding debt is owed by the public sector, the income effects of interest rate changes will become more important than the price effects. In a world of large public debts, conventional monetary policy will affect mainly the flow of interest payments on existing debt rather than new borrowing. Or as Miller puts it,

If government is compelled to borrow on a large scale for such reasons of social policy — i.e., if the expenditure programs are regarded as of such compelling social importance that they cannot be postponed merely for monetary considerations — then it would appear illogical to raise interest rates against government, the preponderant borrower, in order to restrict credit in the private sphere.

Arguably, this consideration applied more strongly in the 1950s, when government accounted for the majority of all debt outstanding; but even today governments (federal plus state and local) accounts for over a third of total US debt. And the same argument goes for many forms of private debt as well.

As a corollary to this argument — and my MMT friends will like this — Miller notes that a large fraction of federal debt is held by commercial banks, whose liabilities in turn serve as money. This two-step process is, in some sense, equivalent to simply having the government issue the money — except that the private banks get paid interest along the way. Why would inflation call for an increase in this subsidy?

Miller:

The continued existence of a large amount of that bank-held debt may be viewed as a sop to convention, a sophisticated device to issue needed money without appearing to do so. However, it is a device which requires that a subsidy (i.e., interest) be paid the banks to issue this money. It may therefore be argued that the government should redeem these bonds by an issue of paper money (or by an issue of debt to the central bank in exchange for deposit credit). … The upshot would be the removal of the governmental subsidy to banks for performing a function (i.e., creation of money) which constitutionally is the responsibility of the federal government.

Finance franchise, anyone?

This argument, I’m sorry to say, does not really work today — only a small fraction of federal debt is now owned by commercial banks, and there’s no longer a link, if there ever was, between their holdings of federal debt and the amount of money they create by lending. There are still good arguments for a public payments system, but they have to be made on other grounds.

The biggest argument against using a single interest rate as the main tool of macroeconomic management is that it doesn’t work very well. The interesting thing about this article is that Miller doesn’t spend much time on this point. He assumes his readers will already be skeptical:

There remains the question of the effectiveness of interest rates as a deterrent to potential private borrowing. The major arguments for each side of this issue are thoroughly familiar and surely demonstrate most serious doubt concerning that effectiveness.

Among other reasons, interest is a small part of overall cost for most business activity. And in any situation where macroeconomic stabilization is needed, it’s likely that expected returns will be moving for other reasons much faster than a change in interest rates can compensate for. Keynes says the same thing in the General Theory, though Miller doesn’t mention it.3 (Maybe in 1956 there wasn’t any need to.)

Because the direct link between interest rates and activity is so weak, Miller notes, more sophisticated defenders of the central bank’s stabilization role argue that it’s not so much a direct link between interest rates and activity as the effect of changes in the policy rate on banks’ lending decisions. These arguments “skillfully shift the points of emphasis … to show how even modest changes in interest rates can bring about significant credit control effects.”

Here Miller is responding to arguments made by a line of Fed-associated economists from his contemporary Robert Roosa through Ben Bernanke. The essence of these arguments is that the main effect of interest rate changes is not on the demand for credit but on the supply. Banks famously lend long and borrow short, so a bank’s lending decisions today must take into account financing conditions in the future. 4 A key piece of this argument — which makes it an improvement on orthodoxy, even if Miller is ultimately right to reject it — is that the effect of monetary policy can’t be reduced to a regular mathematical relationship, like the interest-output semi-elasticity of around 1 found in contemporary forecasting models. Rather, the effect of policy changes today depend on their effects on beliefs about policy tomorrow.

There’s a family resemblance here to modern ideas about forward guidance — though people like Roosa understood that managing market expectations was a trickier thing than just announcing a future policy. But even if one granted the effectiveness of this approach, an instrument that depends on changing beliefs about the long-term future is obviously unsuitable for managing transitory booms and busts.

A related point is that insofar as rising rates make it harder for banks to finance their existing positions, there is a chance this will create enough distress that the Fed will have to intervene — which will, of course, have the effect of making credit more available again. Once the focus shifts from the interest rate to credit conditions, there is no sharp line between the Fed’s monetary policy and lender of last resort roles.

A further criticism of conventional monetary policy is that it disproportionately impacts more interest-sensitive or liquidity-constrained sectors and units. Defenders of conventional monetary policy claim (or more often tacitly assume) that it affects all economic activity equally. The supposedly uniform effect of monetary policy is both supposed to make it an effective tool for macroeconomic management, and helps resolve the ideological tension between the need for such management and the belief in a self-regulating market economy. But of course the effect is not uniform. This is both because debtors and creditors are different, and because interest makes up a different share of the cost of different goods and services.

In particular, investment, especially investment in housing and other structures, is mo sensitive to interest and liquidity conditions than current production. Or as Miller puts it, “Interest rate flexibility uses instability of one variety to fight instability of a presumably more serious variety: the instability of the loanable funds price-level and of capital values is employed in an attempt to check commodity price-level and employment instability.” (emphasis added)

The point that interest rate changes, and monetary conditions generally, change the relative price of capital goods and consumption goods is important. Like much of Miller’s argument, it’s an unacknowledged borrowing from Keynes; more strikingly, it’s an anticipation of Minsky’s famous “two price” model, where the relative price of capital goods and current output is given a central role in explaining macroeconomic dynamics.

If we take a step back, of course, it’s obvious that some goods are more illiquid than others, and that liquidity conditions, or the availability of financing, will matter more for production of these goods than for the more immediately saleable ones. Which is one reason that it makes no sense to think that money is ever “neutral.”5

Miller continues:

In inflation, e.g., employment of interest rate flexibility would have as a consequence the spreading of windfall capital losses on security transactions, the impairment of capital values generally, the raising of interest costs of governmental units at all levels, the reduction in the liquidity of individuals and institutions in random fashion without regard for their underlying characteristics, the jeopardizing of the orderly completion of financing plans of nonfederal governmental units, and the spreading of fear and uncertainty generally.

Some businesses have large debts; when interest rates rise, their earnings fall relative to businesses that happen to have less debt. Some businesses depend on external finance for investment; when interest rates rise, their costs rise relative to businesses that are able to finance investment internally. In some industries, like residential construction, interest is a big part of overall costs; when interest rates rise, these industries will shrink relative to ones that don’t finance their current operations.

In all these ways, monetary policy is a form of central planning, redirecting activity from some units and sectors to other units and sectors. It’s just a concealed, and in large part for that reason crude and clumsy, form of planning.

Or as Miller puts it, conventional monetary policy

discriminates between those who have equity funds for purchases and those who must borrow to make similar purchases. … In so far as general restrictive action successfully reduces the volume of credit in use, some of those businesses and individuals dependent on bank credit are excluded from purchase marts, while no direct restraint is placed on those capable of financing themselves.

In an earlier era, Miller suggests, most borrowing was for business investment; most investment was externally financed; and business cycles were driven by fluctuations in investment. So there was a certain logic to focusing on interest rates as a tool of stabilization. Honestly, I’m not sure if that was ever true.But I certainly agree that by the 1950s — let alone today — it was not.

In a footnote, Miller offers a more compelling version of this story, attributing to the British economist R. S. Sayers the idea of

sensitive points in an economy. [Sayers] suggests that in the English economy mercantile credit in the middle decades of the nineteenth century and foreign lending in the later decades of that century were very sensitive spots and that the bank rate technique was particularly effective owing to its impact upon them. He then suggests that perhaps these sensitive points have given way to newer ones, namely, stock exchange speculation and consumer credit. Hence he concludes that central bank instruments should be employed which are designed to control these newer sensitive areas.

This, to me, is a remarkably sophisticated view of how we should think about monetary policy and credit conditions. It’s not an economywide increase or decrease in activity, which can be imagined as a representative household shifting their consumption over time; it’s a response of whatever specific sectors or activities are most dependent on credit markets, which will be different in different times and places. Which suggests that a useful education on monetary policy requires less calculus and more history and sociology.

Finally, we get to Miller’s own proposals. In part, these are for selective credit controls — direct limits on the volume of specific kinds of lending are likely to be more effective at reining in inflationary pressures, with less collateral damage. Yes, these kinds of direct controls pick winners and losers — no more than conventional policy does, just more visibly. As Miller notes, credit controls imposed for macroeconomic stabilization wouldn’t be qualitatively different from the various regulations on credit that are already imposed for other purposes — tho admittedly that argument probably went further in a time when private credit was tightly regulated than in the permanent financial Purge we live in today.

His other proposal is for comprehensive security reserve requirements — in effect generalizing the limits on bank lending to financial positions of all kinds. The logic of this idea is clear, but I’m not convinced — certainly I wouldn’t propose it today. I think when you have the kind of massive, complex financial system we have today, rules that have to be applied in detail, at the transaction level, are very hard to make effective. It’s better to focus regulation on the strategic high ground — but please don’t ask me where that is!

More fundamentally, I think the best route to limiting the power of finance is for the public sector itself to take over functions private finance currently provides, as with a public payments system, a public investment banks, etc. This also has the important advantage of supporting broader steps toward an economy built around human needs rather than private profit. And it’s the direction that, grudgingly but steadily, the response to various crises is already pushing us, with the Fed and other authorities reluctantly stepping in to perform various functions that the private financial system fails to. But this is a topic for another time.

Miller himself is rather tentative in his positive proposals. And he forthrightly admits that they are “like all credit control instruments, likely to be far more effective in controlling inflationary situations than in stimulating revival from a depressed condition.” This should be obvious — even Ronald Reagan knew you can’t push on a string. This basic asymmetry is one of the many everyday insights that was lost somewhere in the development of modern macro.

The conversation around monetary policy and macroeconomics is certainly broader and more realistic today than it was 15 or 20 years ago, when I started studying this stuff. And Jerome Powell — and even more the activists and advocates who’ve been shouting at him — deserves credit for the Fed;s tentative moves away from the reflexive fear of full employment that has governed monetary policy for so long. But when you take a longer look and compare today’s debates to earlier decades, it’s hard not to feel that we’re still living in the Dark Ages of macroeconomics

Utz-Pieter Reich on the Nominal and the Real

What oft was thought, but ne’er so well expressed1:

The lack of realism in microeconomic value theory has been overcompensated by an unquenched desire for `real’ figures. Idealism in the concepts of theory has resulted in a plethora of empirical concepts for real value, and the development of index number theory is thus characterised by an inventive sequence of euphemistic terms. We have an `ideal’ index, a `true’ (cost of living) index, an `exact’ index, a `superlative’ index and, last but not least, a `hedonic’ index.

At the same time, the word `real’ is employed in more than one sense in economics. It can mean the opposite to `nominal’, in other words a value figure corrected for a change in the value of the currency unit through a general price index. It can also mean `volume’, which is correction by means of a price index specifically tailored to the aggregate under consideration. It may mean `material’ as in `real’ assets rather than `financial’ assets, or the `real sector’ which produces such assets, as opposed to the `financial sector’, which deals with non- produced assets. In none of these uses is `real’ opposed to `fictitious’, but to the layman the difference is nevertheless unclear. The very act of `speaking in real terms’ conveys the idea that one has happily left behind the cloudy and unreliable world of bookkeeping and institutional regulations, and settled safely in the world of tangible objects. …

But the operational issues stirred up by using these terms have not been adequately addressed. To obtain such real variables, nominal figures are simply divided by some notional price index without regard to the ways in which this index is produced and the change in meaning it may imply for the resulting aggregate. …

In this [book] we make every effort to convince the reader that nominal values are real values in the sense of `actual’, and of what is observable as a statistical fact, while real values, as conceived by economic value theory, are constructs. They are imputations in the proper sense of the word… The dual character of the national accounts, distinguishing between institutional units and transactions on the one hand, and functional units and product flows on the other, provides the theoretical background for this view.

From Utz-Pieter Reich, National Accounts and Economic Value

Is Productivity Being Undermeasured?

(I am an occasional contributor to roundtables of economists in the magazine The International EconomyThis month’s topic was: “What are the policy implications if productivity growth is being under-measured in the official data?” My answer is below.)

How many hamburgers equal one haircut? 

In itself, the question doesn’t make sense. They’re just different things. What we can compare, is how much they cost. This is true across the board: The only way we can convert all the endlessly varied objects and activities that make up “the economy” into a single number, is through their market prices. Markets are what let us express all the various products of human labor as a single quantity we call output. 

This means that productivity is only meaningful in the context of market prices. There are lots of things that people do that are useful, important, even essential to economic life, from raising children to following the law, that can’t be expressed as output per hour. 

So it doesn’t really make sense to ask if the nonmarket effects of technological change mean we are undermeasuring productivity. A new technology may transform our lives in all sorts of ways, but we can’t talk about its effect on productivity except insofar as its products are sold. There’s no other basis on which productivity can even be defined – we have to go by market prices. And what market prices are telling us is that productivity growth is slower than it used to be. 

This slowdown is not really surprising. Manufacturing – where the transformation of work by technology has gone farthest, and where productivity growth almost always fastest –  is steadily shrinking as a share of the economy.

It is true that we often think of economic growth as something broader than market prices. It’s supposed to describe a more general rise in living standards. So a more meaningful way to ask the question might be: Does measured productivity growth accurately reflect the material improvements in people’s lives?

The answer here is indeed no. But unfortunately, in the rich countries at least, the mismeasurement probably goes the opposite way as the question suggests.

Measures like life expectancy used to be closely linked with economic growth. In poor countries, this is still the case – higher GDP is associated with longer lifespans, lower child mortality, and similar improvements in health and wellbeing. If anything, today’s GDP growth may be associated with even faster improvement than we would expect based on the historical record. But in richer countries the opposite is true – higher GDP no longer translates reliably into better health outcomes. In some places – like the UK, and much of the US – life expectancy is actually falling, even as income per capita continues to rise. 

Leisure time is another measure of wellbeing — presumably if people were having an easier time meeting their material needs, they would choose to take more time off work. (Adam Smith once suggested that the amount of leisure people enjoyed was the only meaningful standard of economic value across countries.1) On this measure too, living standards seem to be falling short of GDP growth rather than running ahead of them. Between the end of World War II and the early 1980s, the average weekly hours of an employed American fell by about 15 percent. But since then, average hours per worker have been essentially flat. This makes the postwar growth performance look even better, and the more recent performance worse, than the headline numbers suggest.

It seems likely that measured productivity overstates, rather than understates, our real improvement in living standards, at least in the US.  If so, the policy implications seem clear. Policymakers should worry less about growth, and more about concrete interventions that we know improve people’s lives – things like universal access to childcare and health care, high-quality education, and paid time off for all. 

Video: Monetary Policy since the Crisis

On May 30, I did a “webinar” with INET’s Young Scholar’s Intiative. The subject was central banking since the financial crisis of a decade ago, and how it forces us to rethink some long-held ideas about money and the real economy — the dstinction between a demand-determined short run and a supply-determined long run; the neutrality of money in the long run; the absence of tradeoffs between unemployment, inflation and other macroeconomic goals; the reduction of monetary policy choices to setting a single overnight interest rate based on a fixed rule.My argument is that the crisis — or more precisely, central banks’ response to it — creates deep problems for all these ideas.

The full video (about an hour and 15 minus, including Q&A) is on YouTube, and embedded below. It’s part of an ongoing series of YSI webinars on endogenous money, including ones by Daniela Gabor, Jo Mitchella nd Sheila Dow. I encourage you, if you’re interested, to sign up with YSI — anyone can join — and check them out.

I didn’t use slides, but you can read my notes for the talk, if you want to.

“On money, debt, trust and central banking”

The central point of my Jacobin piece on the state of economics was meant to be: Whatever you think about mainstream macroeconomic theory, there is a lot of mainstream empirical and policy work that people on the left can learn from and engage with — much more than there was a decade ago. 1 

Some of the most interesting of that new work is from, and about, central banks. As an example, here is a remarkable speech by BIS economist Claudio Borio. I am not sure when I last saw such a high density of insight-per-word in a discussion of money and finance, let alone in a speech by a central banker. I could just say, Go read it. But instead I’m going to go through it section by section, explaining what I find interesting in it and how it connects up to a larger heterodox vision of money. 

From page one:

My focus will be the on the monetary system, defined technically as money plus the transfer mechanisms to execute payments. Logically, it makes little sense to talk about one without the other. But payments have too often been taken for granted in the academic literature, old and new. In the process, we have lost some valuable insights.

… two properties underpin a well functioning monetary system. One, rather technical, is the coincidence of the means of payment with the unit of account. The other, more intangible and fundamental, is trust. 

This starting point signals three central insights about money. First, the importance of payments. You shouldn’t fetishize any bit of terminology, but I’ve lately come to feel that the term “payments system” is a fairly reliable marker for something interesting to say about money. We all grow up with an idealized model of exchange, where the giving and receiving just happen, inseparably; but in reality it takes a quite sophisticated infrastructure to ensure that my debit coincides with your credit, and that everyone agrees this is so. Stefano Ugolini’s brilliant book on the prehistory of central banking emphasizes the central importance of finality – a binding determination that payment has taken place. (I suppose this was alsso the point of the essay that inaugurated Bitcoin.) In any case it’s a central aspect of “money” as a social institution that the mental image of one person handing a token to another entirely elides.

Second: the focus on money as unit of account and means of payment. The latter term mean money as the thing that discharges obligations, that cancels debts. It’s not evenb included in many standard lists of the functions of money, but for Marx, among others, it is fundamental. Borio consciously uses this term in preference to the more common medium of exchange, a token that facilitates trade of goods and services. He is clear that discharging debt and equivalent obligations is a more central role of money than exchanging commodities. Trade is a special case of debt, not vice versa. Here, as at other points through the essay, there’s a close parallel to David Graeber’s Debt. Borio doesn’t cite Graeber, but the speech is a clear example of my point in my debate with Mike Beggs years ago: Reading Graeber is good preparation for understanding some of the most interesting conversation in economics.

Third: trust. If you think of money as a social coordination mechanism, rather than a substance or quantity, you could argue that the scarce resource it’s helping to allocate is precisely trust.  More on this later.

Borio:

a key concept for understanding how the monetary system works is the “elasticity of credit”, ie the extent to which the system allows credit to expand. A high elasticity is essential for the system’s day-to-day operation, but too high an elasticity (“excess elasticity”) can cause serious economic damage in the longer run. 

This is an argument I’ve made before on this blog. Any payments system incorporate some degree of elasticity — some degree to which payments can run ahead of incomes. (As my old teacher David Kotz observes, the expansion of capital would be impossible otherwise.) But the degree of elasticity involves some unresolvable tensions. The logic of the market requires that every economic units expenditure eventually be brought into line with its income. But expansion, investment, innovation, requires eventually to be not just yet. (I talked a bit about this tension here.) Another critical point here is the impossibility of separating payments and credit – a separation that has been the goal of half the monetary reform proposals of the past 250 years.2

Along the way, I will touch on a number of sub-themes. .. whether it is appropriate to think of the price level as the inverse of the price of money, to make a sharp distinction between relative and absolute price changes, and to regard money (or monetary policy) as neutral in the long run.

So much here! The point about the non-equivalence of a rise in the price level and a fall in the value of money has been made eloquently by Merijn Knibbe.  I don’t think Borio’s version is better, but again, it comes with the imprimatur of Authority.

The fact that inflation inevitably involves relative as well as absolute price changes is made by Leijonhufvud (who Borio cites) and Minsky (who he surprisingly doesn’t); the non-neutrality of money is the subject (and the title) of what is in my opinion Minsky’s own best short distillation of his thought. 

Borio: 

Compared with the traditional focus on money as an object, the definition [in terms of means of payment] crucially extends the analysis to the payment mechanisms. In the literature, there has been a tendency to abstract from them and assume they operate smoothly in the background. I believe this is one reason why money is often said to be a convention, much like choosing which hand to shake hands with: why do people coordinate on a particular “object” as money? But money is much more than a convention; it is a social institution. It is far from self-sustaining. Society needs an institutional infrastructure to ensure that money is widely accepted, transactions take place, contracts are fulfilled and, above all, agents can count on that happening. 

Again, the payments mechanism is a complex, institutionally heavy social arrangement; there’s a lot that’s missed when we imagine economic transactions as I hand you this, you hand me that. Ignoring this social infrastructure invites the classical idea of money as an arbitrary numeraire, from which its long-run neutrality is one short step. 

The last clause introduces a deep new idea. In an important sense, trust is a kind of irrational expectation. Trust means that I am sure (or behave as if I am sure) that you will conform to the relevant rules. Trust means I believe (or behave as if I believe) this 100 percent. Anything less than 100 percent and trust quickly unravels to zero.  If there’s a small chance you might try to kill me, I should be prepared to kill you first; you might’ve had no bad intentions, but if I’m thinking of killing you, you should think about killing me first; and soon we’re all sprawled out on the warehouse floor. To exist in a world of strangers we need to believe, contrary to experience, that everyone around us will follow the rules.

a well functioning monetary system … will exploit the benefits of unifying the means of payment with the unit of account. The main benefit of a means of payment is that it allows any economy to function at all. In a decentralised exchange system, it underpins the quid-pro-quo process of exchange. And more specifically, it is a highly efficient means of “erasing” any residual relationship between transacting parties: they can thus get on with their business without concerns about monitoring and managing what would be a long chain of counterparties (and counterparties of counterparties).

Money as an instrument for erasing any relationship between the transacting parties: It could not be said better. And again, this is something someone who has read Graeber’s Debt understands very well, while someone who hasn’t might be a bit baffled by this passage. Graeber could also take you a step farther. Money might relieve you of the responsibility of monitoring your counterparties and their counterparties but somebody still has to. Graeber compellingly links the generalized use of money to strong centralized states. In a Graeberian perspective, money, along with slavery and bureaucracy, is one of the great social technologies for separating economic coordination from the broader network of mutual obligations.

The central banks’ elastic supply of the means of payment is essential to ensure that (i) transactions are settled in the interbank market and (ii) the interest rate is controlled. The interbank market is a critical component of our two-tier monetary system, where bank customer transactions are settled on the banks’ books and then banks, in turn, finally settle on the central bank’s books. To smooth out interbank settlement, the provision of central bank credit is key. The need for an elastic supply to settle transactions is most visible in the huge amounts of intraday credit central banks supply to support real- time gross settlement systems

“Two-tier monetary system” is a compressed version of Mehrling’s hierarchy of money. The second point, which Borio further develops further on, is that credit is integral to the payment system, since the two sides of a transaction never exactly coincide – there’s always one side that fulfills its part first and has to accept, however briefly, a promise in return. This is one reason that the dream of separating credit and payments is unrealizable.

The next point he makes is that a supply and demand framework is useless for thinking about monetary policy: 

The central bank … simply sets the desired interest rate by signalling where it would like it to be. And it can do so because it is a monopoly supplier of the means of payment: it can credibly commit to provide funds as needed to clear the market. … there is no such thing as a well behaved demand for bank reserves, which falls gradually as the interest rate increases, ie which is downward-sloping.

An interesting question is how much this is specific to the market for reserves and how much it applies to a range of asset markets. In fact, many markets share the two key features Borio points to here: adjustment via buffers rather than prices, and expected return that is a function of price.

On the first, there are a huge range of markets where there’s someone on one or both sides prepared to passively by or sell at a stated price. Many financial markets function only thanks to the existence of market makers – something Mehrling and his Barnard colleague Rajiv Sethi have written eloquently about. But more generally, most producers with pricing power — which is almost all of them — set a price and then passively meet demand at that price, allowing inventories and/or delivery times to absorb shifts in demand, within some range.

The second feature is specific to long-lived assets. Where there is an expected price different from the current price, holding the asset implies a capital gain or loss when the price adjusts. If expectations are sufficiently widespread and firmly anchored, they will be effectively self-confirming, as the expected valuation changes will lead the asset to be quickly bid back to its expected value. This dynamic in the bond market (and not the zero lower bound) is the authentic Keynesian liquidity trap.

To be clear, Borio isn’t raising here these broader questions about markets in general. But they are a natural extension of his arguments about reserves. 

Next come some points that shouldn’t be surprising to to readers of this blog, but which are nice, for me as an economics teacher, to see stated so plainly. 

The monetary base – such a common concept in the literature – plays no significant causal role in the determination of the money supply … or bank lending. It is not surprising that … large increases in bank reserves have no stable relationship with the stock of money … The money multiplier – the ratio of money to the monetary base – is not a useful concept. … Bank lending reflects banks’ management of the risk-return tradeoff they face… The ultimate anchor of the monetary system is not the monetary base but the interest rate the central bank sets.

We all know this is true, of course. The mystery is why so many textbooks still talk about the supply of high-powered money, the money multiplier, etc. As the man says, they just aren’t useful concepts.

Next comes the ubiquity of credit, which not only involves explicit loans but also any transaction where delivery and payment don’t coincide in time — which is almost all of them. Borio takes this already-interesting point in an interestingly Graeberian direction:  

A high elasticity in the supply of the means of payment does not just apply to bank reserves, it is also essential for bank money. … Credit creation is all around us: some we see, some we don’t. For instance, explicit credit extension is often needed to ensure that two legs of a transaction are executed at the same time so as to reduce counterparty risk… And implicit credit creation takes place when the two legs are not synchronised. ….

In fact, the role of credit in monetary systems is commonly underestimated. Conceptually, exchanging money for a good or service is not the only way of solving the problem of the double coincidence of wants and overcoming barter. An equally, if not more convenient, option is to defer payment (extend credit) and then settle when a mutually agreeable good or service is available. In primitive systems or ancient civilisations as well as during the middle ages, this was quite common. … It is easier to find such examples than cases of true barter.

The historical non-existence of barter is the subject of the first chapter of Debt . Here again, the central banker has more in common with the radical anthropologist than with orthodox textbooks, which usually make barter the starting point for discussions of money.

Borio goes on:

the distinction between money and debt is often overplayed. True, one difference is that money extinguishes obligations, as the ultimate settlement medium. But netting debt contracts is indeed a widespread form of settling transactions.

Yes it is: remember Braudel’s Flanders fairs? “The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun.”

At an even deeper level, money is debt in the form of an implicit contract between the individual and society. The individual provides something of value in return for a token she trusts to be able to use in the future to obtain something else of value. She has a credit vis-à-vis everyone and no one in particular (society owes a debt to her).

In the classroom, one of the ways I suggest students think about money is as a kind of social scorecard. You did something good — made something somebody wanted, let somebody else use something you own, went to work and did everything the boss told you? Good for you, you get a cookie. Or more precisely, you get a credit, in both senses, in the personal record kept for you at a bank. Now you want something for yourself? OK, but that is going to be subtracted from the running total of how much you’ve done for the rest for us.

People get very excited about China’s social credit system, a sort of generalization of the “permanent record” we use to intimidate schoolchildren. And ok, it does sound kind of dystopian. If your rating is too low, you aren’t allowed to fly on a plane. Think about that — a number assigned to every person, adjusted based on somebody’s judgement of your pro-social or anti-social behavior. If your number is too low, you can’t on a plane. If it’s really low, you can’t even get on a bus. Could you imagine a system like that in the US?

Except, of course, that we have exactly this system already. The number is called a bank account. The difference is simply that we have so naturalized the system that “how much money you have” seems like simply a fact about you, rather than a judgement imposed by society.

Back to Borio:

All this also suggests that the role of the state is critical. The state issues laws and is ultimately responsible for formalising society’s implicit contract. All well functioning currencies have ultimately been underpinned by a state … [and] it is surely not by chance that dominant international currencies have represented an extension of powerful states… 

Yes. Though I do have to note that it’s at this point that Borio’s fealty to policy orthodoxy — as opposed to academic orthodoxy — comes into view. He follows up the Graeberian point about the link between state authority and money with a very un-Graeberian warning about the state’s “temptation to abuse its power, undermining the monetary system and endangering both price and financial stability.”

Turning now to the policy role of the central bank, Borio  starts from by arguing that “the concepts of price and financial stability are joined at the hip. They are simply two ways of ensuring trust in the monetary system…. It is no coincidence that securing both price and financial stability have been two core central bank functions.” He then makes the essential point that what the central bank manages is at heart the elasticity of the credit system. 

The process underpinning financial instability hinges on how “elastic” the monetary system is over longer horizons… The challenge is to ensure that the system is not excessively elastic drawing on two monetary system anchors. One operates on prices – the interest rate and the central bank’s reaction function. … The other operates on quantities: bank regulatory requirements, such as those on capital or liquidity, and the supervisory apparatus that enforces them.

This is critical, not just for thinking about monetary policy, but as signpost toward the heart of the Keynesian vision. (Not the bastard — but useful  — postwar Keynesianism of IS-LM, but the real thing.) Capitalism is not a system of real exchange — it shouldn’t be imagined as a system in which people exchange pre-existing stuff for other stuff they like better. Rather, it is a system of monetary production — a system in which payments and claims of money, meaningless themselves, are the coordinating mechanism for human being’s collective, productive activity. 

This is the broadest sense of the statement that money has to be elastic, but not too elastic. If it is too elastic, money will lose its scarcity value, and hence its power to organize human activity. Money is only an effective coordinating mechanism when its possession allows someone to compel the obedience of others. But it has to be flexible enough to adapt to the concrete needs of production, and of the reproduction of society in general. (This is the big point people take form Polanyi.) “You can’t have the stuff until you give me the money” is the fundamental principle that has allowed capitalism to reorganize vast swathes of our collective existence, for better or worse. But applied literally, it stops too much stuff from getting where it needs to go to to be compatible with the requirements of capitalist production itself. There’s a reason why business transactions are almost always on the basis of trade credit, not cash on the barrelhead. As Borio puts it, “today’s economies are credit hungry.” 

The talk next turns to criticism of conventional macroeconomics that will sound familiar to Post Keynesians. The problem of getting the right elasticity in the payments system — neither too much nor too little — is “downplayed in the current vintage of macroeconomic models. One reason is that the models conflate saving and financing.“ In reality,

Saving is just a component of national income – as it were, just a hole in overall expenditures, without a concrete physical representation. Financing is a cash flow and is needed to fund expenditures. In the mainstream models, even when banks are present, they imply endowments or “saving”; they do not create bank deposits and hence purchasing power through the extension of loans or purchase of assets. There is no meaningful monetary system, so that any elasticity is seriously curtailed. Financial factors serve mainly to enhance the persistence of “shocks” rather than resulting in endogenous booms and busts.

This seems right to me. The point that there is no sense in which savings finance or precede or investment is a key one for Keynes, in the General Theory and even more clearly in his subsequent writing.3 I can’t help noting, also, that passages like this are a reminder that criticism of today’s consensus macro does not come only from the professionally marginalized.

The flipside of not seeing money as social coordinating mechanism, a social ledger kept by banks, is that you do  see it as a arbitrary token that exists in a particular quantity. This latter vision leads to an idea of inflation as a simple imbalance between the quantity of money and the quantity of stuff. Borio:

The process was described in very simple terms in the old days. An exogenous increase in the money supply would boost inflation. The view that “the price level is the inverse of the price of money” has probably given this purely monetary interpretation of inflation considerable intuitive appeal. Nowadays, the prevailing view is not fundamentally different, except that it is couched in terms of the impact of the interest rate the central bank sets.

This view of the inflation process has gone hand in hand with a stronger proposition: in the long run, money (monetary policy) is neutral, ie it affects only prices and no real variables. Again, in the classical tradition this was couched in terms of the money supply; today, it is in terms of interest rates. … Views about how long it takes for this process to play itself out in calendar time differ. But proponents argue that the length is short enough to be of practical policy relevance.

The idea that inflation can be thought of as a decline in the value of money is effectively criticized by Merijn Knibbe and others. It is a natural idea, almost definitionally true, if you vision starts from a world of exchange of goods and then adds money as facilitator or numeraire. But if you start, as Borio does, and as the heterodox money tradition from Graeber to Minsky to Keynes to Marx and back to Tooke and Thornton does, from the idea of money as entries in a social ledger, then it makes about as much sense as saying that a game was a blowout because the quantity of points was too high.  

once we recognise that money is fundamentally endogenous, analytical thought experiments that assume an exogenous change and trace its impact are not that helpful, if not meaningless. They obscure, rather than illuminate, the mechanisms at work. … [And] once we recognise that the price of money in terms of the unit of account is unity, it makes little sense to think of the price level as the inverse of the price of money. … any financial asset fixed in nominal terms has the same property. As a result, thinking of inflation as a purely monetary phenomenon is less compelling.

“Not that helpful”, “makes little sense,” “is less compelling”: Borio is nothing if not diplomatic. But the point gets across.

Once we recognise that the interest rate is the monetary anchor, it becomes harder to argue that monetary policy is neutral… the interest rate is bound to affect different sectors differently, resulting in different rates of capital accumulation and various forms of hysteresis. … it is arguably not that helpful to make a sharp distinction between what affects relative prices and the aggregate price level…., not least because prices move at different speeds and differ in their flexibility… at low inflation rates, the “pure” inflation component, pertaining to a generalised increase in prices, [is] smaller, so that the distinction between relative and general price changes becomes rather porous.

In part, this is a restatement of Minsky’s “two-price” formulation of Keynes. Given that money or liquidity is usefulat all, it is presumably more useful for some things more than for others; and in particular, it is most useful when you have to make long-lived commitments that expose you to vagaries of an unknown future; that is, for investment. Throttling down the supply of liquidity will not just reduce prices and spending across the board, it will reduce them particularly for long-lived capital goods.

The second point, that inflation loses its defintion as a distinct phenomenon at low levels, and fades into the general mix of price changes, is something I’ve thought myself for a while but have never seen someone spell out this way. (I’m sure people have.) It follows directly from the fact that changes in the prices of particualr goods don’t scale proportionately with inflation, so as inflation gets low, the shared component of price changes over time gets smaller and harder to identify. Because the shared component is smaller at low inflation, it is going to be more sensitive to the choice of basket and other measurement issues. 20 percent inflation clearly (it seems to me) represents a genuine phenomenon. But it’s not clear that 2 percent inflation really does – an impression reinforced by the proliferation of alternative measures.

The Minskyan two-price argument also means that credit conditions and monetary policy necessarily affect the directiona s well as the level of economic activity.

financial booms tend to misallocate resources, not least because too many resources go into sectors such as construction… It is hard to imagine that interest rates are simply innocent bystanders. At least for any policy relevant horizon, if not beyond, these observations suggest that monetary policy neutrality is questionable.

This was one of the main points in Mike Konczal’s and my monetary toolkit paper.

In the next section, which deserves a much fuller unpacking, Borio critiques the fashionable idea that central banks cannot control the real rate of interest. 

 Recent research going back to the 1870s has found a pretty robust link between monetary regimes and the real interest rate over long horizons. By contrast, the “usual suspects” seen as driving saving and investment – all real variables – do not appear to have played any consistent role. 

This conflation of the “real”  (inflation-adjusted) interest rate with a rate determined by “real” (nonmonetary) factors, and therefore beyond the central bank’s influence, is one of the key fissure-points in economic ideology.4 The vision of economics, espcially its normative claims, depend on an idea of ecnomic life as the mutually beneficial exchange of goods. There is an obvious mismatch between this vision and the language we use to talk about banks and market interest rates and central banks — it’s not that they contradict or in conflict as that they don’t make contact at all. The preferred solution, going from today’s New Keynesian consensus back through Friedman to Wicksell, is to argue that the “interest rate” set by the central bank must in some way be the same as the “interest rate” arrived at by agents exchanging goods today for goods later. Since the  terms of these trades depend only on the non-monetary fundamentals of preferences and technology, the same must in the long run be true of the interest rate set by the financial system and/or the central bank. The money interest rate cannot persistently diverge from the interest rate that would obtain in a nonmonetary exchange economy that in some sense corresponds to the actual one.

But you can’t square the circle this way. A fundamental Keynesian insight is that economic relations between the past and the future don’t take the form of trades of goods now for goods later, but of promises to make money payments at some future date or state of the world. Your ability to make money promises, and your willingness to accept them from others, depends not on any physical scarcity, but on your confidence in your counterparties doing what they promised, and in your ability to meet your own commitments if some expected payment doesn’t come through. In short, as Borio says, it depends on trust. In other words, the fundamental problem for which interest is a signal is not allocation but coordination. When interest rates are high, that reflects not a scarcity of goods in the present relative to the future, but a relative lack of trust within the financial system. Corporate bond rates did not spike in 2008 because decisionmakers suddenly wished to spend more in the present relative to the future, but because the promises embodied in the bonds were no longer trusted.

Here’s another way of looking at it: Money is valuable. The precursor of today’s “real interest rate” talk was the idea of money as neutral in the long run, in the sense that a change in the supply of money would eventually lead only to a proportionate change in the price level.5  This story somehow assumes on the one hand that money is useful, in the sense that it makes transactions possible that wouldn’t be otherwise. Or as Kocherlakota puts it: “At its heart, economic thinking about fiat money is paradoxical. On the one hand, such money is viewed as being inherently useless… But at the same time, these barren tokens… allow society to implement allocations that would not otherwise be achievable.” If money is both useful and neutral, evidently it must be equally useful for all transactions, and its usefulness must drop suddenly to zero once a fixed set of transactions have been made. Either there is money or there isn’t. But if additional money does not allow any desirable transaction to be carried out that right now cannot be, then shouldn’t the price of money already be zero? 

Similarly: The services provided by private banks, and by the central bank, are valuable. This is the central point of Borio’s talk. The central bank’s explicit guarantee of certain money commitments, and its open ended readiness to ensure that others are fulfilled in a crisis, makes a great many promises acceptable that otherwise wouldn’t be. And like the provider of anything of value, the central bank — and financial system more broadly — can affect its price by supplying more or less of it. It makes about as much sense to say that central banks can influence the interest rate only in the short run as to say that public utilities can only influence the price of electricity in the short run, or that transit systems can only influence the price of transportation in the short run. The activities of the central bank allow a greater degree of trust in the financial system, and therefore a lesser required payment to its professional promise-accepters.6 Or less trust and higher payments, as the case may be. This is true in the short run, in the medium run, in the long run. And because of the role money payments play in organizing productive activity, this also means a greater or lesser increase in our collective powers over nature and ability to satisfy our material wants.

 

Decarbonization: A Keynesian View

The International Economy has asked me to take part in a couple of their recent roundtables on economic policy. My first contribution, on productivity growth, is here (scroll down). My second one, on green investment, is below. But first, I want to explain a little more what I was trying to do with it.

I am not trying to minimize that challenge of dealing with the climate change. But I do want to reject one common way of thinking about those challenges — as a “cost”, as some quantity of other needs that will have to go unmet. I reject it because output isn’t fixed — a serious effort to deal with climate change will presumably lead to a boom with much higher levels of employment and investment. And more broadly I reject it because it’s profoundly wrong to think of the complex activities of production as being equivalent to a certain quantity of “stuff”.

There’s a Marxist version of this, which I also reject — that the reproduction of capitalism requires an ever-increasing flow of material inputs and outputs, which rules out any kind of environmental sustainability. I think this mistakenly equates the situation facing the individual capitalist — the need to maximize money sales relative to money outlays — with the logic of the system as a whole. There is no necessary link between endless accumulation of money and any particular transformation of the material world. To me the real reason capitalism makes it so hard to address climate change isn’t any objective need to dump carbon into the atmosphere. It’s the obstacles that private property and the pursuit of profit — and their supporting ideologies — create for any kind of conscious reorganization of productive activity.

The question was, who will be the winners and losers from the transition away from carbon? Here’s what I wrote:

The response to climate change is often conceived as a form of austerity—how much consumption must we give up today to avoid the costs of an uninhabitable planet tomorrow? This way of thinking is natural for economists, brought up to think in terms of the allocation of scarce means among competing ends. By some means or other—prices, permits, or plans—part of our fixed stock of resources must, in this view, be used to prevent (or cope with) climate change, reducing the resources available to meet other needs.

The economics of climate change look quite different from a Keynesian perspective, in which demand constraints are pervasive and the fundamental economic problem is not scarcity but coordination. In this view, the real resources for decarbonization will not have to be with- drawn from other uses. They can come from an expansion of society’s productive capabilities, thanks to the demand created by clean-energy investment itself. Addressing climate change need not imply a lower standard of living—if it boosts employment and steps up the pace of technological change, it may well lead to a higher one.

People rightly compare the scale of the transition to clean technologies to the mobilization for World War II. Often forgotten, though, is that in countries spared the direct destruction of the fighting, like the United States, wartime mobilization did not crowd out civilian production. Instead, it led to a remarkable acceleration of employment and productivity growth. Production of a liberty ship required 1,200 man hours in 1941, only 500 by 1944. These rapid productivity gains, spurred by the high-pressure economy of the war, meant there was no overall tradeoff between more guns and more butter.

At the same time, the degree to which all wartime economies—even the United States—were centrally planned, reinforces a lesson that economic historians such as Alexander Gerschenkron and Alice Amsden have drawn from the experience of late industrializers: however effective decentralized markets may be at allocating resources at the margin, there is a limit to the speed and scale on which they can operate. The larger and faster the redirection of production, the more it requires conscious direction—though not necessarily by the state.

In a world where output is fundamentally limited by demand, action to deal with climate change doesn’t require sacrifice. Do we really live in such a world? Think back a few years, when macroeconomic discussions were all about secular stagnation and savings gluts. The headlines may have faded, but the conditions that prompted them have not. There’s good reason to think that the main limit to capital spending still is not scarce savings, but limited outlets for profitable investment, and that the key obstacle to faster growth is not technology or “structural” constraints, but the willingness of people to spend money. Bringing clean energy to scale will call forth new spending, both public and private, in abundance.

Of course, not everyone will benefit from the clean energy boom. The problem of stranded assets is real— any effective response to climate change will mean that much of the world’s coal and oil never comes out of the ground. But it’s not clear how far this problem extends beyond the fossil fuel sector. For manufacturers, even in the most carbon-intensive industries, only a small part of their value as enterprises comes from the capital equipment they own. More important is their role in coordinating production—a role that conventional economic models, myopically focused on coordination through markets, have largely ignored. organizing complex production processes, and maintaining trust and cooperation among the various participants in them, are difficult problems, solved not by markets but by the firm as an ongoing social organism. This coordination function will retain its value even as production itself is transformed.

UPDATE: Followup post on the World War II experience here.