the money moment – Page 3

Review of Dumenil and Levy

The new issue of Rethinking Marxism has my review of The Crisis of Neoliberalism by Gérard Duménil and Dominique Lévy. Since RM is paywalled — a topic for another day — I’m putting the full text here.

Incidentally, I do recommend the book, but I would suggest just reading chapters 3-6, where the core arguments are developed, and then skipping to the final three chapters, 23-25. The intervening material is narrowly focused on the 2008-2009 financial crisis and is of less interest today.

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Historical turning points aren’t usually visible until well after the fact. But the period of financial and economic turmoil that began in 2008 may be one of the rare exceptions. If capitalism historically has evolved through a series of distinct regimes — from competition to monopoly in the late 19th century, to a regulated capitalism after World War II and then to neoliberalism after the crises of the 1970s, then 2008 may mark the beginning of another sharp turn.

That, anyway, is the central claim of The Crisis of Neoliberalism, by Gérard Duménil and Dominique Lévy (hereafter D&L). The book brings together a great deal of material, broadly grouped under two heads. First is an argument about the sociology of capitalism, hinging on the relationship between capitalists in the strict sense and the managerial class. And second is an account of the financial crisis of 2008 and its aftermath. A concluding survey of possibilities for the post-neoliberal world unites the two strands.

For D&L, the key to understanding the transformations of capitalism over the past hundred years lies in the sociology of the capitalist class. With the rise of the modern corporation at the turn of the 20th century, it became more problematic to follow Marx in treating the capitalist as simply the “personification of capital.” While the logic of capital is the same — it remains, in their preferred formulation, “value in a movement of self-expansion” — distinct groups of human beings now stand at different points in that process. In particular, “the emergence of a bourgeois class more or less separated from the enterprise” (13) created a new sociological gulf between the ownership of capital and the management of production.

Bridging this gulf was a new social actor, Finance. While banks and other financial institutions predate industrial capitalism, they now took on an important new role: representation of the capitalist class vis-a-vis corporate management, a function not needed when ownership and management were united in the same person. “Financial institutions,” D&L write, “are an instrument in the hands of the capitalist class as a whole in the domination they exercise over the entire economy.” (57) This gives finance a dual character, as on the one hand one industry among others providing a particular good (intermediation, liquidity, etc.) but also as, on the other hand, the enforcers or administrators who ensure that industry as a whole remains organized according to the logic of profit.

The stringency of this enforcement varies over time. For D&L, the pre-Depression and post-Volcker eras are two periods of “financial hegemony,” in which holders of financial claims actively intervened in the governance of nonfinancial firms, compelling mergers of industrial companies in the first period, and engineering leveraged buyouts and takeovers in the second. By contrast, the postwar period was one of relative autonomy for the managerial class, with the owners of capital accepting a relatively passive role. One way to think of it is that since capital is a process, its expression as an active subject can occur at different moments of that process. Under financial hegemony, the political and sociological projections of capital emanated mostly from the M moment, but in the mid-century more from C-C’. Concretely, this means firms pursued objectives like growth, technical efficiency, market share or technological advance rather than (or in addition to) profit maximization – this is the “soulful corporation” of Galbraith or Chandler. Unlike those writers, however, D&L see this corporation-as-polis, balancing the interests of its various stakeholders under the steady hand of technocratic management, as neither the result of a natural evolution nor a normative ideal; instead, it’s a specific political-economic configuration that existed under certain historical conditions. In particular, managerial capitalism was the result of both the crisis of the previous period of financial hegemony and, crucially, of the mobilization of the popular classes, which opened up space for the top managers to pursue a strategy of “compromise to the left” while continuing to pay the necessary tribute to “the big capitalist families.”

Those families — the owners of capital, in the form of financial assets — were willing to accept a relatively passive role as long as the tribute flowed. But the fall in the profit rate in the 1970s forced the owners to recohere as a class for themselves. Their most important project was, of course, the attack on labor, in which capital and management were united. But a second, less visible fight was the capitalists’ attack on the managers, with finance as their weapon. The wave of corporate takeovers, buyouts and restructurings of the 1980s was not just a normal competitive push for efficiencies, nor was it the work of a few freebooting pirates and swindlers. As theorized by people like Michael Jensen, it was a self-conscious project to reorient management’s goals from the survival and growth of the firm, to “shareholder value”. In this, it succeeded – first by bullying and bludgeoning recalcitrant managers, then by incorporating their top tier into the capitalist class. “During the 1980s the disciplinary aspect of the new relationship between the capitalist and managerial classes was dominant,” write D&L, but “after 2000, … managers had become a pillar of Finance.” (84) Today, the “financial facet of management tends to overwhelmingly dominate” and “a process of ‘hybridization’ or merger is under way.” (85)

These are not entirely new ideas. D&L cite Veblen, certainly one of the first to critically investigate the separation of management and control, and to observe that the “importance of securities in ownership of the means of production [gives] … the capitalist class a strong financial character.” But they make no mention of the important debates on these issues among Marxists in the 1970s, especially Fitch and Oppenheimer’s Socialist Revolution articles on “Who Rules the Corporations?” and David Kotz’s Bank Control of Large Corporations in the United States. Most glaringly, they fail to cite Doug Henwood’s Wall Street, whose Chapter 6 gives a strikingly similar account of the revolt of the rentiers, and which remains the best guide to relations between finance and nonfinancial businesses within a broad Marxist framework. While Henwood shares the same basic analysis as The Crisis of Neoliberalism, he backs it up with a wealth of concrete examples and careful attention to the language of the financiers and their apologists. D&L, by contrast, despite their welcome interest in the sociology of the capitalist class, never descend from a high level of abstraction. D&L would have advanced the conversation more if they had tried to build on the contributions of Fitch and Oppenheimer, Kotz, and Henwood, instead of reinventing them.

Still, it’s an immensely valuable book. Both mainstream economists and Marxists often imbue capitalist firms with a false homogeneity, as if the pursuit of profit was just a natural fact or imposed straightforwardly by competition. D&L offer an important corrective, that firms (and social life in general) are only kept subordinate to the self-expansion of value through active, ongoing efforts to enforce and universalize financial criteria.

The last third of the book is an account of the global financial crisis of the past five years. Much of the specifics will be familiar to readers of the business press, but the central argument makes sense only in light of the earlier chapters: that the ultimate source of the crisis was precisely the success of the reestablishment of financial hegemony. In particular, deregulation — especially the freeing of cross-border capital flows — weakened the tools states had previously used to keep the growth of financial claims in line with the productive capacity of the economy. (It’s an irony of history that the cult of central banking “maestros” reached its height at the point when they had lost most of their real power.) Meanwhile, increased payouts to shareholders and other financial claimants starved firms of funds for accumulation. A corollary of this second point is that the crisis was characterized by underaccumulation rather than by underconsumption. The underlying demand problem wasn’t insufficient funds flowing to workers for consumption — the rich consume plenty — but insufficient funds remaining within corporations for the purpose of investment. Just as investment suffered at the end of the postwar boom when the surplus available to capitalist firms was squeezed from below by rising wage claims, it suffered in the past decade when that surplus was squeezed from above by the claims of rentiers. So higher wages might only have made the crisis worse. This argument needs to be taken seriously, unpalatable though it may be. We need to avoid the theodicy of liberal economists, in which the conditions of social justice and the conditions of steady accumulation are always the same.

The Crisis of Neoliberalism is not the last word on the crisis, but it is one of the more convincing efforts to situate it in the longer-term trajectory of capitalism. The most likely outcome of the crisis, they suggest, is a shift in the locus of power back toward managers. Profit maximization will again be subordinated to other objectives. The maintenance of US hegemony will require a “reterritorialization” of production, which will inevitably weaken the position of fincance. There is an inherent conflict between a reassertion of state authority and the borderless class constituted by ownership of financial claims. But there is no such conflict between the interests of particular states, and the class constituted by authority within particular firms. “This is an important factor … strengthening of the comparative position of nonfinancial managers.”

Are we starting to see the dethroning of Finance, a return to the soulful corporation, and a retreat from the universalizing logic of profit? It’s too soon to tell. It’s interesting, though, to see Michael Jensen, the master theorist of the shareholder revolution, sounding a more soulful note. Shareholder value, he recently told The New Yorker, “is the score that shows up on the scoreboard. It’s not the objective… Your life can’t just be about you, or your life will be shit. You see that on Wall Street.” That business serves a higher calling than Wall Street, is the first item in the managerialist catechism. We might look at Occupy Wall Street and the growing movement against student debt in the same light: By singling out as the enemy those elites whose power takes directly financial form, they implicitly legitimate power more linked to control of the production process. Strange to think that a movement of anarchists could be heralding a return to power of corporate management. But history can be funny that way.

Liquidity Preference on the F Line

Sitting on the subway today, I was struck by the fact that the three ads immediately opposite me were all for what you might call liquidity services. On the left was an ad for “personal asset loans” from something called Borro: “With this necklace … I funded my first business,” says a satisfied customer. Next to it was an MTA ad trumpeting the fact that you can pay your fare with a credit card. And then one from AptDeco.com, which I guess is a clearinghouse for used furniture sales, with the tagline “NYC is now your furniture store.”

the Borro ad was the next one to the left

This was interesting to me because I’ve just been thinking about the neutrality of money, and what an incoherent and contradictory idea it is.

The orthodox view is that the level of “real” economic activity is determined by “real” factors — endowments, tastes, technology — and people simply hold money balances proportionate to this level of activity. In this view, a change in the money supply can’t make anyone better or worse off, at least in the long run, or change anything about the economy except the price level.

Just looking at these ads shows us why that can’t be true. First of all, the question of what constitutes money. All three of these ads are, in effect, inviting you to use something as money that you couldn’t previously. Without the specialized intermediary services being hawked here, you couldn’t pay the startup costs of a business with a necklace (what’s this thing made of, plutonium?), or pay for a subway ride with a promise to pay later, or pay for much of anything with a used couch. And this new liquidity has real benefits — otherwise, no one would be buying it, and it wouldn’t be worth the cost of producing (or advertising) it. The idea — stated explicitly in the Borro ad — is that the liquidity they provide allows transactions to take place that otherwise wouldn’t. The ability to turn a piece of jewelry or a car into cash allows people to use productive capacities that otherwise would go to waste.

And of course this makes sense. The orthodox view is that money is useful — there must be a reason that we don’t live in a barter world, and more than that, that all this huge industry of liquidity provision exists. But money, for some reason, is not subject to the same kind of smoothly diminishing returns that other useful things are. There is a fixed amount you need, you can’t get by with less, and there’s no benefit at all in having more. The problem is worse than that, since the standard view is that money demand is strictly proportionate to the volume of transactions. But, which transactions? Presumably, the amount of economic activity depends on the availability of money — that’s what it means to say that money is useful. And furthermore, as these ads implicitly make clear, some transactions are more liquidity-intensive than others. No one is offering specialized intermediary services to help you buy a hamburger. So both the level and composition of economic activity must depend on money holdings. But in that case, you can’t say that money holdings depend only on the volume of activity — that would be circular. In a world where money is used at all, it can’t be neutral. An increase in the money supply (or better, in liquidity) may raise prices, but it won’t do so proportionately, since it also enables people to benefit from increasing their money holdings (or: shifting toward more liquid balance sheet positions) and to carry out liquidity-intensive transactions that were formerly unable to.

This is a very old issue in economics. The idea that money should be neutral is as old as the discipline, and so is this line of criticism of it. You can find both already in Hume. In “Of Money,” he lays out the argument that money must be neutral in the long run, since it is just an intrinsically meaningless unit of measure; real wealth depends on real resources, not on the units we count them in. Unlike most later writers, he follows this argument to its logical conclusion, that any resources devoted to liquidity provision are wasted:

This has made me entertain a doubt concerning the benefit of banks and paper-credit, which are so generally esteemed advantageous to every nation. That provisions and labour should become dear by the encrease of trade and money, is, in many respects, an inconvenience; but an inconvenience that is unavoidable, and the effect of that public wealth and prosperity which are the end of all our wishes. … But there appears no reason for encreasing that inconvenience by a counterfeit money, which foreigners will not accept of in any payment, and which any great disorder in the state will reduce to nothing. There are, it is true, many people in every rich state, who having large sums of money, would prefer paper with good security; as being of more easy transport and more safe custody. … And therefore it is better, it may be thought, that a public company should enjoy the benefit of that paper-credit, which always will have place in every opulent kingdom. But to endeavour artificially to encrease such a credit, can never be the interest of any trading nation; but must lay them under disadvantages, by encreasing money beyond its natural proportion to labour and commodities, and thereby heightening their price to the merchant and manufacturer. And in this view, it must be allowed, that no bank could be more advantageous, than such a one as locked up all the money it received, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce.

You can find similar language in “On the Balance of Trade”:

I scarcely know any method of sinking money below its level [i.e. producing inflation], but those institutions of banks, funds, and paper-credit, which are so much practised in this kingdom. These render paper equivalent to money, circulate it throughout the whole state, make it supply the place of gold and silver, raise proportionably the price of labour and commodities, and by that means either banish a great part of those precious metals, or prevent their farther encrease. What can be more shortsighted than our reasonings on this head? We fancy, because an individual would be much richer, were his stock of money doubled, that the same good effect would follow were the money of every one encreased; not considering, that this would raise as much the price of every commodity, and reduce every man, in time, to the same condition as before. …

It is indeed evident, that money is nothing but the representation of labour and commodities, and serves only as a method of rating or estimating them. Where coin is in greater plenty; as a greater quantity of it is required to represent the same quantity of goods; it can have no effect, either good or bad, taking a nation within itself; any more than it would make an alteration on a merchant’s books, if, instead of the Arabian method of notation, which requires few characters, he should make use of the Roman, which requires a great many.

From this view — which is, again, just taking the neutrality of money to its logical conclusion — services like the ones being advertised on the F train are the exact opposite of what we want. By making more goods usable as money, they are only contributing to inflation. Rather than making it easier for people to use necklaces, furniture, etc. as means of payment, we should rather be discouraging people form using even currency as means of payment, by reducing banks to safe-deposit boxes.

That was where Hume left the matter when he first wrote the essays around 1750. But when he republished “On the Balance of Trade” in 1764, he was no longer so confident. [1] The new edition added a discussion of the development of banking in Scotland with a strikingly different tone:

It must, however, be confessed, that, as all these questions of trade and money are extremely complicated, there are certain lights, in which this subject may be placed, so as to represent the advantages of paper-credit and banks to be superior to their disadvantages. … The encrease of industry and of credit … may be promoted by the right use of paper-money. It is well known of what advantage it is to a merchant to be able to discount his bills upon occasion; and every thing that facilitates this species of traffic is favourable to the general commerce of a state. But private bankers are enabled to give such credit by the credit they receive from the depositing of money in their shops; and the bank of England in the same manner, from the liberty it has to issue its notes in all payments. There was an invention of this kind, which was fallen upon some years ago by the banks of Edinburgh; and which, as it is one of the most ingenious ideas that has been executed in commerce, has also been thought advantageous to Scotland. It is there called a Bank-Credit; and is of this nature. A man goes to the bank and finds surety to the amount, we shall suppose, of a 1000 pounds. This money, or any part of it, he has the liberty of drawing out whenever he pleases, and he pays only the ordinary interest for it, while it is in his hands. … The advantages, resulting from this contrivance, are manifold. As a man may find surety nearly to the amount of his substance, and his bank-credit is equivalent to ready money, a merchant does hereby in a manner coin his houses, his household furniture, the goods in his warehouse, the foreign debts due to him, his ships at sea; and can, upon occasion, employ them in all payments, as if they were the current money of the country.

Hume is describing something like a secured line of credit, not so different from the services being advertised on the F line, which also offer ways to coin your houses and household furniture. The puzzle is why he thinks this is a good thing. The trade credit provided by banks, which is now “favourable to the general commerce of the state,” is precisely what he was trying to prevent when he wrote that the best bank was one that “locked up all the money it received.”Why does he now think that increasing liquidity will stimulate industry, instead of just producing a rise in prices that will “reduce every man, in time, to the same condition as before”?

You can’t really hold it against Hume that he never resolved this contradiction. But what’s striking is how little the debate has advanced in the 250 years since. Indeed, in some ways it’s regressed. Hume at least drew the logical conclusion that in a world of neutral money, liquidity services like the ones advertised on the F train would not exist.

[1] I hadn’t realized this section was a later addition until reading Arie Arnon’s discussion of the essay in Monetary Theory and Policy from Hume and Smith to Wicksell. I hope to be posting more about this superb book in the near future.

Boulding on Interest

Kenneth Boulding, reviewing Maurice Allais’s Économie et intérêt in 1951:

Much work on the theory of interest is hampered at the start by its unquestioned assumption that “the” rate of interest, or even some complex of rates, is a suitable parameter for use in the construction of systems of economic relationships, whether static or dynamic. This is an assumption which is almost universally accepted and yet which seems to me to be very much open to question. My reason for questioning it is that the rate of interest is not an objective magnitude… The rate of interest is not a “price”; its dimensions are those of a rate of growth, not of a ratio of exchange, even though it is sometimes carelessly spoken of as a “price of loanable funds.” What is determined in the market is not strictly the rate of interest but the price of certain “property rights.” These may be securities, either stocks or bonds, or they may be items or collections of physical property. Each of these property rights represents to an individual an expected series of future values, which may be both positive and negative. If this expected series of values can be given some “certainty equivalent” … then the market price of the property determines a rate of interest on the investment. This rate of interest, however, is essentially subjective and depends on the expectations of the individual; the objective phenomenon is the present market price…

It is only the fact that the fulfilment of some expectations seems practically certain that gives us the illusion that there is an objective rate of interest determined in the market. But in strict theory there is no such certainty, even for gilt-edged bonds; and when the uncertainties of life, inflation, and government are taken into consideration, it is evident that this theoretical uncertainty is also a matter of practice. What is more, we cannot assume either that there are any “certain equivalents” of uncertain series for it is the very uncertainty of the future which constitutes its special quality. What this means is that it is quite illegitimate even to begin an interest theory by abstracting from uncertainty or by assuming that this can be taken care of by some “risk premium”; still less is it legitimate to construct a whole theory on these assumptions … without any discussion of the problems which uncertainty creates. What principally governs the desired structure of assets on the part of the individual is the perpetual necessity to hedge — against inflation, against deflation, against the uncertainty in the future of all assets, money included. It is these uncertainties, therefore, which are the principal governors of the demand and supply of all assets without exception, and no theory which abstracts from these uncertainties can claim much significance for economics. Hence, Allais is attempting to do something which simply cannot be done, because it is meaningless to construct a theory of “pure” interest devoid of premiums for risk, liquidity, convenience, amortization, prestige, etc. There is simply no such animal.

In other words: There are contexts when it is reasonable to abstract from uncertainty, and proceed on the basis that people know what will happen in the future, or at least its probability distribution. But interest rates are not such a context, you can’t abstract away from uncertainty there. Because compensation for uncertainty is precisely why interest is paid.

The point that what is set in the market, and what we observe, is never an interest rate as such, but the price of some asset today in terms of money today, is also important.

Boulding continues:

The observed facts are the prices of assets of all kinds. From these prices we may deduce the existence of purely private rates of return. The concept of a historical “yield” also has some validity. But none of these things is a “rate of interest” in the sense of something determined in a market mechanism.

This search for a black cat that isn’t there leads Allais into several extended discussions of almost meaningless and self-constructed questions… Thus he is much worried about the “fact” that a zero rate of interest means an infinite value for land, land representing a perpetual income, which capitalized at a zero rate of interest yields an infinite value… This is a delightful example of the way in which mathematics can lead to an almost total blindness to economic reality. In fact, the income from land is no more perpetual than that from anything else and no more certain. … We might draw a conclusion from this that a really effective zero rate of interest in a world of perfect foresight would lead to an infinite inflation; but, then, perfect foresight would reduce the period of money turnover to zero anyway and would give us an infinite price level willy-nilly! This conclusion is interesting for the light it throws on the complete uselessness of the “perfect foresight” model but for little else. In fact, of course, the element which prevents both prices from rising to infinity and (private) money rates of interest from falling to zero is uncertainty – precisely the factor which Allais has abstracted from. Another of these quite unreal problems which worries him a great deal is why there is always a positive real rate of interest, the answer being of course that there isn’t! …

Allais reflects also another weakness of “pure”interest theory, which is a failure to appreciate the true significance and function of financial institutions and of “interest” as opposed to “profit” – interest in this sense being the rate of growth of value in “securities,” especially bonds, and “profit” being the rate of growth of value of items or combinations of real capital. Even if there were no financial institutions or financial instruments … there would be subjective expected rates of profit and historical yields on past, completed investments. In such a society, however, given the institution of private property, everyone would have to administer his own property. The main purpose of the financial system is to separate “ownership” (i.e., equity) from “control,” or administration, that is, to enable some people to own assets which they do not control, and others to control assets which they do not own. This arrangement is necessitated because there is very little, in the processes by which ownership was historically determined through inheritance and saving, to insure that those who own the resources of society are … capable of administering them. Interest, in the sense of an income received by the owners of securities, is the price which society pays for correcting a defect in the otherwise fruitful institution of private property. It is, of course, desirable that the price should be as small as possible – that is, that there should be as little economic surplus as possible paid to nonadministering owners. It is quite possible, however, that this “service” has a positive supply price in the long run, and thus that, even in the stationary state, interest, as distinct from profit, is necessary to persuade the nonadministering owners to yield up the administration of their capital.

This last point is important, too. Property, we must always remember, is not a relationship between people and things. it is a relationship between people and people. Ownership of an asset means the authority to forbid other people from engaging in a certain set of productive activities. The “product” of the asset is how much other people will pay you not to exercise that right. Historically, of course, the sets of activities associated with a given asset have often been defined in relation to some particular means of production. But this need not be the case. In a sense, the patent or copyright isn’t an extension of the idea of property, but property in its pure form. And even where the rights of an asset owner are defined as those connected with some tangible object, the nature of the connection still has to be specified by convention and law.

According to Wikipedia, Économie et intérêt, published in 1947, introduced a number of major ideas in macroeconomics a decade or more before the American economists they’re usually associated with, including the overlapping generations model and the golden rule for growth. Boulding apparently did not find these contributions worth mentioning. He does, though, have something to say about Allais’s “economic philosophy” which “is a curious combination of Geseel, Henry George and Hayek,” involving “free markets, with plenty of trust- and union-busting, depreciating currency, and 100 per cent reserves in the banking system, plus the appropriation of all scarcity rents and the nationalization of land.” Boulding describes this as “weird enough to hit the jackpot.” It doesn’t seem that weird to me. It sounds like a typical example of a political vision you can trace back to Proudhon and forward through the “Chicago plan” of the 1930s and its contemporary admirers to the various market socialisms and more or less crankish monetary reform plans. (Even Hyman Minsky was drawn to this strain of politics, according to Perry Mehrling’s superb biographical essay.)What all these have in common is that they see the obvious inconsistency between capitalism as we observe it around us and the fairy tales of ideal market exchange, but they don’t reject the ideal. Instead, they propose a program of intrusive regulations to compel people to behave as they are supposed to in an unregulated market. They want to make the fairy tales true by legislation. Allais’ proposal for currency depreciation is not normally part of this package; it’s presumably a response to late-1940s conditions in France. But other than that these market utopias are fairly consistent. In particular, it’s always essential to reestablish the objectivity of money.

Finally, in a review full of good lines, I particularly like this one:

Allais’s work is another demonstration that mathematics and economics, though good complements, are very imperfect substitutes. Mathematics can manipulate parameters once formulated and draw conclusions out which were already implicit in the assumptions. But skills of the mathematician are no substitute for the proper skill of the economist, which is that of selecting the most significant parameters to go into the system.

Varieties of Keynesianism

Here’s something interesting from Axel Leijonhufvud. It’s a response to Luigi Pasinetti’s book on Keynes, but really it’s an assessment of the Keynesian revolution in general.

There really was a revolution, according to Pasinetti, and it can be dated precisely, to 1932. Leijonhufvud:

By the Spring of that year, Keynes had concluded that the Treatise could not be salvaged by a revised edition. He still gave his “Pure Theory of Money” lecture series which was largely based on it but members of his ‘Circus’ attended and gave him trouble. The summer of that year appears to have been a critical period. In the Fall, Keynes announced a new series of lectures with the title “The Monetary Theory of Production”. The new title signaled a break with his previous work and a break with tradition. From this point onward, Keynes felt himself to be doing work that was revolutionary in nature.

What was revolutionary about these lectures was that they weren’t about extending or modifying the established framework of economics, but about adopting a new starting point. A paradigm in economics can be thought of as defined by the minimal model — the model that (in Pasinetti’s words) “contains those analytical features, and only those features, which the theory cannot do without.” Or as I’ve suggested here, the minimal model is the benchmark of simplicity in terms of which Occam’s razor is applied.

For the orthodox economics of Keynes’s day (and ours), the minimal model was one of “real exchange” in which a given endowment of goods and a given set of preferences yielded a vector of relative prices. Money, production, time, etc. can then be introduced as extensions of this minimal model. In Keynes’ “monetary production” model, on the other hand, the “analytical features which the theory cannot do without” are a set of income flows generated in production, and a set of expenditure flows out of income. The minimal model does not include any prices or quantities. Nor does it necessarily include exchange — it’s natural to think of the income flows as consisting of profits and wages and the expenditure flows as consumption and investment, but they can just as naturally include taxes, interest payments, asset sales, and so on.

I don’t want to suggest that the monetary production paradigm has ever been as well-defined as the real exchange paradigm. One of Leijonhufvud’s main points is that there has never been a consensus on the content of the Keynesian revolution. There are many smart people who will tell you what “Keynes really meant.” With due respect (and I mean it) I’m not convinced by any of them. I don’t think anyone knows what Keynes really meant —including Keynes himself. The truth is, the Hicks-Patinkin-Samuelson version of Keynes is no bastard; its legitimate paternity is amply documented in the General Theory. Pasinetti quotes Joan Robinson: “There were moments when we had some trouble in getting Maynard to see what the point of his revolution really was.” Which doesn’t, of course, means that Hicks-Patinkin-Samuelson is the only legitimate Keynes — here even more than in most questions of theory, we have to tolerate ambiguity and cultivate the ability to hold more than one reading in mind at once.

One basic ambiguity is in that term, “monetary production.” Which of those words is the important one?

For Pasinetti, the critical divide is between Keynes’ theory of production and the orthodox theory of exchange. Pasinetti’s production-based Keynesianism

starts from the technological imperatives stemming from the division and specialization of labor. In this context, exchange is derivative, stemming from specialization in production. How it is institutionalized and organized is a matter that the minimal production paradigm leaves open (whereas the exchange paradigm necessarily starts by assuming at least private property and often also organized markets). Prices in the production paradigm are indices of technologically determined resource costs and, as such, leave open the question whether the system does or does not have a tendency towards the full utilization of scarce resources and, in particular, of labor. …

The exchange paradigm relies on individual self-interest, on consumer’s sovereignty, and on markets and private property as the principal institutions needed to bring about a socially desirable and harmonious outcome. In putting the division of labor and specialization at center stage, the pure production model, in contrast, highlights the “necessarily cooperative aspects of any organized society…

To an unsympathetic audience, I admit, this could come across as a bunch of commencement-speech pieties. For a rigorous statement of the pure production paradigm we need to turn to Sraffa. In Production of Commodities by Means of Commodities he starts from the pure engineering facts — the input-output matrices governing production at current levels using current technology. There’s nothing about prices, demand, distribution. His system “does not explain anything about the allocation of resources. Instead, the focus is altogether on finding a logical basis for objective measurement. It is a system for coherent, internally coherent macroeconomic accounting.”

In other words: We cannot reduce the heterogeneous material of productive activity to a single objective quantity of need-satisfaction. There is no such thing. Mengers, Jevons, Walras and their successors set off after the will-o-the-wisp of utility and, to coin a phrase, vanished into a swamp, never to be heard from by positive social science again.

The question then is, how can we consistently describe economic activity using only objective, observable data? (This was also the classical question.) Sraffa answers in terms of a “snapshot” of production at a given moment. Or as Sen puts it, in a perceptive essay, he is showing how one can do economics without the use of counterfactuals.

For Pasinetti, Keynes’ revolution and Sraffa’s anti-subjectivist revival of classical economics — his effort to ground economics in engineering data — were part of the same project, of throwing out subjectivism in favor of engineering. Leijonhufvud is not convinced. “Keynes was above all a monetary economist,” he notes, “and there are good reasons to believe” that it was monetary and not production that was the key term in the “theory of monetary production.” Keynes made no use of the theory of imperfect competition, despite its development by members of his inner circle (Richard Kahn and Joan Robinson). Or consider his famous reversal on wages — in the General Theory, he assumed they were equal to the marginal product of labor, which declined with the level of output. But after this claim was challenged Dunlop, Tarshis and others, he admitted there was no real evidence for it and good reason to think it was not true. [1] The fact that JMK didn’t think anything important in his theory hinged on how wages were set, at least suggests that production side of economy was not central to his project.

The important point for us is that there is one strand of Cambridge that rejects orthodoxy on the grounds that it misrepresents a system of production based on objective relationships between inputs and outputs, as a system of exchange based on subjective preferences. But this is not the only vantage point from which one can criticize the Walrasian system and it’s not clear it’s the one occupied by Keynes or by Keynesianism — whatever that may be.

The alternative standpoint is still monetary production, but with the stress on the first word rather than the second. Leijonhufvud doesn’t talk much about this here, since this is an essay about Pasinetti. But it’s evidently something along the lines of Mehrling’s “money view” or “finance view.” [2] It seems to me this view has three overlapping elements: 1. The atomic units of the economy are money flows (and commitments to future money flows), as opposed to prices and quantities. 2. Quantities are quantities of money; productive activity is not measurable except insofar as it involves money payments. 3. The active agents of the economy are seeking to maximize money income or wealth, not to end up with some preferred consumption basket. Beside Mehrling, I would include Minsky, Paul Davidson and Wynne Godley here, among others.

I’m not going to try to summarize this work here. Let me just say how I’m coming at this.

As I wrote in comments to an earlier post, what I want is to think more systematically about the relationship between the network of financial assets and liabilities recorded on balance sheets, on the one hand, and the concrete social activities of production and consumption, on the other. What we have now, it seems to me, is either a “real” view that collapses these two domains into one, with changes in ownership and debt commitments treated as if they were decisions about production and consumption; or else a “finance” view that treats balance-sheet transactions as a closed system. I think the finance view is more correct, in the sense that at least it sees half of the problem clearly. The “real” view is a hopeless muddle because it tries to treat the concrete social activity of production and consumption as if it were a set of fungible quantities like money, and to treat money commitments as if they were decisions about production and consumption. The strength of the finance view is that it recognizes the system of contingent money payments recorded on balance sheets as a distinct social activity, and not simply a reflection of the allocation of goods and services. To be clear: The purpose of recognizing finance as a distinct thing isn’t to study it in isolation, but rather to explore the specific ways in which it interacts with other kinds of social activity. This is the agenda that Fisher dynamics, disgorge the cash, functional finance and the other projects I’m working on are intended to contribute to.

[1] It’s a bit embarrassing that this “First Classical Postulate,” which Keynes himself said “is the portion of my book which most needs to be revised,” is the first positive claim in the book.

[2] Mehrling prefers to trace his intellectual lineage to the independent tradition of American monetary economics of Young, Hansen and Shaw. But I think the essential content is similar.

Where Do Interest Rates Come From?

What determines the level of interest rates? It seems like a simple question, but I don’t think economics — orthodox or heterodox — has an adequate answer.

One problem is that there are many different interest rates. So we have two questions: What determines the overall level of interest rates, and what determines the spreads between different interest rates? The latter in turn we can divide into the question of differences in rates between otherwise similar loans of different lengths (term spreads), differences in rates between otherwise similar loans denominated in different currencies, and all the remaining differences, grouped together under the possibly misleading name risk spreads.

In any case, economic theory offers various answers:

1. The orthodox answer, going back to the 18th century, is that the interest rate is a price that equates the desire to save with the desire to borrow. As reformulated in the later 19th century by Bohm-Bawerk, Cassel, etc., that means: The interest rate is the price of goods today relative to goods tomorrow. The interest rate is the price that balances the gains from deferring consumption with our willingness to do so. People generally prefer consumption today to consumption in the future, and because it will be possible to produce more in the future than today, so the interest rate is (normally) positive. This is a theory of all transactions that exchange spending in one period for spending (or income) in another, not specifically a theory of the interest rate on loans.

The Wicksell variant of this, which is today’s central-bank orthodoxy, is that there is a well-defined natural interest rate in this sense but that for some reason markets get this one price wrong.

2. An equally old idea is that the interest rate is the price of money. In Hume’s writings on money and interest, for instance, he vacillates between this and the previous story. It’s not a popular view in the economics profession but it’s well-represented in the business world and among populists and monetary reformers,. In this view, money is just another input to the production process, and the interest rate is its price. A creditor, in this view, isn’t someone deferring consumption to the future, but someone who — like a landlord — receives an income thanks to control of a necessary component of the production process. A business, let’s say, that needs to maintain a certain amount of working capital in the form of money or similarly liquid assets, may need to finance it with a loan on which it pays interest. Interest payments are in effect the rental price of money, set by supply and demand like anything else. As I say, this has never been a respectable view in economic theory, but you can find it in more empirical work, like this paper by Gabriel Chodorow-Reich, where credit is described in exactly these terms as an input to current production.

3. Keynes’ liquidity-preference story in The General Theory. Here again the interest rate is the price of money. But now instead of asking how much the marginal business borrower will pay for the use of money, we ask how much the marginal wealth owner needs to be compensated to give up the liquidity of money for a less-liquid bond. The other side of the market is given by a fixed stock of bonds; evidently we are dealing with a short enough period that the flow of new borrowing can be ignored, and the bond stock treated as exogenously fixed. With no new borrowing, the link from the interest rate is liked to the real economy because it is used to discount the expected flow of profits from new investment — not by business owners themselves, but by the stock market. It’s an oddly convoluted story.

4. A more general liquidity-preference story. Jorg Bibow, in a couple of his essential articles on the Keynesian theory of liquidity preference, suggests that many of the odd features of the theory are due to Keynes’ decision to drop the sophisticated analysis of the financial system from The Treatise on Money and replace it with an assumption of an exogenously fixed money stock. (It’s striking that banks play no role in in the General Theory.) But I’m not sure how much simpler this “simplification” actually makes the story, or whether it is even logically coherent; and in any case it’s clearly inapplicable to our modern world of bank-created credit money. In principle, it should be possible to tell a more general version of the liquidity preference story, where, instead of wealth holders balancing the income from holding a bond against the liquidity from holding “money,” you have banks balancing net income against incremental illiquidity from simultaneously extending a loan and creating a deposit. I’m afraid to say I haven’t read the Treatise, so I don’t know how much you can find that story there. In any case it doesn’t seem to have been developed systematically in later theories of endogenous money, which typically assume that the supply of credit is infinitely elastic except insofar as it’s limited by regulation.

5. The interest rate is set by the central bank. This is the orthodox story when we turn to the macro textbook. It’s also the story in most heterodox writers. From Wicksell onward, the whole discussion about interest rates in a macroeconomic context is about how the central bank can keep the interest rate at the level that keeps current expenditure at the appropriate level, and what happens if it fails to do so. It is sometimes suggested that the optimal or “natural” interest rate chosen by the central bank should be the the Walrasian intertemporal exchange rate — explicitly by Hayek, Friedman and sometimes by New Keynesians like Michael Woodford, and more cautiously by Wicksell. But the question of how the central bank sets the interest rate tends to drop out of view. Formally, Woodford has the central bank set the interest rate by giving it a monopoly on lending and borrowing. This hardly describes real economies, of course, but Woodford insists that it doesn’t matter since central banks could control the interest rate by standing ready to lend or borrow unlimited amounts at thresholds just above and below their target. The quite different procedures followed by real central banks are irrelevant. [1]

A variation of this (call it 5a) is where reserve requirements bind and the central bank sets the total quantity of bank credit or money. (In a world of bind reserve requirements, these will be equivalent.) In this case, the long rate is set by the demand for credit, given the policy-determined quantity. The interbank rate is then presumably bid up to the minimum spread banks are willing to lend at. In this setting causality runs from long rates to short rates, and short rates don’t really matter.

6. The interest rate is set by convention. This is Keynes’ other theory of the interest rate, also introduced in the General Theory but more fully developed in his 1937 article “Alternative Theories of the Rate of Interest.” The idea here is that changes in interest rates imply inverse changes in the price of outstanding bonds. So from the lenders’ point of view, the expected return on a loan includes not only the yield (as adjusted for default risk), but also the capital gain or loss that will result if interest rates change while the loan is still on their books. The longer the term of the loan, the larger these capital gains or losses will be. I’ve discussed this on the blog before and may come back to it in the future, but the essential point is that if people are very confident about the future value of long rates (or at least that they will not fall below some floor) then the current rate cannot get very far from that future expected rate, no matter what short rates are doing, because as the current long rate moves away from the expected long rate expected capital gains come to dominate the current yield. Take the extreme case of a perpetuity where market participants are sure that the rate will be 5% a year from now. Suppose the short rate is initially 5% also, and falls to 0. Then the rate on the perpetuity will fall to just under 4.8% and no lower, because at that rate the nearly 5% spread over the short rate just compensates market participants for the capital loss they expect when long rates return to their normal level. (Obviously, this is not consistent with rational expectations.) These kinds of self-stabilizing conventional expectations are the reason why, as Bibow puts it, “a liquidity trap … may arise at any level of interest.” A liquidity trap is an anti-bubble, if you like.

What do we think about these different stories?

I’m confident that the first story is wrong. There is no useful sense in which the interest rate on debt contracts — either as set by markets or as target by the central bank — is the price of goods today in terms of goods tomorrow. The attempt to understand interest rates in terms of the allocation across time of scarce means to alternative ends is a dead end. Some other intellectual baggage that should overboard with the “natural” rate of interest are the “real”rate of interest, the idea of consumption loans, and the intertemporal budget constraint.

But negative criticism of orthodoxy is too easy. The real work is to make a positive case for an alternative. I don’t see a satisfactory one here.

The second and third stories depend on the existence of “money” as a distinct asset with a measurable, exogenously fixed quantity. This might be a usable assumption in some historical contexts — or it might not — but it clearly does not describe modern financial systems. Woodford is right about that.

The fifth story is clearly right with respect short rates, or at least it was until recently. But it’s incomplete. As an empirical matter, it is true that interbank rates and similar short market rates closely follow the policy rate. The question is, why? The usual answer is that the central bank is the monopoly supplier of base money, and base money is used for settlement between banks. This may be so, but it doesn’t have to be. Plenty of financial systems have existed without central banks, and banks still managed to make payments to each other somehow. And where central banks exist, they don’t always have a monopoly on interbank settlement. During the 19th century, the primary tool of monetary policy at the Bank of England was the discount rate — the discount off of face value that the bank would pay for eligible securities (usually trade credit). But if the discount rate was too high — if the bank offered too little cash for securities — private banks would stop discounting securities at the central bank, and instead find some other bank that was willing to give them cash on more favorable terms. This was the problem of “making bank rate effective,” and it was a serious concern for 19th century central banks. If they tried to raise interest rates too high, they would “lose contact with the market” as banks simply went elsewhere for liquidity.

Obviously, this isn’t a problem today — when the Fed last raised policy rates in the mid-2000s, short market rates rose right along with it. Or more dramatically, Brazil’s central bank held nominal interest rates around 20 percent for nearly a decade, while inflation averaged around 8 percent. [2] In cases like these, the central bank evidently is able to keep short rates high by limiting the supply of reserves. But why in that case doesn’t the financial system develop private substitutes for reserves? Mervyn King blandly dismisses this question by saying that “it does not matter in principle whether the disequilibrium in the money market is an aggregate net shortage or a net surplus of funds—control of prices or quantities carries across irrespective of whether the central bank is the monopoly supplier or demander of its own liabilities.” [3] Clearly, the central bank cannot be both the monopoly supplier and the monopoly demander of reserves, at least not if it wants to have any effect on the rest of the world. The relevant question — to which King offers no answer — is why there are no private substitutes for central bank reserves. Is it simply a matter of legal restrictions on interbank settlements using any other asset? But then why has this one regulatory barrier remained impassable while banks have tunneled through so many others? Anyway, going forward the question may be moot if reserves remain abundant, as they will if the Fed does not shrink its balance sheet back to pre-crisis levels. In that case, new tools will be required to make the policy rate effective.

The sixth story is the one I’m most certain of. First, because it can be stated precisely in terms of asset market equilibrium. Second, because it is consistent with what we see historically. Long term interest rates are quite stable over very long periods. Third, it’s consistent with what market participants say: It’s easy to find bond market participants saying that some rate is “too low” and won’t continue, regardless of what the Fed might think. Last, but not least from my point of view, this view is clearly articulated by Keynes and by Post Keynesians like Bibow. But while I feel sure this is part of the story, it can’t be the whole story. First, because even if a conventional level of interest rates is self-stabilizing in the long run, there are clearly forces of supply and demand in credit markets that push long rates away from this level in the short run. This is even more true if what convention sets is less a level of interest rates, than a floor. And second, because Keynes also says clearly that conventions can change, and in particular that a central bank that holds short rates outside the range bond markets consider reasonable for long enough, will be able to change the definition of reasonable. So that brings us back to the question of how it is that central banks are able to set short rates.

I think the fundamental answer lies behind door number 4. I think there should be a way of describing interest rates as the price of liquidity, where liquidity refers to the capacity to honor one’s promises, and not just to some particular asset. In this sense, the scarce resource that interest is pricing is trust. And monetary policy then is at root indistinguishable from the lender of last resort function — both are aspects of the central bank’s role of standing in as guarantor for commitments within the financial system. You can find elements of this view in the Keynesian literature, and in earlier writers going back to Thornton 200-plus years ago. But I haven’t seen it stated systematically in way that I find satisfactory.

UPDATE: For some reason I brought up the idea of the interest rate as the price of money without mentioning the classic statement of this view by Walter Bagehot. Bagehot uses the term “price of money” or “value of money” interchangeably with “discount rate” as synonyms for the interest rate. The discussion in chapter 5 of Lombard Street is worth quoting at length:

Many persons believe that the Bank of England has some peculiar power of fixing the value of money. They see that the Bank of England varies its minimum rate of discount from time to time, and that, more or less, all other banks follow its lead, and charge much as it charges; and they are puzzled why this should be. ‘Money,’ as economists teach, ‘is a commodity, and only a commodity;’ why then, it is asked, is its value fixed in so odd a way, and not the way in which the value of all other commodities is fixed?

There is at bottom, however, no difficulty in the matter. The value of money is settled, like that of all other commodities, by supply and demand… A very considerable holder of an article may, for a time, vitally affect its value if he lay down the minimum price which he will take, and obstinately adhere to it. This is the way in which the value of money in Lombard Street is settled. The Bank of England used to be a predominant, and is still a most important, dealer in money. It lays down the least price at which alone it will dispose of its stock, and this, for the most part, enables other dealers to obtain that price, or something near it. …

There is, therefore, no ground for believing, as is so common, that the value of money is settled by different causes than those which affect the value of other commodities, or that the Bank of England has any despotism in that matter. It has the power of a large holder of money, and no more. Even formerly, when its monetary powers were greater and its rivals weaker, it had no absolute control. It was simply a large corporate dealer, making bids and much influencing—though in no sense compelling—other dealers thereby.

But though the value of money is not settled in an exceptional way, there is nevertheless a peculiarity about it, as there is about many articles. It is a commodity subject to great fluctuations of value, and those fluctuations are easily produced by a slight excess or a slight deficiency of quantity. Up to a certain point money is a necessity. If a merchant has acceptances to meet to-morrow, money he must and will find today at some price or other. And it is this urgent need of the whole body of merchants which runs up the value of money so wildly and to such a height in a great panic….

If money were all held by the owners of it, or by banks which did not pay an interest for it, the value of money might not fall so fast. … The possessors would be under no necessity to employ it all; they might employ part at a high rate rather than all at a low rate. But in Lombard Street money is very largely held by those who do pay an interest for it, and such persons must employ it all, or almost all, for they have much to pay out with one hand, and unless they receive much with the other they will be ruined. Such persons do not so much care what is the rate of interest at which they employ their money: they can reduce the interest they pay in proportion to that which they can make. The vital point to them is to employ it at some rate…

The fluctuations in the value of money are therefore greater than those on the value of most other commodities. At times there is an excessive pressure to borrow it, and at times an excessive pressure to lend it, and so the price is forced up and down.

The relevant point in this context is the explicit statement that the interest, or discount, rate is set by the supply and demand for money. But there are a couple other noteworthy things. First, the concept of supply and demand is one of monopolistic competition, in which lenders are not price takers, but actively trade off markup against market share. And second, that the demand for money (i.e. credit) is highly inelastic because money is needed not only or mainly to purchase goods and services, but first and foremost to meet contractual money commitments.

[1] See Perry Mehrling’s useful review. Most of the text of Woodford’s textbook can be downloaded for free here. The introduction is nontechnical and is fascinating reading if you’re interested in this stuff.

[2] Which is sort of a problem for Noah Smith’s neo-Fisherite view.

[3] in the same speech, King observes that “During the 19th century, the Bank of England devoted considerable attention to making bank rate ‘effective’.” His implication is that central banks have always been able to control interest rates. But this is somewhat misleading, from my point of view: the Bank devoted so much attention to making its rate “effective” precisely because of the occasions when it failed to do so.

Mehrling on Black on Capital

In a post last week, I suggested that an alternative to thinking of capital as quantity of means of production accumulated through past investment, is to think of it as the capitalized value of expected future profit flows. Instead of writing

α = r k

where α is the profit share of national income, r is the profit rate, and k is the capital-income ratio, we should write

k = α / r

where r is now understood as the discount rate applied to future capital income.

Are the two rs the same? Piketty says no: the discount rate is presumably (some) risk-free interest rate, while the return on capital is typically higher. But I’m not sure this position is logically sustainable. If there are no barriers to entry, why isn’t investment carried to the point where the return on capital falls to the interest rate? On the other hand, if there are barriers to entry, so that capital can continue to earn a return above the interest rate without being flooded by new investment with borrowed funds, then profits cannot all be attributed to measured capital; some is due to whatever privilege creates the barriers. Furthermore, in that case there will not be, even tendentially, a uniform economywide rate of profit.

In any case, whether or not we have a coherent story of how there can be a profit rate distinct from the discount rate, it’s clearly the latter that matters for corporate equity, which is the main form of capital Piketty observes in modern economies. Verizon, to take an example at random, has current annual earnings of around $20 billion and is valued by the stock market at around $200 billion. Nobody, I hope, would interpret these numbers as meaning that Verizon has $200 billion of capital and, since the economy-wide profit rate is 10%, that capital generates $20 billion in profits. Rather, Verizon — the enterprise as a whole, its physical capital, its organization and corporate culture, its brand, its relationships with regulators, the skills and compliance (or not) of its workers — currently generates $20 billion a year of profits. And the markets — applying the economy-wide discount factor embodied in the interest rate, plus a judgement about the likely change in share of the social surplus Verizon will be able to claim in the future — assess the present value of that stream of profits from now til doomsday at $200 billion.

Now it might so happen that the stock market capitalization of a corporation is close to the reported value of assets less liabilities — this corresponds to a Tobin’s q of 1. Verizon, with total assets of $225 billion and total liabilities of $50 billion, happens to fit this case fairly well. It might also be the case that a firm’s reported net assets, deflated by some appropriate price index, correspond to its accumulated investment; it might even also be the case that there is a stable relationship between reported net capital and earnings. But as far as market capitalization goes, it makes no difference if any of those things is true. All that matters is market expectations of future earnings, and the interest rate used to discount them.

I was thinking about this in relation to Piketty’s Capital in the 21st Century. But of course the point is hardly original. Fischer Black (of the Black-Scholes option-pricing formula) made a similar argument decades ago for thinking of capital as a claim on a discounted stream of future earnings, rather than as an accumulation of past investments.

Here’s Perry Mehrling on Black’s view of capital:

As in Fisher, Black’s emphasis is on the market value of wealth calculated as the expected present value of future income flows, rather than on the quantity of wealth calculated as the historical accumulation of savings minus depreciation. This allows Black to treat knowledge and technology as forms of capital, since their expected effects are included when we measure capital at market value. As he says: “more effective capital is more capital” (1995a, 35). Also as in Fisher, capital grows over time without any restriction from fixed factors.

…

For Black, the standard aggregative neoclassical production function is inadequate because it obscures sectoral and temporal detail by attributing current output to current inputs of capital and labor, but he tries anyway to express his views in that framework in order to reach his intended audience. Most important, he accommodates the central idea of mismatch to the production function framework by introducing the idea that the “utilization” of physical capital and the “effort” of human capital can vary over time. This accommodation makes it possible to express his theory in the familiar Cobb-Douglas production function form: y = A(eh)^α(fk)^(1-α), where y is output, h and k are human and physical capital, e and f are effort and utilization, and A is a temporary shock (1995, eq. 5.3).

It’s familiar math, but the meaning it expresses remains very far from familiar to the trained economist. For one, the labor input has been replaced by human capital so there is no fixed factor. For another, both physical and human capital are measured at market values, and so are supposed to include technological change. This means that the A coefficient is not the usual technology shift factor (the familiar “Solow residual”) but only a multiplier, indeed a kind of inverse price earnings ratio, that converts the stock of effective composite capital into a flow of composite output. In effect, and as he recognizes, Black’s production function is a reduced form, not a production function at all in the usual sense of a technical relation between inputs and outputs. What Black is after comes clearer when he groups terms and summarizes as Y=AEK (eq. 5.7), where Y is output, E is composite utilization, and K is composite capital. Here the effective capital stock is just a constant multiple of output, and vice versa. It’s just an aggregate version of Black’s conception of ideal accounting practice (1993c) wherein accountants at the level of the firm seek to report a measure of earnings that can be multiplied by a constant price- earnings ratio to get the value of the firm.

…

In retrospect, the most fundamental source of misunderstanding came (and comes still) from the difference between an economics and a finance vision of the nature of the economy. The classical economists habitually thought of the present as determined by the past. In Adam Smith, capital is an accumulation from the careful saving of past generations, and much of modern economics still retains this old idea of the essential scarcity of capital, and of the consequent virtue attached to parsimony. The financial point of view, by contrast, sees the present as determined by the future, or rather by our ideas about the future. Capital is less a thing than an idea about future income flows discounted back to the present, and the quantity of capital can therefore change without prior saving.

In comments, A H mentioned that Post Keynesian or structuralist economics seem much closer to the kind of analysis used by finance professionals than orthodox economics does. I think one reason is that we share what Mehrling calls the “money view” or, here, the “finance vision” of the economy. Orthodoxy sees the economy as a set of exchanges of goods; the finance vision sees a set of contractual money payments.

Mehrling continues:

In The Nature of Capital and Income, Irving Fisher (1906) straddled the older world view of economics and the emerging world view of finance by distinguishing physical capital goods (for which the past-determines-present view makes sense) from the value of those goods (for which the future-determines-present view makes sense). By following Fisher, Black wound up employing the same straddle.

Piketty may be in a similarly awkward position.

Further Thoughts on Anti-Financialization

I want to amplify the last point from the previous post, about anti-financialization.

If we go back to the beginning of the national accounts in 1929, we find personal consumption accounts for around 75% of GDP. (This is true whether or not we make the C&F adjustments, since in 1929 the imputed and third-party component of consumption were either nonexistent or small.) During the Depression, the consumption share rises to 85% as business investment collapses, during the war it falls to below 50%, and it rises back to around two-thirds after 1945. It’s in the second half of the 1940s, with the growth of pension and health benefits and the spread of homeownership, that we start to see a large wedge between headline consumption and actual cash expenditures by households.

We can think of the ratio of adjusted consumption to GDP as a measure of how marketized the economy is: How much of output is purchased by people for their own use, as opposed to allocated in some other way? In this sense, the steady fall in adjusted consumption as a share of GDP represents a steady retreat of capitalist production in the postwar US. It was squeezed from both sides: from “above” by public provision of health care, education and retirement security, and from “below” by the state-fostered growth of self-provision in housing.

Consumption spending by households bottomed out at 47 percent of GDP in 1981. With the neoliberal turn, the process of de-marketization largely halted — but it did not reverse. Since then, consumption spending by households has hovered around 47-48% of GDP. The phenomena of household financialization, “markets for everything,” etc. are real — but only at the level of ideology. Private life in the US has not become more commodified, marketized or financialized in recent decades; over a longer horizon the opposite. What has happened is that a thickening veneer of fictional market transactions has been overlaid on a reality of social consumption.

In reality, neither collective provision of health care (or of education, public safety, etc.) nor self-provision of housing has been replaced to any noticeable degree by market purchases. What we’ve had, instead, is the statistical illusion of rising private consumption spending — an illusion fostered by the distortion of the national accounts by the dominant economic theory. When health insurance is purchased collectively by government or employers, the national accounts pretend that people were paid in cash and then chose to purchase health coverage individually. When retirement savings are carried out collectively by government or employers, the national accounts pretend that people were paid in cash and then chose to purchase financial assets. When people buy houses for their own use, the national accounts pretend they are profit-maximizing landlords, selling the use of their houses in the rental market. When liquidity constraints force people to hold financial wealth in low-yield forms, the national accounts pretend that financial markets are frictionless and that they are receiving the market yield in some invisible form. Together, these fictional transactions now make up 20 percent of GDP, and fully a third of apparent household consumption.

Of course, that might change. The decline of homeownership and the creation of a rental market for single-family homes may turn the fiction of a housing sector of tenants and profit-seeking landlords into a reality. One result of Obamacare — intended or otherwise — will be to replace collective purchases of health insurance by employers with individual purchases by households. Maybe the Kochs and Mark Zuckerberg will join forces and succeed in privatizing the schools. But none of that has happened yet. What’s striking to me is how many critics of contemporary capitalism — including Cynamon and Fazzari themselves — have accepted the myth of rising household consumption, without realizing there’s no such thing. The post 1980s rise in consumption is a statistical artifact of the ideology of capitalism — a way of pretending that a world of collective production and consumption is a world of private market exchange.

Gurley and Shaw on Banking

Gurley and Shaw (1956), “Financial Intermediaries in the Saving-Investment Process”:

As intermediaries, banks buy primary securities and issue, in payment for them, deposits and currency. As the payments mechanism, banks transfer title to means of payment on demand by customers. It has been pointed out before, especially by Henry Simons, that these two banking functions are at least incompatible. As managers of the payments mechanism, the banks cannot afford a shadow of insolvency. As intermediaries in a growing economy, the banks may rightly be tempted to wildcat. They must be solvent or the community will suffer; they must dare insolvency or the community will fail to realize its potentialities for growth.

All too often in American history energetic intermediation by banks has culminated in collapse of the payments mechanism. During some periods, especially cautious regard for solvency has resulted in collapse of bank intermediation. Each occasion that has demonstrated the incompatibility of the two principal banking functions has touched off a flood of financial reform. These reforms on balance have tended to emphasize bank solvency and the viability of the payments mechanism at the expense of bank participation in financial growth. They have by no means gone to the extreme that Simons proposed, of divorcing the two functions altogether, but they have tended in that direction rather than toward endorsement of wildcat banking. This bias in financial reform has improved the opportunities for non-monetary intermediaries. The relative retrogression in American banking seems to have resulted in part from regulatory suppression of the intermediary function.

Turning to another matter, it has seemed to be a distinctive, even magic, characteristic of the monetary system that it can create money, erecting a “multiple expansion”of debt in the form of deposits and currency on a limited base of reserves. Other financial institutions, conventional doctrine tells us, are denied this creative or multiplicative faculty. They are merely middlemen or brokers, not manufacturers of credit. Our own view is different. There is no denying, of course, that the monetary system creates debt in the special form of money: the monetary system can borrow by issue of instruments that are means of payment. There is no denying, either, that non-monetary intermediaries cannot create this same form of debt. …

However, each kind of non-monetary intermediary can borrow, go into debt, issue its own characteristic obligations – in short, it can create credit, though not in monetary form. Moreover, the non-monetaryintermediaries are less inhibited in their own style of credit creation than are the banks in creating money. Credit creation by non-monetary intermediaries is restricted by various qualitative rules. Aside from these, the main factor that limits credit creation is the profit calculus. Credit creation by banks also is subject to the profit condition. But the monetary system is subject not only to this restraint and to a complex of qualitative rules. It is committed to a policy restraint, of avoiding excessive expansion or contraction of credit for the community’s welfare, that is not imposed explicitly on non-monetary intermediaries. It is also held in check by a system of reserve requirements. … The [money multiplier] is a remarkable phenomenon not because of its inflationary implications but because it means that bank expansion is anchored, as other financial expansion is not, to a regulated base. If credit creation by banks is miraculous, creation of credit by other financial institutions is still more a cause for exclamation.

The first paragraph of this long footnote is a succinct statement of a basic tension in bank regulation that remains unresolved. (Recall that Simons’ proposal to eliminate the intermediation function of banks was recently revived by Michel Kumhof at the IMF.) The other two paragraphs are a good clear statement of the argument I’ve been trying to develop on this blog, that there is no fundamental difference between money and other forms of financial claims, and a macroeconomically meaningful “quantity of money” was an artifact of mid-20th century regulatory arrangements.

Wealth Distribution and the Puzzle of Germany

There’s been some discussion recently of the new estimates from Emmanuel Saez and Gabriel Zucman of the distribution of household wealth in the US. Using the capital income reported in the tax data, and applying appropriate rates of return to different kinds of assets, they are able to estimate the distribution of household wealth holdings going back to the beginning of the income tax in 1913. They find that wealth inequality is back to the levels of the 1920s, with 40% of net worth accounted for the richest one percent of households. The bottom 50% of households have a net worth of zero.

There’s a natural reaction to see this as posing the same kind of problem as the distribution of income — only more extreme — and respond with proposals to redistribute wealth. This case is argued by the very smart Steve Roth in comments here and on his own blog. But I’m not convinced. It’s worth recalling that proposals for broadening the ranks of property-owners are more likely to come from the right. What else was Bush’s “ownership society”? Social Security privatization, if he’d been able to pull it off, would have dramatically broadened the distribution of wealth. In general, I think the distribution of wealth has a more ambiguous relationship than the distribution of income to broader social inequality.

Case in point: Last summer, the ECB released a survey of European household wealth. And unexpectedly, the Germans turned out to be among the poorest people in Europe. The median German household reported net worth of just €50,000, compared with €100,000 in Greece, €110,000 in France, and €180,000 in Spain. The pattern is essentially the same if you look at assets rather than net worth — median household assets are lower in Germany than almost anywhere else in Europe, including the crisis countries of the Mediterranean.

At the time, this finding was mostly received in terms the familiar North-South morality tale, as one more argument for forcing austerity on the shiftless South. Not only are the thrifty Germans being asked to bail out the wastrel Mediterraneans, now it turns out the Southerners are actually richer? Why can’t they take responsibility for their own debts? No more bailouts!

No surprise there. But how do we make sense of the results themselves, given what we know about the economies of Germany and the rest of Europe? I think that understood correctly, they speak directly to the political implications of wealth distribution.

First, though: Did the survey really find what it claimed to find? The answer seems to be more or less yes, but with caveats.

Paul de Grauwe points out some distortions in the headline numbers reported by the ECB. First, this is a survey of household wealth, but, de Grauwe says, households are larger in the South than in the North. This is true, but it turns out not to make much of a difference — converting from household wealth to wealth per capita leaves the basic pattern unchanged.

Per capita wealth in selected European countries. From de Grauwe.

Second, the survey focuses on median wealth, which ignores distribution. If we look at the mean household instead of the median one, we find Germany closer to the middle of the pack — ahead of Greece, though still behind France, Italy and Spain. The difference between the two measures results from the highly unequal distribution of wealth in Germany — the most unequal in Europe, according to the ECB survey. For the poorest quintile, median net worth is ten times higher in Greece and in Italy than in Germany, and 30 times higher in Spain.

This helps answer the question of apparent low German wealth — part of the reason the median German household is wealth-poor is because household wealth is concentrated at the top. But that just raises a new puzzle. Income distribution Germany is among the most equal in Europe. Why is the distribution of wealth so much more unequal? The puzzle deepens when we see that the other European countries with high levels of wealth inequality are France, Austria, and Finland, all of which also have relatively equal income distribution.

Another distortion pointed to by De Grauwe is that the housing bubble in southern Europe had not fully deflated in 2009, when the survey was taken — home prices were still significantly higher than a decade earlier. Since Germany never had a housing boom, this tends to depress measured wealth there. This explains some of the discrepancy, but not all of it. Using current home prices, the median Spanish household has more than triple the net wealth of the median German household; with 2002 home prices, only double. But this only moves Germany up from the lowest median household wealth in Europe, to the second lowest.

The puzzle posed by the wealth survey seems to be genuine. Even correcting for home prices and household size, the median Spanish or Italian household reports substantially more net wealth than the median German one, and the median Greek household about an equal amount. Yet Germany is, by most measures, a much richer country, with median household income of €33,000, compared with €22,000, €25,000 and €26,000 in Greece, Spain and Italy respectively. Use mean wealth instead of median, and German wealth is well above Greek and about equal to Spanish, but still below Italian — even though, again, average household income is much higher in Germany than in Italy. And the discrepancy between the median and mean raises the puzzle of why German wealth distribution is so much more uneven than German income distribution.

De Grauwe suggests one more correction: look at the total stock of fixed capital in each country, rather than household wealth. Measuring capital consistently across countries is notoriously dicey, but on his estimate, Germany and the Netherlands have as much as three times the capital per head as the southern countries. So Germany is richer in real terms than the South, as we all know; the difference is just that “a large part of German wealth is not held by households and therefore must be held by the corporate sector.” Problem solved!

Except… you know, Mitt Romney was right: corporations are people, in the sense that they are owned by people. The wealth of German corporations should also show up as the wealth of the owners of German stocks, bonds, or other claims on those corporations — which means, overwhelmingly, German households. Indeed, in mainstream economic theory, the “wealth” of the corporate sector just is the wealth of the households that own it. According to de Grauwe, the per capita value of the capital stock is more than twice as large in Germany as in Spain. Yet the average financial wealth held by a German household is only 25% higher than in Spain. So as in the case of distribution, this solution to the net-wealth puzzle just creates a new puzzle: Why is a dollar of capital in a German firm worth so much less to its ultimate owners than a dollar of capital in a Spanish or Italian firm?

And this, I think, points us toward the answer, or at least toward the right question.

The question is, what is the relationship between the level of market production in an economy, and the claims on future production represented by wealth? It’s a truism — tho often forgotten — that the market production counted in GDP is only a part of all the productive activity that takes place in society. In the same way, not all market production is capitalized into assets. Wealth in an economic sense represents only those claims on future income that are exercised by virtue of a legal title that is freely transferable, and hence has a market value.

For example, imagine two otherwise similar countries, one of which makes provision for retirement income through a pay-as-you-go public pension system, and the other of which uses some form of funded pension. The two countries may have identical levels of output and income, and retirees may receive exactly the same payments in both. But because the assets held by the pension funds show up on balance sheets while the right to future public pension payments does not, the first country will have less wealth than the second one. Again, this does not imply any difference in production, or income, or who ultimately bears the cost of supporting retirees; it is simply a question of how much of those future payments are capitalized into assets.

This is just an analogy; I don’t think retirement savings are the story here. The story is about home ownership and the value of corporate stock.

First, home ownership. Only 44 percent of German households own their own homes, compared with 70-80 percent in Greece, Italy and Spain. Among both homeowners and non-homeowners considered separately, median household wealth is comparable in Germany and in the southern countries. It’s only the much higher proportion of home ownership that produces higher median wealth in the South. And this is especially true at the bottom end of the distribution — almost all the bottom quintile (by income) of German households are renters, whereas in Greece, Spain and Italy there is a large fraction of homeowners even at the lowest incomes. Furthermore, German renters have far more protections than elsewhere. As I understand it, German renters are sufficiently protected against both rent increases and loss of their lease that their occupancy of their home is not much less secure than that of home owners. These protections are, in a sense, a form of property right — they are a claim on the future flow of housing services in the same way that a title to a house would be. But with a critical difference: the protections from rent regulation can’t be sold, don’t show up on the household’s balance sheet, and do not get counted as wealth.

In short: The biggest reason that German household wealth is lower than than elsewhere is that less claims on the future output of the housing sector take the form of assets. Housing is just as commodified in Germany as elsewhere (I don’t think public housing is unusually important there). But it is less capitalized.

Home ownership is the biggest and clearest part of the story here, but it’s not the whole story. Correct for home ownership rates, use mean rather than median, and you find that German household wealth is comparable to household wealth in Italy or Spain. But given that GDP per capita is much higher in Germany, and the capital stock seems to be so much larger, why isn’t household wealth higher in Germany too?

One possible answer is that income produced in the corporate sector is also less capitalized in Germany.

In a recent paper with Zucman, Thomas Piketty suggests that the relationship between equity values and the real value of corporate assets depends on who exercises power over the corporation. Piketty and Zucman:

Investors who wish to take control of a corporation typically have to pay a large premium to obtain majority ownership. This mechanism might explain why Tobin’s Q tends to be structurally below 1. It can also provide an explanation for some of the cross-country variation… : the higher Tobin’s Q in Anglo-Saxon countries might be related to the fact that shareholders have more control over corporations than in Germany, France, and Japan. This would be consistent with the results of Gompers, Ishii and Metrick (2003), who find that firms with stronger shareholders rights have higher Tobin’s Q. Relatedly, the control rights valuation story may explain part of the rising trend in Tobin’s Q in rich countries. … the ”control right” or ”stakeholder” view of the firm can in principle explain why the market value of corporations is particularly low in Germany (where worker representatives have voting rights in corporate boards without any equity stake in the company). According to this ”stakeholder” view of the firm, the market value of corporations can be interpreted as the value for the owner, while the book value can be interpreted as the value for all stakeholders.

In other words, one reason household wealth is low in Germany is because German households exercise their claims on the business sector not via financial assets, but as workers.

The corporate sector is also relatively larger in Germany than in the southern countries, where small business remains widespread. 14 percent of Spanish households and 18 percent of Italian households report ownership of a business, compared with only 9 percent of German households. Again, this is a way in which lower wealth reflects a shift in claims on the social product from property ownership to labor.

It’s not a coincidence that Europe’s dominant economy has the least market wealth. The truth is, success in the world market has depended for a long time now on limiting dependence on asset markets, just as the most successful competitors within national economies are the giant corporations that suppress the market mechanism internally. Germany, as with late industrializers like Japan, Korea, and now China, has succeeded largely by ensuring that investment is not guided by market signals, but through active planning by banks and/or the state. There’s nothing new in the fact that greater real wealth in the sense of productive capacity goes hand hand with less wealth in the sense of claims on the social product capitalized into assets. Only in the poorest and most backward countries does a significant fraction of the claims of working people on the product take the form of asset ownership.

The world of small farmers and self-employed artisans isn’t one we can, or should, return to. Perhaps the world of homeowners managing their own retirement savings isn’t one we can, or should, preserve.

Liquidity Preference and Solidity Preference in the 19th Century

So I’ve been reading Homer and Sylla’s History of Interest Rates. One of the many fascinating things I’ve learned, is that in the market for federal debt, what we today call an inverted yield curve was at one time the norm.

From the book:

Three small loans floated in 1820–1821, principally to permit the continued redemption of high rate war loans, provide an interesting clue to investor preference… These were:

$4.7 million “5s of 1820,” redeemable in 1832; sold at 100 = 5%.
“6s of 1820,” redeemable at pleasure of United States; sold at 102 = 5.88%.
“5s of 1821,” redeemable in 1835; sold at 1051⁄8 =4.50%, and at 108 = 4.25%.

The yield was highest for the issue with early redemption risk and much lower for those with later redemption risks.

Nineteenth century government bonds were a bit different from modern bonds, in that the principal was repaid at the option of the borrower; repayment is usually not permitted until a certain date. [1] They were also sold with a fixed yield in terms of face value — that’s what the “5” and “6” refer to — but the actual yield depended on the discount or premium they were sold at. The important thing for our purposes is that the further away the earliest possible date of repayment is, the lower the interest rate — the opposite of the modern term premium. That’s what the passage above is saying.

The pattern isn’t limited to the 1820-21 bonds, either; it seems to exist through most of the 19th century, at least for the US. It’s the same with the massive borrowing during the Civil War:

In 1864, although the war was approaching its end, it had only been half financed. The Treasury was able to sell a large volume of bonds, but not at such favorable terms as the market price of its seasoned issues might suggest. Early in the year another $100 million of the 5–20s [bonds with a minimum maturity of 5 years and a maximum of 20] were sold and then a new longer issue was sold as follows:

1864—$75 million “6s” redeemable in 1881, tax-exempt; sold at 104.45 = 5.60%.

The Treasury soon made an attempt to sell 5s, which met with a lukewarm reception. In order to attract investors to the lower rate the Treasury extended the term to redemption from five to ten years and the maturity from twenty to forty years:

1864—$73 million “5%, 10–40s of 1864,” redeemable 1874, due in 1904, tax-exempt; sold at 100 = 5%.

Isn’t that striking? The Treasury couldn’t get investors to buy its shorter bonds at an acceptable rate, so they had to issue longer bonds instead. You wouldn’t see that story today.

The same pattern continues through the 1870s, with the new loans issue to refinance the Civil War debt. The first issue of bonds, redeemable in five to ten years sold at an interest rate of 5%; the next issue, redeemable in 13-15 years sold at 4.5%; and the last issue, redeemable in 27-29 years, sold at 4%. And it doesn’t seem like this is about expectations of a change in rates, like with a modern inverted yield curve. Investors simply were more worried about being stuck with uninvestable cash than about being stuck with unsaleable securities. This is a case where “solidity preference” dominates liquidity preference.

One possible way of explaining this in terms of Axel Leijonhufvud’s explanation of the yield curve.

The conventional story for why long loans normally have higher interest rates than short ones is that longer loans impose greater risks on lenders. They may not be able to convert the loan to cash if they need to make some payment before it matures, and they may suffer a capital loss if interest rates change during the life of the loan. But this can’t be the whole story, because short loans create the symmetric risk of not knowing what alternative asset will be available when the loan matures. In the one case, the lender risks a capital loss, but in the other case they risk getting a lower income. Why is “capital uncertainty” a greater concern than “income uncertainty”?

The answer, Leijonhufvud suggests, lies in

Keynes’ … “Vision” of a world in which currently active households must, directly or indirectly, hold their net worth in the form of titles to streams that run beyond their consumption horizon. The duration of the relevant consumption plan is limited by the sad fact that “in the Long Run, we are all dead.” But the great bulk of the “Fixed Capital of the modem world” is very long- term in nature and is thus destined to survive the generation which now owns it. This is the basis for the wealth effect of changes in asset values.

The interesting point about this interpretation of the wealth effect is that it also provides a price-theoretical basis for Keynes’ Liquidity Preference theory. … Keynes’ (as well as Hicks’) statement of this hypothesis has been repeatedly criticized for not providing any rationale for the presumption that the system as a whole wants to shed “capital uncertainty” rather than “income uncertainty.” But Keynes’ mortal consumers cannot hold land, buildings, corporate equities, British consols, or other permanent income sources “to maturity.” When the representative, risk-averting transactor is nonetheless induced by the productivity of roundabout processes to invest his savings in such income sources, he must be resigned to suffer capital uncertainty. Forward markets will therefore generally show what Hicks called a “constitutional weakness” on the demand side.

I would prefer not to express this in terms of households’ consumption plans. And I would emphasize that the problem with wealth in the form of long-lived production processes is not just that it produces income far into the future, but that wealth in this form is always in danger of losing its character as money. Once capital is embodied in a particular production process and the organization that carries it out, it tends to evolve into the means of carrying out that organization’s intrinsic purposes, instead of the capital’s own self-expansion. But for this purpose, the difference doesn’t matter; either way, the problem only arises once you have, as Leijonhufvud puts it, “a system ‘tempted’ by the profitability of long processes to carry an asset stock which turns over more slowly than [wealth owners] would otherwise want.”

The temptation of long-lived production processes is inescapable in modern economies, and explains the constant search for liquidity. But in the pre-industrial United States? I don’t think so. Long-lived means of production were much less important, and to the extent they did exist, they weren’t an outlet for money-capital. Capital’s role in production was to finance stocks of raw materials, goods in process and inventories. There was no such thing, I don’t think, as investment by capitalists in long-lived capital goods. And even land — the long-lived asset in most settings — was not really an option, since it was abundant. The early United States is something like Samuelson’s consumption-loan world, where there is no good way to convert command over current goods into future production. [2] So there is excess demand rather than excess supply for long-lasting sources of income.

The switch over to positive term premiums comes early in the 20th century. By the 1920s, short-term loans in the New York market consistently have lower rates than corporate bonds, and 3-month Treasury bills have rates below longer bonds. Of course the organization of financial markets changed quite a lot in this period too, so one wouldn’t want to read too much into this timing. But it is at least consistent with the Leijonhufvud story. Liquidity preference becomes dominant in financial markets only once there has been a decisive shift toward industrial production by long-lived firm using capital-intensive techniques, and once claims on those firms has become a viable outlet for money-capital.

* * *

A few other interesting points about 19th century US interest rates. First, they were remarkably stable, at least before the 1870s. (This fits with the historical material on interest rates that Merijn Knibbe has been presenting in his excellent posts at Real World Economics Review.)

Second, there’s no sign of a Fisher equation. Nominal interest rates do not respond to changes in the price level, at all. Homer and Sylla mention that in earlier editions of the book, which dealt less with the 20th century, the concept of a “real” interest rate was not even mentioned.

As you can see from this graph, none of the major inflations or deflations between 1850 and 1960 had any effect on nominal interest rates. The idea that there is a fundamentals-determined “real” interest rate while the nominal rate adjusts in response to changes in the price level, clearly has no relevance outside the past 50 years. (Whether it describes the experience of the past 50 years either is a question for another time.)

Finally, there is no sign of “crowding out” of private by public borrowing. It is true that the federal government did have to pay somewhat higher rates during the periods of heavy borrowing (and of course also political uncertainty) in the War of 1812 and the Civil War. But rates for other borrowers didn’t budge. And on the other hand, the surpluses that resulted in the redemption of the entire debt in the 1830s didn’t deliver lower rates for other borrowers. Homer and Sylla:

Boston yields were about the same in 1835, when the federal debt was wiped out, as they were in 1830; this reinforces the view that there was little change in going rates of long-term interest during this five- year period of debt redemption.

If government borrowing really raises rates for private borrowers, you ought to see it here, given the absence of a central bank for most of this period and the enormous scale of federal borrowing during the Civil War. But you don’t.

[1] It seems that most, though not all, bonds were repaid at the earliest possible redemption date, so it is reasonably similar to the maturity of a modern bond.

[2] Slaves are the big exception. So the obvious test for the argument I am making here would be to find the modern pattern of term premiums in the South. Unfortunately, Homer and Sylla aren’t any help on this — it seems the only local bond markets in this period were in New England.