Notes for the Money Seminar Econ 7500

Hans G. Ehrbar

December 1998 Contents

1 Syllabus Fall 1998 7

2 Neoclassical and Marxian Derivations of Money 9 2.1 Pure Exchange Economy Without Money ...... 9 2.2 Simple Commodity Production ...... 11

3 First Chapter in Niehans’s Book 14 3.1 The Neoclassical Tradition ...... 14 3.1.1 Money and efﬁciency ...... 14 3.1.2 The Neutrality of Money ...... 15 3.1.3 Integration of Monetary and Value Theory ...... 16

4 Bordo’s Palgrave entry 18

5 Lavoie’s PostKenyesian Monograph 20 5.4 Credit and Money ...... 20 5.4.1 The Monetary Circuit ...... 20

6 Foley’s Palgrave Entry 23 6.1 [The Nature of Money as a Social Relation] ...... 23 6.1.1 [Relationship between money and real economy] ...... 24

7 Humphrey’s Article Quantity Theory of Money 26

8 Monetarism Chapter in Smithin’s Book 31 8.3 Monetarism and the Quantity Theory of Money ...... 31 8.3.1 Introduction ...... 31 8.3.2 The Quantity Theory of Money ...... 31 8.3.3 3.3 Friedman’s restatement as a monetary theory of nominal income ...... 31 8.3.4 Friedman’s Policy Proposals ...... 32 8.3.5 Monetarism and the New Classical School ...... 33 8.3.6 Monetarism and Free Banking ...... 33 8.3.7 Endogenous Money ...... 33 8.3.8 Concluding Remarks ...... 33

9 Notes about The Evolution of a Free Banking System 35 9.1 Introduction ...... 35 9.2 Commodity Money ...... 35 9.3 Banking Firms ...... 35 9.4 Transferable Instruments ...... 36 9.5 Regular Note-Exchange ...... 36 9.6 Clearinghouses ...... 36 9.7 Mature Free Banking System ...... 36

2 CONTENTS 3

10 Gertler’s JMCB Review Article 38

11 Bernanke/Blinder Articles about Credit Channel 42

12 Lipietz, Enchanted World 45 12.1 The Two Sides of the Economy in Marx ...... 46 12.2 A First Look at the ‘Enchanted World’ ...... 47 12.3 Other Social Relations Come Into Play ...... 49 12.4 The Solidity of the ‘Enchanted World’ ...... 50 12.4.1 Price Rigidities and the Antevalidation of Products ...... 51 12.5 Esoteric versus Exoteric: the Contradictions ...... 51 12.6 Credit Money and Real Constraint ...... 52 12.6.1 The Development of Fetishism and the Development of Money ...... 52 12.6.2 Origin and Logic of Credit Money ...... 53 12.6.3 Real Constraint ...... 53 12.7 Inﬂation in Monopolist Regulation ...... 54 12.7.1 Stagﬂation ...... 54

13 Simpliﬁed Version of Foley’s Capital Flow Through Model 56

14 Foley: Financial Instability Leads to Limit Cycles 58 14.1 Introduction ...... 58 14.2 A Model of the Capitalist Enterprise ...... 59 14.3 Macroeconomic Interaction ...... 59 14.4 A Simpliﬁed Model ...... 59

15 Foley: Stabilization Policy Yields Limit Cycles 60 15.1 Model of Capitalist Economy ...... 60 15.1.1 Enterprises ...... 60 15.1.2 Government ...... 61 15.1.3 Markets ...... 62 15.1.4 Model as a Whole ...... 62 15.2 Simple Model of Deﬁcit-Financed Monetary Policy ...... 63

16 Dumenil´ and Levy’s´ Pitchfork Model 64

17 Notes about Panico’s Book 68 17.1 The Literature Before Marx ...... 69 17.2 Marx on the Interest Rate ...... 69 17.2.1 Introduction ...... 69 17.2.2 Marx’s Historical Approach and the Nature of Interest ...... 69 17.2.3 Influence of Rate of Profits on Average Interest Rate ...... 69 17.2.4 2.4 Determination of the Interest Rate: The Analysis of the Working of the Money Market . . 70 17.2.5 2.5 Determination of the Average Interest Rate ...... 70 17.3 2.6. Conclusions ...... 70 17.4 3. Marx on the Relation between Interest and Profit ...... 70 17.5 Keynes on the Interest Rate ...... 71 17.6 Keynes on the Relation between Interest and Profit ...... 71

18 Notes about Reiner Franke CJE 1988 74 4 CONTENTS

19 Eichengreen about Gold Standard and Great Depression 76 19.1 Introduction ...... 76 19.1.1 How the Gold Standard Worked ...... 76 19.1.2 Causes of the Great Depression ...... 77 19.1.3 End of Gold Standard and End of Depression ...... 78

20 Fred Block, Origins of International Economic Disorder 79 20.1 Introduction ...... 79 20.1.1 Nature of International Monetary Order ...... 79 20.1.2 Gold Standard vs. National Capitalism ...... 79 20.2 The Decline of the Nineteenth Century Gold Standard ...... 80 20.2.1 Gold Standard and Britain ...... 80 20.2.2 Interwar Years ...... 80 20.3 Bretton Woods and the British Loan ...... 80 20.4 The Marshall Plan and Rearmament ...... 82 20.5 Toward European Convertibility ...... 84 20.6 Roots of the U.S. Deﬁcit ...... 85 20.7 Managing the U.S. Deﬁcit ...... 86 20.8 The International Monetary Order in Crisis ...... 86

21 Guttmann’s “How Credit Money Shapes the Economy” 88 21.1 The Economy in Transition ...... 89 21.1.1 The Bitter Taste of Victory ...... 89 21.1.2 Globalization of Economic Activity ...... 89 21.1.3 The Limits of Neoclassical Orthodoxy ...... 89 21.1.4 The Central Role of Money ...... 91 21.2 Economic Activities as Monetary Circuits ...... 91 21.2.1 Defining Money as a Social Institution ...... 91 21.2.2 Going Beyond a Functional Approach to Money ...... 92 21.2.3 The Circuits of Exchange, Production, and Credit ...... 92 21.2.4 Credit Money and the Strategic Role of Banks ...... 93 21.2.5 The Bifurcation of Money Capital: Industrial Versus Financial ...... 95 21.2.6 Finance Capital and Fictitious Capital ...... 95 21.3 The Cyclical Growth pattern of Capital Accumulation ...... 95 21.3.1 3.1 Business Cycle Dynamics ...... 96 21.4 Transition from Commodity Money to Credit Money ...... 96 21.5 Postwar Monetary Regime and its Inflationary Bias ...... 96 21.5.1 5.1 Advantages of Elastic Money ...... 96 21.5.2 State Management of Credit Money: Monetary Policy ...... 97 21.5.3 State Management of Credit Money: Financial Policy ...... 97 21.5.4 Credit Money in the Regime of Monopolistic Regulation ...... 97 21.5.5 Postwar Monetary Regime as a Debt Economy ...... 98 21.6 Stagflation and Financial Instability ...... 99 21.6.1 From Boom to Stagnation ...... 99 21.6.2 Standard Inflation Theories ...... 99 21.6.3 Stagflation as a New Form of Structural Crises ...... 100 21.6.4 The Debt-Inflation Spiral and Credit Crunches ...... 100 21.7 The Disintegration of the Postwar Monetary Regime ...... 101 21.7.1 Collapse of Bretton Woods ...... 101 21.7.2 Flexible Exchange Rates as Source of Global Instability ...... 102 21.7.3 Dollar Devaluation and Global Stagflation ...... 102 21.8 The Legacy of Reaganomics ...... 102 21.9 The Dilemmas of Monetary Policy ...... 102 21.10Financial Fragility and the Lender of Last Resort ...... 102 CONTENTS 5

21.11Regulatory Overhaul and the Restructuring of US Banks ...... 102 21.11.1 11.1 Slow Death of Traditional Commercial Banking ...... 103 21.11.2 Financial Innovation and Regulatory Evasion ...... 103 21.11.3 Bank Reform: a Difﬁcult Balancing Act ...... 104 21.11.4 Financial Capital and Economic Development ...... 106 21.12Deal Mania and Fictitious Capital ...... 107 21.12.1 Dominance of Fictitious Capital ...... 107 21.12.2 The Cyclical Nature of Corporate Stock ...... 109 21.12.3 Stock Market Boom and Merger Wave ...... 109 21.12.4 Computerization of Securities Trading ...... 110 21.12.5 Stock market Collapse [1987] and its Effects ...... 110 21.13The Challenges of Global Integration ...... 111 21.14The International Monetary System in Flux ...... 111 21.14.1 Gold: True Form of World Money or “Barbarous Relic”? ...... 111 21.14.2 National Currencies as International Mediums of Exchange ...... 112 21.14.3 The Instability of Our Multicurrency System ...... 114 21.15Supranational Credit Money ...... 114 21.15.1 The Bancor Plan of Keynes ...... 114 21.15.2 The Bancor Plan of Keynes ...... 114 21.15.3 Special Drawing Rights ...... 115 21.15.4 European Currency Units ...... 115 21.15.5 Economic and Monetary Union in Europe ...... 115 21.15.6 Europe’s Currency Crisis of 1992 ...... 115 21.15.7 The Uncertain Prospect of the Union Treaty ...... 115 21.16Towards a True Form of World Money ...... 115 21.16.1 Finding a Viable Form of World Money ...... 115 21.16.2 The Issue of Supranational Credit Money ...... 115 21.16.3 16.3 The International Payments System ...... 116 21.16.4 16.4 Deﬁcit Financing and Adjustment Policy ...... 116 21.16.5 Global capital transfers ...... 116 21.16.6 16.6 Exchange Rates ...... 116 21.17United States at the Crossroads ...... 117 21.17.1 17.1 The end of American Hegemony ...... 117

22 De Grauwe’s Textbook on European Monetary Integration 119 22.1 Costs of Common Currency ...... 119 22.1.1 Shifts in Demand (Mundell) ...... 119 22.1.2 Different inflation/unemployment preferences ...... 119 22.1.3 Differences in Labor Market Institutions ...... 120 22.1.4 Different growth rates ...... 120 22.1.5 Different fiscal systems ...... 120 22.1.6 Conclusion ...... 120 22.2 Critique ...... 120 22.2.1 How relevant are differences between countries? ...... 120 22.2.2 Nominal and real depreciation of currency ...... 120 22.2.3 Devaluation, time consistency, and credibility ...... 121 22.2.4 Cost of monetary union and openness of countries ...... 122 22.2.5 Conclusion ...... 122 22.3 Benefits of Common Currency ...... 122 22.3.1 Direct gains from elimination of transaction cost ...... 122 22.3.2 Direct gains from elimination of transaction cost ...... 122 22.3.3 Welfare gains from less Uncertainty ...... 122 22.3.4 Exchange Rate Uncertainty and the Price Mechanism ...... 122 6 CONTENTS

22.3.5 Exchange Rate Uncertainty and Economic Growth ...... 122 22.3.6 Benefits of a Monetary Union and the Openness of Countries ...... 122 22.3.7 Conclusion ...... 122 22.4 Cost and Benefits Compared ...... 122 22.4.1 Cost and Benefits Compared ...... 122 22.4.2 Monetary union, wage rigidity, labor mobility ...... 122 Chapter 1

Syllabus Fall 1998

Two interesting new books have appeared which I will also be useful to others. These notes also contain exer- use when I teach this class the next time: the Marxist cise questions which allow you to prepare for the exams. [IL98] and the very neoclassical [Wal98]. H.E. These notes do not replace the assigned readings, but are The class meets Monday Wednesday 12:00–1:20 at probably only useful in conjunction with these readings. BUC 207. Students can buy these notes at the University Copy Cen- Instructor: Assoc. Prof. Dr. Dr. Hans G. Ehrbar ter, ask for the course materials for Econ 7500. 319 KDGB, 581 7797, [email protected] There will be two in-class midterms in 11th session and Office hours: Tuesday and Thursday 11:30 am – 12:30 20th session, and one final. All three exams will have pm, or by appointment (email me). equal weights; the second midterm will cover material We will meet twice per week, i.e., we will have 30 class since the first midterm, and the final will cover material sessions of 80 minutes each during the Semester. All class since the second midterm. Questions for these exams will participants are also required to subscribe to an electronic be similar to the exercise questions contained in the course mailing list set up especially for this class. Hans will get materials. your email address from you during the first class session This class is held at a time of widespread international and subscribe you; but you can also subscribe yourself. currency and stock market turmoils. Some interesting To do this, you must send an email message from your commentary about these current events can be found on email account to the internet. Hans will forward relevant materials to the money [email protected] mailing list. The following three international mailing lists seem to have the most pertinent material: which has only one line in its body, saying lbo-talk (Doug Henwood’s Left Business Observer), pen-l (progressive economists network) and pkt (Post- subscribe money Keynesian Thought). Each participant is required to make two 30-minute in- The material for this class was selected on the assump- class presentations during the Semester. Written sum- tion that older debates about money can be very instruc- maries of the assigned readings must be emailed to the tive even today, and that the Marxiam critique of the neo- money email list at least 24 hours in advance of the pre- classical framework has substance and will also lead to sentation. If this email does not arrive in time, the pre- a deeper understanding of the neoclassical theory itself. sentation will be re-scheduled. These summaries should Here the material is broken down into 15 “weeks”, but explain, in as simple words as possible, the main ideas some of these “weeks” can be done in one session, and of the assigned readings. The other students are expected others may take more than 2 sessions. Not all of the ma- to work through the same material in advance and actively terial listed here can be covered: discuss the material and give feedback to the presentations 1: Neoclassical theory of money. We will read [Nie78, of their peers. These presentations will not be graded. pp. 1–19]; supporting literature is [Bor87] and [Sam47, p. Each student must also make two minor presentations, 117–122]. 10 minutes each, or alternatively substantial contributions 2: Marx’s derivation of money and capital. Readings to the money mailing list. are Marx’s Capital, chapters 1–6. The instructor Hans has detailed paragraph-by- 3: The Postkeynesian and other alternative theories of paragraph notes about some of the assigned readings. Al- money. [Gut94, Preface and Chapter 1] then [Lav92, be- though these notes were originally written for his own use, ginning of Chapter 4, pp. 149–157] then [Gut94, Chapter Hans is making them available in the hope that they may 2] and also a small presentation of the first half of Foley’s

7 8 CHAPTER 1. SYLLABUS FALL 1998

Palgrave Entry [Fol87b, pp. 248–251:2]. 4: Quantity theory of money [Hum74] and monetarism [Smi94, Chapter 3]. Palgrave entry about Currency Boards and other books about Currency Boards: [Wil95] seems good here. 5 The Free Banking theories, [SW87] and perhaps other articles from [Whi93]. 10/19–21: Mainstream economics of credit markets by information asymmetries [Ger88] [San84] [KP77] 10/26–28: Does monetary policy work through the “liquidity channel” or the “bank loan channel?” [BB92] and [BB88] . Background also [Ber93], a nice survey article with many references. 11/2–4: Marxian theories of credit markets and crises [Lip83] and [Hen97] . 11/9–11: Foley’s capital ﬂow-through model which can be found in [Fol86a] or [Fol82] or chapter 5 in [Fol86b]. 11/16–18: [Pan88, p. 1–11] Bank reforms in the US, [Gut94, chapters 11 and 12] A different Foley, monetary policy in a dynamic model: [Fol89] 11/23–25: How did the gold standard work? Editor’s introduction in [Eic85, p. 1–35]. or [Eic92] perhaps look also at [EF91]? 11/30–12/2 How did the Bretton-Woods system work? [Blo77] [DG97] [Goo98] [Gut94, chapter 7] See also [Hel94] about the Marshall Plan. 12/7–9: International credit money, [Gut94, chapters 14–16] plus [Fel95] and other articles in the collection [Gut97], but about the Tobin tax there is also [uHea96]. Chapter 2

A Comparison of the Neoclassical and Marxian Derivations of Money

2.1 Pure Exchange Economy With- bundle can be written as xi∗. This bundle depends on the out Money price vector p = [p1,...,pq]>, and it depends on ith person’s endowment through p>x¯i, since it maximizes person The simplest neoclassical model is a pure exchange econ- i’s utility function subject to the budget constraint (2.2), = ( , ) omy such as the following: The ith economic agent re- i.e., it can be written xi∗ xi∗ x¯i p . ceives a flow of endowments x¯i (which is q-vector since If for a vector p∗, no good is in excess demand, i.e., if there are q commodities), and trades this endowment on the market against his or her consumption bundle xi. The ∑x¯i ∑xi∗(x¯i,p∗) o (2.4) ith agent’s utility flow depends on this consumption bun- i − i ≥ dle then this p∗ is a general equilibrium price vector. There Ui = Ui(xi) (2.1) may be excess supply, because there may be undesirable goods which can be disposed of freely, but in equilibrium All agents obey the same price vector p and maximize the no good is in excess demand. utility derived from their consumption stream subject to This equilibrium price vector reconciles the individual the budget constraint utility functions and endowments in a remarkable fashion: at these prices, the social supply is exactly the sum of the p>(xi x¯i) = o. (2.2) − individual demands. This solution is Pareto-efficient, i.e., no redistribution of goods is possible which would make If one writes x¯i = [x¯1,...,x¯q]>, suppressing the subscript i indicating whose endowment it is, and similarly at least one agent better off and nobody worse off. xi = [x1,...,xq]>, the first-order conditions for this max- Formula (2.4) characterizes the equilibrium prices imization problem are the constraint (2.2) and the q 1 mathematically, but does not give a mechanism how this marginal conditions − equilibrium price is arrived at in the economy. As a model for this adjustment process, neoclassical economy uses ∂U ∂U the device of an auctioneer. The auctioneer is calling out ∂x ∂xq 1 = = (2.3) a sequence of “virtual” price vectors, i.e., price vectors p ··· p 1 q which are not actual prices but which are to be tested as These marginal conditions have an intuitive interpreta- possible price vectors. For every such price vector the tion: if the ith agent has one extra dollar, he or she can agents indicate how much they would demand at these either buy 1/p1 units of good 1, in order to get an increase prices, and the equilibrium price is that price at which the ∂U in utility of /p1, or similarly with the other goods. All sum of all these demands is equal to or smaller than the ∂x1 these utility increments must be equal, because otherwise sum of all supplies. the agent could increase his or her utility by subtracting In this economy, people do not hold money and they one dollar’s worth from one good and add it to a certain do not buy and sell their goods for money, but they are other good. bartering their goods. Nevertheless, one cannot say that By solving these first-order conditions one gets the de- money is completely absent from this economy, since all mand functions: the ith person’s desired consumption goods have prices.

9 10 CHAPTER 2. NEOCLASSICAL AND MARXIAN DERIVATIONS OF MONEY

Incorporating Money into the Pure Exchange Question 1 In the literature, the utility of money can be Economy defined in several ways. Discuss these. What are the arguments for and against putting money The equilibrium price vector is only determined up to a into the utility function? constant factor. If p∗ is an equilibrium price vector, then λp∗ is an equilibrium price vector as well. This is an Samuelson approvingly cites [Les43], whose model we opening which can conveniently be filled with a theory will discuss next. Leser circumvents the necessity to put of money. prices into the utility function by representing the money stock by the goods this money may buy. He writes in Equation of Exchange [Les43, p. 124]: A good discussion of the equation of exchange is Bordo’s The consumer, having bought the quantities Palgrave entry [Bor87]. x1,...,xq of the goods during his budget period, may at the end still be in possession of the Demand for Money Function amount H in cash. If we define x10 ,...,xq0 by the equations If one restricts oneself to the volitional element in money holdings, then the next step in sophistication writes down p1x10 = = pnxq0 = H, (2.5) a money demand function, without however deriving this ··· demand function from any utility function. This is the this amount of money will enable him at any Cassel approach. Look at Niehans for that. time in the future to buy the quantity xr0 of the Here the issue of “no money illusion” comes up. See rth commodity ... . Patinkin’s Palgrave entry about it. It must be homogeneity with respect to all prices and all monetary assets. There Then Leser puts the xr0 into the utility function alongside was a famous error in the literature, See Modigliani. the xr:

U = U(x1,...,xq,x10 ,...,xq0 ) (2.6) Money in the Utility Function denotes the utility derived from consuming the xr plus If one puts the money stock into the utility function, then having the option of buying an arbitrary convex combi- one must also put prices into the utility function. This is nation of the xr0 . (A convex combination is a linear com- seen as problematic. Niehans says in [Nie78, p. 13:2] bination in which the coefficients add to 1). It was sometimes argued that the endeavor to Now let M be the amount of money in the hands explain prices by the marginal utility of money of the consumer at the beginning of his budget while the latter, in turn, depended on prices period. Then he will choose x ,...,x and H in amounted to a vicious cycle. 1 q such a way that Patinkin [Pat65, pp. 114–116] gives a good answer to this: When the consumer maximizes his or her utility subject to U(x1,...,xq,x10 ,...,xq0 ) = Max, (2.7) the budget constraint, prices are given anyway, and therefore prices in the utility function are unproblematic. And where then when the equilibrium price is determined, we only H H speak of the individual demands, here prices are not con- x10 = ,...,xq0 = , (2.8) p1 pq sidered fixed. Already earlier, Samuelson [Sam47, p. 121] dismisses these philosophical doubts. Samuelson in turn bases him- p1x1 + + pqxq + H = M (2.9) ··· self on Walras [Wal54]. According to Samuelson, Walras has shown that the utility of money can be derived in a With the notation modified version of the usual utility function approach. ∂ ∂ Samuelson commends Walras for being U U ∂ = Ur ∂ = Ur0 (2.10) xr xr0 able to remain undisturbed by the fears of liter- ary writers that there was something viciously the first order conditions are circular in assuming the existence of prices and U U U U0 of a “value for money” in the midst of the pro- 1 = = q = 10 + + q (2.11) cess by which that value was to be determined. p1 ··· pq p1 ··· pq 2.2. SIMPLE COMMODITY PRODUCTION 11

This last expression is the marginal utility of money. to denote “the marginal utility of the goods for Leser makes a complete mathematical treatment of this. which the money can be exchanged.” Instead, In this setup, money is very similar to other goods, with our concern is with the utility of holding money, two exceptions: (1) since H can be spent in future peri- not with that of spending it. This is the concept ods, the one-period optimum will not repeated in the next implicit in all cash-balance approaches to the period unless the consumer happens to spend exactly his quantity theory of money; and this is the one or her current income. (2) If M changes, the Slutsky de- that will be followed explicitly here. composition into income effect and substitition effect now Now here is the model in [Nie78, equation (1.3.1) on has 4 terms: a direct and an indirect income effect, and a p. 15:1]. It has the third interpretation of the utility of direct and indirect substitution effect. money, and the consumer choice is set up slightly differ- Samuelson [Sam47, p. 121] makes now the following ently. The utility function has the form (2.12), i.e., it de- point: Whenever the utility function has the form pends on the money stock and prices. But this time the

U(x1,...,xq,H, p1,..., pq), (2.12) consumer makes a sequential decision: first he chooses how much of monetary assets he wants to hold. This first where xi are the real consumption flows and H is the nom- decision is not modeled in Niehans’s book, but the total inal stock of money left over, and whenever the utility money value of assets A¯ is given exogenously. In the sec- function is homogeneous of degree zero in the nominal ond part of their decision, consumers choose how much money amount and all prices of this they want to hold in bonds and how much in cash, and at the same time they make the decision which com- U(x ,...,x ,H, p ,..., p ) = (2.13) 1 q 1 q modities to consume. Unlike in Leser’s model, the choice is not between holding more money versus spending it, = U(x1,...,xq,λH,λp1,...,λpq), (2.14) but between holding one’s assets in the form of cash versus holding it in the form of interest-bearing assets which then U is equivalent to Leser’s utility function. Proof: Set- cannot be used as a means of purchase. λ ting = 1/H, this could be written as This return of the assets enters the budget constraint. p1 pq Equation (2.17) is Niehans’s equation (1.3.2): = U(x1,...,xq,1, ,..., ) (2.15) H H Q Finally, this can be written also as a function which has ∑ pq(xq x¯q) i(A¯ H) = 0. (2.17) − − − the inverses as the second group as arguments: q=1 H H Maximizing utility subject to the budget constraint yields = F(x1,...,xq,1, ,..., ) (2.16) the Q + 1 marginal conditions (1.3.4): p1 pq ∂ ∂U U ∂U But this is exactly Leser’s utility function (2.6). ∂ ∂x ∂ x1 = = q = H = λ (2.18) Leser’s model favors an approach in which the utility p1 ··· pq i of money is identified with the utility of the goods money can buy. There are two other possible meanings of the These first order conditions have a nice intuitive interpre- “utility of money”: it could be the utility of the money tation: if I have one extra dollar, I can either buy 1/p1 units of good one, in order to get an increase in utility of commodity, and it could be what Patinkin [Pat65, p. 79] ∂U /p1, or similarly with other goods, or I can add this calls the utility of holding money, not spending it. In this ∂x1 ∂U last interpretation, U is the utility derived from having dollar to my money stock, to get a gain in utility of ∂H enough money to be able to make payments at random from now until eternity. The present value of this flow of ∂U intervals, i.e., this includes Keynes’s transactions, precau- utility, discounted at the current rate of interest, is ∂H /i. tionary, and speculative demands for money. This present value must be equal to the marginal utility of Here is Patinkin, [Pat65, p. 79] in his own words: spending one dollar in the current period. It is thus essential to make clear at the outset the sense in which “utility of money” will be used 2.2 Simple Commodity Production in the present discussion. Clearly, it does not represent Marshall’s use of the term. Nor is it Now how does Marx proceed? intended to denote the utility of the money com- Marx never looks at a society in which people start with modity; indeed, we continue to assume a fiat pa- a set of “endowments” of unspecified origin, indeed they per money precisely in order to avoid any am- might have fallen from the sky. In Marx’s view, produc- biguity on this score. Nor, finally, is it intended tion is central for the structure of economy. Marx would 12 CHAPTER 2. NEOCLASSICAL AND MARXIAN DERIVATIONS OF MONEY say that in a neoclassical exchange economy, it is not pos- coat is something he produced and the linen something he sible to know what people do with their endowments since wants to consume. According to Marx, this asymmetry we do not know where these endowments come from. is the root of the asymmetry between commodities and Instead of a pure exchange economy, Marx’s sim- money. plest paradigm is simple commodity production, in which Now what are the criteria by which the linen weaver everybody’s initial endowment is that person’s product, decides to do an exchange? Marx does not say that the which he or she produces as an independent producer, us- linen weaver compares the utility which the linen gives ing his or her own labor and means of production. her with the utility the coat gives her. She already has After production, the individual private producers go to enough linen, in terms of utility she would probably be the market and exchange their products. And here one willing to give the linen away for much less than a coat. sees another difference between Marx and the neoclassi- Rather, Marx holds that every barter has two purposes cal pure exchange economy. Marx does not assume that for each party involved: all economic agents let their transactions be guided by the same price vector. Marx argues: in order to formulate get the use value one needs, and • such a price vector, one already needs money—not money realize the value of the commodity one has to sell. that is physically present, but money of account. • Thirdly, the exchange decisions by individual market This is different than the mainstream which sees only one participants are not based on a comparison of the utility purpose, namely, the use values. of the endowments with the utility of a bundle given in Since the selection of use values is a private decision, exchange. Marx assumes a division of labor, in which the Marx does not say much about it. sellers bring specialized products to the market for which they themselves have very little use. In such a situation, About the value aspect, Marx says: the linen weaver almost every exchange will improve their utility even if will accept the exchange if (a) she needs a coat and (b) the one in the process “gives away the farm.” Grimm’s fairy coat is an appropriate reward for making the linen, i.e., if tale “Lucky John” [Gri60] is a parable expressly designed the coat is an expression of the value of the linen. For the to warn children that they should not go by their tastes tailor, who made the coat, the relationship is the opposite: alone when they make an exchange. for him the linen must be an expression ofthe value of the Neoclassicals can get away with ignoring this elemen- coat. tary wisdom only because they assume that there will be This is therefore in contradiction to the neoclassical no “false trades.” If nothing is traded before an equi- paradigm of revealed preferences. Modern theory says: librium price is established, then no harm is done if the if the linen weaver trades 20 yards of linen for one coat, agents only go by their individual preferences. But this this indicates that the use value of the coat is greater to her assumption ignores that virtually every transaction in any than the use value of the linen. Marx by contrast says: The real price adjustment process is a false trade. Patinkin sur- linen has no use value for her at all. Linen is coming out mises in [Pat65, p. 532–5] that Walras was not sufficiently of her ears. The judgment she is making in the exchange aware ot this fundamental difference between his auction- is not a comparison of the use values, but she compares eer story and the actual workings of markets. the use value of the coat with the time and effort it took her to make the linen. In Marx’s words, the use value of Question 2 What happens if the participants in a Wal- the coat is an expression of the value of the linen. rasian auction do not wait until equilibrium is reached, These two different theoretical criteria also lead to dif- but make trades amongst each other at prices which are ferent actions. If the linen weaver does not get enough not equilibrium prices? coat for her linen, she will start producing coats instead of linen. In the modern revealed preference paradigm, she The situation is therefore: there is no general price vec- would be consuming her own linen rather than the coat. tor by which the commodities can be valued and com- Since in capitalism the individauls are excluded from pro- pared, but two individual commodity producers, say a duction, they are not even allowed to think about produc- linen weaver and a tailor, meet on the market to exchange tion. their products. Although the exchange itself is a symmet- Now the drawback of this is that the judgment whether ric act, the exchange of 20 yards of linen for 1 coat is also or not a coat is sufficient reward for the labor producing an exchange of 1 coat for 20 yards of linen, each of the 20 years of linen is an individual decision which does not exchangers sees it as an unsymmetric relationship. The easily generalize to a social consensus. The coat is an linen weaver gives 20 yards of linen and receives 1 coat. expression of the value of the linen only for the weaver, For her the linen is something she produced, and the coat but not for others in society. It cannot be a building block is the use value she wants to consume. For the tailor, the for a general social consensus about the value of the linen. 2.2. SIMPLE COMMODITY PRODUCTION 13

As his next step towards formulating a framework for make an exchange which is not to their liking, and since individual actions which satisfy individual needs and at they make this exchange once they re-constitute the con- the same time help form a social consensus about the ditions under which they are forced to make the exchange value of the linen, Marx looks at all the linen weavers again. Their displeasure with the wage bargain will not together. Here he discovers that some linen weavers ex- generate the market signals to raise wages. Translated change their linen with a coat, others with bread, still oth- into a Walrasian auctioneer framework, workers do not ers with tea, etc. Also the same linen weaver will ex- have time to wait until the auctioneer calls out a price at change his linen today with a coat and tomorrow with which the market clears but must make trades at prevail- bread. With the development of commodity exchange, the ing “false” prices. linen weavers will exchange their linen with all other use values offered in the economy. This is the “Expanded” form of value. Now the value of the linen is no longer expressed in one use value, but in a whole array of use values. Since we are looking at all linen weavers together, the individual idiosyncracies of the one weaver are eliminated. Now it is no longer a private relation. But it still cannot be the basis for a social consensus, because this long list of equivalents for the linen is not simple enough. But it has one basic advantage: here all commodities are placed in relation with the linen. This leads us to the next step: if linen is exchanged against all other commodities, then all the other commodity producers exchange some of their commodities against linen. I.e., for each of these other individuals, at the other end of the exchange relationship with the linen, linen is an expression of the values of their products, be it coat, tea, bread, etc. The values of these commodities have therefore a simple and uniform expression, which is therefore capable of a consensus. And the ﬁnal step is to institutionalize this general equivalent. This needs a deliberate social decision. This deliberate social decision is different than that postulated in neoclassical theory, according to which everybody must agree to accept money for their products. The paradigm of simple commodity production explains why money is accepted everywhere, the only social decision that has to be made which material or which social institution (central bank debts) represents money. Money is accepted because the labor of the producers is wasted unless they sell their product. The neoclassical paradigm has to explain how everybody agrees that one thing should be generally accepted as money. In the Marxian paradigm, this one thing always crystallizes out. The social act is the lesser act on agreeing which commodity should be money. What would a Marxist say about the requirements of tatonnement that there should be no false trades? He would say that this assumes away an important element of capitalism. In the exchange which is central to the capitalist economy, the sale and purchase of labor power, the existence of a market mechanism transmitting the preferences of the workers to the market at large is explicitly denied by Marx in Chapter 23. The workers are forced to Chapter 3

Notes about First Chapter in Niehans’s The Theory of Money [Nie78]

3.1 The Neoclassical Tradition fore it is impossible to come up with a nonarbitrary monetary theory singling out one of the goods as money. In This chapter gives Niehans’s views on the debate in neo- the first chapter of his book, Niehans gives an account of classical economics. Not all the points of that debate are these attempts to theorize money in a frictionless econ- fully explained. The chapter is therefore a little sketchy. omy, in order to show that without exception they resort Much can be considered Niehans’s reaction to Patinkin. to unsatisfactory expedients. Niehans comes to the conclusion that all the theories sur- 1:3–2:4 Four propositions: three equilibrium, one dise- veyed are unsatisfactory because in his mind one needs quilibrium. a theory of frictions to explain money. I.e., he is critical The use of money increases the efficiency of the of neoclassical theory, but his criticism is not very deep; • Niehans still accepts many of the premises of the neo- economy classical tradition. Niehans’s book itself, of which this Money is neutral is Chapter 1, is summarized in the Palgrave entry [Nie87]. • Difference between money and other commodities is • Introduction in degree, not in kind; basically the value of money can be understood with same analytical apparatus 1:1 Niehans starts with the questions: “Why do people use than the value of other commodities money? What do they use as money? How much money do they wish to hold? How do they use it?” Conspic- (Disequilibrium) In the short run, a change in the • uously absent is the question: what is money? Niehans money supply can have powerful real effects. considers money as a good whose only use value it is to The three equilibrium propositions will be discussed in be accepted by everyone, so that it can serve as means the three sections of this introductory Chapter. of circulation. These questions therefore look at money from a very specific point of view: money is a good with specific properties. 3.1.1 Money and efficiency 1:1–2 Niehans’s central thesis is that money is a device [Qualitative and Quantitative Efficiency] invented to overcome certain imperfections in the market, and therefore eludes neoclassical “formal models” which 2:5–3:1 Although there has been a strong sense that do not incorporate these imperfections. money increases efficiency, these efficiency gains could A perfect market is one whose trading rules are equiv- never be accurately formalized. Niehans distinguishes be- alent to the existence of an auctioneer: people have the tween qualitative and quantitative gains. time to barter as long as they need to find the equilibrium Qualitative gains are efficiency gains in the transition prices, yet people are not allowed to make any trades be- from barter to a monetized economy. Money adds effi- fore the equilibrium price is established. In other words, ciency because of its “portability, indestructibility, homo- this notion of a “perfect” market assumes away everything geneity, divisibility, and cognizability.” But this has never that would make money necessary in the real world. been quantified. The lack of exact measurement of effi- At market clearing prices, every good is money, ciency is an oddity if efficiency is supposed to be the basis (Niehans says that a little later in footnote 5 to 3:0), there- of money.

14 3.1. THE NEOCLASSICAL TRADITION 15

3:2/o–4:0 After the (qualitative) question why is our the actual k (instead of containing the desired value for economy monetized Niehans jumps to the quantitative k). Finally, it becomes a theory of the price level, the question how much cash versus other assets individuals so-called quantity theory of money (or better: “quantity hold in an economy which is already monetized. And he theory of prices,” and this is what we will call it hence- immediately makes another step: he assumes that individ- forth) with the following additional assumptions: In equi- ual money holdings are those which maximize the money librium, money demand is equal to money supplym ¯ . This holder’s utility. money supply (1) can be changed exogenously, (2) such a What follows is a nice concise overview of the usual change has no lasting effect on k, and (3) also not onx ¯. neoclassical approach to money. [Money in General Equilibrium] [The Money Demand Function] 4:1–6:0 discusses money demand function, which in the 6:1–6:2 Putting money demand functions into a general equilibrium model. In addition to the money demand we most general case depends on all quantitiesx ¯q (the bar means that it is exogenous, and Niehans seems to consider have Q goods demand functions it a stock of wealth at a given time, he calls it endow- θ ments in 5:1. Since wealth is continuously created and xq(x¯1,...,x¯Q; p1,..., pQ; ). (3.3) consumed, it may be better thought of as a ﬂow divided Because of the budget constraint, they must satisfy “Say’s by time) and prices pq, as well as a parameter θ indicating the opportunity cost of holding cash balances: law”

m = m(x¯1,...,x¯Q; p1,..., pQ;θ) (3.1) ∑ pq(xq(x¯1,...,x¯Q; p1,..., pQ;θ) x¯q) = 0. (3.4) q − Here m is the desired money holdings. Equation (3.1) which is Niehans’s (1.1.1), ﬁrst holds for any individual, This is an identity which each individual and therefore and if one assumes that the aggregation problem can be also the aggregate goods demand functions must satisfy. solved, it also holds for the economy at large. Note that the running up or depleting of cash balances is An often-used special form (which is hovewer not not an option here (this is why he calls it “Say’s law” and needed in Niehans’s arguments that follow) is not “Walras’ law”).

Q Q Now it is important to correctly count the equations and pqx¯q variables. Assuming that time preference θ and the sup- m = k ∑ pqx¯q = kp ∑ = kpx¯, or mv = px¯ q=1 q=1 p pliesx ¯q are given exogenously, and that the money supply (3.2) m¯ is fixed by policy, we have Q endogenous prices pq left. They must satisfy the Q equations that demand must be where p is a price index,x ¯ (without subscript) an aggre- equal supply for all goods. But the goods market clearing gate measure of real resources, k is desired cash balances conditions count only as Q 1 equations: due to Walras’s divided by monetary value of the other assets (the Cam- law, if Q 1 of these equations− hold, then the Qth holds bridge k, which is really a portfolio choice variable), and as well. Therefore− we need one more equation to deter- v = 1/k is the (desired) velocity. mine prices uniquely. This is the equation that demand of Mathematically this is a trivial reformulation, but it money equals supply. Therefore everything is determined. suggests that the left hand side is the effect of 3 different 6:3/o Side remark that the market clearing levels of real influences: individual portfolio preferences k, price level cash balances are not optimal. With a positive θ, individ- p, and the real value of the endowmentsx ¯. uals think that holding cash balances is costly. But from Niehans brings the equation of exchange as a special a social point of view it is costless. In equilibrium, less case of the money demand equation. Such an approach money is supplied than would be optimal. bars the systemic interpretation of the equation of ex- 7:1 Niehans’s critique of this approach, which he later change, i.e., it favors the Cambridge formulation over the calls the “Cassel approach:” Since this theory does not Fisher’s and Pigou’s formulation. Therefore it is not sur- contain any factors making money more useful than hold- prising that Niehans says that the alternative form mv = px¯ ing goods, there is no scientific basis for derivation of is economically equivalent. I am more convinced by money demand function. Bordo’s [Bor87] arguments that it is not. Excellent footnote 14 about three interpretations of the same equation: either as demand equation or, if m is not 3.1.2 The Neutrality of Money the desired but the actual cash balances held, as accounting identity, the so-called equation of exchange, defining Compare here also [Pat87]. 16 CHAPTER 3. FIRST CHAPTER IN NIEHANS’S BOOK

Question 3 Neutrality of money is sometimes defined in goods, which are derived from utility theory). As it turns terms of equations of a model of the economy (certain de- out, it is difficult to give such foundations. mand functions are homogeneous of a certain degree— 13:2 First difficulty in a utility-based approach: utility such a definition was given by Niehans), and sometimes of money depends on prices. Niehans says, so what. in terms of economic reasoning independent of a rep- 13:3–14:1 A more serious problem is how to assign resentation in a model (such a definition was given by utility to money stocks. Humphrey). Give both definitions. 14:2 One approach is to do as if money was just another good. Initiated by Walras [Wal00], also described 7:2–8:1 Money is not demanded for its own sake. in [Pat65, pp. 541 ff], in the part that was left off in the Therefore money demand homogeneous of degree 1 in second edition! prices. And the equilibrium of demand and supply of money can be rewritten as Question 4 Why is it so difficult to integrate money into the neoclassical framework with utility functions and pro- m¯ = p1m(x¯1,...,x¯Q;1, p2/p1,..., pQ/p1;θ) (3.5) duction functions? One common approach to this integration is to treat And the goods demand functions are homogeneous of de- money as one of the goods. (Walras, Samuelson, gree 0 in prices, which gives the equilibrium conditions Patinkin). Which special properties does this “good” have? (Be specific, maybe giving formulas for the utility θ x¯q = xq(x¯1,...,x¯Q;1, p2/p1,..., pQ/p1; ) (3.6) functions etc.) How can this approach be criticized? Which other approaches are there to do this integra- If one writes them like this, (3.5) and (3.6) are a recur- tion? sive system, which means: neutrality implies dichotomy. (3.6) has only the Q 1 relative prices but not the price 15:1 Formalization of the Walrasian approach which − level p1 as endogenous variables, and since one of these metaphorically treats money as if it were a consumer demand equations depends on the others, it can be solved good. This is the model behind figure 1.1.1. Opportunity for those. Therefore (3.6) can be solved first for all rel- cost of money is the interest forgone. ative prices, independently of nominal money supplym ¯ , The utility function depends on prices: and this nominal money supply affects the price level p1 but not relative prices. Neutrality therefore implies the U = U(x1,...,xq;m; p1,..., pq) (3.7) quantity theory of prices. For this derivation, the money m is a stock, but x ,...,x are flow quantities. But here the demand function does not have to have the special form 1 q choice is not between holding more money versis spend- (3.2). ing it, but between holding one’s assets in the form of cash 8:2–12:1 Three additional remarks about neutrality: versus holding it in the form of bonds. Total money value 8:2–3 First: neutrality in the stronger sense that the of assets A¯ given exogenously, but people can choose how amount of real cash balances does not matter does not much of this they want to hold in bonds and how much in hold. cash. b is the number of bonds, each bond being a consol 9:1 Secondly: neutrality does not hold if there is com- paying $1 per year (i.e., the number of consols b is at the modity money, same time the return from the consols). If the interest rate 9:2–12:1 Third: those people who tried to argue that is i and the price of each consol is p , then ip = 1. is neutrality does not imply dichotomy are making a basic b b equation (1.3.2): logical plunder. But this is an issue which has wasted too many brain cells already. b = i(A¯ m) (3.8) − 3.1.3 Integration of Monetary and Value This return of the assets enters the budget constraint (1.3.3): Theory Q 12:2 In neoclassical theory, money is just one of the ∑ pq(xq x¯q) i(A¯ m) = 0. (3.9) goods. q=1 − − − But in order to be able to treat money with the same Maximizing utility subject to the budget constraint yields analytical apparatus as the other goods, one needs its dis- the Q + 1 marginal conditions (1.3.4): tinguishing property. “Most marketable,” “liquidity.” ∂ 12:3–13:1 “Cassel Approach” is what we did above: ∂U U ∂U ∂ ∂x postulate money demand function but not derive it from x1 = = q = ∂m = λ (3.10) some deeper theory (unlike the demand functions for p1 ··· pq i 3.1. THE NEOCLASSICAL TRADITION 17

Here is the usual reasoning for these first order conditions: if I have one extra dollar, I can either buy 1/p1 units of ∂U good one, in order to get an increase in utility of /p1, ∂x1 or similarly with other goods, or I can add this dollar to ∂U my money stock, to get a gain in utility of ∂m from now until eternity. The present value of this flow of utility, dis- ∂U counted at the current rate of interest, is ∂m /i, and this must be equal to the marginal utility of spending one dollar in the current period. 15:2/o First flaw: Putting money into the utility function is problematic because money is not demanded for its own sake. (The utility of money stocks depends on the economy, and can therefore not be used to explain the economy.) 16:1 An illustration of this: the homogeneity of the goods and money demand functions is not derived from rationality but is built into that utility function. 16:2–17:2 To Niehans, the most promising approaches are theories about holding money as a means of exchange. Possible elements of such theories are: transactions costs, payment habits, uncertainty of when you get paid, portfolio choice. His Dvoretzky reference in footnote 42 is an appendix in Patinkin’s book [Pat65, pp. 450–55]. 17:3–18:1 But these are partial equilibrium theories. Niehans’s general equilibrium approach incorporates tim- ing differences and transactions costs, but not uncertainty. Concludes that uncertainty not necessary for explaining money. Chapter 4

Bordo’s Palgrave entry [Bor87]

Bordo’s article shows that mathematically equivalent economically equivalent. Bordo says they are not. formulations can have different meanings. Why do the two economists arrive at different conclu- 151:1 Irving Fisher’s variant of the equation of ex- sions? Because money has more than one function. One change MV = PT is an economy-wide accounting iden- function of money is means of circulation; but another tity. Left side: flow of money, right side: flow of goods. function of money is hoard, store of value. Money per- T is the physical volume of transactions (including secu- forms the former function when it changes hands, and rities), and P is a price index for these transactions. V is the more often it changes hands, the more goods it cir- the turnover speed of money, i.e., the average number of culates. Money performs the latter function by just sit- times a given piece of money changes hands per year. This ting there. But also hoards are eventually spent, i.e., they is the mathematical formulation of the economic law that also move, and a means of circulation simply sits there all flows of goods are accompanied by flows of money in between circulation acts. Therefore one cannot really see the opposite direction. whether a given dollar is kept as means of circulation or 151:2–152:1 Empirical difficulties with measuring T as hoard. But the ‘motion’ point of view favors the func- and P, and the development of national income account- tion of means of circulation, and the ‘rest’ point of view ing, led to the income version by Pigou: MV = PY. Here favors the function as a hoard. If one is interested in the Y is national income expressed in constant dollars. By function as means of circulation, it is logical to count only contrast to Fisher’s variant, Y only measures final out- that money which immediately effects exchanges, cur- put, i.e., it ignores all sales and purchases of intermedi- rency and checkable deposits, while those interested in ate products and of existing assets. Therefore V obtains a hoards also would like to include non-checkable deposits different meaning; it not only depends on payment habits and other liquid assets. and institutions but also on the degree of vertical integra- A similar distinction between active/passive money, tion of the economy. one held for transactions purposes and the other as hoard 152:2–3 Third version: Cambridge Cash Balance Ap- (and the former determined by institutional factors, be- proach M = kPY. Mathematically, k = 1/V, but the in- cause the costs involved are minute (shoeleather), and the terpretation is different: k is the proportion of nominal other more explicitly determined by utility function) is income which the agents are holding in the form of cash. made in [Heg69, p. 205–217], and also by J. W. Angell, Bordo distinguishes a ‘motion’ approach to the velocity I think. Hegeland means The Behavior of Money, New of money, which counts how many times a given piece of York 1936. But Hegeland makes the error of misplaced money turns over per year, and a ‘rest’ approach, which concreteness: from the fact that money serves two func- measures which fraction of the year the money rests be- tions does not follow that one can tell exactly which part fore it moves again, or, equivalently, which portion of a of the money is hold for transaction purposes and which person’s annual income is held by that person in the form part is held as a hoard. of cash. This switch also implies a different theoretical Question 5 Define the differences between Irving framework: emphasis is no longer technical factors de- Fisher’s, Pigou’s, and the Cambridge version of the termining how quickly money changes hands, but on the “equation of exchange.” Why is the money stock in the intentional element of how much money the economic ac- first two usually only currency and checkable deposits, tors want to hold. while that in the third version also includes non-checkable Friedman explains this second view in his Palgrave bank deposits and other liquid assets? entry p. 2:4. This is a mathematical equivalence, and Niehans [Nie78, p. 5] says the two approaches are also Then 152:4–153:3 Bordo distinguishes between even

18 19

more functions for the equation of exchange than Niehans (see Question ??).

Question 6 The “equation of exchange” MV = PY, or M = kPY, has several different interpretations: either as an accounting identity, or as a money demand equation, or as a mathematical formulation of the Quantity Theory of Money, etc. Each of these interpretations may be associated with a slightly different deﬁnition of M, V, k, P, and Y. Give the interpretations and the associated deﬁnitions.

153:4–155:0 (end of the article) gives a chronological overview of the forms and the roles of the equation of exchange in economic theories. Chapter 5

Notes about Lavoie’s Monograph [Lav92]

5.4 Credit and Money money in bank deposits, and they own government bonds or firm equities. Production has two sectors, consumption 149:1 The theory of money must be the entry point for goods and investment goods. macroeconomcis, not merely an afterthought, because As production starts, firms must pay revenue (both any production, in a modern economy, requires access to wages for the coming period and interest and dividends credit. from the past period) to the households. All interest goes 149:2 Distinguishes three strands of Post-Keynesian to the households, because the interest paid to banks is views about money: the French circuit approach, the hor- passed on either in form of wages to the households work- izontalists, and the structuralist endogenous view. Their ing in the banks or in form of interest on deposits to the monetary theories have a common core which will be dis- households holding bank deposits. cussed below. This is an alternative to the neoclassical 153:1 Credit are the assets of the banks, and money the supply and demand approach, which Lavoie says is com- liabilities. pletely wrong. Question 7 Fill in the boxes in the T-diagrams below 149:3/o The post-Keynesian theory of money is very which describe a simple overdraft economy. In order to old. “Can be related to Thomas Tooke and the Bank- start production, firms must borrow whatever they pay ing School, as well as to the non-orthodox monetary side out. The money they pay amongst each other is ignored of Marx, Wicksell and Schumpeter.” Scriptural means of here. Use the symbol R for revenues of the households payment among bankers older than commodity money. c working in the consumption sector, and R in the invest- His table 4.1 is our Table 5.1: i ment sector. After the firms have obtained the bank loans 150:1 Elaborates on neoclassical column in table 4.1. but before paying revenues to the households, the bank 150:2/o goes through the postclassical column with balance sheet is: some minor clarifications. Loans to firms Deposits of firms 5.4.1 The Monetary Circuit 151:1 Fluff about history of theory. Deposits of hhs 151:2/o Sources from which Lavoie distilled what he is going to write.

The Circuit without a Central Bank This will only last for an instance, then the firms pay these 152:1 important: characterization of the three sectors: funds to the households: firms, households, and banks. Firms produce, borrow, and Loans to firms Deposits of firms pay interest. They do not hold cash or any other monetary assets. Households work, spend, and save. Banks accept deposits and loan money. Here is a stylized time-sequence of actions in the econ- Deposits of hhs omy: All firms plan production at same time. Firms do not hold cash, they borrow from banks. Households hold their

20 5.4. CREDIT AND MONEY 21

Characteristics Neoclassical theory Post-classical theory Money enters in exchange in production Money is an individual requirement a social convention Money is a given endowment as efﬂux/reﬂux Money is exogenous endogenous Interest rates are endogenous exogenous Focus of analysis is substitution and portfolio on income effects and effects liabilities

Table 5.1: Money in Neoclassical and Postclassical Theory

After this the households spend everything except their (2) 156:4/o Firms in this model to not hold liquidities. savings Sh. Now the bank balance sheet is: In the real world they do, because their loans for fixed capital assets do not have to be paid back immediately. Loans to firms Deposits of firms (3) 157:1 Firms cannot pay interest on their current loans. This interest must be borrowed from the banks the next time around. 157:2 In real life, circuits are interwoven; therefore Deposits of hhs continuous increase in finance requirements.

The Circuit with a Central Bank Now assume there is a minimum reserve requirement with This again lasts only an instant. The firms use their de- a reserve ratio t , i.e., in the situation of the last balance posits to repay a part of their initial loans: d sheet shown above banks must find reserves of the amount Loans to firms Deposits of firms tdMh. In the absence of currency or government securities they must borrow these reserves from the Central Bank. The banks therefore have the following balance sheet:

Cons. loans to firms Deposits of hhs Deposits of hhs Mh Mh = Sh Eh Reserves Borrowing− from Centr. Bk. tdMh tdMh and the Central Bank has Finally, the households invest part of their savings, called Eh, in the shares and bonds issued by the firms. The rest Loans to banks tdMh Deposits of banks tdMh of their savings is Mh = Sh Eh, money they are holding. − The Central Bank has no control over the amount of re- Loans to firms Deposits of firms serves, but it can set the interest rate. What if households desire to hold the fraction tcbMh of their money holdings in currency? They go to the bank and withdraw this amount from their deposits. The banks Deposits of hhs must borrow the currency from the Central Bank: Cons. loans to firms Deposits of hhs Mh (1 tcb)Mh Reserves Borrowing− from Centr. Bk. td(1 tcb)Mh td(1 tcb)Mh +tcbMh Lessons from this: − − (1) 156:3 Firms can never attract more money than they and the Central Bank has have distributed at beginning. Assuming households increase their savings and therefore also their holdings of Loans to banks Deposits of banks td(1 tcb)Mh +tcbMh td(1 tcb)Mh money over time, this means firms will become more and − − more indebted to the banks. Notes outstanding tcbMh 22 CHAPTER 5. LAVOIE’S POSTKENYESIAN MONOGRAPH

The Circuit with a Government Question 8 The Postkeynesian overdraft model gives rise to a quite different view of money than the Neoclassical 166:2 Now assume there is a government sector running model. Discuss these differences. a deficit Dg. Assuming that neither firms nor households hold treasury bills, the government sells its bills to the banks. Therefore now the bank balance sheet is initially Cons. loans to firms Deposits of hhs Mh (1 tcb)Mh − T-bills Dg Deposits of gvt. Dg Reserves Borrowing from Centr. Bk. td(1 tcb)Mh td(1 tcb)Mh +tcbMh − − But the government will withdraw its deposits to purchase things, and its deposits will therefore be held by households, who spend it again except the part of their savings they wish to hold as deposits or bank notes. That amount which they do not save ends up in the hands of the firms, which can therefore pay back a larger amount of their loans: Cons. loans to firms Deposits of hhs Mh Dg (1 tcb)Mh − − T-bills Dg Reserves Borrowing from Centr. Bk. td(1 tcb)Mh td(1 tcb)Mh +tcbMh − − But now the banks no longer have to borrow their reserves from the Central Bank; they can sell some of their Treasury bills to the Central Bank in order to get reserves. The Central Bank ends up holding treasury bills instead of loans to the banks: Cons. loans to firms Deposits of hhs Mh Dg (1 tcb)Mh Treasury− bills − Dg td(1 tcb)Mh tcbMh − − Reserves− td(1 tcb)Mh − and the Central Bank has Treasury bills Deposits of banks td(1 tcb)Mh +tcbMh td(1 tcb)Mh − − Notes outstanding tcbMh Lavoie stresses that there is no crowding-out. 170:1 is good summary: (1) endogeneity at juncture between firm and bank. When firms worthy of credit ask for a loan, banks create one. (2) endogeneity at juncture between household and bank. When households make a portfolio decision with respect to their wealth, the money which they wish to keep has already been created, and their residual demand for money is necessarily accommodated by the banks. (3) endogeneity at the juncture between commercial bank and central bank. The latter must provide the high- powered money the former requests. Chapter 6

Foley’s Palgrave Entry [Fol87b]

6.1 [The Nature of Money as a So- a sale is not a barter between gold and another commodity. cial Relation] 249:2 Foley claims that it is not necessary to have a monetary standard. Although he admits that this may lead 248:1 Nice; examples demonstrate irreducibility of social to instability of the price level, he says that commodity relations to the individual. But he should also have men- money gives instability too. My counterarguments; when tioned the raison d’etreˆ of this social relation. Money is people hoard gold they know they have real value, which a form of value, i.e., it is a social relation which brings will neither rot nor rust, even if the price of gold changes home to the individuals the social constraint of value. by a few percent. If they hoard paper dollars, they must 248:2 Apparently Foley tried to characterize Marx’s be confident that the dollar will maintain its value. method here, but he was not very successful. Marx’s analysis is not comparative. It is also not primarily historical, Question 9 [Fol87b, p. 249] How can promises to pay even though it works out the inner logic of the historical function as money? Explain Foley’s “pyramid” of trust- peculiarities of capitalism. worthy liabilities. Is this pyramid related to Lipietz’s dis- 248:3 I also disagree with the formulation that the im- tinction between synchronous value and value in process? portant thing in capitalism is the degree to which products are controlled by the producers acting in their own 249:3 Important: basis of credit money is to circulate interest. This is illusion. In reality, self-interested mar- a third person’s promise to pay, and that promise to pay ket activity leads to a pervasive lack of control over so- must be socially more acceptable than your own. cial relations. The deepest way to characterize the market 249:4/o If these promises to pay are money, what does economy is that producers equate their labors. it then mean for someone to pay? Foley says that means to 248:4 Starting with the observation that products can give the recipient a promise to pay which is more reliable be added up, Marx concludes: this shows that they have a than your own. Normal people pay with banks’ promises common quality. Foley skips over this step, says nothing to pay, banks pay with the central bank’s promise to pay. about the quality of value, but immediately goes over to [Foley does not say this here: if that promise to pay does the definition of a quantitative unit, without saying what not come through then you are obligated to come up with this is a unit of. We know that a kilogram is a unit of a promise which is one credibility step higher. But nowa- physical mass, but what is a dollar a unit of? Foley has days the banking system is insured: the state sees to it a word for it, he calls it value, but he does not say what that the bank promises to pay always come through.] In a value is. I.e., he looks at the surface relations but does not commodity money system, transfers of gold are at the top ask what the sum of surface interactions does for the core of the pyramid. In state paper money system, the state can of the economy. print the money with which it pays. 249:1 Introduces commodity money as the historically 250:1 Foley confuses two questions: (1) what is the earliest form of money. Instead of Marx’s analysis of ultimate liability, and I still would maintain that only in the value forms in Section 3 of Chapter One of Capital the unquestioned political and economic hegemony of one I, Foley brings the following abbreviated argument: one country can it be state paper money of that state. (2) legally defines one dollar to be a certain amount of gold, why are people content to hold liabilities which are not and therefore the exchange relations between gold and the ultimate? Because of the convenience of circulating the commodities become prices. This is not the same as these lower-grade liabilities? Or because the issuers of the Marx’s argument. It does not explain why gold is accepted lower-grade liabilities know that they can get away with as a means of purchase for everything. Marx stresses that it? They issue credit in these lower-grade liabilities.

23 24 CHAPTER 6. FOLEY’S PALGRAVE ENTRY

Certain lower-grade liabilities in this credit system may 252:2–4 Adam Smith sees effects of money on two lev- become widely accepted (bills of exchange), indeed so els: One time effect from the institution of the banking widely accepted that they do not have to pay interest. system, which sets gold free. 250:2 Summary of the things he said so far. And then, this is the origin of the real bills doctrine: Foley’s points are amazingly ambivalent: banks should lend money only on things that were sold, Point 1: Money is value separated from a particular i.e., by discounting bills of exchange, in order to bridge commodity: does that mean from a particular use value, or the time gap for money as a means of payment! If that does that mean from any use value, i.e., values separated would be the case then there would be no difficulties in from commodities period? maintaining convertibility, i.e., bank notes would then cir- Point 2 is what Marx discusses in Chapter Two, it is true culate at par with gold. and Foley will use also historic developmental arguments. 252:5 Ricardo says: In Napoleonic wars, the pound was Point 3 promises to pay can take the place of the money made inconvertible, and the price of gold rose above par- commodity altogether. There again it is only the promise ity. Why? Against those who said this reflected real fac- to pay whatever is at the top of the pyramid which can tors, poor harvests, that had created a trade deficit and had take this place! driven the pound to a discount against foreign currencies Point 4: Pyramiding can happen with or without a defined in terms of gold, Ricardo says it was overissue of money commodity. the inconvertible bank notes. (Like Marx). This overissue put more money in the hands of the public than they wanted to hold. 6.1.1 [Relationship between money and real 253:1 Ricardo raises the question of the effect of incon- economy] vertible paper money. His conclusion is that their overis- 250:3/o Two sides of relationship between economic ac- sue has no influence on real economic activity, because tivity and credit money. One the one hand credit is created the real quantity of money was endogenous. in the course of economic activity, therefore one should 253:2 Later he argued with Say’s law that money is a expect it to be endogenous, it merely reflects the economic veil, has no real influence at all. activity. On the other hand the availability of credit is an 253:3/o Now Marx: 3 important criticisms: exogenous constraint. (1) Quantity theory of money is wrong, prices are de- 251:1 But it is also a regulator of economic activity. In termined prior to quantity of money. order to produce, an individual either has to have the cash, (2) Say’s Law is wrong. Foley says movement of or it must be able to convert its own liability into a liability money in and out of hoards causes a discrepancy between of higher acceptability by borrowing. sales and purchases, while Marx would reverse the causal- 251:2 Theories of money can be classified according ity: the discrepancy comes from people’s desire to real- to how those two aspects are reconciled. 18th and early ize their value and keep it in this realized form, and this 19th century theories emphasized money as a a reflector of causes the movements into hoards. economic activity, which is determined by non-monetary (3) Prices are determined by value. Quantity of money factors. does not determine the price levels because of hoards not Hume’s quantity theory makes the real amount of all of money is in circulation. money endogenous, therefore money does not have an ef- Then the last thing Foley says is blatantly wrong” for fect in economic activity. Marx, money only communicates real forces. No, on the Then Hume has a second mechanism which Foley calls contrary, the production process is shot through with value contradictory, because it makes the physical quantity of categories. money endogenous as well. But I see this as the mech- 254:1 Prices depend on labor content of gold anism by which the quantity theory of money obtains 254:2 How does quantity of money adjust? Through worldwide validity: total gold internationally is determin- hoards. ing the price level, therefore physical gold distributes it- 254:3/o His theory of inconvertible paper money is self between the nations in proportion to the commodities same as Ricardo’s. traded. Foley calls this the long run, while the quantity 255:1 Economic activity is determined by how well relationship within one country is the middle run. capital can accumulate (profit rate etc), crises may have 252:1 Hume’s Short run: if there is more money and monetary manifestations, but most of them have intrinsic prices have not yet adjusted, then the money has an effect. reasons, the contradictions of capital accumulation. 252:4 Also, Hume, as Smith, says that money has no 255:2 Concluding summary of classical theories. effect on interest rate, which has a “conventional” relation 255:3 Now theories in the century after 1875: large ex- to the profit rate. pansion of credit, credit panics, wars which have also pro- 6.1. [THE NATURE OF MONEY AS A SOCIAL RELATION] 25 foundly transformed the monetary systems. empirical claims. Money demand function is less stable 255:4/o During World War I money was made incon- than Friedman claims. [Monetarists apparently tried to vertible, and people discovered that it worked and that this get around this by picking that monetary aggregate which inconvertibility gave enormous latitude to the state is the most stable; this is ex-post theorizing.] 256:1 is interesting: according to the old theories, in the 259:2/o James Tobin: Adopts demand for money func- presence of inconvertible paper currencies a commodity tion but supplements it with demand functions for all other standard would spontaneously emerge, and state curren- assets. Changes in the quantity of money have influences cies would have various discounts against gold. This in- on the interest rate and investment, and only in the very deed was the case between the wars, but then after WWII, long run will they turn into just price changes ad Fried- surprisingly, the dollar was accepted as world money, man claims. which called into question the classical monetary theories. 260:1 Robert Mundell gives an open economy twist to Foley thinks the dollar is an abstract unit of account. it. In the open economy, the quantity of money is endoge- 256:2 This called into question the classical theory. nous; if government prints too much money people will Here Foley is making connections backward in time. switch into other currencies and the exchange rates will 256:3/o Irving Fisher is the neoclassical story which we be affected. Monetary policy has its effects through the all know, a quantity theory of fiat money. There is an ex- exchange rate. Overall a quantity theory of money. (This ogenously determined amount of money which has some looks very much like how I see the Humean equilibrating exogenously determined velocity, therefore it determines mechanism). the nominal value of transactions. Changes may be real 260:2 Rational expectations, Robert Lucas, turn Fried- changes in the short run, but in the long run it will all be man’s claim of the irrelevance of money in the long run just nominal effects. already to the short run, by people seeing what the mone- 257:1–2 Keynes correction to Fisher: Fisher only con- tary authority is doing and offsetting it. Monetary policy siders prices as the variable which adjusts. Keynes says can only have an effect when it is unpredictable, i.e., when quantities can also adjust to the supply of money. The it feeds noise into the econ omy, i.e., when it has a bad mechanism is the interest rates. People have to hold effect. Foley does not see that the rational expectations money together with the other assets, and in order to in- school was not monetarist! clude money into their portfolio, the interest rate changes, It seems to me those theories can only be developed in other words, velocity depends on the interest rate. after the experience of an activist policy has been made, and activist theories were only possible after the experi- 257:3–258:1 Keynes couches his theory in very tradi- ence was made that government’s hands had not been tied tional terms. This is important to stress. Therefore he does by the gold standard. not adopt the view that money is largely endogenous. 260:3/o Patinkin, Arrow, Hahn, general equilibrium 258:2 Important remark: Keynes says that policy mak- theories. Patinkin: one cannot separate price level from ers are not bound by convertibility but can affect the econ- relative prices. Hahn: many general equilibrium models omy. The economy is not a self-regulating system but have “nonmonetary” equilibria, i.e., equilibria in which need policy interventions. money has a zero price, but at depressed levels of output, 258:3 Keynes provided the framework (and I think here which allows one to gauge the benefits of money. Foley is describing the IS-LM model) for post-war theo- 261:1 Hyman Minsky: competitive pressures force rizing which came to quite different conclusions. firms to borrow more and more undermine the soundness 258:4/o 1945–55 Keynesians were strongly nonmone- of their positions, which causes a collapse of this web of tary: money does not matter because quantity of money deteriorating liabilities. (Quality of credit changes, not can be replaced by near-moneys. (It seems to me also the just its quantity.) argument was: you cannot push on a string). But expec- 261:2/o Kalecki: availability of credit confines accu- tations are paramount. This extreme non-monetary recep- mulation, or level of production within overall capacities. tion of Keynes fell into disfavour and policy makers relied 262:2 Concluding paragraph: There are very strong more on monetary policy again. forces going both ways between monetary and real econ- Foley does not mention here the role of fiscal policy at omy. In equilibrium they balance each other. Therefore all. you must look at them outside equilibrium. 259:1 Friedman a response to the nonmonetary tendencies of Keynes; he restores Fisher’s quantity theory in the Keynesian framework by saying the basic behavioral equation is not a consumption function but a money demand function. It is stable, i.e., velocity does not depend on the interest rate. Foley mentions that these are lots of Chapter 7

Humphrey’s Article Quantity Theory of Money [Hum74]

The pagination is from the collection book. coded into the equation. If one writes m = m(p,y) then 77L:1 History of QTM proportionality prevails only if there is homogeneity. 77L2 History of debates around QTM 77L3/o purpose of article 2 Causal Role of Money This goes a little beyond what Niehans says. Niehans just What is the Quantity Theory? has the equilibrium condition. H says there must be some mechanism which establishes equilibrium, a linkage from 77R1 Its conclusion: price level p depends on money money to prices. stock m. 77R2 Supporting propositions or more precise conclu- Question 10 Those who postulate a causal role for the sions, see the 5 subsection titles which follow. [The bun- quantity of money, i.e., a linkage from the quantity of dle of all these should be considered to be constituting the money to prices, usually distinguish between two mech- QTM. Some authors use a weaker and some a stronger anisms by which this linkage occurs, a direct effect and form.] an indirect effect. Describe as well as you can these two linkages. Something H does not say but takes for granted: the equation M = m(p,y) is like a demand/supply re- (a) First linkage: if people have more money they will lation, which is the aggregation of many individual de- spend more. Now this can resolve the imbalance for the mand/supply relations, not the residual of other stuff. See individual, but not for the group. One person’s spending [Heg69, p. 170] on this. Hegeland also differentiates be- is another person’s receipt. Therefore an excess stock of tween active and passive money balances. money will lead to a general increase in spending. Since there is full employment, this will end up driving prices 1 Proportionality Postulate up until the desired cash balances will be equal to the real balances. Friedman described this nicely in his Palgrave The strict proportionality between p and m is implied by entry [Fri87]. the speciﬁcation of the money demand function in terms (b) indirect effect: more money, therefore money hold- of real money balances. It seems very compelling (no ers buy bonds with this money, this bids up the price of money illusion) but you will only get (empirical) stabil- bonds, lowers the interest rate, until the interest rate is so ity of the money demand function if people are both will- low that people are satisﬁed with holding this much cash. ing and able to adjust their money balances to the desired But those lower interest rates stimulate investment, and as level. before, this affects output, and this affects prices. See what Osborne says about stability. Proportionality postulate reduces to two things: (a) 3 Neutrality Postulate Money demand depends on real cash balances, and (b) money demand is constant, does not depend on other vari- Neutrality postulate: changes in M do not affect y. This is ables. If the quantity theory of money is written in the a necessary condition for the QTM: y determines money form m = kpy then the proportionality postulate is hard- demand, and this y is not determined by money supply.

26 27

Neutrality means generically that the relationship be- Development of QTM up to the 19th tween commodities is not affected by money. For instance Century [Mil71, p. 488] wrote “the relations of commodities to one another remain unaltered by money” and “there cannot, 80L:2 Locke 1691: p is always proportional to M. in short, be intrinsically a more insignificant thing, in the Hume 1752 Variations in M will cause variations in economy of society, than money.” p with a lag. This is taken up by classical economics: The word “neutrality” was not introduced by Mill but QTM is a comparative static analysis comparing equilib- by Hayek in [Hay31, pp. 27/8], and apparently the fol- rium states, but there is an effect during the transition. lowing sentence from [Pat65, p. 75] was from [Hay35, 80L:3/o Cantillon and Hume distinguish between long pp. 129/30]: the mere conversion of a barter economy to run equilibrium and short run adjustment process. a money economy does not affect equilibrium prices and interest. Patinkin argues that in terms of equations, such Question 11 The neutrality of money is a supporting hy- economies cannot be compared, and therefore the way out pothesis of the quantity theory of money. Explain what it is to say that the economy is unchanged if nominal money means that money is “neutral” and give the mainstream supply changes. (But the real money supply remains con- reasoning for the neutrality of money. stant, therefore the limiting case of the nominal money Even mainstream theories say that money is not neutral going to 0 is not very meaningful). in the short run. Which mechanisms are responsible for the non-neutrality of money in the short run? Monetary changes have no effect on real changes. Other economic theories say that money is not neutral Whereas Niehans only writes it up in equations, H gives even in the long run. Which arguments can be brought the economic rationale: real quantities depend on tastes, forward against the neutrality of money? endowments, and technology. That means, money is only a veil, can have effects only in the short run, not in the long run. Both short term nonneutrality and long term Question 12 Both Cantillon and Hume said that the neutrality are part of the QTM. quantity of money is not neutral in the short run. But He does not even address the question here whether the they had different mechanisms for this non-neutrality. De- real stock of money balances has an effect, but this comes scribe their theories as well as other mechanisms in 19th later. century theories. Cantillon puts emphasis on: who gets the new money? Would be neutral if new money holdings were propor- 4. Monetary Theory of the Price Level tionate, if total money stock increases by 10%, then those whose individual money stock increases by less than 10% are disadavantaged, and thsoe with more are advantaged. This is neutrality going the other way: only monetary vari- 80R:1 Hume’s story is interesting: different degrees of ables affect the price level, real variables do not affect it. money illusion among income recipients will cause costs I.e., crop failures, embargoes, monopoly power, excise to lag behind prices. This will give higher profits, hence taxes, etc., will only affect relative prices, not the price higher investment. level. 80R:2 Other effects in 19th century theory causing the adjustment to be non-neutral: Lag of wages behind prices 5. Nominal Money stock is exogenous • Inflation reduces real debt • Now H gives nice examples! In gold standard, money Forced saving, i.e., those who have higher propensity stock was determined by gold production and net gold • to save receive more income. flows. Stimulus to investment by the temporary fall in the In what he calls paper money, it requires a stable link • interest rate. between the high-powered money issued by the central bank, and bank notes and deposits issued by the banks. 80R:3/o Cantillon-Hume thought adjustment processes Important here: QTM has never denied that near moneys would be very important, classical economists thought influence spending just as money does, but they say that they would be completely unimportant. Interesting rea- there is a stable linkage between those near moneys and sons why Ricardo may have understated transition effects. the high powered money. Did not want to give arguments for the inflationists. 28 CHAPTER 7. HUMPHREY’S ARTICLE QUANTITY THEORY OF MONEY

Cantillon-Hume however relied on the direct mecha- 84R:1 Interestingly, the currency school only regulated nism! With bank notes also the indirect mechanism en- bank notes, and not bills of exchange or deposits. They ters. thought this would be enough. They postulated a stable 81L:1/o First author of indirect mechanism is Henry link with those near moneys. Thornton. According to H, Thornton treated bank loans One more thing which I didn’t stress before: near on a par with bonds, as substitutes for bonds, while money must be clearly distinguishable from money [BB92] treats them differently. proper.

Role of QTM in Classical Policy De- Anti-Quantity Theory Views bates Classical and modern. First a summary of criticisms: (1) If there is unemployment, issue of new money leads Price Specie Flow mechanism. Good article in New Pal- to rise in output rather than rise in prices, i.e., will have a grave. Link to the monetary approach to Balance of Pay- permanent real effect. ments, also referenced in Palgrave. (2) Postkeynesians will say: velocity (i.e., demand for Bullionist Controversy: Just an application of QTM money; H does not distinguish those!) is not stable but and specie flow. But their addition is the linkage with erratic. near moneys: country bank note issue was linked to issue (3) Real bill doctrine says: all that matters is that money in London banks. is issued for titles of real value or value in creation. It 88L1/1 Issue in Currency-Banking debate is: how to means banks are passive. maintain fixed exchange rates and convertibility of gold As long as this is so, any overissue will return to the and stable price levels? Fixed exchange rates is interesing, Bank, because nobody needs it. It flows back rather than this is one aspect of the measure of value issue! being devalued. Currency school: one has to make the mixed paper-gold Look at Roy Green’s article. currency behave exactly as would a whole metallic cur- Palgrave on real bills doctrine is interesting, lots of rency. Marx quotes. Has to do with law of reflux, which is again. Is this desirable? Law of reflux means: money supply is endogenous. And if it is desirable, is it enough to require gold con- (4) Money is endogenous vertibility, i.e., obligate the central bank to convert, to get (5) monetary expansion may be ineffective for at least this effect? No; convertibility is the “banking principle.” 3 reasons: 83:1–2 Gives the interpretation. (a) may be absorbed into hoards. Convertibility means: a bank issues bank notes by re- (b) spending may be interest insensitive: [can lead the discounting good bills of eschange, and on other hand horse to the water but cannot make it drink.] converts banknotes into gold. This would be a stable con- (c) money supply may be demand-determined. trol mechanism. Currency school had said Specie Flow mechanism does not work. Depletion of gold reserves will cause restric- Antibullionists tion of note issues, but this is too late, will not be able Economic disturbances did not have monetary reasons to prevent running out of gold and therefore having to and therefore do not need monetary remedies. Instead: suspend convertibility. Self-fulfilling prophecy, run on prices rose because of crop failures and heavy military banks, there is no lender of last resort, they just don’t have expenditures abroad. enough gold. Doubt that overissue of currency was cause of gold out- Answer: both think money must be regulated, main- flows, and that contraction of currency would be sufficient taing convertibility is not enough. Also: to remedy it. 83R:3–84 Why it does not work: too long time lags. Adhered to real bills doctrine: overissue of money im- This is exacxtly the same argument the monetarists have possible if only productive, nonspeculative bills of ex- been using about an activist monentary policy. chagne are monetized. Extra money flows back (law of re- (But if there is reflux, then the effect is not so long flux). This is origin of Post-Keynesian theory that money term!) supply is solely demand determined. 84R:2 Bank charter act of 1844: marginal gold reserve 85R:2 Banking School challenged virtually all aspects requirement of 100% behind note issue. of QTM. Good discussion is in [Vis74, p. 187]. 84:34/o Clearly causality was from quantity of money Monetary expansion or contraction will not affect to prices. prices 29

Supply of money and credit cannot influence spending 88R:3 Short run non-neutrality of money re- because: excess will go into gold hoards, Abzugskanale.¨ emphasized. Gold inflows and outflows will come from these hoards. Supply of money determined by needs of trade. Cur- rency issue must be restricted to self-liquidating “com- Keynesian-Monetarist Controversy mercal or agricultural paper” i.e., bills of exchange. But they went further than the antibullionists: law of reflux erupted 1936 with General Critique. Fivefold Keynesian prevents overissue even if real bills doctrine is violated. attack: 85R:3/o Tooke said prices were determined by factor Question 13 Give the five points of the Keynesian attack incomes (wages, rents, profit), not by money stock. Early on the Quantity theory of money. version of income expenditure approach to monetary theory, in terms of determinants of aggregate demand. 89L:1 (1) QTM assumes full employment. In unem- 86R:1 Tooke left open how these incomes themselves ployment, prices are rigid and output variable. were determined! 89L:2 (2) velocity of money extremely unstable. 86R:2 Also changes in expected profits affected prices. 89L:3/o Monetary policy ineffective because: 86R:3 Stock of money passive, demand-determined (a) if depression, idle money balances perfect substi- variable. tutes for bonds (liquidity trap). (1) changes in economic activity precede and cause (b) investment spending may be interest-insensitive. changes in money supply 89R1/o (4) consumption function instead of demand for (2) money supply not independent of money demand money is basic stable relationship. (3) Central bank does not control but only accommo- 90L:1 (5) Non-monetary explanation of Great Depres- date. sion. Disappearance of profitable investment opportuni- 87L:1 Disputed that control of money means control ties and then collapse of confidence. of money substitutes. Look at overall structure of credit instead of just money supply. This exemplifies: Post Keynesian Extensions (1) Impossibility to make watertight distinction between money and money substitutes. Inflation predominantly cost push, not monetary (2) If policy attempts to control money stock, there will Monetary policy can be used to peg interest rate (mini- be an endless array of money substitutes. mizing burden of debt) and to peg unemployment rate. Policy implications of Banking School: Radcliffe Committee was revival of banking school: (1) Less regulation of banking than Currency School (one cannot distinguish money from substitutes, money Banks’ self-interest best guarantee. demand devoid of volitional content! (2) discretion rather than rules Liquidity key determinant of spending. (3) do not try to regulate prices by monetary policy. This is putting the cart before the horse. Monetarist Counterattack (1) theory of real balance or wealth effect means that Neo-Classical Reformulation money matters. Weakens Keynesian case: escape from liquidity trap, contradicts underemployment equilibrium. 87R:1/o Despite Banking School criticisms, QTM re- Money not just substitute for bonds but for a wide array mained official doctrine until 1930’s. of assets. Currency School doctrine became English monetary or- (2) Qty theory reformulated as theory of demand for thodoxy after 1850. money rather than determination of prices. And this de- Real bills doctrine fallacious: demand for credits was mand was stable. Specifically against Keynes. insatiable. Also empirical research. (3) Neoclassical mathematical refinements. [In my 91R:3 Then policies: view, this mathematization stunted the debate.] 88L:1 Irving Fisher’s Mv = pT and Cambdge M = kpy. 88L:2 Now they could determine conditions under Survival of the Classical Quantity which it holds. Velocity was considered stable. 88L3/o Policy implications: monetary policy would in- Theory in Modern Monetarist Ap- fluence prices. proach 88R:1 Control over the money supply in a fractional reserve system. 92L:1 Milestones in the development: 30 CHAPTER 7. HUMPHREY’S ARTICLE QUANTITY THEORY OF MONEY

Bodin’s hypothesis about 16th century price revolu- Keynesians by contrast concentrate on a narrow range of • tion assets and interest rate. 93R:2/o (6) exogeneity of money supply. Agree with Cantillon-Hume distinguishes between long-run • Bullionists and Currency School. More specifically, neutrality and short-run nonneutrality money supply has 3 determinants: (1) monetary base (2) reserve/deposit ratio (3) the individuals’ desired cur- Classical economists used it for monetary policy • rency/deposit ratio Mathematical restatement by Neoclassicals 94L:1 Also have same policy implications: critical of • central bank. Similar to Ricardo, they say interest rate is Friedman’s reformulation of quantity theory as a the- not a good policy target. Like currency, convertibility is • ory of the demand for money. insufficient safeguard. he relates this to the long and variable lags, I guess this is why convertibility cannot work. 92L:2 But theory itself did not really change; it was the 94L:2/o Monetarists do not insist on rigid proportional- same theory adapted to the evolving state of economics. ity: because desired quantity of money is not a numerical 92R:1 Since this is the case, it is fitting to compare clas- constant but it depends on other economic variables. (For sical with modern monetarist approach. Gives 6 points in instance expected inflation). the classical theory, and then uses one or several para- 94R:1 But this difference is not very great. graphs to discuss their counterparts in the monetarists. I will give those points as I discuss the counterpart para- graphs: 92R:2 (1) Neutrality of money in the long run. Mon- etarists say: long run expansion path of output is determined by real factors. Also interest rate is non-monetary: productivity and thrift (contra neo-Keynesians). Also unemployment not monetary (again contra neo-keynesians). 92R:3/o (2) temporary non-neutraility of money. Mon- etarists say sudden changes in money supply or its rate of growth will distort prices, since some prices adjust more quickly than others, but in the end all prices adjust completely. 93L:1 (3) causal role of money in transmission mechanism: Money stock changes precede and cause changes in nominal income (but I remember now: how this splits between real income and price changes is determined by the real factors determining real income; therefore money stock must grow at the right rate, the rate determined by real income.) Money is chief source of economic distur- bance (contra Marx who says the disturbances come from the inner contradictions of the society; they express themselves in money but usually do not originate there). They explain Great Depression and post-1965 inflation to erratic behavior in money supply (remember H’s article was written in 1974!). 93L:2 Money has active roal also in “monetary adjustment process” to new equilibrium. Motivating force is discrepancy between actual and desired real money balances. 93L:3/o Regarding transmission effect (I assume of monetary policy?) modern monetarists stress interest rate more than classical quantity theory. (Despite lip service to direct effect). 93R:1 Despite the greater role of interest rate, they agree with classicals on strength of adjustment: mechanisms are numerous, and monetary policy has full impact. Chapter 8

Notes about Monetarism Chapter in [Smi94]

8.3 Monetarism and the Quantity 31:2 As accounting identity it deﬁnes V. Theory of Money 32:1 But with the following three additional assumptions

8.3.1 Introduction V constant • 29:1 Milton Friedmann, the most important monetary y determined independently of monetary influence economist since Keynes, is responsible for the remarkable • revival of the ancient quantity theory of money in 2nd half M exogenous of 20th century. • 29:2 Before Friedman, QTM was at a low ebb, and in one gets a simple caricature version of the QTM. 90s low ebb again. 32:2 From there you get that the rate of inflation is 30:1 Friedman’s essential contribution is that money the gap between the policy determined rate of growth of matters, but QTM itself was not a good way to try to prove money supply and the rate of growth of the real economy, this, because it says that modern money can be made to which is determined by real factors. behave as if it was a simple commodity money. 32:3 This can be criticized in three ways: Monetarism worked in the 60s and 70s when monetary V variable, so that changes in money supply ab- institutions were stable, but less well in 80s and 90s when • sorbed in a numerical change in velocity there were many financial innovations. 30:2 Plan of Chapter. y may be affected by monetary factors, money not 30:3/o Does not discuss Friedman’s technical and em- • neutral pirical work, and also not the more esoteric optimum quantity of money. M may be endogenous, perhaps causality running • from nominal income to money stock rather than re- 8.3.2 The Quantity Theory of Money verse. Question 14 Which three assumptions are needed to turn Friedman attempted to breathe life into the QTM by meet- the equation ing each of these objections head-on MV = Py into a simple “caricature version” of the quantity theory 8.3.3 3.3 Friedman’s restatement as a mon- of money? How can each of these assumptions be criti- etary theory of nominal income cized? How does Friedman’s monetarism counter each of 32:3/o It was Friedman’s perception that Keynes consid- these criticisms? This question is based on [Smi94] ered velocity of money as highly unstable (liquidity trap). 31:1 Friedman would have preferred the term “quantity This may not have been Keynes himself, maybe some of theory” to the term “monetarism.” his followers, like the Radcliffe Report. Version of QTM surviving in modern textbooks is Now Smithin says: velocity is either unstable or purely passive. This would make the notion that money matters, MV = Py whether for prices or output, difficult to sustain.

31 32 CHAPTER 8. MONETARISM CHAPTER IN SMITHIN’S BOOK

Maybe marxists can say: money matters, but it is not will be an effect on real income, and 18 months or 2 years the money supply itself that matters. later this effect will have dissipated, and there will only Friedman says: velocity is a stable function of a limited be a nominal effect. Friedman calls it a theory of nominal number of variables. Depends on real money balances, income, since the effect on nominal income is a certainty, nominal rate of return on bondes, nominal rate of return but the question how this nominal income is distributed on equities, rate of inflation, “ratio of human to nonhu- between real income and inflation changes over time. man wealth” (wage rate), and real income, and tastes and 37:1 Exogeneity of the money supply is the third big preferences. challenge. One line of criticism is that this exogeneity 33:0 This helps the quantity theorist to escape from the does not hold in a small country, in which the money sup- constant velocity, but still keeps velocity determinate. ply is determined endogenously, in response to balance 33:1/o This money demand function is not that different of payment developments. There are two ways to answer from the bastard Keynesian LM function. At least this is this. Either you need some global version of the QTM, what I think Smithin says. It is not that new. as the specie-flow mechanism was, and that can be used 34:1/o There is an overshooting phenomenon in infla- today too (is that the monetary theory of the balance of tion, which is apparently the basis of Cagan’s inflation ar- payments?). The other defense would be to call for flexi- ticle. There is a clear textbook version of this mechanism ble exchange rates which would allow central banks to set in Parkin. their own money supply. Friedman was indeed a propo- I guess this growth rate formulation is relevant because nent of flexible exchange rates. this is what they tested empirically. This convinced the 37:2–38:1 Second challenge: definition of money monetarists that the QTM can no longer be attacked on stock. Initially Friedman adopted a broad definition of the basis of the instability in the velocity. the money stock and said it was unproblematic; Now what is the difference between instability and velocity being a merely passive variable. 38:2 In terms of endogenous money creation the argu- 35:1 Second line of criticism of QTM: changes in the ment is that the banks are constrained by reserve require- money stock do not affect prices, because prices are sticky ments. Money multiplier relationship. in the short run, but affect real income. 35:2 Friedman’s way out there is similar to what already Hume had said: money can have impact on output in the short run but not in the long run. In this way, Fried- 8.3.4 Friedman’s Policy Proposals man also had a new explanation of business cycles: simply blame them on the central bank. 38:3 The most famous policy was constant growth of the 35:3/o Friedman believed that in the long run there was money supply. Although one could have been more so- a natural permanent growth rate which is independent of phisticated with some optimality rule, Friedman opted on monetary influences, and also a natural real rate of inter- political grounds to stick to the simple rule, since this is est. This is similar to the neoclassical growth model, but easier to understand. he has some special literature references. There is a be- 39:1 But it evolved over time. In the late 40s he had lief that the capitalist economy can expand indefinitely at been concerned with automatic stabilizers and “functional a constant rate (i.e., if there are resource limitations, then finance.” At that time he also promoted 100% reserves. technological advance will take care of them. 36:1 In the short run, changes in monetary growth have 39:2 In 1960 the concern with automatic stabilizers is non-neutral effects, because the economic agents are slow dropped. Constancy is introduced there? At this time he to adapt their inflationary expectations. It is expressly still has 100 percent reserves, but this will no logner be a transitory phenomenon which will be dissipated in the mentioned after 1960. A new thing then is also flexible long run. exchange rates. 36:2 Summary: since Friedman’s theory allows for 39:3/o–40:1 The most interesting changes are in his short-term nonneutrality, this protected the QTM from definition of the money stock. First he thought it was the criticism that it is bankrupt because it cannot explain some version of M2, but later when he was pushing for things like the Great Depression. Friedman and Schwartz a constitutioinal amendment he realized that M2 was too explain Great Depression by the central bank. In other elusive and changeable, and he retreated to say that the words, in the long run even a slump as big as the Great monetary base must be regulated. In addition he said the Depression would have no real effects. monetary base should have zero rate of growth, thus ac- 37:1 In Friedman’s theory the transition from the short knowledging the innovations which would allow the effe- run to the long run goes as follows: In six months there ictive money stock to grow anyway. 8.3. MONETARISM AND THE QUANTITY THEORY OF MONEY 33

8.3.5 Monetarism and the New Classical technical monopoly features in the production of School • fiduciary currency 40:2 A different important recent development in eco- third-party externalities from monetary disorders nomics is the rational expectations revolution. At first it • was thought it would strengthen the monetarist case, To- Although the free banking school thinks central banks bin at some point called in “monetarism Mark II” but later should have been abolished, it recognizes that this would it was recognized that rational expectations undermined have been politically unrealistic, and monetarism is the the monetarist doctrine. second-best thing. 41:1 The essence of monetarism is that money matters: [IL98, p. 175–181] is also an interesting essay about in the long run for the inflation rate, and in the short run free banking for the business cycle. New classical theory supports the long run proposition but not the short run. 8.3.7 Endogenous Money 41:2 New classicals distinguished between anticipated and unanticipated changes in monetary policy. Although 44:2 Instead of the money supply being fixed by pol- Friedman had talked about actual and anticipated changes, icy and affecting the price level, the postkeynesian and this is not the same thing. His constant money supply rule endogenous money school says that money stock is a is irrelevant in the new classical view, since they say that byproduct of bank lending, which comes from y. any systematic policy has no real effects. 44:3 Misleading to call it endogenous money. Endo- 41:3 In the early days a ‘monetary misperceptions’ the- geneity is not the issue. Issue is whether money follows ory of the business cycle (Lucas 1981), fell out of favor, real production. I.e., changes in nominal income cause and neoclassicals replaced it by a nonmonetary real busi- changes in money, and inflation is cost-push, expecially ness cycle theory. wage-push in the eyes of the Post-Keynesians, and central 41:4 Somewhat ironic that the real business cycle the- bank accommodates this. ory arose in the 1980s when there seemed to be obvious 45:1 Friedman says against this: monetary policy is still empirical evidence that monetary policy mattered. The constrained by high-powered money. Postkeynesians say: New Keynesians latched on to this, but the new classical Central Bank cannot refuse to create this monetary base, school was unconvinced ... either through discount window, or through its lender of 42:1 ... because they said a theory of monetary influ- last resort functions. The only thing it can do is change ences must be anchored in a theory of money, and in the the interest rates at which it grants those credits. There- Walrasian framework there was no good theory explain- fore interest rate should be considered the main policy in- ing the existence of money. strument of the central bank. 42:2 Friedman himself does not have an explanation of 45:2 This is a big challenge, because they have an al- money either. ternative explanation of the empirical correlation between money and income: it goes the other way. 8.3.6 Monetarism and Free Banking More detailed econometric studies investigating the causality are inconclusive. 42:4/o Again a challenge to monetarism from a friendly quarter, because Friedman has been advocating laissez- 8.3.8 Concluding Remarks faire policicies in other spheres, then why not in banking. 43:1 Friedman’s position was: although he did not want 45:3/o Around 1979 USA and England adopted mone- the Central bank to do discretionary policies, he did not tarist policies. want to abolish the Central Bank. A stable monetary 46:1 Effects were not what the monetarists predicted. framework was a necessary prerequisite which the mar- Money certainly seemed to matter. This policy forced the ket itself could not provide. interest rates sky-high, severe recessions. 43:2/o Friedman defended government involvement on The rates of growth of the broader monetary aggregates 4 reasons: actually increased. Later there was rapid growth of monetary aggregates without inflation. Any commodity based systems will evolve into fidu- Monetary targeting was abandoned in both countries, • ciary systems because of the resource cost [and pre- and they reverted to a traditional interest rate policy. sumably a private fiduciary system is not trustwor- 46:2 All this has to do with deregulation and innovation thy], at the same time. scope for fraud and deception and difficulties of en- Conclusion: money matters, but not in the way Fried- • forcing promises to pay in a fiduciary system. man anticipated. 34 CHAPTER 8. MONETARISM CHAPTER IN SMITHIN’S BOOK

46:3/o Friedman’s contribution is that money matters, but his heroic attempt to reinstate the QTM was quixotic. Chapter 9

Notes about The Evolution of a Free Banking System [SW87]

This article is also very similar to Chapter 2 in [Sel88]. Development of coinage: in order to save costs of weighing and of assessing their quality, merchants mark irregular gold nuggets, and then also use each other’s 9.1 Introduction marks. In order to prevent sweating and clipping, the marks cover the whole nugget. Coins at standardized val- 439:1–2 Uses “logical evolutionary explanation” of mon- ues developed because nonstandard coins must circulate etary institutions as an alternative to the explanation of at discount since they impose additional computational banks by information asymmetries, as in [San84]. Cites burden, therefore their production is unprofitable. Hicks and Menger but of course not Marx, although much Although private coining would have been feasible, the of what he writes is parallel to Marx. state took over the monopoly because it is a symbol of 440:1 This paper gives a counterfactual development rule and conveys seignorage. how a free banking system would have evolved in the absence of state intervention. 440:2 After a standardized commodiity money, e free banking system evolves through three stages: (1) ba- 9.3 Banking Firms sic money-transfer services substituting for the physical transportation of species; (2) emergence of easily assignable and negotiable bank demand liabilities (in- Gives several possible scenarios how banks may have de- side money); (3) arrangements for clearing inside monies veloped: among rival banks. 442:1–2 Merchants must go through money changers “Each successive step ... originates in individuals’ dis- to exchange local currencies into currencies of other lo- covery of new ways to promote their self-interest, with calities. Then it is convenient to have a standing account the outcome an arrangement at which no individual con- balance with them, so that the merchant does not have to sciously aims.” In other words, it is an explanation in the carry in or pick up local coins all the time. These deposits sphere of competition. may first be nontransferable, but then it turns out that it is very convenient to use these deposits also for payments which do not involve foreign currencies. 9.2 Commodity Money 422:3/o Alternative way: instead of money changing it may have evolved from safekeeping (goldsmiths). S’s account of the development of commodity money fol- 423:1–2 Transfer banking originally not connected lows Menger [Men92]: people discover that for the dou- with intermediation between borrowers and lenders, but ble coincidence of wants it is better to trade for some com- the following two factors allow this: (1) depositors do not monly used commodity first, and the more often a certain have to be repaid with the same coins they brought in, and commodity is used for this, the more motivation others (2) law of large numbers allows a smaller overall reserve have to follow suit (snowballing of salability). fund. This is also possible with grain, not money. Makes First moneys were cattle, but because of nontransporta- the effective money supply greater than the stock of specie bility and nonuniformity they were supplanted by metals. alone.

35 36 CHAPTER 9. NOTES ABOUT THE EVOLUTION OF A FREE BANKING SYSTEM

9.4 Transferable Instruments 447:2 Third alternative: (2”) agreements to accept each others’s notes helps these bank notes to circulate more Next step is: assignability and negotiability of deposited widely money. (1) Such a transfer initially requires presence 447:3–448:2 Historical examples of all three parties involved, transferor, transferee, and banker. But from there it can develop in two ways, either banknote or check. 9.6 Clearinghouses The banknote development is: (2) first bank-issued promissory notes develop which are transferable by en- Next step: from bilateral arrangements between banks to dorsement. (3) next step: fully negotiable notes, assigned multilateral clearing. May happen if the note-exchange not so anyone in particular but payable to bearer. agents of the same banks meet each other repeatedly. Then after a multilateral clearing is arranged, in which Alternative would be (2’) nonnegotiable check allow- only the balance is paid in specie, the next step is that ing one party to transfer their deposit to a specific payee. the balance is paid by transferring deposits. Then also (3’) negotiable checks which can be repeatedly endorsed collusion in terms of interest rates and exchange rates, and or made out to cash also help each other in a crisis. For this also the clearing These are the modern forms of inside money: re- house may audit the member banks. deemable bearer bank notes and checkable deposits. 444:3/o brief historical examples. 9.7 Mature Free Banking System 9.5 Regular Note-Exchange Unregulated development does not lead to natural monopoly but an industry consisting of numerous com- Question 15 Why did banks at first not accept each peting banking firms. They have checking accounts pay- other’s bank notes, and which competitive mechanisms ing competitive yields and circulate paper notes, which do exist that would cause banks to accept the notes of the not bear interest, despite Neil Wallace. other bank? Question 16 Which competitive mechanisms, short of a The impediment now is that these transfers at the FDIC, might prevent runs on banks? present time are only possible between depositors of the Will the checkable accounts be demand deposits with same bank, and a bank will only honor and redeem its a predetermined payoff? This might cause bank runs To own bank-notes. (Reasons: their acceptance of the other’s forestall runs: advertised holding of large equity cush- bank notes makes the other bank notes more acceptable, ion, or accounts with postdetermined rather than prede- and there are information costs for the bank to know termined payoff. Authors say the computational costs for which other notes are good.) this are declining. Traders will accept the notes of banks which are not 452:1 Assets of unregulated banks: short-term com- local only with a discount, since they are not so familiar mercial paper, bonds of corporations and government, and with the reliability of that bank, and since they are not so loans. Liabilities, besides notes and checking accounts: familiar with the look of the bank note and therefore may time deposits and travelers checks. Sidelines: production be victim of counterfeit notes. of bullion and token fractional coins, credit cards, mutual This gives rises to bank note brokers, similar to foreign funds. They would be “financial supermarkets.” currency brokers today. 452:2/o Commodity money would circulate rarely, Banks enter the broker business because (1) it is less therefore demand for the money commodity would even- costly for them, since they pay with their own notes, and tually be completely nonmonetary. [What about illegal (2) they benefit from the float, (3) if banks accept each uses of money?] Now he says that there should be an op- other’s notes, then there will be an increase of bank note tion clause allowing the bank a specified period to gather holding versus specie holding, therefore everybody gains. the necessary money. Can you believe anybody would Another scenario says (1’) acceptance of the other bank like to hold this money? The person withdrawing his or notes in order to present them for redemption all at once her money may have his or her own deadlines to meet. (note-picking and note-duelling). (2’) but the other banks This vision differs from other literature in which there reciprocate, which replenishes the reserves again. (3’) is no money and no reserve asset. Since this is costly and everybody loses, there will in the 453:2 If there are no reserves then one would not know end be non-aggression between banks. what is being promised to pay. “In a moneyless system 447:1 Historical examples it is not clear what forces limit the expansion of payment 9.7. MATURE FREE BANKING SYSTEM 37 media nor what pins down the price level” (I thought the expansion of payment media would be prevented by the brand names printed on these media, and the price level was tied to a numeraire?) 453:3/o “Unregulated banking would be much less rad- ically unconventional, and much more akin to existing financial institutions than recent literature on the topic suggests.” 454:1 But there would be no central bank (this is what also Bagehot said). Competitively no tendency towards interbank deposits. 454:2/o Instead, clearinghouses would develop. Chapter 10

Gertler’s JMCB Review Article [Ger88]

559:1–560:0 In received theory, the main interaction 562:3 Macroeconomics after Keynes concentrated on between real and financial spheres is money as means of money and liquidity preference, rather than credit directly exchange. Applied economists have believed for a long (see also 560:1 about this). time that credit is important, but academic economists of- 562:4 Disagreement about how important the influence ten assumed that credit markets run so smoothly that they of money on real activity was. Early Keynesians empha- can be ignored. New empirical research and new theo- sized real factors (fiscal policy), Monetarists were a reac- ries re-kindled interest in credit markets also in academia. tion to that. This paper surveys these new theories as well as their 562:5 Friedman and Schwartz 1963: money supply the roots in older theories. only financial variable that matters. Alternative theory of 560:1–561:3 Survey of paper Great Depression: caused by mismanagement of money supply. 562:6/o Gertler blames this “preoccupation with 1 Traditional Literature money” on Liquidity Preference Theory and Friedman- Schwartz. 1A From Fisher and Keynes to Friedman and This preoccupation also implies that the only financial Schwartz intermediaries which were looked at were banks (because 561:4–562:1 Irving Fisher argued in Econometrica 1 that their liabilities make up the money supply). Great Depression was due to “poorly performing” financial markets. Borrowers obtained more credit than they 1B From Gurley and Shaw to Tobin should have. When business turned sour, there was an avalance of bankruptcies. 563:1 Gurley and Shaw [GS55] redirect attention to other In addition to these pyramiding business failures there financial channels: role of financial intermediaries in was an indirect effect which was perhaps even more im- credit supply. portant: deflation shifted purchasing power to creditors, 563:2 Highly developed system of financial intermedi- i.e., away from producers and consumers. This is com- ation, therefore efficient intertemporal trade, exists only monly called the debt-deflation theory, although it is not in developed countries. a deflation of debt but its opposite, the burden becomes 563:3 Exclusive focus on money supply is only justified heavier due to currency deflation. in early stages of financial development, when most lending goes through commercial banking, therefore money Question 17 Explain the so-called debt-deflation effect supply is a proxy for credit extended. which has deepened the Great Depression. 563:4/o Also theory of exogenous money stock unreal- 562:1 Already the pre-Depression literature had been istic: changes in demand and supply for transactions me- aware of this. dia of minimal importance. 562:2 For Keynes, credit was important, but his follow- This does not make monetary policy ineffective, but its ers emphasized liquidity. Hyman Minsky in [Min75] says effects do not go through money stock. that Keynes distinguishes two determinants of “state of 564:1 More relevant than money stock is “financial ca- confidence”: borrowers’ belief about the yield of the in- pacity,” i.e., borrowers’ ability to absorb debt without re- vestment projects, and lenders’ confidence that they will ducing spending. Determined by balance sheets, procycli- be repaid. Either can bring the system down, but both cal, related to the earlier so-called “debt-deflation theo- must be in good repair for a recovery. ries.”

38 39

564:2 Intermediaries improve financial capacity, an im- higher correlation with output than monetary base. Ben portant service which cannot be duplicated by market. Friedman: debt has much more stable relation to output 564:3 Importance of financial considerations in other than money stock. literature. 568:2 New theoretical developments in Economics of information and incentive (adverse selection and moral 1C Consequences of the Modigliani-Miller hazard) allowed to theorize role of banks. theorem, the Methodological Change in Macroeconomics, and Vector-Autoregressive 2. Current literature Studies 565:1–2 Modigliani-Miller [MM58] “proves” the unim- 568:3 Overview: we need to start with asymmetric in- portance of the financial structure, against which Gurley formation on Micro level, then theory of financial inter- and Shaw did not have the theoretical tools to argue at mediation as institutions which optimally respond to the that time. Was convenient excuse for empirical research market inefficiencies due to asymmetric information, then to omit the complicated financial structure as determinant Macro. of investment decisions.

Question 18 What does the Modigliani-Miller theorem 2A Allocative Effects of Informational Prob- say? What were the consequences of the MM theorem lems in Financial Markets for the question whether money supply or credit matters? 569:1 Lemons’ problem: Buyers’ lack of information 565:3–5 Also microfoundations approach served to causes wealth transfer from sellers of high quality to those eliminate theories of financial structure. Financial struc- of low quality products, depresses activity and may pre- ture irrelevant in the Arrow-Debreu idealization and diffi- vent markets from opening. cult to incorporate in more realistic models, especially if 569:2 Credit rationing (in the form of a maximum size one wants to derive it endogenously. of loans) optimal because it protects good borrowers from 565:6/o In vector autoregressions with money and out- the costs inflicted by bad borrowers. (This model uses the put, output could be forecast by money. [ES86] says that fact that bad borrowers want big loans). this relationship still holds today. This stimulated models giving money a true causal role. Question 19 Whenever there is rationing in the market, 566:1 Early rational expectations models came up with the presumption is that there is inefficiency. Explain a new transmission between money and output: misper- how credit rationing can be more efficient than a market- ception of price level changes (which are generated by clearing interest rate if there is “asymmetric informa- monetary policy) versus relative prices. Again, this em- tion.” Define adverse selection, moral hazard, and costly phasized money and diverted attention away from other state verification, and discuss which forms of contracts aspects of financial structure. are appropriate in these situations.

1D Revival of Interest 569:3–570:0 Another variation on this theme is Stiglitz/Weiss: Loan supply curve may bend backwards, 566:2–567:1 New empirical evidence on Great Depres- because rising interest rate prices the good borrowers out sion: household net financial position had significant in- of the market and thus reduces average borrower quality. fluence on consumer demand. Bernanke [Ber83] gives If supply and demand curve do not intersect, that interest Gurley-Shaw-like interpretation of Depression, in which rate prevails which maximizes supply, and borrowers are bank failures removed a source of financing which could rationed. (This model focuses on the fact that bad borrow- not be duplicated by the market, and tests it successfully ers do not mind paying high interest rates). against Friedman-Schwartz. Not the changes in bank lia- 570:1–2 Results of similar approaches (without a “nar- bilities (money) but those in bank assets (loans) were dis- rowly defined” credit rationing) depend greatly on partic- ruptive factor. ulars, nevertheless two basic conclusions usually emerge: 567:2–568:1 Also new empirical evidence about post- (a) distortion of equilibrium towards underlending, (b) war time: Money stock does not seem to be driving force lending more sensitive to exogenous disturbances than after all. Reduced form correlation was no longer consid- otherwise (what he calls elsewhere an analogue of the ered sufficient evidence for causality—as Tobin [Tob70] income-accelerator effect). Example: a small rise in risk- had argued much earlier! Inside money, which is endoge- less interest rate may cause the interest on loans to go to- nous, determined by demand, was found to have much wards infinity, i.e., market collapses. 40 CHAPTER 10. GERTLER’S JMCB REVIEW ARTICLE

570:3/o Asymmetric information also in equity mar- models richer. kets: is new equity due to the need for fresh capital or 574:5–575:1 Trend in literature is exemplified by two an effort to pass off bad assets? This uncertainty raises papers by Fama. 1980 paper argues from Modigliani cost of issuing equities. Miller theorem that intermediation is indeterminate and 571:1–3 Since results are very sensitive to institutional irrelevant. 1985 paper says bank loans have higher inter- detail, it was attempted to make institutions endogenous. est rate than open market debt issues because banks, with Here is for instance a model which endogenously derives their special advantages in monitoring the debt, can sup- bankruptcy rules: It is costly for lender to monitor the bor- ply credit where the market cannot. rower’s rate of profit, and loan is not fully collateralized, 575:2–4 Diamond 1984 early explanation of existence giving borrower incentive to understate his profits. Under of financial intermediaries. Assume costly state verifica- such costly state verification, the optimal contract form is: tion, but lenders only loan small amounts. Then lenders have a no-default interest rate without auditing, and if the lend to intermediaries who do the state verification with profit rate is less than that, then costly auditing. economies of scale, and who have a diversified portfolio 571:3/o If firms must borrow in order to buy inputs, so that they do not need monitoring themselves. Proper- and lenders cannot costlessly observe output, then input ties of such intermediaries very similar to actual banks: is restricted because marginal cost of funds includes risk smoother payoff patterns to depositors than they get from premium for the higher leveraging. borrowers, in order to solve incentive problems. 572:1 Similar result in credit market context. 575:5–576 More papers, combining and enriching the 572:2 Considers costly state verification to be too above thoughts: crude, therefore looks at richer descriptive features. 575:5/o Rise of intermediaries mitigates rationing aris- 572:3–573:0 Bernanke and Gertler paper studies effects ing from costly state verification. of lemons problem on investment. Borrowers have pri- 576:1 Boyd and Prescott 1986: everyone has a limited vate knowledge of the investment projects, which enables amount of wealth and a project whose quality is private them to pass off the burden of some of the bad projects information. These agents endogenously form coalitions to the lenders; therefore lenders have to raise interest rate which design incentives leading to the optimal outcome to compensate for this; curb on investment and therefore that those with projects of bad quality become savers, inefficient. Optimal contracts can discourage this to some while those with projects of good quality borrowers. extent by state contingent combinations of debt, equity, 576:2 Since multiperiod contracts can deal better with and intermediary credit lines. the incentive situation, banks have the advantage that they 573:1–574:1 Testable predictions which can be derived have repeated relationships with borrowers. Also a risk from these models: First is Fisher-Gurley and Shaw argu- diversifying argument for large banks. ment that the balance sheet position affects cost of obtain- 576:3 Loan commitments as opposed to actual loans ing funds in a procyclical way. Furthermore, this makes may be optimal responses to the borrowers’ uncertainty investment excessively sensitive to current cash flow; and about how much money they need. related models also explain why current consumption is excessively sensitive to current income. Question 20 Which type of loan contracts can be consid- Second: new borrowers face tighter financial con- ered “partial insurance against the rationing risk?” straints than old ones; and third: small firms tighter constraints than big firms, both because information cost per 577:1 According to these models, intermediation works loan is higher. so well that banks need not be regulated, which contra- 574:2 Cites empirical paper which finds all these ef- dicts received wisdom since Great Depression. fects. 577:2 Some argue this received wisdom is wrong, regulation itself creates the inefficiencies which call for further regulation. 2B. Models of Financial Intermedia- 577:3 Other possibility: natural factors exist, which are tion not contained in those models, that can disrupt the intermediation process; namely liquidity crisis. 574:3–4 New literature about financial intermediation in- 577:4–5 Main approach by Diamond and Dybvig is: incorporates ideas of Gurley and Shaw and others, but uses dividuals face liquidity needs, which are not publicly ob- new methodology; explains the existence and structure servable and therefore not insurable. Banks can provide of intermediaries as optimal devices to overcome capital this insurance by deposits with flexibility of time of with- market imperfections caused by information asymmetries. drawal. This is susceptible to self-feeding runs of banks, Is still in nascent state; open question how to make the therefore FDIC for banks is justified. 41

577:5/o Are there private mechanism that make FDIC Concluding Remarks superfluous? One proposal is to make deposit returns contingent on number of withdrawals. 582:3–583:0 The results of this rigorous research indicate 578:1 But this is not observed in practice; maybe some- that business cycles are a breakdown in trade. Their major thing else is missing in theory. limitation is that they are difficult to test empirically. 578:2 Paper argues for FDIC because laissez faire arrangements are suboptimal. If banks privately pool their resources through clearing houses, then they will invest in illiquid assets and rely too much on the clearing house for liquidity, therefore the government should subsidize either through FDIC or through discount window lending at low rates. 578:3–579:1 How do banks differ from other financial intermediaries? Their assets are not readily marketable because highly idiosyncratic and imperfectly collateralized. Then it is theorized that it is this function and not the provision of liquidity for which banks require special attention such as FDIC or discount window. 579:1–3 Bernanke and Gertler paper develops this by a formalized Gurley and Shaw argument: overall bank net worth governs scale of bank credit, therefore investment and outputs. Banks are important for their assets, not their liabilities (for which perfect substitutes exist). Coincides with theories that monetary policy is not important for bank assets but for liabilities. This paper requires price rigidity so that real lending volume can be influenced by monetary policy. A paper by Farmer does not. 580:1 Empirical evidence on this is mixed.

2C: Models of business ﬂuctuations

580:2 Economists in private sector have stressed financial influences more than those in academia; DRI model has had link from balance sheet positions to output behavior. 580:3 Borrowing constraints can increase variablity of consumption; two individuals with negatively correlated productivity risk who cannot borrow or lend must self- insure which leads to cycles. 580:4–581:1 Asymmetric information between lender and borrower with exogenous contracts leads to bankruptcy option as optimal contract. Makes lending volume highly sensitive to interest rate or to productivity disturbances. 581:2–3 Papers formalizing how the balance sheet effects can enhance investment and output fluctuations, and also modeling the procyclical redistribution effects from borrowers to lenders. 581:4 Cyclical effects of equity rationing. 581:5–582:2 Three limitations of these models: (1) abstract from multiperiod arrangements, (b) have unclear policy implications, and (c) are not well integrated with monetary theory. Chapter 11

Bernanke/Blinder Articles about Credit Channel

Theoretical Article [BB88] function of the interest rate. In the present case, both interest rates enter: They do not use rationing to distinguish bank loans, but [Bli87] does, see footnote 1. y = Y(i,ρ) (11.3) 435R:1 discusses loan demand L(ρ,i,y) (here ρ is interest rate on bank loans and i on bonds). Bank loans and II Graphical Representation bonds are not perfect substitutes; they require different paperwork, a different goodwill relationship to the banks, They have one graph with the equilibrium condition for and bonds may not be open at all to some firms. Allowing the money market, and one with the equilibium condition for these differences, borrowers go where they can find a for the loan and goods market (with the loan interest rate better interest rate. I think one should consider this de- hidden in there). mand function as an aggregate of different individual demand functions: some firms are unable to raise capital on Question 21 [BB88] come up with a framework which is the capital markets, therefore they are completely depen- very similar to the IS-LM framework, but their modified dent on bank loans. others have a choice, etc. IS-curve (which they call CC-curve) shifts due to changes 435R:2 discusses loan supply, which is a portfolio deci- in monetary policy. Which economic mechanism causes sion by the banks: their total loans plus bonds is (1 τ)D, this shift? where τ is the reserve requirement, and they have− some preference λ(ρ,i) how this should be split up, which de- To understand this model, they make a IS-LM type pends on the interest rates. graph. There is more mathematics involved, and it makes Demand equals supply for loans is therefore: it really economically harder to understand. The upshot is that the replacement of the IS curve, the L(ρ,i,y) = λ(ρ,i)(1 τ)D (11.1) CC curve (which has bank loans in it), which is shifted by − monetary policy R. This can be solved for ρ: 436R:2 is interesting: horizontal LM curve not from liquidity trap but from the fact that financial innovation ρ = φ(i,y,R)D (11.2) allows people basically to pay their bills with bonds, or to have interest-bearing money. Now this is conditional on D, which is determined by the money market, which is discussed in 436L:1. The Question 22 One of the results of [BB88] is that a tight R simplest model would be D = τ , where the reserves R monetary policy may be accompanied by a fall in the bond are exogenously determined by the Fed. But BB allow interest rate i. Show how this “perverse” effect can come for an influence of the interest rate: banks will only be about by the CC and LM curves, and also give a verbal ε fully loaned up if the interest rate is high. If (i) is economic explanation, which makes this result plausible the proportion of their free deposits which they want to without the use of CC and LM curves. hold as excess reserves instead of loaning out, one gets Dτ + ε(i)(1 τ) = R therefore D = R . The explanation of the perverse effect of monetary pol- − τ+ε(i)(1 τ) 436L:2 The real part of the economy is− condensed in icy (a tight monetary policy may go along with a rise in their IS curve. In the usual IS curves, y is a declining the bank loan rate ρ and a decrease in the bond interest

42 43 rate i): There are two interest rate channels, and it is pos- from the past, and also not from the contemperaneous sible that one of them is so strong, that the other one is economy. Then make Granger causality tests, and see how backed up. these shocks propagate through the unrestricted VAR, us- Assume a decrease in R drives up ρ so much that it ing the impulse response function. chokes off bank lending, and y collapses. Therefore peo- Now some econometric details: The most general ple have a lower transaction demand for money, they structural model they consider is their (1) and (2). switch everything into bonds, and this depresses the bond yt = B0yt + B1yt 1 +C0 pt +C1 pt 1 + ut (11.4) market. − −

pt = D0yt + D1yt 1 + Gpt 1 + vt (11.5) Notes about [BB92] − − Here yt is the tth column of the matrix Y which has in This article is about as ‘left’ as the mainstream will go. each row a diferent timeseries of nonpolicy variables. And it is excellent econometrcs, we can learn a lot from Of course the diagonal elements of B0 are known to be the article in this respect. zero here, but this matrix is important because of its off- pp. 901–903 are a detailed summary: diagonal elements. B0 are the contemperaneous effects of 901L:1 Two among the most important and controver- the nonpolicy variables. Note that BB made policy vari- sial questions in macroeconomics: Does monetary policy ables depend not on present values of other policy vari- affect the real economy? By which transmission mecha- ables, but only on lagged values. Why? nisms do these effects occur? This system is not identified. If there is only one non- 901L:2 Paper’s original purpose was to test [BB88]. policy and one policy variable, then this system is identi- 901L3/o Microeconomic justification of the credit cal to the system in [End95, p. 294]. But if one either sets view: bank loans are special. Banks have a lot of expertise D0 = O or C0 = O then one gets identification. Again in and can give loans to firms which would be unable to get the simpler case this is described in [End95, p. 302/3]. loans on the open market. If the banks restrict their loans Once one has identification, one knows the error terms, to these firms, the firms will no longer be able to produce, and one can write down a MA representation of the error therefore real effects. terms which is the impulse response function. To get the impulse response function one has to specify Question 23 There are several theories about the trans- the order of the variables. Look at (3) and (4): the error mission mechanism between monetary policy and its real term in (3) is simply vt , therefore one can get estimates effects. On the one hand, one can distinguish between the of vt from OLS on (3), and using this and the residuals of “liquidity channel” and the “bank loan channel.” The OLS on (4) gives us estimates of vt . This is why pt must “liquidity channel” on the other hand may be effective be placed first in the ordering here. via a “direct effect” and an “indirect effect.” Describe With the other assumption, yt must be first and pt last the differences between these theories, and describe how in the ordering. they can be represented in mathematical models. (Which End of econometric detail. customary “laxness” in the mathematical formulation of As the variable whose unanticipated shocks represent macroeconomic models makes it difficult to see the bank monetary policy they use the Federal Funds rate. loan channel?) Which empirical evidence? Question 24 What is the Federal Funds rate? Bernanke Are you aware of other transmission mechanisms which and Blinder show that the FF rate is an excellent predic- cannot be subsumed under the above? What is mone- tor of industrial production, capacity utilization, unem- tarism’s position about this transmission mechanism? ployment, pesonal income, etc., which is significant even in the presence of many other predictor variables. What How to do it right? They say there are two alternatives: conclusions do they draw from this which are releveant (1) estimate a structural model. This was done in [Ber86]. for their argument regarding the Credit Channel? What’s the drawback of this? Result depends very much on the assumptions about the structure, and Bernanke had I. Information Content of Federal Funds to use covariance restrictions to get identification, i.e., the Rate model is also very sensitive to the data, very imprecise. (2) In the present paper BB use the following strategy: 904L:1–904R:0 Nice summary of the “money leads nom- Include a variable in the model whose innovations, i.e., inal income” debate. whose unanticipated shocks, represent monetary policy. They use [McC83], perhaps I should look at it. They Unanticipated in the sense that they cannot be forecast want to show that the FF rate is a policy target. 44 CHAPTER 11. BERNANKE/BLINDER ARTICLES ABOUT CREDIT CHANNEL

M1 M2 3 month T-bill 10-yr gvt. bonds Federal funds Industrial production 0.92 0.10 0.071 0.26 0.017 Personal income 0.38 0.24 0.35 0.59 0.049

Table 11.1: Marginal Signiﬁcance Levels

The first of the three tests for this, as summarised in 903L:1, uses Granger causality. Definition: if future y can be forecast better by past y and z than by past y alone, then z granger-causes y. See [End95, p. 315], [Mad88, 329/30] Or say: if the coefficients of the lagged z are significantly different from zero in the presence of lagged y, in the pre- diction of today’s y, then z Granger-causes y. 904R:3 shows what they did. Then they do it also with a different metric (variance decomposition), which is described in [End95, pp. 310– 312]. Then on 908R:2 they introduce some damaging evidence, the spread between 6-month commercial paper rate and 6-month treasury rate CPBILL is a much better predictor than the funds rate. In 910L:1 they resolve this, come up with an explanation which salvages their hypothesis: CPBILL is an indicator of Fed policy. This is why CPBILL is better in Granger-causality and FUNDS better in the variance-decomposition sense.

II The Federal Reserve’s Reaction Function Second of the three tests that the Federal Funds rate is indeed a policy variable, as summarised in 903L:2: look at disturbances which the Fed would probably react to and see whether the FF rate responds in the expected fashion. All I have to do here is look at Figure 2. If someone doubts whether the FOMC indeed looks at the FF rate and tries to nudge it up or down in order to make policy, here is evidence that they do.

III Supply and Demand for Bank Reserves Tries to show the same thing again as II, but with different methodology. If the FED has a target rate for the FF rate which they maintain through exogenous shocks, then these shocks should only have a small inﬂuence on the FF rate. Can be skipped here.

IV Transmission of Monetary Policy This section is the meat of the article. Chapter 12

Lipietz, Enchanted World [Lip83]

Presentation 1:2 Marx’s theory has increasingly been narrowed to “class struggle.” Bettelheim’s Presentation gives some of Lipietz’s main 1:3/o Yet an accumulation of criticism against Marx’s points: positive theory of political economy. xi:3 (a) Lipietz’s concept of value in process. 2:1 Wants to make specific contribution to theory of (b) how values and nominal prices are related, which value, price, and incomes. Lipietz sees contradiction be- he does by reinstating Marx’s distinction between exoteric tween discredit of LTV on the one hand and emphasis on and esoteric economy. Policies based on the apparent reg- productivity on the other. Very nice point! ularities of the exoteric economy can be overturned by the 3:0 Marx emphasized class struggle, however “oppo- esoteric economy. nents in society do not exhaust themselves in an endless xii:2 Credit money has become real money: it is the a struggle but in everyday life they have to be in a way part- priori canonization of private labor as social labor. ners” therefore at least temporarily those conflicts must be xii:3/o Bettelheim gives the Eurodollar as an applica- regulated. tion of Lipietz’s theory of credit money. “Creation of 4:0 Lipietz talks about the substantialist weakness of credit money involves a loan for which repayment can al- vulgar Marxism which reduces value to a sort of immate- ways be demanded, even though the issuer of the money rial yet quantifiable product of human labor incorporated may be unable to pay.” in commodities. xiii:1/2 “Through the development of credit money, He says one should concentrate on the value-form. prices determine the vaue of the monetary unity, while I don’t see an opposition between this and the question the value of money depends on the laws governing in- Lipietz is asking, which is: how is labor being socialized? comes.” This refutes the “phantastic” quantity of money 4:1 Interesting: Marxism see-saws between substantial- ideas which permeate modern monetary theory. ism and formalism. “There are two sides to every social xiii:3-xiv Bettelheim ends with saying how Lipietz’s relation, what the relation consists of, and the form in theory would give rise to much better policy recommen- which the agents involved in it perceive their own mode dations. of entry.” 4:2/o something important for commodity fetishism: Preface to English Edition people delude themselves over the relations they are in, but the only relations in which they actually participate Lipietz’s preface to the English edition has one interesting are the ones they themselves perceive. I disagree. Form point: and content are tightly integrated: what people do on the xvii:1 “regulation” in French means more homeostasis surface is the expression of something they may not know and cybernetics, while in English it evokes regulation by but they are nevertheless persistently creating the society the state. without knowing. 5:1 World of perceived relations, “enchanted world” (reference is given in 12:2) is Marx’s surface. [It is not Introduction just that the perceptions are different than the thing which is being perceived, but the thing itself has a visible outside 1:1 Book has three purposes: (1) defeat Marx’s critics (2) and an invisible inside!] propose a research programme (3) warn of danger of mon- 5:2 Cartoon character walking over a cliff and keeping etarist policies to the workers of this world. on walking. In other words if we come to an understand-

45 46 CHAPTER 12. LIPIETZ, ENCHANTED WORLD ing that credit money is not real social validation, and to 11:0 He uses the word “realist” correctly, in the sense an understanding why it seems to be such, this will be of depth realism. quite exciting. 11:1/2 Good analogies given in Table 12.1 I agree very much that Marx has given us an incredi- 11:3 also important: Esoteric/exoteric distinction is ble wealth of ideas and of tools, whose transposition to form-essence distinction, which is “transverse” to the modern times is worth while. classification into higher or lower levels of abstraction. 7:1 Lipietz explains his emphasis on policies by his Footnote 3 on p. 16 is important, cites [M82]´ (full refer- modesty. He cannot resolve the crisis of Marxism, but ence is given in footnote 3 on p. 8). For every fundamental he can help the capitalists to deal with their crises. Sure. connection there is an apparent connection. 7:3 Refers to his paper with Hausmann, I think it is 12:1 Without using the word he is saying that in astron- [HL81], as the guiding thread for this book. omy, the Ptolemean system is reducible to the Coperni- can (but the Copernican not reducible to the Ptolemean). By contrast, in Marx, competition is not fully reducible 12.1 The Two Sides of the Economy to capital in general, but has relative autonomy. This is a very important thought. Amazing how realist Lipietz is. in Marx 12:2/o Important paragraph about relation between exoteric world and individual agency. Begins as follows: This has nice description and collection of quotes on competition. As far as economic agents are concerned, the Here is my own collection of quotes, taken from independence or efficacity of external connec- [Kur73, volume 1] (the whole volume is devoted to tions constitutes the only reality they come into such quotes): [mecw28]340:4/o;G31644–31718 contains contact with, determining their motives, their an important sentence what competition is “concep- expectations, their behaviour and what Bour- tually.” [mecw28]475:0;G450:0, [mecw29]37:5–40:2; dieu call their ‘habitus’. It is in this ‘enchanted G542:5–545. [mecw29]135:6/o;G637/8. Is surface and world’ (Capital, III, p. 806) that the actors play sphere of competition the same? out roles which, though of course dictated by 9:1 Marx reception has evolved over the years. hidden social relations, do have a considerable 9:2 Theories of fetishism and money are his main ex- contribution to make to ‘reality’ through inter- amples of the exoteric sphere. It is not the theories but pretation of them. In fact social relations have reality itself which must be so classified. He says the no material existence outside this network of in- transformation problem is so far the main transition from stitutions, the permanence of these ways of be- esoteric to exoteric which has been discussed. having and so on. If we drown this sensible re- 9:3/o stresses distinction. ality in the concept of the relations which deter- 10:1 Marx quote from TSV, until [mew26.2]162bottom mine it, we shall ignore the fact that the whole Bad translation, “Vorstellungsweise” with “ways of pre- reproduction of these relations the activity of sentation”. Berechtigung should probably be: claim to these agents in the representational space of the correctness. Obscure is not the same as hidden, should be enchanted world. hidden I think. Physiology versus the external phenomena I would argue here that the surface is not the only reality as they seem and appear. Look at Marx’s formulations the agents come in contact with. They come in contact there! with, indeed they produce, all of society, core and surface, 10:2 Marx quote with esoteric and exoteric is MEW not only the surface. But they coordinate their activities 26:2, 163:0, I have it in th2 right now. Wages esoteric? only through the surface. The error Lipietz makes here This is probably a mistranslation, it should be wage labor. is related to the error he makes in 18:3 where he says the 10:3/o Here he identifies the esoteric with the social re- capitalist mode of production does not exist. lations. This is wrong. He writes: The ‘internal’ con- In 12:2, L argues that agency makes a significant consists of all the objective social relations which structure tribution to “reality” through its interpretation of the exo- economic life (commodity relations, wages, class strug- teric world. Ontology of social relations is network of in- gle, etc.) and determine its dynamic—what Marx calls its stitutions, permanence of ways of behaving. “If we drown ‘tendencies’, ‘immanent laws’, and so on. The ‘phenome- this sensible reality in the concept of the relations which nal’ embraces all the representations created by economic determine it” probably means: if we drown (i.e., reduce) agents in connection with their own behavior and the con- this reality perceptible to the senses to the relations which ditions they face, but which are in fact dictated by internal determine them. relations.” Also interesting how he brings in contradictions: exo- More examples. teric gives the agents room to express the contradictions, 12.2. A FIRST LOOK AT THE ‘ENCHANTED WORLD’ 47

Sun seems to rise Proﬁts seem to be markup on cost Earth’s movement around the sun surplus value is a fraction of the value added by abstract labor Inclination of the earth’s axis (interest is a share of proﬁt?) Movement of the planets etc. Other social relations distribute this surplus value betw. soc. classes

Table 12.1: Correspondence Table for Eso-Exo Astronomical Analogy now he says of the relations which enclose them, maybe 15:1 Esoteric-exoteric distinction is related to macro- it should be: of the underlying relations? This is elabo- micro distinction, but not the same. Much in mainstream rated more in [Lip79]. Cites places from Bourdieu, which macro is exoteric, not esoteric! Consumption function could have been from Bhaskar. Relationship between ex- is exoteric; Kalecki’s interpretation in terms of: workers oteric and esoteric changes over time. This goes beyond consume all their income and capitalists save gives its es- Marx, but it is an important aspect. Stresses that one cuts oteric underpinnings. oneself off from large parts of reality if one does not pay 15:2–16:0 Defense why this book deals with exoteric attention to the exoteric. categories. 13:1–14 give reasons why this distinction has been so 16:1/2 Survey of book. much neglected. 13:1 Objective reason: autonomy of the exoteric has been asserted only recently! 12.2 A First Look at the ‘Enchanted Subjective reasons: Ricardo concentrated on the eso- World’ teric. After him a systematization of the exoteric connections, of visible activity, discarding internal relations. However, he seems to draw the dividing line on the wrong Marx calls this “vulgar economy.” Excellent Marx quote! place. He draws it more where the real presuppositions 13:2 Vulgar economics prevailed because of its political are, does not recognize that the real motive force is very implications, of denying capitalist class relations. abstract, it is value! Denies the reality of the abstractions he is dealing with. How can he then understand money? Question 25 Deﬁne Marx’s concepts of “esoteric,” “exoteric,” and “vulgar economics.” Why does vulgar eco- 18:3/o “The ‘capitalist mode of production’ does not nomics concentrate on the exoteric and ignore the eso- exist. It is a construction of our thought which refers teric? On the other hand, why have modern Marxists ig- to the regularity with which certain contradictory social nored the exoteric? practices are reproduced.” This is a mixture of right and wrong: 13:3/o Turning it around and asking why modern Marx- On the one hand he correctly recognizes that the cap- ists do not like exoteric economics, he gives three an- • italist relations are not comprehensive. “To identify swers: a society as capitalist is not to reduce it to the set of (1) In order to denounce capitalism, esoteric relations relations characteristic of capitalism, but at least to are enough. But Marx wanted to do more than denounce: recognize that a great deal of social life is organized he wanted to make exploitation intelligible in every-day around the reproduction of these relations.” life. 14:1 (2) Marx’s theory of this distinction at the end of On the other hand he does not seem to give these re- Volume III and mostly in TSV made it less accessible. • lations much reality, he identiﬁes them with the prac- Lipietz says the distinction is there right from the begin- tices necessary to reproduce them. He considers the ning, but it only becomes a source of major contradictions relations themselves to be a mere construction of our right at the end. Then it is no longer just an ideologi- thought which help understand the social practices cal question. The present book will take off from where that reproduce them. Marx left. 14:2 (3) Since vulgar economists specialize on the ex- I think he is ceding valuable ground in order to defend oteric, Marxists think that looking at the exoteric sphere himself against the reproach of reductionism. If he says vulgarizes the theory. the social structure does not exist, all he can mean by this 14:3 Now Lipietz’s counterarguments to this last point: is that it has no material existence apart from the activities Vulgar economics is not popular economics, but it is very which are caused by them, and by which they are repro- sophisticated mathematically and econometrically. duced. This is indeed what he says in 12:2: “In fact social 14:4/o vulgar versus popular economics. relations have no material existence outside this network 48 CHAPTER 12. LIPIETZ, ENCHANTED WORLD

of institutions, the permanence of these ways of behaving Exoteric aspect: value of labor-power appears as wage and so on.” This does not disqualify these structures from of labor. being causal agents, i.e., from being real! Lipietz partially 24:2–25:1 seems to be an attempt to pull out an corrects himself in 57:0. esoteric-exoteric distinction from the transition of value His main mistake is to identify society with relations of labor and value of labor pwer. between individuals. Society is a structure which has its own necessities (it has to reproduce itself, it has to allow Dispossession the individuals living in society to meet their necessities to live, and has to discipline them to attend to the needs 26:2–28:0 Third relation is dispossession, cites [Bet76]. of society etc.). Reducing soceity to social relations is the Is this the continuation and deepening of the separation, same as reducing the human body to the nervous system. on a real instead of a formal level (real subsumption ver- The body also has bones, muscles, and a stomach. sus formal subsumption)? 19:1 Marx did not distinguish which forms of capital- Esoteric: increasing inability of direct producers to run istm in 19th century England were external to capitalism production process, skills built into capital rising organic composition of capital technical progress⇒ and de- (family), and which forms were special to the capitalism ⇒ of this time. I don’t like his last sentence, where he calls valuations. it a “subjective morphography” justified by the “light it Exoteric: Productivity appears as productivity of capi- casts on reality.” tal. Displacement of the laborer by machines. Falling rate 19:2–20:1 Capitalism consists of three fundamental of profit. contradictory relations. Summary which will then be What is the contradiction? That increases in productiv- much elaborated. ity mean devaluation? Lipietz de-emphasizes the obvious unity between these relations and presents them as three separate things that II: Birth of the exoteric economy happen to come together. 28:1 Combination of those three moments is capitalism. Each of these three relations has an esoteric and an ex- 28:2 Refers back to commodity fetishism. oteric aspect, and a contradiction. 28:3–29:0 New level of fetishism, namely, value in process. L does not give a reference, but I think he refers to Commodity Relation Capital I, p. C165:2/o;V256:1;G169:2/o: 20:2–23:2 Interesting, although I am not sure whether it By contrast, in the circulation M–C–M, value is right. According to Lipietz, the main contradiction is suddenly presents itself as a self-moving sub- the one between social character of production and private stance, which passes through a process of its engagement of labor. own, and for which commodities and money are Lipietz separates the two aspects of the exchange: (1) both mere forms. social validation of the labor in the commodity, and (2) 29:1 Value is social and synchronic, value in process is commodity owner thereby acquires the right to validate individual and diachronic. something himself, he calls this “permutation.” Strangely, L does not seem to distinguish between C– When he talks about the exoteric, he goes back to M–C and M–C–M, it is all value in process for him. But phrases like: “people’s perception is not that some need perhaps one can say: the connection in the C–M–C circle to produce a coat while others need to produce linen, but is the reproduction of the labor power. Marx should have that “20 yards of linen = 1 coat.” mentioned that in Chapter Four. People have to pay atten- 22:2 has a good example of external and internal mea- tion to their credit rating because they have to reproduce sure! “As we shall see, money is not the only external their labor power also in the future. measure of value.” What is he referring to? At the end of 29:1 a nice metaphor with a wave: the successive oscillations of the molecules of water appear as Economic Property and Wage Labor a wave, or conversely that the creation of a wave sets the molecules in motion. Waves are emergent entities. (Same 23:3–26:1 Separation of direct producer from means of with hurricanes.) production Separation between constant capital and 29:2–30:0 “In fact, under capitalism the second ⇒ value added Fact that worker only gets part of the value fetishism is dominant and, with the development of what ⇒ added. we call monopoly regulation, gradually acquires a greater Esoteric aspect: direct producer is separated from coherence.” What does he mean by this? Is this domi- means of production. nance just a contingent fact? What are the conditions for 12.3. OTHER SOCIAL RELATIONS COME INTO PLAY 49 it becoming dominant? Coherence greater than the first labor among the productive branches and between the so- fetishism, or coherence greater than under the competi- cial classes.” If we stay on this level, the only problem is tive regulation? Its coherence comes from the fact that the transformation problem. But besides the above three starting point and endpoint are the same. Then he goes social relations there are other relations, monsieur bank- into volume II matters by saying there are capitals and ing capital and madame real estate, and many more. labor-powers, but again he does not use C–M–C for labor- 45:2–46:1 Commercial capital. Good remark that C– power, but shows them as M–C–M also. M’ can be taken over by a different capitalist. There are constraints on these processing values because they are interlinking. Reproduction schemes on the Question 26 Define Lipietz’s concepts of antevalidation, one hand indicate the proportions of values in process prevalidation, and pseudovalidation. (See p. 45, note 1 among the different departments, and on the other hand on p. 52, p. 48, p. 83, p. 91, p. 97, and note 15 on p. 104; the proportions of living labor. That might be the clue to also Guttmann, p. 96:1 is helpful here—but Guttmann’s Erdos’s analysis [Erd71]. prevalidation is what Lipietz would call antevalidation). 30:1–31:1 Conditions for simple reproduction as a speical case of the woof-warp duality, that the values Definitions of antevalidation and prevalidation in foot- in process (woof=shuttle in weaving) interlink with the note 1, which is on p. 52. Antevalidation is the “private” warp=laterally aligned threads in weaving (synchronous establishment in advance (better than a priori), which still value relations). Distinction between synchronous value has to be “socially” confirmed, of the social validity of the and value in process is a contradiction. Like a wave which privately engaged labor. Prevalidation is the assignment wants to propagate itself, but suddenly runs out of water. of a part of new value to one of its claimants before the This is a multisector version of Foley’s model [Fol82]. new commodity is realized in money or even produced. 31:2–32:1 Brings in revenues and calls them also value [What if it is not socially confirmed? then whoever ante- in process. Doesn’t that confuse the individual point of validates it has to pay for it out of his own pocket. This is view with the objective laws? Not every continuous flow perhaps why such validation can only be done in conjunc- of value is value in process. Somehow he seems to avoid tion with earning profits, i.e., by commercial or banking identifying capital as the culprit. capitalists.] 32:2–33:2 Nice parallel development of wages and Pseudovalidation is the process by which the Central profits. Wages as revenue from labor, and profits from Bank ratifies the antevalidation of the banks by creating capital. They seem to be causal, so the source of profits the reserves necessary to sustain the credits issued by the seems to be the ownership of capital (and, I would add, banks. Lipietz writes this in 92:0 The central bank may labor seems to produce no more than the wage). do this by antevalidating some labor itself (discount window), or by Open Market Operations, or whatever. Does 33:3–36:0 Capitalist competition and Neo-Ricardian not matter. Even by paying for government expenses. price equation. The important aspect is that it increases the high-powered 36:1–38:1 General about transformation problem. He money. treats both ways of measuring surplus-value in parallel. For commercial capital: it is antevalidation because it is He says, either you measure the value of the uses of purchased but not by the final consumer, and it is prevali- wages, or you measure the labor performed at the source. dation, because the industrial capitalist gets his revenue, Both seem justified ways of looking at it, while our obit- consisting in the wholesale markup. Antevalidation is uary takes a stand in favor of the one, he would call it source of commercial crises. [By the same logic: if someone-sided, my partial results which unfortunately mislead one buys steel and pays for it and then makes refrigerators people are not accidents. And his tensor of exploitation is out of it, does he not antevalidate the steel? I.e., also in- apparently closely related to my k (trunit). dustrial capitalists antevalidate?] 38:2–39:0 Provisional conclusion. Assumptions so far 46:0 Cost of metamorphoses is not a part of the constant have been social validation and stable value-equivalent of capital constituting the value of the product, but on the money. This will be relaxed now. other hand for the capitalist it appears as cost. It is preval- 39:1–40:2 Notes about transformation. Then footnotes. idated surplus-value which takes the form of circulating capital. Compare 48:2 where he seems to say the right thing. “the wage-earners of commercial capital are also 12.3 Other Social Relations Come paid out of this surplus-value, but the profit appropriated Into Play by commercial capital is, of course, an inverse function of the wages it pays.” This is the common fallacy. The 44:1–45:1 “This two-character enchanted world is still profit commercial capital gets is a markup over the capital very close to the hidden world of the distribution of social it has to advance, and among this capital is the prevali- 50 CHAPTER 12. LIPIETZ, ENCHANTED WORLD dated surplus-value, including the average wages. Only the material basis. Therefore he makes the error of as- wages above or below this average affect profit inversely. signing the independence only to the exoteric, rather than But since laborers perform unpaid labor, this minimizes already to the esoteric value. the unproductive circulation costs. Footnote 2, page 64, is important too! 46:1 Exoteric aspect is a little thin, which I attribute to 55:1 Distinction between inner laws and coercive his errors in the esoteric analysis. forces. He is incorrect to distinguish the inner laws by 46:2–48:2 Banking Capital. their being tendencies: all laws are tendencies. There he confuses money-dealing capital, which is 55:2 I wonder if he denies the reality of the esoteric; analogous to commercial capital, with interest-bearing looks at it only as a way of explanation. Compares the di- capital, which is capital as a commodity. chotomy between inner laws and competitive constraints Seems to say: just as commercial profit takes on the as the one between the Lagrangian view of physics, which form of a markup on prices, the profit of money-dealing sees the world as a rational system maximizing some capital takes on the form of interest. Marx does it differ- objective function, and Newtonian physics which traces ently: that money “seems to make money just because it through the forces. Lagrangean physics is only an inter- is money” is not specific to banking capital. pretation, and a false one at that, celestial bodies do not Interest rate a matter of conjuncture, becomes target of maximize some Lagrange function or anything else. On monetary policy! This is good observation! the other hand, capital does have the inner purpose of ex- 48:1 Interest is prevalidated part of profits, but the panding itself. A seemingly teleological argument is ap- banker runs less risk than the commercial capitalist! propriate here. From the breakdown of profits into interest you get 55:3–56:0 This still makes exoteric reducible to eso- capitalization of a revenue, and you get fictitious capital, teric. Intersting: Marx’s tracing of cash flows is his search which is an external measure of value in process. for places where the exoteric has independent influence! 48:2 Here he has it right about the cost factor of com- (Already the “circulation sweats out money” is one). mercial capital. Compare 46:0. 56:1 Introduces a third level besides capital in general 48:3–49:2 Management salaries, another prevalidated and competition, namely, the level of motivations, the part of proft. agency level. 56:1–57:0 Correctly makes a distinction between 49:3–52:2 remarks about rent, taxes, revenue of inde- agency level (motives) and social level. pendent producers. I no longer understand what I meant by this: but in- correctly, in my view, assigns the independence of, and reality of, the social laws to that distinction. 12.4 The Solidity of the ‘Enchanted Discussion of fetishism. There are always social re- World’ lations pre-existing individual activity. This is not the source of fetishism under capitalism. Fetishism desig- “Solidity” denotes independent existence and possession nates a certain character of the social relations, which has of own laws Eigengesetzlichkeit. its own behavioral presuppositions! At the end he par- 54:1 Long quote from trinity chapter; this is where he tially seems to correct the error I criticized him for in has the title of his book from. 18:3/o. 54:2 first sentence: when he says the esoteric creates 57:1/o puts special importance on the fact that capital- the exoteric, he apparently sees it as a mode of explana- ists in their competition anticipate the reactions of others. tion, not as a process actually going on (epistemic fallacy). This might be another crisis-prone element, but to me it Unrelated to that about the second sentence: “Yet we does not seem to have the importance he assigns to it. have not discussed the reasons why, unlike in astronomy, Says in 58:0 that Marx today would be a quantity con- apparent motion cannot simply be reduced to a reflection strained disequilibrium economist. of real motion.” It means, there is an independence of the 58:1 Distinguishes himself from Althusser. Seems in- form of appearance. But again it becomes apparent that teresting although I don’t understand. he has a different definition of the esoteric-exoteric dis- 58:2/o tinction than I would consider correct. He collapse two 59:1–2 back to trinity formula, alternative of law of distinctions: on the one hand, the distinction between the value, neoclassical approach: values defined as the sum social form and the productive etc. social activities which of the incomes of the factors of production, marginal pro- assume this form, and on the other, the separation of the ductivity. Question: how is this compatible with the con- exoteric and exoteric, which I consider a separation within ception of value proportions as marginal utilities? The the capitalist form, not a separation between the form and identity of these two in equilibrium? 12.5. ESOTERIC VERSUS EXOTERIC: THE CONTRADICTIONS 51

59:3 again seems the epistemic fallacy: as if the differ- 12.5 Esoteric versus Exoteric: the ence between exoteric and esoteric is only two ways of Contradictions looking at the economy. 60:1–2 Nice quote about harmony implied in trinity for- 67:1–2 So far we went from the esoteric to the exoteric. mula. Trinity formula practically relevant because this is Now we have to close the loop, make the exoteric compat- in fact how pricing is done; payment of incomes is almost ible with its foundation. Discuss figure 1, very important! as necessary as payment of suppliers (despite the absence But I think there is a typo in that figure: the two exterior- of any built-in mechanism in the market itself that market ization arrows should only go up, and the coupling arrow participants should earn sufficient income with it). only down. Here is my interpretation of this figure. In the core of the economy is the division of new value into wages and surplus value, and the division of the surplus value into 12.4.1 Price Rigidities and the Antevalida- profit, rent, interest, and wages, which are the revenues tion of Products accruing to business, land, money, and labor. (It is unfortunate that the diagram says revenue “from” business, etc., this is where the revenue goes to, not where it comes 61:1 Very interesting quote from Theories 3 about from. But exoterically, it seems as if these revenues come that. Marx stresses importance of prepaid surplus-value: from their recipients: they are seen as the price paid for P3510:2/o;[mew26.3]500:2/o: the contributions from the factors of production, which together give the price of the new product. But now the coupling problem is whether that price still corresponds Die hochste¨ Festigkeit, die dieser Schein des to value. Resultats als selbstandige¨ Bedingungen an- nehmen kann, ist gegeben, sobald Teile des 67:3/oo Transformation problem is a special case of Mehrwerts—als Preise von Produktionsbedin- this. gungen—in den Preis eintreten. 69:1–3 Dashed arrow in diagram, coupling, is what needs to be discussed. Overlooked by neoclassicals and Marxists. This is where crisis occurs. He only sees the (the translation “are included in the price” is not precise! unity of the internal laws, and contradiction between es- Remark about translation is in my notes about Th.) Lip- oteric and exoteric, but not the contradiction within the ietz says this is also true for circulation workers. Sees a internal laws. contradiction between this and the fact that the internal 69:4/o Contradiction = unity and struggle is good point. laws constitute prices. The neo-Ricardians will never see If reproduction of the capitalist system would not be pos- this contradiction! sible in the first place, crises could not occur either. The judgment is made that it is not just accidental, contingent, 61:4/o refers to Kosik’s theory of factors, pseudo- that capitalism has heen reproducing. concrete. Factors subject to internal relations hidden from 70:1–71:0 Good quote by Marx about when this cou- the pseudo-concrete. Next Chapter will discuss how this pling is satisfied. Implicit an excellent critique of neo- will be “coupled.” Ricardians. Neo-Ricardians use the commutativity of this 62:1–63:1 important: the eternal question which in- diagram in equilibrium to argue that the exoteric is redun- comes buy the part of the net product in which surplus- dant. value is crystallized. It cannot be the profits, because the 71:4 Terrible translation glitch: instead of labor-power profits only arise afterwards. This is the problem which it says manpower. also Rosa Luxemburg saw. Answer is: there is prevali- 71:1–72:4 His: esoteric synchronic, exoteric diachronic dated surplus-value, or there is a realization outside cap- relation is not quite right. But: both evolve over time, italism (Rosa Luxemburg’s solution), government expen- and in this evolution, the exoteric-exoteric relation may diture, and in addition banks which lend amounts to the get strained! Good observation: dynamic transformation capitalists that are equivalents of the surplus-value which procedure. they will generate. (I.e., both monetary and fiscal poli- 72:5–73:0 Now he makes the point I just made. But this cies!) is no reason to distinguish esoteric and exoteric time! 63:2–3 Relevance of this: prevalidation is necessary 73:1–74:1 There is no smooth adjustment of this dis- for accumulation, but it is, of course, also crisis prone, crepancy, but the discrepancy leads to crisis, because of because it is only prevalidation. In this he sees the root prevalidated surplus-value. I think there are more general causes of inflation. reasons. 52 CHAPTER 12. LIPIETZ, ENCHANTED WORLD

74:2–76:0 What happens if divergence: either not all and nominal price of gold is fixed. Therefore prices are goods validated, or wages and profits modified, or LEM fixed. Constraint “by the particular value of money.” (labor equivalent of money) changes (which is inflation). 77:1–78:1 In boom or crash this adjustment may be de- 76:1 He calls all this crisis. Why the adjustment takes ferred. the form of a crisis was addressed, wrongly as I think, in 73:1–74:1. The details of that readaptation depend on the “regulation.” 12.6 Credit Money and Real Con- straint II Monetary Constraint in the Case of Gold- Money There is a place in Marx’s theory of the value form to get around the requirement that money is value. 76:2–77:0 Monetary constraint is this “coupling” 76:2 Marx had two adjustment processes in mind preventing the capitalists from imposing any arbitrary rate of 12.6.1 The Development of Fetishism and profit or rent. One is still valid, the other isn’t. the Development of Money Now there is no mention of the first adjustment process, 81:4–82:0 Preliminaries only the second one. Is this a translation glitch? 76:3 The second adjustment, which was valid then but no longer is, is the “monetary constraint in the strict Value Form and Commodity Money sense.” On the esoteric level, social validation of private labor only possible if the private labors form a coherent 82:1–83 Goes through value form, his analysis is very schema of reproduction. compatible with what I have in my Annotations. But on the exoteric level, validation occurs by individu- 83:1 Defines money as “the sole equivalent that is never als being able to sell their goods to each other at the prices relative, the only immediately social representative of pri- they expected from the exoteric connections. vate labor” and asks: under which conditions is the privi- Now how are these levels connected? In boom times, lege of being money acquired? inventories are low and all goods can be sold, and in such 83:2 Defines better what this privilege consists in: as a situation there is a tendency for prices to rise because a rule, all labor will eventually be socially validated. But the producers see an opportunity to make profits. The the labor producing money is canonized by an a priori only potential problem with this is that there might not be decision of society. enough gold to circulate the goods at these higher prices; 83:3 Although it seems that a certain use value (gold) is but since commodity circulation is fast, only little overall privileged, what is really privileged is the labor producing gold is needed. Therefore during boom times, the adjust- this use value. ment is deferred. 83:4 Don’t quite understand, but I think he says: the In a downturn, prices fall and goods cannot be sold. difference between commodity money and credit money One might expect the fall in prices to result in higher real is that in a commodity money regime, all labor produc- balances which would translate into more demand, but ing a particular use value is prevalidated, while in a credit since the turnover speed of money declines at the same money regime, the banking system prevalidates labors of time, this cash is not available. Therefore the fall in prices various kinds which promise to be socially necessary. and output does not self-correct but leads to a crash. The procyclical movement of turnover speed of money From the Consolidation of Values-in-Process to Credit allows both booms and recessions to go unchecked, there- Money fore the check does not come through market adjustment but through a crash. 84:1 Refers to the higher degree of fetishism of one goes 76:4/o Under the gold money system, if prices are in- from synchronic value to value in process flated by the adding-up of too high revenues, then the pro- 84:2 Description of money in a synchronic value rela- duction of gold would become unprofitable, therefore a tion. lack of money would develop. Marx, in Contribution, 84:3–85:3 Now assume a monopoly regulation in only explained the opposite case, in which gold became which validation of the goods produced is almost guar- cheaper, therefore prices of goods traded with the gold anteed. producers became higher, which spreads. The opposite 85:4 In such a situation, no banker would refuse a loan case seems harder to explain. In equilibrium, relative to a worker who is employes or an active business. This prices reflect production conditions plus wages, rent etc. is of course an overstatement. 12.6. CREDIT MONEY AND REAL CONSTRAINT 53

85:5–86:2 takes a gradualist approach, goes from a def- these committments. It pseudo-validates them.” Footnote inition of money by instantaneous values to one by values 15 on p. 104 indicates that there is an alternative interpre- in process. tation in [BC74]. 91:3–92:1 Histrorical process (of what?) occrrred in 3 12.6.2 Origin and Logic of Credit Money stages: 1. The central bank acquired a monopoly over issuing The Experience of Credit paper money that represented gold. 2. After 1914 the central banks’ banknotes and deposits 87 Joke with the cash payer: credit money is no longer were no longer convertible into gold because they became impersonal. Individuals are made responsible! One needs legal tender. a credit rating! This is the switch to value in process. Since the individual has to protect his or her credit rat- 3. Since 1945 an international fiduciary money has ing, he or she becomes the representative of value in pro- been recognized from the dollar-standard to Special cess. I guess banks do something similar to a credit rating Drawing Rights. (Marx’s last function of gold money was with businesses. The joke shows that cash payment is not to serve as a worldwide universal money). Initially for- more solid than this credit regime. In a cash society, only eign currency reserves and Eurodollars came to be used the thing counts. It is assumed that the person who has the as international credit money. cash has acquired it rightfully. Lizzy’s despair illustrates 4. After 1971 when gold convertibility ended and with that this is as big a leap as the assumption that the person the Special Drawing Rights, the central bank became the who writes the check will honor it. true international pseudo-validator. The central bank does not have to repay its own debt, and antevalidates by printing new money. The banks wait for the independent val- Credit Money ues they represent to return in the shape of already rec- 90:4 Lipietz writes: Assume B is trusting enough not to ognized money. The banks pseudo-validate credit by so- do any of these things. It is not a matter of trust. This re- cially sanctioning the validity of commitments. quires a certain regularity of reproduction, i.e., monopoly 92:2–95:3 I think one can consider today’s system as if regulation. all banks that issue cheking-accounts were note-issuing, 90:6 important. History of money is “gradual granting and the reserve requirements are that they are required by of ‘real money’ status to what was initially the represen- law to possess the equivalent of a fraction of their own tative, in circulation, of ‘real money’ that did not circulate notes in central bank notes. Another thought: payment but [which] remained ultimately the only method of pay- by check has the advantage that the buyer and seller need ment.” (Substitution of Baking principle for the Currency not meet in person, and that the payment can be verified principle as he says in footnote 13 on p. 104. Gives a nice and cancelled if there is fraud. This seems to be a major quote from a French Macroeconomics textbook: reason for checks nowadays. In any case, Lipietz claims that under these circum- New forms of money only appear very gradu- stances the quantity constraint no longer works. Mone- ally, and are at first rarely seen as compemen- tary divisor instead of multiplier. The divisor indicates tary to the existing forms: they appear more the proportion of bank antevalidation which is pseudoval- as ‘promises of money’ that are a technical de- idated by the Central Bank. vice to make (real) money circulate. But as this This is different than Hilferding, who says that there technique spreads, its use, which was initially can be no overissue of banknotes covered by real trans- seen as a way of economizing on money, be- actions, and I think also from Marx, who is studying the comes more and more difficult to distinguish laws of the accumulation of credit. I guess this is compat- from ‘real’ monetary use. The perspective then ible with what Lipietz says on p. 97:0, one has to look at switches round, and the instrument is soon rec- the aggregates! ognized as money. 95:4/o Eurodollar deposits not subject to reserve re- 91:2 There can only be one central bank. Concept of quirements, therefore volume of dollars worldwide is un- pseudo-validation: antevalidation by central bank, which regulated. does not have to repay its own debt. Antevalidation with newly printed money? I am not so sure about these defini- 12.6.3 Real Constraint tions. He says the central bank “does more than antevalidate credits by waiting for the independent values they 96:1 Back to problem of coupling represent to return in the shape of ‘already-recognized 96:2 Risk of underliquidity under gold standard made money’. The bank itself sanctions the social validation of the banking principle acceptable. 54 CHAPTER 12. LIPIETZ, ENCHANTED WORLD

The New Face of Monetary Constraint 12.7.1 Stagﬂation

96:3/o Final ability of the system of credit money to clear 107:3/o How did the exoteric and the esoteric get apart depends on aggregate conditions, this is what the Postkey- 1974–83? Technical composition increased, but at the nesians don’t see. same time there were productivity gains which prevented the rate of profits and the real wages from falling. But 97:1/o Instead of a local opposition between commodi- at some point the productivity gains were no longer fast ties and money a hierarchical credit structure backed up enough to make up for the increase in the technical com- by last-resort pseudovalidation. This hierarchy cushions position of capital. Therefore esoteric rate of profit fell. the central bank, since it makes selective credit deval- orizations possible. 98:1 There is no ‘monetary constraint in the strict Crisis of Fordism sense’ as under the gold standard. If central bank has “re- 108:2 gives a general framework of what can happen in sponsible” policy, then trinity formula determines prices this situation: if due to pre-validated surplus value the and the quantity of money. Monetarists think the reverse: nominal profits are not allowed to fall, then there is in- quantity of money determines the level of prices. flation, a decrease in the labor equivalent of money. On I.e., level of prices determined by exoteric factors. But the one hand this means the capitalists can no longer re- this means a discrepancy between values and prices! I place their fixed capital. On the other hand this leads to would think that a “responsible” monetary policy must falling real wages, so that the workers can no longer con- make the link to the esoteric instead of just preserving and sume as much as before. Therefore demand falls, i.e., the reproducing the exoteric. decrease in the rate of profit induces a realization crisis. 98:2–4 Antevalidation endogenous, assuming custom- Lipietz constrasts this with the thirties where a realization ary growth is maintained. crisis erupted without a fall in the rate of profit. Now if workers can fight against the erosion of their wages, then the maintaining of the old too-large markup Coupling in Credit Money will lead to higher costs and will therefore not be able to prevent the rate of profits from falling. But if there is in- 99:1–2 But what this rate of growth is can only be deter- flation and the books are kept in historic costs, then the mined by esoteric laws. numerator in the rate of profit is undervalued, will this 99:3–100:0 Contradiction between surface and esoteric therefore prevent the apparent rate of profit from falling? laws no longer shows in the realization of price but in M– See Guttmann around p. 108, but somewhere he said that C phase: money cannot longer buy enough commodities, stock market investors had lost confidence in the account- inflation. ing profits. 100:1–5 Math formulation, trivial. Well, Lipietz says that wages could not be reduced due to resistance of organized labor. 100:6 Latent inflation if productivity devalues com- But nominal markups are still at the old levels. Until modities but prices remain constant. late 70s, depending on the country, rise in nominal cash 100:7–101:1 Quote where Marx had anticipated infla- flow continued to prevent collapse in profit rates. tion. 102:1 Policy implication: differential inflation rates be- Question 27 According to Lipietz [Lip83, p. 110], in the tween countries cannot be influenced by monetary poli- 1930s there was a realization crises without a fall in the cies, incomes policies necessary. rate of profit, i.e., profitability was high but there was not 102:2 Theoretical implication: no “dichotomy” enough purchasing power to buy the output. In 1974–83, 102:3–103 Summary however, there was a realization crisis which arose as a consequence of a fall in the rate of profit. Describe the possible mechanisms how a fall in the rate of profit can lead to a realization crisis. 12.7 Inflation in Monopolist Regu- 110:1 Lipietz says in 1930s it was a realization crisis: lation productivity gains were there, but wages did not increase enough. Paradoxically he calls this a “direct” crisis of 107:1 Monopoly regulation gives increasing autonomy to overproduction. the exoteric. Here the Grundrisse quote would be appro- But in 1974–83, profit rates fell, but continued formal priate that capital seems totally free but in reality it feels markups gradually priced the products out of the reach of its own limits. those who should buy them? Is this what he means? Is 12.7. INFLATION IN MONOPOLIST REGULATION 55 there also an injection of debt? Or that wages seemed to III The Oil Crisis become too high and this caused more capital intensive Exoteric redistribution of incomes with unchanged value investment? Where did I get this from? It is not 110:4. system. 110:4 is very interesting. Class struggles in production 118:2 Some economists argued: consumers will be caused management to substitute machines for workers worse off, their demand for other goods will fall, there- even though this was no longer profitable due to falling fore other prices will fall. Most economists said: oil is wages and rising interest rates. [Or was that just a lag more expensive, therefore prices will rise. in adjustment?] Perhaps one can also say: they expected This is the difference between the gold standard regu- demand to remain strong and invested because of this, not lation and the monopolistic regulation. seeing that they were being squeezed on the profit side. I.e., the esoteric-exoteric difference helps to make sense 111:2–112:2 discuss [NK78], I should look at this; it of that stuff. seems to do similar things as [Fol86a] but in a different framework. IV ‘Monetary Discipline’ and the Monetarist 112:3–114:1 But there is a different inflationary spiral Catastrophe including fixed capital. Reaganomics in part esoteric: reduce taxes from the rich 112:3 According to Lipietz, the fixed capital is cheap- and dismantle the welfare state in order to have more sur- ened by productivity increases, which is a counter- plus value available and to force workers to work at a tendency to the falling rate of profit. Along with the lower wage. cheapening of new fixed capital, also the depreciation al- Provide new outlets by boosting military expenditure lowance on already existing (more expensive) fixed capi- (exoteric, trying to prevent a realization crisis) tal should be lowered. But in the monopoly regime with Refuse to pseudo-validate and limit access to credit (ex- full cost pricing it is not. oteric) (This gives me an idea: they can also pass the unpro- Effects: demand plummeted, military spending was not ductive expenses on!) enough to offset it. Government had to borrow, and since 112:4 Advantages: innovatory business investing in it was told to keep monetary policy tight it drove up the in- new and quickly devaluing fixed capital is not penalized. terest rates. These high interest rates caused a worldwide 112:5/o Disadvantages: inflation. inflow of capital, bidding up the value of the dollar. This deprived US industry of foreign customers too. Since oil 113:1 Now he is trying to argue why inflation even mat- prices are denominated in dollars, this also increased the ters to businesses. price of oil for other countries. With higher price of oil 113:2 Return on the gross cash flow becomes less and and high interest rates the other countries were in a simi- less able to recover the accelerating investment costs. Ap- lar position as the US. parently there is a translation glitch in this sentence. (Be- cause the investment goods do not fall in price, due to monopoly regulation?) 113:3 Lets try again, but here he seems to say the opposite: Esoterically: rate of profit falls, due to rising organic composition. Exoterically: nominal rate of profit is raised by inflation. But nominal depreciation allowance is not sufficient to replace fixed capital. Numerical example in [Tho81]. (Is this the same author as in [Tho87]?) Thomas also shows that they have to pay too much taxes. Therefore investment dries out due to insufficient cash flow. Dan Rogers says they prefer to pay taxes and showing high profits which gives them access to credit. But in an undistorted economy, the general level of profits would be lower, and therefore lenders would not expect such high interest rates! This looks more like an explanation why the firms could not switch to a more realistic valuation. Chapter 13

Simpliﬁed Version of Foley’s Capital Flow Through Model

Answer: Combine (??) with (??) to get This depends on the growth rate g and the pass-through time TP independently of which combination of p and q R(t) = (1 + pq)R(t TP) (13.1) generated g. − For the computation of the proﬁt rate it is convenient to or, using (??), rewrite (13.8) as R egt = (1 + pq)R eg(t TP) (13.2) pq 0 0 − P(t) = Q(t). (13.10) g or, simplifying Proﬁt rate is then 1 = (1 + pq)e gTP . (13.3) − qQ(t) qgQ(t) g r = = = (13.11) This can be solved P(t) pqQ(t) p

egTP = 1 + pq (13.4) From this follows the Cambridge equation and asympto- tially, using (13.5), also and therefore g pq q r = = (13.12) 1 pq p ≈ TP p TP g = ln(1 + pq) . (13.5) T ≈ T P P Answer: Output of the farmers if R(t). They imme- Answer: diately get cash for this, i.e., their inﬂow of money from sales is also R(t). Since they keep all money for time T , 1 1 M Q(t) = R(t) = R egt (13.6) they spend at time td what they had previously received 1 + pq 1 + pq 0 at time t TM, which is R(t TM). Their money stock therefore− follows the differential− equation P˙(t) = R(t) Q(t) = (1 + pq)Q(t) Q(t) = − − M˙ (t) = R(t) R(t TM) (13.13) pq gt − − = pqQ(t) = R0e (13.7) 1 + pq With the steady state regime one gets

Integrating gt gt gTM gTM gt M˙ (t) = R0e R0e e− = (1 e− )R0e (13.14) − − pq 1 P(t) = R egt +C (13.8) and therefore 1 + pq 0 g 1 1 e gTM gTM gt − If one imposes the “transversality condition” M(t) = (1 e− )R0 e = − R(t) (13.15) gT − g g limt ∞ P(t) = 0 it follows C = 0. Since 1 + pq = e P , (13.8)→− can also be written as Businesses are assumed to be on an overdraft regime: they must buy materials at the rate R(t) and they pay this gTP gTP e 1 1 gt 1 e− out of their bank overdraft. But simultaneously with these P(t) = − R0 e = − R(t) (13.9) egTP g g purchases they also sell ﬁnished whiskey to the farmers

56 57

at the rate R(t TM). They can credit these receipts to their bank account,− i.e., their overdraft is immediately di- minished again by this amount. Therefore the business’s overdraft balance follows the equation:

D˙ (t) = R(t) R(t TM) (13.16) − − This is the same differential equation as that for the farmer’s money stock. Business indebtedness is therefore the same as the money stock:

1 e gTM D(t) = − − R(t) (13.17) g Answer: With the balanced growth regime one gets

ht ht hTM hTM ht ∗M˙ (t) = ∗R0e ∗R0e e− = (1 e− )∗R0e − − (13.18) and therefore 1 1 e hTM hTM ht − ∗M(t) = (1 e− )∗R0 e = − ∗R(t) − h h (13.19) and also 1 e hTM D(t) = − − R(t) (13.20) ∗ h ∗ The real money balances are

1 e hTM M(t) = M(t)/m(t) = − − R(t) (13.21) ∗ h

I.e., the real money balances grow at the same rate g as Rt an indeed all real magnitudes, but they are overall smaller than in the absence of inﬂation. In order to show that they are smaller and not larger we ∂ xy 1 e− need ∂y −y < 0. Using the differentiation rule (u/v)0 = (u v uv )/v2 this derivative is 0 − 0 e xy(1 + xy) 1 − − y2 Now we need the inequality 1 + xy < exy and therefore, xy xy since e− > 0, e− (1 + xy) < 1. This makes this derivative < 0. Plugging the formulas for ∗D(t), m(t), and P(t) into equation (??), i.e., using formulas (13.20), (??), (??), and (13.9), we get

1 e hTM 1 e gTP − − R eht = e(h g)t − − R egt (13.22) h ∗ 0 − g ∗ 0 or 1 e hTM 1 e gTP − − = − − (13.23) h g

This is an equation which deﬁnes h once g, TM, and TP are given. Chapter 14

Foley [Fol87a]: Financial Instability Leads to Limit Cycles

A related paper with a more preliminary version but a tio of sales to productive capital rises (i.e. inventory/sales more complex model is [Fol89]. ratio falls and capacity utilization rises), then firms will not decrease demand but increase it, in order to replenish inventories or build new capacity. (2) an additional finan- 14.1 Introduction cial effect: if firms borrow more when the rate of profit But this unstability is limited not by a resource constraint 363:1 Profit-seeking firms are fundamental actors. Foley but by a financial constraint: if firms reduce their capital says this could also be a worker-managed firm or a nation- outlays when they have a low rate of money and financial alized company (but this model does not apply to social- assets to total capital, then the result can be a limit cycle ism, does it?) in the growth rate, profit rate, and interest rate. 363:2 Decisions of households play no macroeconomic Definition of all variables: M money holdings of firms, role. F financial assets held by firms. (trade receivables, i.e., 364:1 Review of similar models in the literature, similar credit issued by firms to their customers during ordinary to [Fol89, 200:2/o]. business?) X is productive capital (inventories plus fixed 364:2 Enterprises (1) produce in order to sell, and since capital), D debt issued by firms. The interest rate they production takes time, they always have a certain value receive on F and the rate they pay on D is assumed equal, tied up as productive capital. It is not just that production called i. Flow of sales is S, and flow of capital outlays C. L takes time but: means of production and produced inputs is lending by firms, and B borrowing. Government debt is are needed. (2) they hold positive stocks of money and Z, government deficit U. FG is the government’s holding issue debt. (3) sell their output for profit. of loans, and FB the banks’ holding of loans. What Foley 364:3 Since households spend all their incomes in- denotes F should really be called FF . We have FB + FB + stantly, they do not influence aggregate demand. Capital F = D + Z. R are the central bank reserves. outlays of enterprises create demand for output. No gov- The markup q is defined slightly differently than in the ernment except a central bank, and no foreign sector. capital flow model: it is the percentage of the gross sales 364:4/o Abstractuion is made from resource con- price which exceeds cost. I.e., instead of the usual straints. Assumption: real wages given and consistent Markup = q Cost with profit margin. However the model does not know · how profit margins are arrived at. One of the ways I am Foley defines here thinking of here is: the central bank uses monetary policy to keep profit margins in line with the underlying capacity Markup = q Sales price of the economy to produce surplus value. I.e., the central · bank does the coupling of the exoteric with the esoteric, therefore he gets: see [Lip83]. Cost = Sales Price Markup = Sales Price (1 q) 365:1 Two endogenous macro variables are aggregate − · − demand S (sales) and interest rate i. In the text in the middle of p. [Fol89, 202] Foley defines 365:2 Important paragraph summarizing the paper: the profit rate as Steady growth path exists but may be unstable. Desta- qS r = . bilizing mechanisms are: (1) the accelerator effect: if ra- X

58 14.3. MACROECONOMIC INTERACTION 59

Rate of growth of money stock (controlled by govern- 366:5 About borrowing: ment) is µ. B Foley writes arguments of functions as a square bracket, = b[r i]; b1 > 0 (6) which is a good idea and is reproduced here. X − 366:6/o Lending also depends on the firm’s liquidity: 14.2 A Model of the Capitalist En- L M = `[r i, ]; `1 < 0, `2 > 0 (6) terprise X − X Firms can use their money for something other than the 365:3 interaction of firms with banking system. turnover of capital, i.e., they don’t have to invest. They 365:4/o State of enterprise at any moment is described need this alternative, otherwise they would be locked into by its balance sheet: the same fifo process. This lending may represent mobility of capital between firms, but also to fictitious capital. Assets Liabilities This leakage depends on difference between their profit M D rate and the interest rate. F In this model, firms do not change prices, i.e., their X E markup is fixed. It could be explained as follows: firms expect goverment policies to get them out of the slump. Table 14.1: Firm Balance Sheet (This condition is relaxed in [Fol89].)

Equations (1)-(4) are just accounting identities between 14.3 Macroeconomic Interaction stocks held by firms and flows: These equations will not be used. Go to the next section. M˙ = i(F D) + S C + B L (1) − − − F˙ = L (2) 14.4 A Simplified Model

X is increased by C and decreased by the cost of the prod- My guess is: the other equations say that nothing else is ucts sold which is (1 q)S (see my notes about the deﬁ- happening in the economy. nition of the markup).− Therefore S = C (22) X˙ = C (1 q)S (3) − − means that there is no other demand than that generated D˙ = B (3) by ﬁrms (and their workers).

366:2 Enterprises can not decide about sales S and M + F = D (23) about interest rate i. Decision variables of the enterprises: C, L, B (although this rules out rationing in capital mar- since aggregate financial assets are equal to debt. kets), and q. The behavioral equations governing these decisions are (6)–(8). M r i = p[ ] p1 > 0 (24) 367:1 Look at third behavioral equation of the firms, − X equation (8): Interest rate is determined by firm liquidity. C˙ M + F = a[r, ](8) Now Foley solves this, and his result is as announced in C X the first section. There is no indication whether C is above or below (1 If I want to type this in, I have to introduce the notation: q)S. These are very subjective equations! The rate of cap-− lower case letter = that upper case letter divided by X. ital outlays depends on the instantaneous profit rate, basi- He gives the parameters and functions used for his sim- cally on how fast things sell, regardless of how long the ulation. goods sold were in inventories. Subscripts of a function means partial derivatives. Partial derivatives are a1 > 0, a2 > 0. Other behavioral equations determine how enterprises lend and borrow. Chapter 15

Foley [Fol89]: Monetary Stabilization Policy Leads to Limit Cycles

Introduction The markup q is defined slightly differently than in the capital flow model: it is the percentage of the gross sales This paper was written for a conference with emphasis on price which exceeds cost. I.e., instead of the usual nonlinear models. It is preliminary with various typos. A Markup = q Cost related, better worked-out paper, which however does not · have monetary policy in it, is [Fol87a]. Foley defines here 200:1 Boundedness of empirical business cycles does not mean that the equilibrium is stable, but it may indicate Markup = q Sales price · a limit cycle. therefore he gets: 200:2/o Review of similar models in the literature. This paper has an unstable accelerator mechanism Cost = Sales Price Markup = Sales Price (1 q) − · − which is kept in bounds by financial constraints. In the text in the middle of p. 202 Foley defines the profit rate as qS r = . 15.1 Model of Capitalist Economy X Rate of growth of money stock (controlled by govern- 201:2 Enterprises are the key agents. They act with ment) is µ. limited horizon, react to the evidence of disequilibrium To simplify notation, Foley writes the time derivative of (which is the Marxian paradigm). Government mediates, a variable as that variable in slanted font. We will not use influencing the environment and in this way possibly sta- this shortcut but mark the time derivative by a dot on top bilizing, and households are passive, spending all their in- of the variable, which is also Foley’s notation in [Fol87a]. come as soon as they get it. Foley also writes arguments of functions as a square Definition of all variables: M money holdings of firms, bracket, which is a good idea and is reproduced here. F bonds held by firms. I don’t know why Foley compares F to commercial paper, which is short term bonds issued by firms, i.e., liabilities of firms. F is an asset, I think 15.1.1 Enterprises trade receivables is a better analogy which is credit issued by firms during ordinary business. X is productive capital Assets Liabilities (inventories plus fixed capital), D debt issued by firms. M D The interest rate they receive on F and the rate they pay F on D is assumed equal, called i. Flow of sales is S, and X NWF flow of capital outlays C. L is lending by firms, and B borrowing. Government debt is Z, government deficit U. Table 15.1: Firm Balance Sheet FG is the government’s holding of loans, and FB the banks’ holding of loans. What Foley denotes F should really be Equations (1)-(4) are just accounting identities between + + = + called FF . We have FB FB F D Z. E is defined stocks held by firms and flows: on p. 202 as the total financial assets of enterprises E = M + F. R are the central bank reserves. M˙ = i(F D) + S C + B L (1) − − − 60 15.1. MODEL OF CAPITALIST ECONOMY 61

A L Other behavioral equations determine how enterprises R M lend and borrow: F NW B B L M = n[r i, ]; n1 < 0, n2 > 0 (6) Table 15.2: Bank Balance Sheet (R = M) X − X B = b[r i]; b1 > 0 (7) X − F˙ = L (2) Firms can use their money for something other than the turnover of capital, i.e., they don’t have to invest. They ˙ D = B (3) need this alternative, otherwise they would be locked into X˙ = C (1 q)S (4) the same fifo process. This lending may represent mobil- − − ity of capital between firms, but also to fictitious capital. Equation (4): X is increased by C (the assumption here This leakage depends on difference between their profit is that workers will instantaneously produce and therefore rate and the interest rate. increase inventories, which are measured at cost, by an Finally the firms set their markup according to demand S amount equal to their wages) and decreased by the cost of as evidenced by X : the products sold which is (1 q)S (see the above remarks about the definition of the markup).− S q = q[ ], q1 > 0 (8) What is the difference between this and the capital flow X model? Purchases of productive capital depend on the If there is (both high capacity utilization and—but I think instantaneous profit rate, but this profit rate is not deter- Foley misunderstands his own model here, since there is mined by the dual influences of turnover time and physi- no production at all in this model) a low level of invento- cal productivity as in Senchak’s dissertation [Sen83], but ries compared with sales, then firms will raise their price. by turnover time alone! X should be viewed as inventories Dumenil-Levy has the additional quirk that, if capacity of finished products alone, see also [Fol87a, 364:4/o]. utilization is high, they may raise investment (which is This model is keeping track of the intra-economic flows procyclical since it leads to even lower levels of invento- but does not keep track of the flows through the enterprise ries), and they also say that quantity adjustments are the itself. primary force, not price adjustments. But Foley does not Once the productive capital is purchased, Foley does have investment in there as a separate branch. not keep track of how it goes through the production pro- Answer: If sales are high, firms raise their markup, this cess; I guess since it is a matter of inventories alone, a gives a higher profit rate, which gives more capital invest- FIFO approach would be just fine. If one wants to incopo- ment C, therefore even higher sales. This is explained in rate production, one should go in the direction of Dumenil [Fol87a, 367:2]. In conventional accelerator models, in- and Levy’s model. vestment depends on rate of change of sales; here, rate Enterprises can not decide about sales S and about in- of change of capital outlays depends on the current profit terest rate i. Decision variables of the enterprises: C, L, B rate. (although this rules out rationing in capital markets), and [Fol87a, 368] also makes the firm interactions explicit: q. The behavioral equations governing these decisions are firms interact by capital outlays, and by the interest rate. (5)–(8). Look at first behavioral equation of the firms, equation (5): 15.1.2 Government C˙ M + F D = a[r, , ](5) C X X A L F R ( G There is no indication whether C is above or below 1 Z ) − q S. These are very subjective equations! The rate of NW capital outlays depends on the instantaneous profit rate, G basically on how fast things sell. Subscripts of a function Table 15.3: Government Balance Sheet means partial derivatives. Partial derivatives are a1 > 0, a)2 0, a3 0, and a2 + a3 0. This last equation means:≥ someone≤ with assets of≥ 1 million and debts of 1 The government sector also includes the central bank. million will spend more than someone with no assets and P. 203: government has two functions, controls µ and U. no debts. (Because the former can always pay off his debts Foley does not write down the equations, which are sim- as one of his options.) ple. One of the government functions is the creation or 62 CHAPTER 15. FOLEY: STABILIZATION POLICY YIELDS LIMIT CYCLES

destruction of money. Rate of growth of money stock is or M µM U µ, therefore the equation is b[r i] n[r i, ] = − . − − − X X M˙ = µM, M µM U Now the assumption is that for each value of X and X− there is exactly one r i which solves this equation, write which is the second equal sign in Foley’s equation (12). it as − Government can also finance its spending or transfers M µM U r i = v[ , − ](15), by borrowing, therefore − X X i.e., interest rate is determined by demand and supply of ˙ Z = U loanable funds. This equation is not in Foley. There are no taxes. While the government can create money or print trea- 15.1.4 Model as a Whole sury bills, it cannot determine where this money or these Foley does not give this subtitle, which should come be- securities go. And they are then governed by an aggregate fore 205:2. From now on, a variable in lower case is that equation, which is equation (9), variable in upper case divided by X. M + F = D + Z (9) Equation (17) has a typo too, it should read Z˙ X˙ which shows that at every instance the sum total of finan- z˙ = z = u q[s]sz + uz (17) X X cial assets is equal to sum total of liabilities. − − Note that on the balance sheets on p. 203 FG = R, i.e., because of (16) and Z˙ = U, therefore Z˙/X = u. the government’s holding of loans is identical to the re- Equations (18) and (19) are correct. serve assets of the central banks. All the debt which the M˙ government is holding is monetized. = m(µ q(s)s + u)(18) X − 15.1.3 Markets (19) is also correct. Here is its derivation: By (9), M + F = D + Z, and since D˙ = B by equation (3), and Z˙ = Two markets: one between goods, one between loanable U, it follows E˙ = B + U. From (7) follows b = b(r funds (for interest rate). i). The letter b denotes here two different things, on the− Ultimate source of demand for goods is capital outlays lefthand side it is b = B/X, and on the righthand side it of enterprises, (which again depends on stocks of capital: is the behavioral function b(r i) defined in (7). Finally, it is a stock which resists getting too small. Does it? It plugging in equation (15) for r− i gives equation (19). should, it is modeled by the growth rate!). And there is − ˙ ˙ also demand generated by governemt expenditures. E X e˙ = e = b[v[m,µm u]]u q[s]se + ue (19) Why are the interest payments omitted in (12), which X − X − − says It seems equation (20) has a typo as well. To derive M˙ = S C + B L? (12) what it should be, start with (5), C˙/C = a(r,e,D/X). Look − − Because of the last paragraph on p. 102: “For simplicity I at the arguments: In the text in the middle of p. 202 Foley assume that profits of the banking system return as trans- defines r = qS/X = qs, and combining that with (8) gives fers to the money holdings of enterprices, so that in the r = q(s)s. From (9) follows D = M + F Z = E Z, − ˙ − aggregate net interest of enterprices is zero.” therefore D/X = e z. Therefore we can write C/C = a(q(s)s,e,e z). From− (11) follows C = S U, therefore There is a typo in (14); it should read − − C˙ C˙ C C˙ j j M j = = (s u) = a(q(s)s,e,e z)(s u). ∑b [r j i]Xj +U = ∑n [r j i, ]Xj + µM. (14) X C X C − − − ∗ j − j − Xj Next, from u = U/X follows Here he writes b j and n j instead of b and n to avoid j j ˙ confusion with the partial derivatives. Then Foley makes U UX˙ UX˙ U˙ U X˙ U˙ u˙ = ! = − = = u(q(s)s u), the simplifying assumption that all firms are identical, i.e., X X2 X − X X X − − j j M j/Xj = M/X, b [ ] = b[ ], n [ , ] = n[ , ]. Of course X = · · · · · · ∑Xj and M = ∑M j. Therefore (14) becomes therefore U˙ /X = u˙ + u(q(s)s u). Adding this to gives − ∗ M S˙ C˙ U˙ Xb[r i] +U = Xn[r i, ] + µM = + = a(q(s)s,e,e z)(s u)+u˙+u(q(s)s u). − − X X X X − − − 15.2. SIMPLE MODEL OF DEFICIT-FINANCED MONETARY POLICY 63

Now we still have to subtract s(X˙ /X) = s(q(s)s u), which means that equation (20) should read −

s˙ u˙ = a(q(s)s,e,e z)(s u) (s u)(q(s)s u). (20) − − − − − − 15.2 Simple Model of Deﬁcit- Financed Monetary Policy

This five-equation system (16)–(20) is too complicated. Therefore Foley introduces some drastic simplifications to get any results. The middle of p. 206 is important: Fed must set ist policies so that firms have exactly enough room on the market that their profits match up with the surplus-value created by their workers. But this equilibrium is not stable, it has a limit cycle. If government will not do it consciously, the economy will not stably go to it. Monetary policy cannot make this system stable: Deficit financed money transfer policy increases frequency of cycles. Goods are only demanded by firms (C) and the state (U). If the monetary policy and thereby government demand decisions are based anticyclically on S, it is not surprising that the frequency of the cycles is increased. By contrast, pure inside money policy trying to lean against the wind increases amplitude of cycles. Chapter 16

Dumenil´ and Levy:´ The Pitchfork [DL86]

Figure 16 is a graphical representation of the model in tive parameter εh indicating the speed of adjustment: “Des´ equilibre´ et Stationnarite”´ [DL86]. (On the Acrobat reader, not all lines may be visible in normal magnifica- It+1 = I¯t+1h(ut u¯;εh) (16.1) tion. Use magnification to see the whole picture.) It is a − h(u u¯;εh) 0 (16.2) discrete time model in which every time period first has − ≥ h(0;ε ) = 1 (16.3) production and then market activity. At the bottom of fig- h Π h(u u¯;0) = 1 (16.4) ure 16, capital stock K, profits , output Y, potential out- − put varY, and inventories S are shown for period t. These h1(u u¯;εh) 0 (16.5) enter certain decisions represented by the boxes (a box − ≥ h2(u u¯;εh) 0. (16.6) with double margin means this decision is represented by − ≥ 2 equations, and the box with triple margins actually represents 5 equations). The model has the following details: 5. Output decision: again two parameters, a σ with 0 σ < 1 and a ε 0, are included into the reaction≤ function, indicating≥ the speed of the reaction to 1. Prices and wages are fixed, and the units of the prod- divergences of u and s from their desired values. This uct and of labor are chosen such that the price of the adjustment function is written as g(u u¯,s¯ s;σ,ε), product and the wage are unity. so that positive arguments indicate− an overheating− economy and negative arguments an economy in recession. g has the following properties: 2. Production follows a fixed coefficient production function, per unit of output one needs 1/b units of 0 g(u u¯,s¯ s;σ,ε) 1 (16.7) fixed capital and a/b units of labor. ≤ − − ≤ All partial derivatives of g are nonnegative.

3. Investment in equilibrium, when capacity utilization g(0,0;σ,ε) = u¯ (16.8) u and inventory-sales ratio s are at their normal levels g(u u¯,s¯ s;0,0) = u¯ (16.9) u = u¯ and s = s¯: If fixed capital is increased by one − − g(u u¯,0;ε,σ) < u for u > u¯ (16.10) unit, potential output is increased by b units. If the − ratio of inventories to potential output is to remain g(u u¯,0;ε,σ) > u for u < u¯ (16.11) s = s¯, inventories must increase by bs¯ units. Further- − more, if capacity utilization is to remain u = u¯, then The last two conditions mean: if capacity utilization output must increase by bu¯ units, and therefore labor is above normal and inventories are normal, then ca- by (a/b)bu¯ = au¯ units. In total, for every unit of fixed pacity utilization falls in the next period, although it capital, a total value of κ¯ = 1 + au¯ + bs¯ is necessary may still be above normal, and vice versa for below in order to remain in equilibrium. If, therefore Πa is normal. the amount available for accumulation, then Πa/κ¯ is that part of it to be invested in fixed capital. Stability of the normal equilibrium and location of stationary disequilibrium points depends on the values of εh, ε, and σ. In order to be able to get concrete results, the au- 4. Modification of fixed investment if capacity utiliza- thors introduce some additional simplifying assumptions. tion is not at its desired level depends on a nonnega- The first group of assumptions refers to the functional

64 65

St+1

Figure 16: Dumenil´ and Levy’s´ Model with Pitchfork Goods market St+1 = (St +Yt ) (Dt + It+1) (Des´ equilibre´ et Stationnarite)´ [DL86] −

Dt It+1

IV. Consumption decision: no personal savings Πc Dt = Wt + t Π (1 δ)Kt+1 t+1 Yt+1 Y¯t+1 − Πc Wt t

III. Production Potential output Y¯t+1 =bKt+1 Decision: Actual output Yt+1 =Y¯t+1g(ut u¯,s¯ st ;σ,ε) − − (Five equations) Wages Wt+1 =Yt+1a/b Depreciation δKt+1 Proﬁt Πt+1 =Yt+1 Wt+1 δKt+1 − −

Kt+1

New capital stock Kt+1 = (1 δ)Kt + It+1 − It+1

II. Investment decision: Maximum ﬁxed investment that would lead to the accumulation Supply of all of Πa is I¯ = δK + Πa/κ¯, but actual t t+1 t t Y + S investment depends on previous capacity uti- t t lization: It+1 = I¯t+1h(ut u¯;ε ). − h

Πa t

Πc t

Capacity utiliza- Inventory sales Πc I. Distribution of profit: t is the part of tion ut is a mea- ratio st , also profits going into final consumption, assumed sure of disequi- a measure of Πc proportional to stock of fixed capital: t = librium: disequilibrium: Πa Π Πc dKt . The remainder, t = t t , available Yt S − = . t for accumulation. ut u¯ ¯ u¯ st s¯ = s¯. − Yt − − Y¯t −

Π (1 δ)Kt t Yt Y¯ St − t 66 CHAPTER 16. DUMENIL´ AND LEVY’S´ PITCHFORK MODEL

forms of h and g: not last long: if capacity utilization stays equal for a while longer, then inventories rise (because production is above h(x;εh) = H(εhx); (16.12) the normal level), and therefore the signal from invento- H(x) 0 (16.13) ries weakens, so that capacity utilization will eventually ≥ fall. But the “perverse” signals coming from investment H(0) = 1 (16.14) may make this an equilibrium position, since higher than H0(x) 0 (16.15) ≥ normal capacity utilization generates higher than normal H0(0) = 1 (16.16) investment demand, so that inventories are drawn down g(x,y;ε,σ) = G(σx + εy) (16.17) as quickly as they are built up. And if the adjustment parameters are right, this may be a stable position at which 0 G(x) 1 (16.18) ≤ ≤ the economy gets “stuck,” although it has higher capacity G(0) = u¯ (16.19) utilization and lower inventories than the agents desire. G0(x) > 0 (16.20) Dumenil and Levy call these states “stationary disequilib-

G0(0) = 1 (16.21) ria.” The next important component of this story is: if the G(x) u¯ + x if x 0 (16.22) ≤ ≥ economy is at a stable normal equilibrium, and firms in- G(x) u¯ + x if x 0 (16.23) ≥ ≤ crease the speed with which production reacts to changes in inventories, then they may cause the normal equilib- A second group of assumptions ensures that capacity rium to become unstable. This mathematical result can utilization will never fall so much that the economy no be made intuitive in the following way: In an unplanned longer has a positive growth rate, and that buyers will economy there are always losses due to friction and the never be rationed by inventories falling to zero. wrong production proportions etc. If every agent tries to The authors simulate a model which has all these spe- push these losses away from themselves, by increasing cialized assumptions. Here are their results regarding the their adjustment speed, the result may be that the losses number and stability of stationary states of the economy are not absorbed in the economy but are amplified and ε if is varied, the other two adjustment parameters being make the system as a whole unstable. Dumenil and Levy fixed. A graph of probably the most important parame- explain the business cycle by the normal equilibrium be- ter in these stationary states, namely, the achieved level ing unstable and the existence of two stationary disequi- ε of capacity utilization u, plotted against the values of , libria. The economy is bounced around by random distur- together with an indication which of these equilibria are bances between the attraction regions of these two dise- locally stable, is given in figure 16.1. It has the famous quilibria. “pitchfork” shape. (Solid lines indicate stable equilibria, One can tie the falling rate of profit into this story as broken lines unstable equilibria.) follows: if the profit rate falls, firms try to counteract this For certain combinations of these parameters, the nor- by increasing their reaction speed. Such an increase seems mal equilibrium is therefore unstable. If inventories are the perfectly rational thing to do from an individual point below normal, capacity utilization rises to replenish in- of view. This is why Dumenil and Levy speak about a ventories. Investment injects a destabilizing component “tendencey for rising instability.” (the so-called accelerator effect) because demand for investment increases with increasing capacity utilization. If investment demand rises, inventories will be drawn down even further, therefore capacity utilization rises even more, etc. Although the normal equilibrium is unstable, other equilibrium positions may exist which are stable. These are equilibria in which u and s are not at their desired levels. A stable “overheating” state can come about as follows: Assume capacity utilization is above normal and inventories below normal, where the normal level is that at which production can sustain the normal demand generated by the economy. Production obtains two diverg- ing signals: From capacity utilization it obtains the signal to fall, and from inventories it obtains the signal to rise. There may be a position at which these signals momen- tarily cancel out. Without investment, such a state would 67

Figure 16.1: The Pitchfork (acc-1056) u = 1

u¯

0 0 ε Chapter 17

Notes about Panico’s Book [Pan88]

Introduction in the marginalist (neoclassical) approach, the “surplus- extraction” approach, and the Kalecki-Neo-Keynesian 1:1–3 1. Dominant view in classical economics: in long approach. Panico argued for a synthesis between the two run, interest rate depends on profit rate, and in short run, latter approaches, which closes some gaps left by Marx on monetary factors. Keynes’ General theory is the most and Keynes. Give a brief sketch of his theory. famous but not the only attempt to reverse this causality. Also Sraffa suggested a relationship in the reverse, without elaborating. 1:4/o 2. This book tries to elaborate on Sraffa’s suggestion and to develop a “monetary theory of the rate of profit,” along with an alternative theory of value and distribution going along with it. Can Kaldor’s suggestion 6:2–7:3 0.5 No consensus in alternatives to neoclassical “The progressive reduction of interest rates in successive theory. Kaldor’s 1955 Alternative Theories of Distribu- steps would have an important cost-reducing effect” be tion [Kal55] distinguishes Marxian approach, which has made exact? wage exogenous, from Kalecki’s approach with degree of 2:2–4:1 3 Birds-eye view of neoclassical theory. Real monopoly, and a neo-Keynesian approach in terms of the quantities and income distribution determined from util- rate of growth and capitalist propensity to consume. Pan- ity function, production functions, and endowments, with- ico observes that these last two have profits exogenous out reference to money. Distributive variables determined and wages as residual. Sraffa suggests to reformulate the endogenously together with equilibrium prices. [I.e., the surplus approach in the same way. distribution is hardwired into the economy, distributional variables pose as prices, leaving no room for distribu- 7:4–9:3 0.6 Sraffa’s suggestion picked up by Nuti 1971, tional struggles.] For Walras, interest coincided in equi- Dobb 1973 (stubbornly long-lived notion of a normal long librium with rate of profit, but Wicksell distinguished rate term interest rate may indicate that they are really using of profit, i.e., real rate of interest, from monetary rate of interest rate to “set a substantial minimum to profit share”) interest. The first is determined by real factors, and the and Garegnani 1979. Panico is looking for a theory in difference between second and first by monetary factors. which monetary forces, especialy policy, affect interest Modern neoclassical literature does not have a uniform rate, interest rate affects the profit rate, and the wages are rate of profit, and the interest rate is the result of intertem- the residual. He claims that sometimes the relation is one poral allocation decisions. (Footnote 2 interesting here.) in which wages limit profits, and sometimes one in which 4:2–6:1 4. Birds-eye view of surplus approach. Defines the interest rate, and through it profits, limits the wage. values independent of distribution. Data: A matrix, output bundle, wage (or rate of profit). Has one degree of free- 9:4–10:2 7 To carry out this program two points: (a) dom. One of distributive variables is taken exogenous, there can be variations both temporary and long lasting in namely, the wage. Interest is part of profit, therefore its monetary interest rate which do not depend on the profit rate must be below rate of profit, but it is independently rate, and (b) there must be a competitive mechanism by determined by monetary forces. Ricardo: must be half of which those variations influence the profit rate. He will profit. use mainly Keynes and Marx volume III. Question 28 Describe the relationship between the interest rate and the distributional variables (wage, profit) 10:3–11:2 8 Summary of book.

68 17.2. MARX ON THE INTEREST RATE 69

17.1 The Literature Before Marx 17.2.3 Influence of Rate of Profits on Aver- age Interest Rate 17.2 Marx on the Interest Rate 56:1–3 2.3.1 Panico says: Marx had two contradictory views. On one hand, profit is residual, from wages, and 17.2.1 Introduction interest rate follows profit rate. On the other hand, influenced by Tooke and Mill from 1820, and seeing growing 47–49:2 2.1.1 Marx’s theory of interest rate difficult to influence of banking sector, Marx says interest rate is de- read, people thought he didn’t have one. Schumpeter said termined independently of profit rate. that Marx, like all classical economists, identified interest 56:4–57:6 2.3.2 Enumeration of some of the factors and profit, others comparing Marx and Keynes thought which in Marx’s view affect the interest rate; some of Marx neglected interest rate because it did not have an them are indeed independent of profit rate. effect on other variables (which they tended to agree to). 57:7–58:3 2.3.3 Gives quotes from chapters 21 and 22 where Marx claimed there is no natural rate of interest. 49:3 2.1.2 Marx’s view was that interest rate must always be below the profit rate, but within this interval, de- 58:4–59:3 2.3.4 Why can there be no law governing the termination of interest rate has a historical and conven- natural rate of interest? Because interest-bearing capital tional character. does not enter production. Marx does indeed say that but Panico makes this much more the central point of the ex- 49:4–50 2.1.3 Summary of sections 2.3–2.4, 2.4 is the planation than Marx. crucial one. Panico sees ambiguity in Marx’s theory: Marx simultaneouly held that wages were determined ex- Question 29 Explain Marx’s theory of the interest rate. ogenously and that banks had an exogenous influence on Why is there, according to Marx, no “natural” rate of interest rate. Marx on the one hand followed Ricardo’s interest? How does Marx’s theory relate to Keynes’s view surplus approach, on the other hand anticipated Keynes that the rate of interest is “conventional” and to the view and Minsky. Marx analyzed the influence on the inter- held by many modern Postkeynesians and others that the est rate of pressure groups in conjunction with the gov- rate of interest is determined by monetary policy? ernment, cleared up the confusion between money capital and real capital, and claimed, contrary to received wisdom 59:4–60:5 2.3.5 In Marx’s view, interest rate is empiri- of the time, that banks can actively cooperate to determine cal indicator of profit rate, but not a reliable one. the level of liquidity and therefore interest rate. My comment: Obviously, Panico finds this limited dependency hard to accept. Marx brings one argument in favor of a dependency: how something is split up must de- 17.2.2 Marx’s Historical Approach and the pend on how big it is in the first place. But Marx stresses Nature of Interest that there are many factors that prohibit this basic relationship from being effective. How these factors play out 51:1–3 2.2.1 Marx did not consider interest rates to be one cannot say because there is no underlying principle the revenue accruing to capital, but the result of haggling determining how big these two parts should be in relation between lenders and borrowers over part of the surplus to each other. Despite the fuss Panico makes about this, it product. Therefore in some historical periods interest rate is not a contradictory position. regulated by profit rate, in others reversely. 2.3.6 60:6–61:3 Panico disagrees with Marx. In the combination of liquidity or risk preference of asset hold- 51:4–52:5 2.2.2 In pre-capitalist times, interest rate de- ers and the equalization of profit rate which includes the termined the profit rate. Emerging capitalists faced the banking sector, Panico sees a mechanism by which the interest rate down. relationship between interest rate and profit rate can be 52:6–54:5 2.2.3 Short summary of Capital III, chapter reliably developed. He will do this in his models below, 21. Ownership versus operating capital. and we will comment on them in time. But furthermore 54:6–55:3 2.2.4 Some points from chapter 23 in Capital Panico also tries to say that these ideas were already in III. Marx, but in a contradictory and undeveloped form. This 55:4–56:0 2.2.5 Money capital is not an independent is not so. Marx was quite clear about his own position. source of profit, therefore interest must be part of profit. Panico also distinguishes between the determination of According to Marx, there is no law how great this part the interest rate and the working of the forces which make should be; it is determined accidentally by the strength interest and profit move together. According to Panico, of the contending forces. Panico finds such a non- Marx has a monetary and historically relative determina- deterministic law puzzling and hard to digest. tion of the average interest rate, through pressure groups, 70 CHAPTER 17. NOTES ABOUT PANICO’S BOOK state intervention, and institutions. Marx would probably 2.5.5 Marx versus Overstone: credit demand is not only quibble with the word “average.” He would say, yes, identical to real accumulation. these are the factors which determine the interest rate at 2.5.6. Marx versus Tooke. every given moment, but an attempt to derive from this a 78:0 Isn’t that also the PostKeynesian view? necessary long term level of the interest rate is “pedantry 2.5.7 Marx is similar to Keynes. or phantasizing” (C363;G375:1). What Panico sees as an inconsistency in Marx’s theory is in fact a real inconsistency, or possibility of crises. 17.3 2.6. Conclusions Absence of a law determining the interest rate and nevertheless the inderdependency of the two is exactly what Good summary, read it! crises are made of. Panico tries to assert, in the analytical Marxian tradition, that Marx’s problems were nonprob- lems. Then he blames Marx for not taking a neoclassical 17.4 3. Marx on the Relation be- position. tween Interest and Profit

17.2.4 2.4 Determination of the Interest Panico is hunting for a sharp and determinate relationship Rate: The Analysis of the Working between interest and profit. His basic idea is to derive of the Money Market such a relationship and then to turn it around, thus getting a monetary determination of the rate of profits. He 2.4.1 Mathematical model of demand and supply of claims that such a relationship is implicit in Marx’s work, money which is supposed to represent Marx’s framework. especially that about the money-dealing capital. Here is 2.4.2. Since interest rate is determined by demand and a model which is apparently Panico’s view how Marx supply, it is appropriate to first discuss all different com- should have done it. (I reformulated it so that prices are ponents of demand and supply and then to trace the his- row vectors, instead of column vectors, because this fits torical evolution of these components. Here Panico gives together with my other notes elsewhere): a good summary of Marx’s theory of the interest rate. P introduces q as the amounts of (short term) loans and 64:1–70:4 2.4.3. Here he backs up with Marx quotes d as the amounts of bank deposits per unit of output in the equations given in 2.4.1. every industry. i is the interest rate paid on short term loans, and τ is interest rate received on deposits. The introduction of q and d, is based on the claim that a certain 17.2.5 2.5 Determination of the Average In- amount of indebtedness (trade payables and receivables) terest Rate is part of every business and differs from industry to industry. Here P can only be referring to short-term loans 2.5.1. So far, structure and working of the money market as they arise in the ordinary course of business from the was discussed. Panico says that this shows how a change function of money as a means of payment, i.e., basically in the interest rate can come about. I don’t quite under- from the technicalities of the transfers of goods and ser- stand. Does this come from Marx’s hypothesis of a mon- vices. He does not explain the return on what Marx calls etary determination of the interest rate? In a second stage interest-bearing capital, he only explains the returns banks of the analysis the question is asked which factors were make in their capacity as money-dealing capital. indeed active. P holds τ and the money wage w constant. He does not 2.5.2. Emphasizes again that there are no natural laws. explain very well why he considers τ exogenous. Perhaps Is the reference he gives here the “waldeigentumliche”¨ one can justify it by an appeal to the facts. Interest on rate of interest? deposits was very often zero anyway, it was not the price 2.5.3. Factors are (a) common consensus (like Keynes), everything else depended on. (b) organization of credit system, (c) world market, (d) Here are the equations: noneconomic conventional factors, (e) institutional factors, which reflect power relations in society. p> = (1 + r)(p>A + wl>) + iq> τd> (17.1) 2.5.4. Banks: important for economy but also have − their own interests. Main error of both currency and bank- Next he introduces another column kb in the A matrix and ing schools: they confuse demand and supply for real an entry `b in the l vector for the banking sector, plus capital with that for banking capital. (Is the neoclassical some “equity” capital B which may be necessary for the recognition that it is stocks, not flows, also in this direc- banks to perform their business. (This equity capital is tion?) indeterminate, this is one critique of the model.) Banks 17.6. KEYNES ON THE RELATION BETWEEN INTEREST AND PROFIT 71 do not get their profits from sales revenues, but from the 4.3.1 After 1932, Keynes viewed depression no longer spread between τ and i. a cyclical phenomenon but the product of autonomous influences of monetary phenomena on output. z>qi = (1 + r)(p>kb + w`b) + Br + z>dτ (17.2) 4.3.2. In 1930 and 1931, Keynes still had the traditional view with some new and contradictory ideas: (a) mon- In this model, output is assumed a fixed vector z. It does etary authorities may have difficulties controlling invest- not enter prices, and enters the banking sector only in the ment, (b) market interest rate may diverge from natural combinations which Panico calls D = z>d, and Q = z>q; rate for a long time, (c) Recovery may require deliberate then B consists of Q D plus any reserve requirements and vigorous monetary policy. − and cash reserves. In the second version of the model at 4.3.3. Radical break began with his attempts at “mone- the end of the book B has disappeared. tary theory of production,” see quote 124:2. Explicitly re- There are n + 1 equations for the n + 2 variables p, r, jects that the traditional theory was still valid in long run. and i; i.e., one degree of freedom. It can be eliminated by Different monetary conditions engender different levels of either taking the real wage bundle as given, or by taking i output. as given. 4.3.4. For this a theory of the interest rate is crucial. When i rises, then r and p rise as well and, with nomi- 4.3.5. Abandons concept of natural rate of interest nal wages fixed, real wages fall. If the real wage is given, 4.3.6. Important: Keynes’s theory of the interest rate. there is no longer an indeterminacy regarding how the Liquidity preference only a competitive mechanism. In- profits would be distributed between operating capital and terest rate determined by convention and policy. finance capital. Panico takes this to be another evidence 4.3.7. This theory of interest rate is different than tradi- that Marx’s approach was contradictory. tional one. 4.3.8. Evidence that Keynes wanted to find the fatal flaw in orthodox reasoning, which he suspected to be its 17.5 Keynes on the Interest Rate lack of a satisfactory theory of the interest rate. 4.3.9. Since Keynes did not succeed in this criticism, 4.1 Introduction his General Theory has, in the eyes of Panico, two weak- 4.1.1. Concentrates on period when Keynes turned nesses: (a) his analysis of investment contaminated by tra- away from marginalist school to a monetary theory of the ditional theory of interest, (b) acceptance of a positive full interest rate. employment rate of interest. This is why his theory could 4.1.2 What Keynes did and did not do: he did (a) aban- be reintegrated by the neoclassicals. don concept of natural rate of interest, (b) criticize the the- 4.3.10. Summary, pointing out similarity of Keynes’s ory determining this rate, (c) proposed alternative mone- theory of interest rate with that of Marx. tary theory of interest rate, but here is what he did not do: (d) put on solid ground his critique of marginalist theory, and (e) study thoroughly enough the factors determining 17.6 Keynes on the Relation be- “average” or “durable” interest rate. tween Interest and Profit Panico makes an interesting claim here: liquidity preference is only a competitive mechanism, but does not de- 5.1. This will give a different mechanism than that of termine the equilibrium rate. (See 129:2 about this.) But Marx how the interest rate can affect the profit rate. Keynes failed to address those factors that do. 5.2.1. Section 5.2. will give Keynes’s theory. 4.1.3. By-product of this investigation is assessment 5.2.2. Keynes’s theory of “own interest rates” and of of literature about Keynes: 103:2–104:3 Patinkin, and the tendency to their equality is related to theory of equal- 104:4/o Shackle. Both say Keynes ultimately studied dis- ization of rates of profit. Keynes recognized that (col- equilibrium situations. Panico says that in General Theory lected writings vol XIV pp. 102/3), but he did not develop Keynes wanted to criticize the real determination of out- a view of price formation different from that of Marshall. put and prices and substitute a monetary theory for it. Panico will try to develop Keynes’s views in a different 4.1.4 Summarizes Panico’s views on Keynes: he tried view of price formation. Keynes’s main concern was: how but was only partially successful in developing a purely do changes in interest rates affect investment and output. monetary theory. Panico’s concern will be: how do monetary factors and 4.2 Treatise already has liquidity preference but still ad- policies affect distribution and prices. heres to natural rate of interest. Monetary factors can be Panico concentrates on chapter 17, which was obscure effective only in the short run. and new to Keynes himself. 4.3 From the Treatise to the General Theory. 159:4/o summary how he will proceed. 72 CHAPTER 17. NOTES ABOUT PANICO’S BOOK

5.2.3. About equalization of rates of return in Trea- premium, which Keynes discusses elsewhere but not in tise four arguments: (a) Investors compare long term rate chapter 17. of interest with rate of return on fixed capital, but cur- 5.2.7. Keynes also does not define money very clearly. rency authority can only control short term interest rate. Panico defines money here. (b) Keynes however says that there is a strong correlation 5.2.8. Short term and long term bonds. Panico men- between short term and long term rates, through the fol- tions the complication that certain short term bonds are as lowing mechanisms: investors may borrow short in order liquid as money, but assumes that there is one short term to buy long term securities; investors, who like liquidity, and one long term bond, the short term being not liquid may find short term securities more attractive than long enough to give this complication. Long term rates should term ones if short term yields are high; and because of be higher because of possible fluctuations in the prices of psychology and ignorance about the future: “the value of these bonds due to short term rates. (This is a different a company’s shares, or even of its bonds, will be found to argument than saying that long term rates are somehow be sensitive to a degree, which a rational observer might closer to profit rates.) I.e., the illiquidity discount of short consider quite absurd, to short-period fluctuations in its term rates σb > 0 and σL > σb. known or past profits.” Panico makes a big deal out of the fact that there are dif- (c) About relationship between short term lending and ferent opinions about future interest rates etc., and present speculative holding of “liquid capital” which must be in- price comes from the market interaction of individuals ventories etc: the cost of carrying inventories is: deterio- with different views. ration in quality or suitability of the product, warehouse 5.2.9. More about this uncertainty. Chapter 17 talks and insurance charges, interest charge on basis of short about the market forces, while the other chapters dis- term interest rate, and risk premium against changes in cussed individual motivations. Nevertheless Panico says money value of the commodity. This risk premium has uncertainty enters in the same way. been missing in the comparison of short term and long 5.2.10. About the own rate of interest of real capital term loans. assets. Here Keynes runs into the problem of allocating 5.2.4. Summary about Treatise: shows how different the return on capital to the different kinds of capital assets. rates of return are connected, but does not do it very sys- 5.2.11. About real capital assets: its yield is that inter- tematically, and does not try to show that the interest rate nal rate of return ρk which makes the present discounted may influence the equilibrium position of the economy. value equal to the normal supply price of the capital. Chapter 17 in General Theory tries exactly that. Central Keynes disregards its rate of appreciation ak, Panico ex- concept is the own rate of interest: In terms of an asset, plains this because capitalists are not interested in selling the own rate of interest is yield q minus carrying cost c their factories. Then the risk premium must be higher than plus liquidity premium l. The own rate of money interest that of long term bonds: σk > σL. adds the excess percentage appreciation with respect to 5.2.12. How do these rates of return on different capi- money, called a. Therefore the own rate of money interest tal assets tend to equality? Keynes’s story is diminishing is q c + l + a. In equilibrium, these own rates of money marginal returns: if an asset yields higher rates of return, − interest will be equal. more of this asset will be employed, and the rate of return 5.2.5. Remarks once more that the analysis in chap- will decrease because of that. But such an explanation is ter 17 was intended to be a long period analysis: no asset not necessary. It can also go through price adjustments. was assumed to have a larger own rate of money interest 5.2.13. About this price adjustment he says it is slow, than money itself. Long period character can also be seen some good reasons in 175:1. But adjustment of rates of from the fact that he uses the long term supply price of return on financial assets is fast. Nevertheless, the trans- capital, not the short term deviations important for adjust- mission between different kinds of financial assets is slow ment processes. But sometimes he is inconsistent since he again, see 175:5/o. And Keynes says changes in deposit sometimes maintains the separation of real and monetary rates τ tend to lag behind. Panico argues that this τ is sim- economy, saying that market forces would bring interest ilar to the price of produced commodities. Banks need the rate down to the level where there is full employment. deposits and do not want to lose their customers. 5.2.6 Now Panico uses this framework for his own anal- 5.2.14. Now Panico asserts that the interest rate can ysis. He introduces the following variations: yield net of affect profit rate, although it is a slow process. First he carrying costs ρ = q c. Also value of assets and future asserts that the central bank can fix interest rate, and with revenues are all in money− terms. This seems to be an im- a lag affect the deposit rate τ. This will enable capitalists portant point about own rates of interest: the “yield” they to lower prices and therefore give a lower profit rate. deliver is often in terms of other assets, therefore must 5.2.15. Concluding summary section. Link between be translated by prices! Third modification: includes risk profit rate and interest rate is given by (here i is the short 17.6. KEYNES ON THE RELATION BETWEEN INTEREST AND PROFIT 73

term interest rate, and τ is the deposit rate, and the three liquidity discounts σ are exogenous):

τ = i σb (17.3) − τ = iL σL (17.4) − τ = r σk (17.5) − Therefore τ is no longer exogenous, but these equations determine τ and therefore i and iL once r is given. Chapter 18

Notes about Reiner Franke CJE 1988 [Fra88b]

In a simple fixed coefficient production model Franke Now he plugs the wage-profit frontier π = π(w) into the adds demand for loanable capital, and ends up with one left and the behavioral equation into the righthand side of degree of freedom between profit rate, rate of interest, and (18.1) to get the following relationship between w, r, and wage rate. Then he also adds supply for loanable capital i: and then both profit rate and interest rate are determined by the wage rate. π(w) = a(i,r)r + 1 a(i,r) i (18.4) − His model differs from Panico’s because he only looks at long term indebtedness, not the short term liquidity con- an equation which represents the distribution conflict be- siderations. tween industrial and financial capitalists. Here he obtains the interesting result that this gives his The vector p>Adiag(z) represents the capital advances in every period, he calls it K, but he does not distin- curve in figure 1. guish between industries and therefore we might as well For his growth model in section 3, he has to model how the households spend their interest and profit revenues work with the total capital advance p>z. The proportion a of this is owned and draws the profit rate r, the again. There is a constant propensity to save sc out of rest is borrowed and draws the interest rate i. (But why interest and profit. Therefore the monetary amount to be should two firms which sell exactly the same thing but spent for consumption is which have different ownership relations draw different (1 sc)(p> p>A wl>)z + wl>z = (18.5) rates of profit? This Question is dodged to some extent by − − − the assumption that all ownership relations are the same.) = (1 sc)(p> p>A)z + scwl>z, (18.6) − − Therefore the effective profit rate is and this is spent on the consumption bundlec ¯, therefore π = ar + (1 a)i (18.1) the actual consumption is − With the part of capital laid out in wages not drawing (1 sc)(p p A)z + scwl z profit this gives the familiar c = − > − > > c¯ (18.7) p>c¯ p> = (1 + π)p>A + wl> (18.2) The constant propensity to save indicates that a part of π If the wage and A are given, this determines , but there surplus value is exogenously reinvested. Some of it is in- is one degree of freedom with i and a. vested in real capital, and some in financial capital. It K is total capital. aK is owned, draws profit rate r, seems once this investment decision is made, the financial and (1 a)K is borrowed, draws interest rate i. There- − capital will remain financial capital for ever. The propor- fore gross profit = tion how much to invest directly is β, and that depends on aKr + (1 a)Ki = (ar + (1 a)i)K = πK (18.3) r and i at the time. − − Now he looks at steady state growth characterized by In other words, combined profit and interest are still proportional to K, with proportionality factor π = (ar + (1 z = (1 + g)Az + c. (18.8) a)i). Now this π is determined by the wages by the wage-− profit frontier. Two of the three r, i, and a can be chosen, The first observation he makes is that the growth rate and the third follows. does not depend on the way accumulation is split between

74 75 real and ﬁnancial capital, but only on the savings rate, via the Cambridge equation

g = scπ (18.9)

Then he speciﬁes β, the proportion of the accumulation that goes into owned capital, as a function of i and r again, with properties analogous to those of a: it is decreasing in i and increasing in r with

β(r,r) = 0 (18.10) β(i,∞) = 1 (18.11)

1 β can be considered a supply function for ﬁnancial capital.− The condition that demand of loanable capital equals its supply, as long as (18.9) holds, is simply

a = β (18.12)

The whole model consists of the above numbered equations plus one normalizing prices and one normalizing output levels. Counting equations and variables gives one degree of freedom. But it can be analyzed as follows in a recursive way: Assume w is given: you get z from (18.8) and (18.7). Then one needs (18.4) and (18.12) to get a(i,r) = β(i,r). Those two equations, decoupled from the rest, determine the interplay between profit rate and interest rate. He says there is at least one but there may be more than one steady growth path. Uniqueness can be obtained if he assues that a and β combine i and r in the same way. Then he gets the two frontiers, one is a wage interest rate frontier, and the other a wage profit frontier. In both the wage is given in terms of how many units of a fixed commodity bundle it can buy. This bundle can be considered the numeraire, i.e., the price level is normalized by holding the price of the wage bundle to unity. And he gets the result that a change in the wage w does not affect the proportions a and β (which must be equal to each other by (18.12)). 268:7/o Now he turns the causality around: influence of monetary policy on the wage. Decrease in i will cause r to fall and real wage to rise, and conversely. If one assumes that nominal w = 1 then a fall in the interest rate will cause prices to fall and vice versa. Same result as Panico. If households spend less of their investment funds on real capital, then also the equilibrium will fall (i.e., no perverse effect), and the profit rate will rise. Interest rate may go either way: it is depressed by the higher supply of loanable capital, and increased by the higher profit rate. In some cases he can show that i will at least rise less than r. Chapter 19

Eichengreen about Gold Standard and Great Depression [Eic92]

19.1 Introduction tained, and that existing parities would be maintained in a cooperative manner. 3:1 If finance is the nervous system of capitalism, then 6:1–3 Why credibility? Because link between mone- capitalism had a chronic neurological disorder in the in- tary policy and unemployment was not understood. No terwar years between WWI and WWII. theory how central bank policy would affect economy, and 3:2 Since all countries were affected by the Great De- labor movement was unable to challenge this. pression, one should look for its cause in the financial sys- 6:4 This started to change in first decade of 20th cen- tem linking these countries. tury. Still external targets were more important than inter- 3:3 Under the pre-WWI gold standard there was no nal targets. comparable slump. 6:5/o There was also no fiscal policy but a balanced 3:4/o After the gold standard was reconstructed in budget rule. No income taxes; revenues came primarily 1925, it quickly began to crumble again, starting 1929. from import duties. 4:1 In the prevailing interpretation, this collapse of the 7:1 Summary on credibility (domestically) gold standard caused a modest downturn to become an 7:2/o But ultimately credibility rested on international unprecedented slump. cooperation. If B of E adjusted bank rate, other Central 4:2 Therefore gold standard is traditionally associated Banks did the same. with financial stability, and its demise with crisis. This 8:1 In major crises there was open cooperation between book argues that, conversely, the gold standard itself was Central Banks. principal threat to financial stability. 4:3/o Why did the interwar gold standard work so 8:2 commitment credible because international poorly while its pre-war predecessor worked so well? 8:3 Difference to hegemonic role: in tranquil periods, How is the gold standard connected with the Great De- England was tacit leader, but in crises, international coop- pression? We must also show that removal of gold stan- eration was key. dard established precondition for recovery from Depres- 9:1 It is known that gold standard was a managed sys- sion. tem. But this management was done cooperatively by several countries. 9:2 WWI eroded credibility and cooperation. Adopt- 19.1.1 How the Gold Standard Worked ing corporatist strategies for labor peace, wartime govern- 4:4/o Common knowledge is: gold standard was so stable ments encouraged unionism. Wages became a political because it was effectively managed by its leader before the question. Employment policies. Doubts whether balance War, but between Wars England England was too weak of payments would prevail. Doubts about commitment to and United States unwilling to stabilize system. (Theory gold. Therefore capital may flow in destabilizing direc- of hegemonic stabiliity). tions, intensifying pressure on countries that were losing 5:1 E argues that there was not one hegemonic leader, reserves. but gold standard before WWI was decentralized multipo- 9:3 Monetary policy was publicly debated. lar system. 9:4 Therefore explosive inflations. Lesson was drawn 5:2 But credibility and cooperation were different. to insulate central banks from political pressures. But Credibility: that convertibility into gold would be main- their hands were tied. They could not even extend help

76 19.1. INTRODUCTION 77 to foreign Central Banks in need. This thwarted coopera- 13:2 Description of international capital flows in inter- tion. war period. 10:1 Fiscal policy was politicized even more. Therefore 13:3/o At first ample opportunity for American capital taxes and expenditures could no longer be regulated to to make profits in the countries emerging from hyperinfla- defend the gold standard. tion, 10:2 Summary. 14:1 This is a much more positive assessment of ac- 10:3 obstacles to international cooperation: commodating American monetary policy than others who (1) Domestic interest groups of those who would lose say this policy caused the stock market bubble. But this would prevent adjustment in economic policy that would boom is an unsolved mystery. have facilitated cooperation. 14:2 Causaly between boom and monetary policy goes (2) Dispute over reparations and war debts. the other way: in 1928 boom caused Fed to tighten since (3) Lack of a common framework prevented policy they thought speculation was diverting capital from pro- makers from reaching a common understanding. ductive uses. This curtailed US foreign lending. 14:3 First there was hope that capital flows would be 10:4/o France, which had persistent inflation, said one resumed soon, but then Depression came, therefore coun- should adhere more rigidly to gold standard and not do tries overseas defaulted: Latin America 1931, Germany discretionary monetary policy. Britain, which had avoided 1933. inflation and was witnessing the increasing multipolar nature of the international economy, said that intervention 14:5–15:3 Why was the recession so deep? Previously and cooperation (which sometimes allowed them to vio- most attemopts tried to explain it by domestic factors, but late the gold standard constraints) was necessary. E says reason is international. Exports had already fallen before onset of recession, therefore increase of exports 11:1 Federal Reserve of US was newcomer. Unpre- could not soften onset of recession. dictable because of conflict between FR Bank of New These exports had fallen because of the stoppage of York, which wanted international cooperation, and Board capital outflows had caused contractionary policy, Asym- of Governors in Washington DC, which did not think they metry of gold stnadard that only deficit countries must ad- had to. Therefore informal cooperation on a clubby base just. was disturbed. 15;4/o Why no natural maret rsponses to crisis (lower 11:2 A more formal venue might have helped, but wages etc.)? Answer is “coordination failure”: groups was not established due to conceptual and other differ- would have been willing to sacrifice had they known other ences. BIS 1930: since it concentrated on reparations, US groups would sacrifice too. congress refused to permit Fed to join. 16:1–17:0 Why these bad contractionary fiscal poli- 11:3 Examples how cooperation was prevented by con- cies? The states had no choice because of the gold stan- flicts. dard. 12:1 Since both credibility and cooperation decreased 17:1–2 If all countries would have reflated in synch, abruptly, interwar gold standard was unstable. these reflations would have stimulatd the economy without introducing trade deficits and capital flight. 19.1.2 Causes of the Great Depression 17:2–3 Is this right? The only way out would have been international cooperation. 12:2–13:1 New explanation of Great Depression. 17:2 France 1934/5 and US 1932 were aborted attempts 12:2 After WWI, BoP of USA was extremely strong to reflate. and that of all other nations weak. In mid-20s the external 17:3 London Economic Conference was opportunity to accounts of other countries balanced tenuously only by coordinate reflationary initiatives but failed, because of long term capital outflows from US. If these capital flows different theories. were interrupted the coutnries would have to go into a re- 17:4/o Summary: we explained the destablizing im- cession to balance their payments. pulse and why it propagated. 12:3/o This is what happened Summer 1928. Increas- 18:1 And why was it amplified? By the financial insta- ingly stringent Federal monetary policy cut off overseas bility which spread starting in the second half of 1930. capital investments. By an unfortunate coincidence, mon- Bank failures and financial chaos. etary policy in France was tight for independent reasons. 18:2 Why didn’t policy makers intervene to prevent col- Therefore gold drained into US and France, therefore lapse of banks? monetary contragion and also tightness of fiscal policies Because the gold standard made it impossible. in therest of world (Europem, Latin America). 18:3 Even if the central banks risk convertibility in or- 13:1 ?? der to save their banks then speculators would assume that 78 CHAPTER 19. EICHENGREEN ABOUT GOLD STANDARD AND GREAT DEPRESSION the central bank is not fully devoted to the gold standard 22:1 Many countries waited 6 months to a year after and speculate against the currency. and take their money abandoning gold standard before reflating the economy, out of the country, therefore the additional funds would be they made sure there would not be runaway inflation. This useless or even have perverse effect. is why currency depreciation was only effective with a lag, 18:4/o This effect was strongest where foreign deposits which created the impression that it was not effective at were most prevalent, namely in Europe. all. 19:1 Germany 1931 22:2 Beggar thy neighbour effect was stronger if they 19:2 Also USA 1933 and Belgium 1934. Conversely, did not reflate. Denmark 1931 and Sweden 1932 could contain incipient 22:3 Foreign countries who suffered should have gone banking crises, since they were already off the gold stan- off gold standard themselves. dard. 22:4 Instead, other countries raised tariffs and tightened 19:3/o cooperation would have helped, but it would quota, which made cooperation even more difficult. have had to be multilatoral cooperatio nbecause aof the 23:1 These haphazard devaluations caused the central sums necessary. banks to substitute gold for foreign exchange reserves. A 20:1 Structure of international banking system was at more orderly devaluation like that negotiated by France in fault; Central bank held gold and convertible foreign ex- 1936 could have prevented this. change. A minor deterioration in the position of one of the [Here E uses the ratex doctrine that only unxpected pol- countries might induce the Central Banks to adjust their icy is effective.] portfolios of foreign exchange, which has amplifying ef- 23:2 Why did countries stay wedded to the gold stan- fect. dard so long, and why did those who abandoned it fail to 20:2 Gold was supplanted by foreign exchange because pursue expansionary policies more aggressively? In part there was not enough gold. This is the Triffin dilemma. because of the balance of political power. Farmers who Could also be called the Milnarsky dilemma. (Refer- were both debtors and producers of traded goods wanted ences). evaluation, labor was ambivalent. Financial interests, who 20:3/o Threats to gold standard and domestic banking traditionally did not want to tamper with the gold stan- system were mutually reinforcing. Gold standard should dard, changed their mind when the banks were collapsing. not be looked at in isolation, but in connection with other 23:3–24:2 Different historical experiences. Some coun- factors. tries had experienced hyperinflations and therefore had phobic fears of inflation. Ironic that in the depth of Great Depression inflation was a dominant fear. 19.1.3 End of Gold Standard and End of 24:3–6 These inflations were often the effect of distri- Depression butional conflicts. 25:1–26:1 Countries with proportional representation 21:1 Conventional wisdom: deopreciations made possible were more likely to suffer inflationary crises. by abandoning the gold standard did not help domestically 26:2 Not only the views of the policy makers but also and hurt the other nations. But evidence says otherwise. the prejudices of the public are important. 21:2 Departure from gold standard freed up monetary 26:3 Summary: policy played a pivotal role in Great and fiscal policies. Keynes: “There are few Englishmen Depression. who do not rejoice at the breaking of our gold fetters.” (This is apparently where the name of the book came Question 30 According to Eichengreen, the gold stan- from.) dard worked well before WWI, but it did not work well, 21:3 Not only the gold standard, but also the gold ethos and was an important factor causing the Great Depres- (financial orthodoxy) had to be abandoned. sion, in the interwar years. What was the difference, 21:4–22:0 Belgium did it right: used devaluation as op- why did it not work any more? Eichengreen’s theory of portunity to expand domestic credit. xxx propelled by do- the Great Depression has many lessons for policy today. mestic spending; little change in real exchange rate, na- What are they? tional competitiveness, or trade balance. Checoslovakia depreciated without expanding credit: domestic goods became cheaper compared to foreign goods, and exports more competitive. Strengthened balance of paymetns, but output and employment slow to recover. Britain followed a course midway between these ex- tremes. Perversely adopted measures neutralizing the benefits of depreciation. Chapter 20

Fred Block, Origins of International Economic Disorder, [Blo77]

Preface tions whether a nation needs things produced abroad, or whether there are enough goods produced abroad to fill ix–x:0 The basics of international monetary matters are that nation’s needs have nothing to do with the other ques- not that hard to understand. Economists try to make them tion of whether this nation has the foreign exchange nec- seem complicated to obscure this system’s function of essary to buy these goods. From this Block draws the maintaining power relations among classes and nations false conclusion that it is the purpose of every nation to (what does he think power is? Money does not have balance its inflows and outflows of international money, power; its functioning must be backed by power.) and he classifies them according to the means which they Block realizes that the separation of the disciplines pol- use to do this balancing, into open and closed. itics, economics, sociology, history helps this obscuration. Continuum between open nations, which have mar- x:1 About earlier part of period many more sources ket forces determine their international transactions, and available. closed nations, which determine them without. Mone- x:2-xi:1 Acknowledgements tary order is: how a nation adjusts if it has discrepancies xi:2 To his wife: interesting. between receipts and expenditures of foreign exchange. Open harsh on working class, closed economies restrict prerogatives and interests of the capitalist class. 20.1 Introduction 3:3–4:1 The most powerful nations determine character of monetary order. 20.1.1 Nature of International Monetary Order 20.1.2 Gold Standard vs. National Capital- 1:1 His intent is to use international monetary history to ism illuminate the relationship between U.S. and Western Eu- rope. This sounds as if he regarded the history of interna- 4:2/o Mythological golden age 1875–1914 tional money to be a part of the whole relationship, from 5:1 Good description of mechanisms. which the whole relationship can be unraveled. 6:1 Capital flows and government policies under gold Is this correct? Or do we rather have to say: there is standard. an economic and a political side to this relationship, and 6:2 Ideologically, openness was justified on grounds of monetary history only refers to the economic side? I think comparative advantage, infant industry arguments were this second point of view is false since money only works downplayed. Openness benefited Great Britaon. as money as described in CI because this working is en- 6:3/o Reasons why this openness remained unques- forced politically. tioned. Then very nice explanation. 7:1/o In 30s there was another, now largely forgotten, Go where? A nation can buy goods from abroad only critique of openness. Keynes: let goods be homespun if it has international currency. This is an important con- whenever it is reasonably and conveniently possible, and straint which every nation must watch, and which forces above all let finacne be primarily national. many nations to do things which they otherwise would 8:1 Description of national capitalism. [It is an illu- not do; and it is an extraneous constraint since the ques- sion.]

79 80 CHAPTER 20. FRED BLOCK, ORIGINS OF INTERNATIONAL ECONOMIC DISORDER

8:2/o Block thinks it might be a possibility economi- U.S. Policy Debate during WW II cally. 33 Central issue: will there be a postwar depression? 9:1 But political pressures against it, because it might Fear that this would endanger the continuation of capital- be stopping point on road to some kind of socialism. ism. In clear text that means: how to preserve the reasons 9:2/o After WW2, European nations were on the way for depression without having one break out after the war. towards national capitalism, but US prevented that. One strand was Keynesianism (with labor unions); an- 10:1 Preventiong national capitalism was more impor- other was Business: supply siders, international competi- tant for US than danger of invasion from USSR. tion, small government. The compromise way out seems 10:2 This is the perspective shaping this book. to have been: not government as stimulus but strong exports! But how to pay for the exports? By imports and in the long run capital exports! PART 1: The Making of an Interna- 36:1 Requires open economy; eliminate privileged ac- tional Economic Order cess of imperial countries to their colonies. 36:2 National planners wanted closed economies for full employment policies. Here it seems that the “open” 20.2 The Decline of the Nineteenth and “closed” principally referred to capital movements, Century Gold Standard since this is what interferes with those policies! The policy debate was therefore presumably also the reflection of 12:1 In the interwar period they tried to reestablish the some deeper contradiction between capital and national gold standard, but there was no nation which could and states. It is actually the basic contradiction, that the state wanted to assume hegemonial power. That’s why it failed. can be useful for capital only within its territory, and the above compromise is its overcoming by imperialism. 20.2.1 Gold Standard and Britain 37:1 Idealist wing wanted a global New Deal. 37:2 Their ideals served to legitimize institutions for 12:2/o “Gold standard” was Britain’s means to function- the global exercise of U.S. power. Example: IMF con- alize the world for its economy. ceived as facilitating expansionary domestic policies. 13:1 As the main beneficiary, Britain took the most re- Treasure vs. State sponsibility to make the system work. While French and 38:1–40:0 Treasury: Top positions usually held by key German bankers often insisted on tying their loans to ex- bankers or industrialists; also initially under FDR, but ports, British bankers attached no such condition. Cites when they objected to some of his financial positions, [Blo59] and [Hir69]. I should look that up, if there is a FDR hired his long time friend Morgenthau. (Here it connection with the Bank Act. When British BoP was shows: the state is subject to the influence of business negative, Bank of England raised bank rate (this seems to only if it wants to be; it can rid itself of this influence be the 1844 Bank Act), tolerated ensuing unemployment if it no longer serves its goals.) Morgenthau a populist, al- as price to keep the international system going. British though not a Keynesian himself he had a staff consisting trade deficit allowed other nations to accumulate £. of Keynesians, including the left-leaning White. 13:2 Britisch Hegemony was also Achilles Heel. Sys- 40:1–41:2 State department. Hull: world markets for tem could not survive when Britain lost its lead. Signs world peace; Acheson: for maintaining capitalism; Clay- that after 1900, British had begun to abuse the unique role ton: export surplus to prevent unemployment. it had in the international order, and tried to evade adjust- 41:3 German industrial recovery necessary for multi- ment. Where does Block have this from? This is very lateral trade. See the very interesting Fn. 29 on p. 233. relevant for present situation of US. This was one way of making the accumulation of other nations useful for the U.S. Here the U.S. organized world 20.2.2 Interwar Years competition, although not in the general form described in Resultate 5; it probably emerged in the general form 14:1 Restoration of golcd standard after WW1 was only described there only as the sum of many partial decisions. form bereft of its substance. 41:1/o In contrast White and Morgenthau ... ? Origins of the IMF Roosevelt knew about the differences, nevertheless 20.3 Bretton Woods and the British gave both factions input in planning (to maintain his own Loan freedom to decide?). White charged with plan for IMF. See 43:2: in the earlier drafts it could even discount 32 Introductory, summary of domestic power struggle and rediscount bills! Fund designed to tide countries 20.3. BRETTON WOODS AND THE BRITISH LOAN 81 through BoP difficulties so that they did not have to deflate to regulate the private sector, while Congress wanted to their economies! Belief that rather independent national regulate the governments. Keynes wanted to set up a situ- growth would lead to international harmony. The quantity ation in which Britain had to compete, but could compete of credit which could be given is relevant! Changes in ex- successfully, and wanted to insulate this competition as change rates were made difficult, the bank had the right far as possible from U.S. control. to infringe on national policies! Made undesirable capi- The Fund and its Critics tal exports controllable (on the theory that one should not 50:6–51:2 Bretton Woods was a dictate of this plan to allow capital to flow freely!) the other nations. The size of the quotas was the only Modifications significant point of discussion. Less role for bank and more for fund. 51:3–52:1 Description of provisions of IMF. Quotas in Fund no longer to veto domestic economic measures. the Fund were like reserves in the banking system, but Here you can see the understanding that the Americans these reserves were not the means to clear payments! Is deserve their power and rightly guard their sovereignty: this a relevant difference? Read Bagehot! “The idea that some foreigners would try to tell Ameri- 52:2 Block’s criticism: 1) Fund irrelevant for recon- cans how to run their economy was bound to arouse the struction. If one thinks of it, it was really an impudence to ire of many legislators.” impose on those countries, who had much different con- Final form of Fund decided September/October 43 in cerns, the long term regulation, with the threat in the back- negotiations between the British and U.S. Treasury ex- ground that they would not get help in reconstruction if perts. they would not follow. I should work that out better in Keynes: became convinced that British should partici- Resultate 5, Chapter 2! Of course, also the thing with the pate in multilateral order. Why? See pp. 3–18, esp. 9–10, void. of vol 3 of [Hor] Alternative plans: For Keynes’ pro-bilateral plans only a few months pre- 52:3 Williams viously see [Gar69, pp. 41–42]. 52:4–54 Banking Community back to gold standard. In Keynes saw 3 problems: 1) Britain’s pursuit of full em- comparison with gold standard the fund looks really good. ployment policies after the war, 2) Due to war debt, over- However the gold standard would not have been polit- seas investment earnings could no longer finance imports ically feasible, and the Fund was a means to introduce of food and raw materials, so Britain at first needed credit, something like that over time. therefore trade bilateralism, and 3) afraid of “irresponsi- 54:1 Transformation of the fund as a strategy. In the bility” of American policies. political debate it looks like it was a strategy against the 48:1 Trick to lay burden of adjustment on surplus coun- fund, but I think it is correct to say that it was the only tries! But this violates the principles of competition. That purpose for the fund on which both parties could unite. it is hard to enforce is only a symptom of that. Did he want One can even say that this transformation continued into to force the surplus countries to invest? Compromise: the Seventies! small fund, in first years trade barriers allowed which The British Loan would be gradually removed. Here it shows that the U.S., 55:2 On the one hand Block said that FDR’s death since it did not see any reason to give up its sovereignty, caused a significant change, on the other that FDR would prevented a truly internationalist solution. The only thing have had to repudiate the Treasury’s foreign policy even- that remained was a commitment to multilateralism with- tually anyway. out any supranational authority, so that a void was created 55:3–56:1 No longer destruction of Germany’s heavy which could be filled by the U.S. whenever it wanted to. industry, and with this break with Soviet Union. 49:1 Scarce currency clause just a token. 56:2 The State department’s arguments against Bret- 49:2/o Now when it came to the conditions at which ton Woods: departure from gold standard, and it allowed the fund would loan, Keynes was in favor of loans with- Britain to maintain controls for 5 years. Revived Key cur- out conditions. White was leaning the same way. but rency plan. Two aims: Congress, which before was such an advocate of national 56:3–57:1 1) Attempt to buy Britain’s relinquishment sovereignty, was here on the side of interventionism: the of the discrimination of the sterling bloc against the dollar. reason Block gives is that Congress would not want to Was not the first such attempt historically. Specifics of this pay money without having control over it. One can al- discrimination. Alone the fact that the sterling bloc had ways find good reasons for something: Block did not see to discriminate against the dollar and that the U.S. could the purpose and direction in which these political actions offer such a price showed that the economic conditions for were going. Block also says that White was intervention- Britain’s imperial power were no longer there. ist and compares him with Congress: but White wanted 57:2–58:1 2a) Key currency plan: Since the dollars 82 CHAPTER 20. FRED BLOCK, ORIGINS OF INTERNATIONAL ECONOMIC DISORDER would be too scarce, a convertible Sterling should be 20.4 The Marshall Plan and Rear- the means of circulation supported by the London capi- mament tal markets. They needed something that had all the characteristics of the form of value enumerated in section 3 70:1 But in 1946/47 new dangers became apparent. Do- of CI, chapter 1, and which because of its being capital mestically an anti-internationalist mood; in war-ravaged also would serve as a means of payment for international European countries resistance against capitalism, in the trade. And: the obstacles to be overcome that such a plan poor countries rise of nationalist forces, and enhanced can become implemented. power of U.S.S.R. 58:2/o 2b) Second thing for which U.S. needed British 70:1/o Interconnection of these cooperation was the removal of trade barriers. 71:1 British loan and similar other loans were ap- 59:1 Britain was to be bridge between U.S. and rest of proved, modification of IMF design was started, and world; had to be kept not too weak and not too strong. meeting to create ITO. But winter 46/47 it became clear 59:2/o U.S. wanted trade concessions from others with- that new policies were necessary to achieve multilateral out removing its own tariffs; instead it tried to get them by goal. “financial leverage.” Approving the British Loan. 71:2 In British Parliament Britain’s options 71:3–73:1 In Congress strong currents against it, ques- 60:1 Alternatives for Britain: either £ as world currency tion how to relate to Soviet Union, anti-Soviet argument and not controls on international transactions, or £ only in carries it. a limited area, shielded from outside. 73:2 This made other loans virtually impossible. 60:2/o After Keynes’s failure to obtain a clearing union First meeting of Bretton Woods institutions assuring international credit, labor and left was leaning 74–75:1 Keynes 3 goals to minimize American influ- towards continuation of extensive controls. ence, none was successful, heart attack. 61:1 Joined conservatives who wanted to concentrate International Trade Organization on Empire. 75:1–76:1 Doomed to fail because trade liberalization was not feasible, with the economic difficulties of most 61:2 London City interests and certain business in- nations involved. terests generally opposed to government control favored multilateral trade. The Situation in Europe 76:2–77:1 Economic difficulties and harsh winter; 61:3/o Even after Bretton Woods and Keynes’ conver- trend not toward liberalization but toward controls and sion to multilateralism still undecided. “Seemed” to de- bilateralism. Books give many examples how bad the pend on role U.S. will take. Did Block mean to say that planning worked, as an excuse why free market economy was a misconception? would be better; but in fact there seems to have been a Negotiating the Loan great danger that the states would go national-capitalistic 62:1 Lend-lease cut off suddenly after V-J day earlier path which would not be profitable for the Americans. than expected. Strength of the Left 62:2–63:1 New Labor government had to rely on This and the next two headings describe forces driving Keynes to negotiate the loan, thus was pushed in more Europe away from multilateral trade. liberal direction. 77:2–79:1 Population desired social reforms. Employ- ers raise prices to catch up. Tis inflation made free foreign 63:2–64:3 What if there would not have been a loan? trade impossible. Danger that control of foreign trade be 64:4–68:1 Americans ready to be generous but wanted extended to domestic industry. three things: The International Weakness of European Capitalism (1) Remove controls on sterling transactions (dollar 79:2–81:1 Old trade pattern money following the sun pooling) broke down. Hence pressure for Europe to 1) discrim- (2) Partial writeoff of sterling balances held by India, inate against dollar, and 2) establish bilateral trade with Egypt, Argentina, etc. colonies. The Power of the Soviet Union (3) Trade liberalization 81:2–82:0 Finlandization would also put pressure on Conclusion: West Europe against multilateral trade 68:2/o It seemed the U.S. had licked the problem of U.S. Economy and International Situation instituting multilateralism, but the British Loan was going 82:1–83:1 U.S. exports rise sharply but peak in mid to be a failure. 1947 because of depletion of foreign exchange by im- 20.4. THE MARSHALL PLAN AND REARMAMENT 83 porting countries. Major U.S. aid program proposed, to 95:2/o This crisis provoked several strategies in U.S. finance exports and attack all other forces against multi- Treasury Plan lateralism. 96:1 Proposed devaluations of European currencies and 83:2 March 47: Truman doctrine, invoked Red scare full convertibility, to allow American investment to fi- for aid for Greece, was successful nance American exports 83:3/o May 47: Acheson: necessity to rebuild Germany 96:2/o There had been no devaluations earlier, because and Japan. June 47: Marshall Plan. Second half 47: Com- they would have brought perverse effects. munists pushed out Italian government, deflationary mea- 97:1 But not time war ripe for realistic exschange rates sures in expectation of Marshall Plan. as backdrop for liberalization. 84:1 ITO no further progress 97:2 U.S. uses IMF to push exchange rate realignments 84:2–86:0 Convertibility to Sterling failed. Reasons: (in violation of IMF Articles of Agreement) (1) No confidence in £ because Britain’s economic weak- 97:3/o £-devaluation in unfriendly Anglo-U.S. inter- ness. (2) Britain had not negotiated settlement with large change sterling holders. Keynes died before getting to it. Why 98:1–99:0 Devaluations in September 18, 1949?, but not? Exporters hoped to sell British goods to them. did not bring end to trade restrictions. Treasury plans had 86:1 Yet loan had advantages: solidify Anglo- been unrealistic, to be abandoned. American relationship, made British addicted to dollar, The European Cooperation Administration Plan ready for another fix. Prevented definite move toward bi- 99:1–100:0 Pushed economic integration, to force Eu- lateralism. ropean producers to become more competitive, and mar- Marshall Plan: Theory and Practice ket American investments. 86:1–87:1 Technicalities of its implementation. “Fall” 100:1 European Payment Union to be first stage. of Czechoslovakia background for a war scare. 100:2/o British problems with EPU: wanted to remain 87:2–88:0 first half: Several goals accomplished: bilateral in European trade because of vulnerability of 88:0 second half –89:0 Paradoxical nature of Marshall pound. Also interesting: British suspicious of EPU be- Plan. Recipients had to earn dollars, i.e., become compet- cause it substituted an intergovernmental credit mech- itive. In the last analysis to be resolved by private invest- anism for the historic credit-providing role of British ment. Important! bankers. Agreed due to armtwisting by U.S. 89:1 Large American political influence in framework 101:1 Also interesting: treasury department feared, of Marshall Plan. EPU, relieving bilateral discipline, would lead to] infla- 89:2–92:0 Three economic goals of Plan: multilateral- tion. ism, price stability, recovery of production. 102:1–2 Weaknesses of integration plan too long term, 89:2/o Multilateralism little progress danger that results in regional national capitalism. 90:1–91:0 Price stability: drastic deflations in State Department Plans Italy, France, Germany; split labor movement along 102:3–103:1 Kennan plan, economic integration of communist-anticommunist lines U.S., Canada, Britain. Drastic, shows how serious the 91:1–92:0 Investment goals: conflicted with deflation. problem was considered. Way out: planning was to make the investment as effective 103:2/o Acheson and Nitze Plan: rearmament in U.S. as possible. and Europe, to create demand in U.S., allow continued The Crisis of the Marshall Plan aid to Europe, and prevent Europe from closing itself off 92:1 Despite short-term gains it was not yet certain from U.S. whether long term goals would be reached by 1952 104:1– Evolution of rearmament policies. 92:2/o Prolongation not possible for domestic political 104:1 Fall 1949: S.U. exploded atomic device and rev- reasons olution in China, hence plan to develop hydrogen bomb 93:1 In addition three problems. irresistible. 93:2–94:0 First recession, not only inventory but reluc- 104:2–105:1 Required increase in defense expendi- tance to invest, because exports too unstable. Anxiety that tures, not willing during inflationary conditions of 1948. Depression would return. Argument that SU wanted U.S. to arm itself to death. 94:1–95:0 As a consequence: sterling crisis, chronic Might also have jeopardized Marshall Plan Aid. First sec- problems became acute, Britain asked for increase in Mar- retary of defense, Forrestal, favored increases but was un- shall Plan allotments. successful. Second secretary of defense Johnson was bud- 95:1 Crisis in OEEC, which ignored some U.S. de- get cutter, successful. mands, therefore was relieved of responsibility to dis- 105:2–106:0 Deliberations between defense and state tribute Marshall Plan moneys. department Jan–March 1950 NSC-68: state department 84 CHAPTER 20. FRED BLOCK, ORIGINS OF INTERNATIONAL ECONOMIC DISORDER wanted to raise defense ceiling to 3–4 times original fig- 111:1/o Prohibition of Marshall recipients from draw- ure. Block takes it as indication that it was not just a de- ing from Fund not only give Marshall bureaucrats more fense necessity? leverage but also had effect on fund: allowed U.S. to es- 106:1/o Also Negotiation from strength indicated that tablish strict criteria precedents for drawing on Fund. accommodation with Su at that time would have excluded 112:1 Important: Another element in fight against un- Europe from international trade context, bilateralism. controlled liquidity creation is keeping gold price low! 107:1 Rearmament would resolve recession in machine (although U.S. owned most of gold). Argument that in- tool and aircraft industries. Military Keynesianism did not crease of gold price was inflationary. have to rely on national economic planning. Two proposals to liberalize Fund rejected by U.S. 107:2 Also would strengthen ties with Europe 113:1 Opposition to increasing IMF’s resources. 107:3/o Outbreak of Korean war created political cli- 113:2 Advantages: Fund would simulate traditional mate to press for rearmament. discipline of gold standard, increase leverage of U.S. aid 108:1 Large part of appropriations used for long-term and desirability, therefore clear path politically, for U.S. rearmament. Investment. Inflation danger. investment. 108:2 Finds ironic that war that was to absorb overpro- Also U.S. had to be careful that liquidity did not be- duction led to more production. In long run it would zap come too scarce, so that countries would continue to play economic strength of U.S. by the rules. State always has this dilemma when enforc- ing capitalist constraints! 114:1–2 Would have been ideal to resolve liquidity shortage by private investment, as England in 19th cty. 20.5 Toward European Convertibil- But until 1955 not enough was forthcoming due to lack ity of convertibility. Therefore Aid, Marshall Plan, military policy was their means to pump dollars at that time. 109:1 Summary: Closing of dollar gap in fifties achieved Rearmament and Foreign Economic Polciy by rearmament and support for European regionalism, 114:3–115:1 After beginning of Korean War $5 billion both of which would undermine the long-term dominant military aid to NATO nations, but not all of this repre- position of U.S. sented dollar outflows. 109:2/o Technically the trick was amount of interna- 115:2 Also Korean war expenditures and military bases tional liquidity: Footnote: “Sum of international assets around the world increased dollar flows. held in national reserves, and readily available credit in in- 115:3/o Other byproducts of military dependence are ternational currencies.” Too little liquidity would induce closer economic dependence. Presence of troops counter- countries to make bilateral agreements and close them- weight to “pull” of Soviet Union. selves off to mulilateralism (world market). Too much 116:1–117:0 Danger that West Germany would alter its liquidity would lead to inflation. Trick was find right pro-Western stance and become neutral. Political struc- amount. ture by occupation forces was artificial, danger that SPD 110:1 Political obstacles to liquidity creation: protec- and business interests with historic ties to East would tionists prevented creation of liquidity by more imports, change Adenauer’s Western orientation. and anti-internationalists opposed direct aid payments. 117:1–119:0 Since original strategy to tie Germany to American policy makers fought to block proposals for West by economic means alone did not seem effective uncontrolled international liquidity creation, and to in- enough, strategy to rearm West Germany. EDC failed due crease liquidity flows under American control. to French resistance, but rearmament with full sovereignty Important concepts: in addition to monetary constraints in 1954. discussed in volume II, in the international context there The Costs of the Rearmament Policy is also the question that the different parts of the interna- 119:1 Domestic rearmament made trade liberalization tional economy have to have not only the money avail- less urgent. Congress dragging feet in tariff reductions able, but also the right international currency (but it was a throughout 1950s. question of access to the dollar). U.S. tried to control the 119:2/o Propaganda with Soviet threat might backfire access which other nations had to the dollar. into saying that Europe was indefensible, fortress Amer- 110:2/o Phases in struggle against uncontrolled liquid- ica. ity creation: Defeat of Keynes’ credit union scheme, with- 120:1–121:0 Importance of Europe’s industrial capac- drawal of White’s plan, After Bretton Woods American ity. In 1951, arm twisting so that France and Eng- pressure to make conditions for drawing on IMF more land would start rearmament, since this would improve stringent than original intentions. Congress’s willingness to help with the arms. 20.6. ROOTS OF THE U.S. DEFICIT 85

121:1 In Britain rearmament caused disenchantment in preceded by long debates. labor party, Conservatives into power, new Sterling crisis. 130:1–131:0 Germany: trade surplus since Korean war France: sharp political protests, speculation against Franc. boom, chronic creditor nation in EPU, which became ob- New import quotas in both. stacle, since much of its credit within EPU could not be 121:2/o After 1953 defense spending decreased again, used to balance deficits outside EPU. Pushed toward hard- liberalization resumed, but weakening of £ and permanent ening settlement mechanism within EPU. loss of markets to West Germany, 131:1–133:0 Britain: In retrospect, ties with Sterling 122:1 Domestic cost of rearmament: high tariffs and area seem very costly. Plans of Sterling convertibility on inefficient plant, undermining U.S. trade balance in long floating basis rejected by U.S. De facto convertibility of run. Sterling since 1955. Setback due to Suezs crisis in 1956, Support for European Regionalism therefore actual convertibility in 1958. 122:2/o Danger that regionalism would develop into na- 133:1–134:1 France: Despite high investment difficul- tional capitalism with inconvertible currency into dollar, ties because of wars in Algeria and Indochina, and mil- and import restrictions. To counteract this, U.S. throws itant labor movement. In 1955, de Gaulle successfully support behind “little” European region. implemented austerity and devaluation. 123:1 Important difference between EPU and Keynes’s Conclusion clearing union: in EPU, pressure of adjustment was on 134:2–137:1 American goal of convertibility was deficit countries. Block gives as reason that otherwise reached, later than planned, and at higher cost. 1958 was surplus countries would lose competitiveness with U.S. also first year with sizable drain on U.S. gold stock. This Growth as a more intrinsic reason? deficit was related to means by which convertibility was 123:2/o Another strand was removal of quota in Eu- restored. Still high tariff levels both in U.S. and Common rope, even though this would discriminate against U.S. Market. Danger that Common Market would close itself goods, on the rationale that this would increase compet- off. itiveness and in long run promote free trade. Gold drain: U.S. ran BoP deficit throughout 50s. In first 124:1 European Coal and Steel Community to defuse half, foreign countries kept dollars as reserves. In second conflict between France and West Germany over Saar and half they had enough reserves to convert some of it into limit Germany’s warmaking abilities. gold, at same time, U.S. deficit increased. In first half, 124:2/o Reasons for little Europe. First does not seem economic and military aid had to do pumping since there to make sense: that liberalization between nations would was no investment. In second half, investment was added, also lead to liberalization to outside. Perhaps because it and military apparatus could not be dismantled. Also de- would induce more competitiveness? But customs unions terioration of U.S. trade balance because of increase of compensate for higher tariffs to outside by liberalization European and Japanese competitiveness. U.S. firms, in- inside. stead of modernizing, built branch plants overseas, which worsened deficits. Second reason: would bind West Germany without 136:2/o important: Claims that U.S. failed to provide making all of Europe less easily accessible to American the multilateral institutions necessary. I wonder if his mul- goods. tilateral decentralized vision would have been possible. 125:1–126:0 Six all agreed with U.S. on basic eco- 137:1/o Important: no safeguard against speculative nomic issue and anticommunism. U.S. would have liked capital flows! Britain to join, but Britain’s commitments in Sterling Question whether U.S. would be able to provide re- area would have watered down integration efforts. Af- sponsible leadership for the system it built up. He seems ter British refusal to join ECSC, full US support for little to imply: although the U.S. was not as irresponsible as in Europe. interwar period, it still was not meeting all its responsibil- 126:1–2 European political community was defeated, ities. but in 1957 Treaty of Rome founding EEC and European Atomic Energy Community. 126:3–129:1 Competition between larger free trade as- 20.6 Roots of the U.S. Deficit sociation and EEC, resolved by close ties between Ade- nauer and de Gaulle and de Gaulle’s commitment to mul- 140:1 This obscurantist: “there is no objective technique tilateralism. This assured that things went the way the for a country’s international payments position! Second U.S. wanted, even without England. point, the importance of the publication of the number, is The Road to Convertibility a much more relevant argument. 129:2/o In December 1958 EPU was dispelled, all ma- 142–144 Government account: in fifties necessary to jor Western European currencies became convertible, but supply dollars; afterwards not an optional item any more. 86 CHAPTER 20. FRED BLOCK, ORIGINS OF INTERNATIONAL ECONOMIC DISORDER

Military expenditures soared in Vietnam War, and interest withdrawals, Japan access to U.S. capital markets, Canada payments on government bonds really soared in 70s even had to limit its reserves to get access! Defense of 144–149:1? Trade: strong after war, 57 high point, 59 pound, which was both lightning rod and bulwark of de- deficit (but both have to do with reorientation of trade due fense. Attacks up in 1964 when Labor government come to closing of Suesz canal), then 60–64 rose again steadily, to office: inherited desperate situation from conservatives then decline. Surplus declining in consumer goods, in- who tried to win the elections by stimulating the economy. creasing in capital goods 186:2–189:1 Wilson should have devalued, but didn’t. 146:1–147:1 Why decline? Competition of Europe and Renewed speculation against £. U.S. helped, but devalu- Japan, who had “advantage of backwardness,” (statred ation 1967 ended U.S. commitment to use £ as front line with state of art equipment). Before mid 60s, no inno- of defense for the $. Was very costly for Britain. vations in U.S. industry due to tariff protection and the 189– Last line of defense of $ was international mon- investment abroad. Rearmament drain of technical talent. etary reform. Alternative sources of liquidity, since in- 147:2 Rise in capital equipment due ot military equip- creases of $ would end up in a run on gold. Creation of ment. Block gives good reasons against specialization in SDR’s was rather a diversionary tactic. Conceded in fact high-tech products: limited size of market, other countries veto power to EEC (192:3/o)) and could be used to protect might want their own. $ against speculative attack! 148:1 Some reasons for the lead are political, and lead Third Phase: threat with import surcharge caused EEC is shrinking to lower tariffs. 148:2–149:0 Raw materials strongly negative after 71 193:1–194:0 After 1967 speculation against $; caused 149:1 But agricultural products strongly positive after Vietnam escalation to stop. 71. 194:1 Abandonment of gold pool let others bear the Services, tourism, private remittances burden of defending the value of the dollar. 149:2 slowly deteriorates 194:2–196:1 Financial deterrent, i.e., threat to end con- 152–155 Direct investment, net flow positive from prof- vertibility, based on Kindleberger, etc. Finally the U.S. its on earlier investments recognized that gold would not be a hindrance for them. 155 Other long term capital much too short discussion 196:1–197:44 Nixon implemented that policy. 159:1–163 The traditional remedies would not work; 197:2–199:1 Europeans did not fight but accept Amer- 163 quite lucid! ican move, floating exchange rates logical consequence. Evaluating the Passive Strategy 199:2/o Huge increase in freedom of action. 20.7 Managing the U.S. Deficit 200:1 Also some disadvantages to floating. 200:2 Therefore central banks intervene to make mar- 164 Three phases of policies 58–75 Speculation requires kets more orderly, but limits to “dirty floating” hazy. and strains international cooperation, danger of run on States might try to competitively depreciate their curren- gold stock and crisis was exaggerated in early years. cies. 1956–64 Atlantic alliance: detente was a threat to it; Also danger of vicious circle devaluation—inflation. also U.S. taking influence in the newly emerging third 201:1 Especially the U.S. must avoid inflation for its world countries. Aid: OEEC into OECD, EEC prefer- international strategy. ential relations with parts of Africa. Arms: MLF rejected, France and Britain own nuclear deterrent. Trade: 201:2/o Uncertainty of gains due to low exchange rates. Kennedy round belated; British entry to EEC vetoed by 202:1 That is why there is still debate about going back France. Finance: Swap agreements, gold pool, expansion to fixed exchange rates. of IMF resources divided: France and Germany against, England and U.S. for Roosa bonds. This period ended with the interest equalization tax! 20.8 The International Monetary 1964–68 Holding action with increasing capital con- Order in Crisis trols: Thought Vietnam war victory was just around the corner, afterwards they would strengthen BoP again. 203:1 U.S. successively broke the rules, or forced other 183:2 measures and connection with escalation steps in countries to break the rules (floating rates) in order to have Vietnam. Domestic inflation. more freedom of action. 183/184 Interesting point: tax increase was ruled out 204:1 Block blames inflation on monopoly power, in- for fear that this would consolidate resistance to the war. stead of a missing or a too elastic monetary constraint 184/185 Secret agreements with foreign central banks 204:2/o Dangers of deflation (but Reagan showed it was not to convert dollars—Germany threat of U.S. troop possible) 20.8. THE INTERNATIONAL MONETARY ORDER IN CRISIS 87

205:1 Incomes policy, why it is not feasible 205:2/o Policies made more difficult in open economy 206:1 International spread of other inflationary processes 206:2/o Inflation exacerbated by international liquidity 207:1 Despite international linkages, inflation will not equalize between nations. 207:2/o These divergences in inflation create balance of payment difficulties. Exchange rate adjustments. 208:1–209:0 Exchange rate adjustments may not work as desired, since (a) devaluation induces higher prices, and (b) quantity of exports may not increase enough 209:1 This is why floating exchange rates are not the panacea. 209:2/o Point: adjustment mechanisms can intensify inflation 210:1–211:0 Reform is needed. Chapter 21

Guttmann’s “How Credit Money Shapes the Economy” [Gut94]

An interesting companion volume is [Gut97]. Newer xix:3 G is a little opaque here. I think crisis was averted literature see [BJ95]. by Reagan’s arms buildup and safe-haven capital inflows. Debt apparently rose even faster than before, but this time with high interest rates and budget deficits. This extraor- Preface dinary rise of debt kept the US economy growing at a moderate pace for nearly 8 years. xvii:1–3 Skip this nonsense. xix:4 Debt grew faster than income, and interest rates xvii:4/o Money is not another good, it is a social institu- were above growth rate. This could not last, there was a tion which integrates but also can disrupt—both by break- recession in 1990, and therefore now (1994) G sees the ing connections due to hoarding, and by inviting overex- need for long term restructuring. tension in its abundance. xix:5/o Symptoms of this need for restructuring: dein- xviii:1 Therefore the modalities of creation, distribu- dustrialization, structural unemployment, asset deflation, tion, and circulation of money are very important. They shifting fiscal priorities of government, pressure from for- have been different in different historical periods. eign competition. Less visibly, a remaking of the finan- Question 31 Guttmann emphasizes the importance of cial system. “Prospects of US economy depend on how monetary institutions. He says the most important insti- well we manage to contain the social cost of private bank tutional change happened during the Great Depression. money: tendency towards credit overextension, propen- Which change does he mean, and which effects did this sity for high interest rates, and the growing dominance of institutional change have? short term financial capital.” Additional complicating factor is the technological switch to electronic money. xviii:2 The most important change took place during Question 32 In the 1980s, the USA became the world’s the Great Depression, when the gold standard was re- largest debtor nation. Guttmann argues that this is in placed by inconvertible credit money. This made things contradiction with it being the issuer of the key currency. much more elastic, and therefore provided the institu- Why? Which historical example can Guttmann point to? tional underpinnings for monopoly pricing, regulation of wages by collective bargaining, deficit spending by the xx:1 Reform also needed internationally. US became public sector, and lender of last resort interventions. This the world’s largest debtor nation, and that is in contradic- “greatly contributed to the amazing economic expansion tion with it being the issuer of the key currency. Why? As of the first two postwar decades.” issuer of the key currency, you need a stable currency, and xix:1 Under the gold standard, the stagflation of the 70s as a debtor nation there is the tendency to devalue. Great would have been depression. Britain could not escape this contradiction in the late 20s xix:2 During the 1970s ever rising borrowing needs col- and early 30s. Nor will the United States in the 1990s. lided with declining creditworthiness of debtors Was mit- xx:2 Three scenarios for the future: (1) continuation of igated at first by accelerating inflation and artificially low leading industrial nations’s cooperation in managing the interest rates. But banks could not make money this way, emerging multicurrency system. and when they revolted, in 1979, the US economy suffered (2) World economy will gradually disintegrate into 3 a classic debt deflation adjustment not seen since the 30s. competing blocks: Americas, Europe, and Pacific Rim, (More details pp. 133/4.) with the leaders United States, Germany, and Japan.

88 21.1. THE ECONOMY IN TRANSITION 89

(3) Most difficult yet most satisfactory: international tinue to plunder the world. Much of this seems to me a monetary system replacing all key currencies with a consequence of the internationalization of capital rather supranational form of credit money. than its reason.] Shortage of skilled workers makes it re- xx:3/o Book written for widest possible audience with- liant on “brain drain.” [G seems to think we must make out making simplifications. Also tries to move forward sure this continues, instead of educating our own people.] the often sterile debate on money among the economists. Many firms have production capacities which far exceed what they can sell at home. Foreign debt is best serviced out of export earnings. Part I: Theory of Money 21.1 The Economy in Transition 21.1.2 Globalization of Economic Activity 6:3/o capitalism always epansive. After WWII this glob- 21.1.1 The Bitter Taste of Victory alization was under American leadership (Bretton Woods, Gatt, Marshall Plan). 3–4:1 Collapse of Soviet socialism showed backwardness 7:1 Today’s globalization is qualitatively different, be- of their system, but rising income gaps and the disman- cause world is rapidly becoming a single economy. tling of the social safety net also shows the brutality of market system. 7:2 All countries have become dependent on trade, 4:2 After victory in Cold War: what will happen with • even USA. Increases interdependence. military-industrial complex and how to achieve bipartisan foreign policy consensus, how to redefine national secu- 7:3 No longer multinational but global corporations. • rity, how to convert a bloated defense industry, how to use Amazing wave of international mergers, ability to peace dividend? avoid regulation and taxes. 4:3/o No longer the military strength decisive, but eco- 7:4/o Global information technology nomic competitiveness. Powerful challengers Japan and • a reunited Germany. Several countries with large popu- 8:1 Large migrations of population, increased mobil- lation surplus and important natural resources: Mexico, • ity South Africa, Nigeria, India, China. 5:1 Loss of US hegemony is apparent in loss of market 8:2/o Business cycles much more synchronized since shares, huge trade deficits, accumulation of debt owed to • early 70s, due to floating exchange rates. G consid- foreigners, turned from largest creditor to largest debtor ers the oil price hikes as sympoms of a flawed cur- nation. rency system since 1971, rather than as symptoms of 5:2 Productivity growth slowed to a crawl. US rein- a flawed international economic order, in which oil vests much less than Germany or Japan, lags behind in and raw materaials have been falling in ;rice since research and development, and directs most of it towards 1945. the military. This is especially troubling since we are at the threshold of several new technologies. Dismal edu- Truly international problems: debt crisis; shortage of • cation system. Crumbling infrastructure: roads, railroad, savings to meet long term global investment needs airports, water and sewer systems. Adversarial labor- [how does he measure here “shortage”? by prof- management relations. Short term planning and invest- itability?]; degradation of environment; threats to ment horizon of corporations, high cost of capital. food supply; arms race [he does not mention the pro- 5:3/o These are structural problems long in the mak- liferation of nuclear weapons]; AIDS epidemic; ex- ing, and covered up for a long time, before they could no plosive population growth. longer be ignored. 6:1 Such a difficult situation invites isolationism, which 9:2 We need a new mega-economic theory of the is is dangerous. US must play leading role integrating emerging international economy. world economy and preventing it from falling into three blocks. [G is concerned with: how to preserve the hege- 21.1.3 The Limits of Neoclassical Ortho- mony of the US, prevent the US from going down the doxy drain like the UK.] 6:2 US cannot isolate itself economically [as if this 9:3 Big changes recently in the economy: workplace, needed any further proof as long as we have capitalism]: technology, structure of key industries, economic policy, needs to import crucial products such as oil, steel, semi- international relations. Therefore economists should be conductors, consumer electronics. [G wants the USto con- busy. 90 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

10:1 However economists are myopic, specialized, and 11:5 Ignores uncertainty (which is not qunatifiable mathematical. Don’t see the big picture. Why? Because like risk) which prevents the agents from optimizing and of commercialization, in whjich economists p;rovide spe- forces them to be satisficing (is this G’s word for a dialec- cific services for paying customers (publishing for tenure, tical analysis and acting on reasons?) run financial models for corporations, investment letters, 11:6/o Instead of uncertainly they have a notion of re- policy advice.) General theoreticians are dying out. versible logical time, where mistakes can be undone, in- 10:2/3 Problem goes even deeper. (Now he goes from stead of historical time. sociology of science to the inability of economics to ex- 12:1 stresses again the absence of the time dimension plain reality:) mainstream school lacks the tools to the- of production in NC economics. This is indeed an argu- orize the dramatic changes we are currently witnessing ment for the Foley model. Depreciation of capital, debt because it looks at equilibrium only. [This critique does maturities, payoff periods for investments. not go far enough. This static outlook makes it ahistori- Besides, it is also ahistoric. cal, follows from the assumption that economic structure 12:2 This system also ignores what makes the economy is centered in human nature. Ultimate reason for the bad a social system, moves straight from individual behavior theory is the class nature of society.] to the economy as a whole. Again it is not very clear, 10:4 NC economics based on homo oeconomicus with but he addresses here methodological individualism. They perfect information and foresight. G does not criticize it also consciously abandon the concept of value in favor of for methodological individualism here, but makes noises subjective utility. Redefines economy from growth and in this direction in 12:2. Does also not criticize the mod- distribution of wealth to the allocation of resources. eling of all decisions as quantiative decisions. In NC eco- 12:3/o An example of the consciously nonsocial analy- nomics, marginal effects count, the last dollar spent on sis the analysis of markets, which reduce them to the sum- different goods brings the same marginal utility, and pro- mation of individual demand and supply. This cannot be ducers produce at output levels at which marginal costs a summation, but market participants observe each other and revenues are equal. and react to each other. Every market has a specific dis- 10:5 Market demand and supply is just the addition of tribution of power, forms of competition, [information,] those microeconomic optimization rules. That is perhaps etc. some kind of critique of MI, this is reducing society to the 13:1 It is logically consistent and beautiful [I think this individual. Marx says that for demand and supply one has is the third time that he says this] and it legitimizes free to know the relations of the classes. markets, private enterprise, profit maximization. But it 10:6/o The simultaneous functioning of individual mar- does not explain how the economy really works. kets gives general equilibrium. Transition to general equi- 13:2 Changes very quickly, which creates winners and librium depends on the unrealistic asssumption of an auc- losers. Also has a cyclical behavior which there is no tionnier. Leads to Pareto efficient outcome. room in neoclassical theory. Comparative statics says that 11:1 Factors of production: labor, machine, land, give it moves from one equilibrium to another. income to their suppliers. [If one reads this, one thinks 13:3 Income inequality and cyclical instability call for they should give incomes, due to their sarcity. But one government intervention, but conservatives believe that does not ask why there is a scarcity of supply of machines; the market can self-regulate, despite evidence to the con- there should be as many machines as are needed. The only trary. They have a religious belief in the market. They scarce and costly input is labor. even condemn activist policies. 11:2 Factor substitutability, perfect foresight, and freely 13:4/o World wide deregulation in the face of widening flexible prices also in growth models. income gaps, speculative excesses, uneven development, 11:3 On macroeconomic level, these assumptions lead and environmental degradation. These are not just limited to the economy automatically tending towards full em- market failures. ployment equilibrium between aggregate demand and 14:1 8 years of uninterrupted growth during Rea- supply. gan/Bush give the illusion of renewed vigor and lasting 11:4 G’s assessment: beautiful logical construction, prosperity, but it was based on the inflation of the na- some useful insights about individual reactions and mar- tional debt. “Rapidly growing pyramid of debts and rapid ket adjustments, but instead of explaining how the econ- rechanneling of capital flows.” omy truly functions, it is an ideological justification of 14:2/o Which policies will give the structural change its virtues. It tries to show that the blind pursuit of self- greater coherence? Neoclassical theory cannot tell us that. interest by individual agents leads to socially optimal out- Marx and Keynes’s dynamic theories deserve revival. comes. [This is a moralistic critique; G ignores here the 15:1 Did not Marx fail in the Soviet Union and Keynes structural flaws in capitalism.] with the Keynesian policies? These failures due to the 21.2. ECONOMIC ACTIVITIES AS MONETARY CIRCUITS 91 butchering of the followers. Marx and Keynes themselves self is socially created, and the rules by which it is created very relevant. are very important.” 15:2 No coincidence that both were essentially mone- 17:4/o Important, very nice overview of the book. tarist economists. 21.2 Economic Activities as Mone- 21.1.4 The Central Role of Money tary Circuits 15:3 Neoclassical paradigm focuses on efficient allocation. Should focus more on creation and distribution of 19:1 Standard economic theory has little to say about income like the classical economists. globalization (which falls in the purview of G’s “megae- 15:4/o No accidents that the two most prominent critics conomics”). We need heterodox approaches which con- of economic orthodoxy, Marx and Keynes [G does not see ceive of the economy as a “monetary production economy Keynes’s conservatism] considered the theory of money in forward motion.” the achilles heel ofthe NC paradigm.] 16:1 Mainstream dichotomy shoved money to the side. 21.2.1 Defining Money as a Social Institu- Interesting: once money is placed at the center of economic activity, any notions of equilibrium become invalid. tion [I read this as: capital’s drive for self-expansion is not an 19:2 Money works differently in different societies. equilibrium concept.] [Good point: money is not a good but the surface reflec- 16:3 How do they incorporate money? It is a special tion of a relation of production.] Therefore it is necessary good. Supply function is fixed by policy, demand function to understand the system in which it functions. For incomes from the fact that it gives its holders liquidity. stance money in the Eastern Bloc has different properties, 16:3/o Monetary sphere leaves real sphere intact (neu- therefore practical question of convertibility of money. trality). And the accounting identity M V = P Q is [No, the whole relations of production were different, this × × reinterpreted as a monocausal relationship from money is where the difficulties came from. G. like most Post- stock to price level. Footnote: first done by Irving Fisher, Keynesians, reduces, reifies the differences in relations of modern version is Friedman. production into differences of money.] 17:1 Stresses something which Marx stressed: money 19:3/o G Commits the same reification when he says is only considered a technical means, to facilitate ex- money makes markets. He considers money as something change and the accumulation of wealth, but does not affect more active than it really is. “The structural features of the rest of the economy. any market, including its demand and supply curves, are 17:2 [Now he comes with his own spin on money which invisible to the naked eye.” What he means is that the so- has it backwards too.] We live in a cash flow economy. cial relations of production are hidden and beyond control. [Does he mean it is a cash in advance constraint? Don’t But also see 12:3/o. I think G refers here to the theories see much evidence of this theory in his book.] Another that the market power of the capitalists determines their thing he says: money represents income, and its acqui- markup. [Marx would say here (Chapter Five of Capital): sition shapes the decisions and actions of all economic the maneuvers on the market do not create profits, they agents. [This is methodological individualism.] “It is a only distribute them. They are created in production.] powerfully homogenizing force, making otherwise het- The observation that the visible things are monetary is erogeneous products commensurable and subjecting pri- important though, this is money as a surface relation. vate activity to social validation in the market place.” [It 20:1–2 [Only discusses C–M–C, not M–C–M.] He is not money which makes the products homogeneous, but starts with M–C which is easy, and then he says C–M is the fact that the products have abstract labor in them. G much more difficult because it depends on others, not us. even says this himself in 22:4, to my surprise! And money Marx sees it exactly the other way round: for him, M–C is not what subjects the private activity to social valida- is so easy because everybody who has produced has to do tion. The private activity must somehow be integrated into C–M in order to get reimbursement for the labor put in. a social context, this necessity comes from human social 20:3 Like Marx he says: circulation of commodities reproduction needs, not from money. Money is merely sweats out money, but then he contiues: you must fish the instrument how it is done.] “Money forces individual the money back out of circulation which you spent when market participants into a complex network of social rela- you bought your things. [I don’t think this is the right tions”: [Again the power of money comes from the lack way to look at it. Commodity producers must (1) proof direct relations among the individuals.] duce something that is (2) in demand, and (3) once (1) 17:3 “To individuals, money seems given, but money it- and (2) are taken care of, the economic institutions should 92 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY” do the rest. In other words, following Marx, the produc- 22:4 1. Money as price standard. Brings in the labor tion of surplus value is primary, the proportionality sec- theory of value! Value is what homogenizes goods from ondary, and the technicalities of having enough means of the inside. circulation tertiary. G acts here as if the third point was 22:5/o 2. Money as medium of exchange. Derives this the most important. This confusion of levels leads him to function from money’s ability to represent value. think that workers and capitalists have common interests From point of view of individual agents, money thus because money circulates between them. comes to symbolize income. Income and expenditure flow G does not see that there are more permanent economic is the glue which holds economy together, but: character masks than those of buyer and seller, and he also 23:1 there is also antagonism, because sellers want to does not see the difference between C–M–C and M–C–M. sell at highest and buyers buy at lowest possible price. 20:4/o Markets are also the source of information (see Marx would say: this is a secondary contradiction, be- 20:0). They give observable events, and these observa- cause everybody is both buyer and seller. The M–C–M tions guide individual actions. [Fra88a]. Marx would take and C–M–C contradiction is more important here. G: “As exception to the sentence: “what happens in our economic a socially accepted means of exchange it binds agents and system is observed.” The important things oin teh core of thus is an integrative force, as representative of private our economy are exactly not observed, the market alone income on the other hand it sets those agents apart and gives a very distorted picture which causes the economic thus acts as a separating force. Much of its institutional agents to have no control over their own social relations regulation by the state as well as private agents focuses (fetishism of commodities). on balancing this contradictory aspect of money.” [Don’t 21:1 G sees a part of this: he says expectations cannot quite see it, but interesting. Sees money as a complex of be rational because there is not enough information. several things.] 21:2 Evidence how important this observation is: ad- 23:2 [Not very systematic here] production creates vertisement, consumer reports, trade magazines, consul- value and circulation validates it. tants, investment letters. 23:3 Money as a store of value. [it seems so obvious to 21:3 All those observations are monetary. Marx would us that it is, but this is a different function than the social say here: money does not only socialize behavior in the validation we just talked about. I should look at Marx’s marketpalce, but most importantly also in production. G transition in Chapter Three.] While it is kept as a store of does not seem to think things have to be produced. Ex- value it can be loaned out. ample with snob appeal goods where rising prices drive 23:4o This is due to Marx, but Marx fails to formulate up demand is an illustration how perversely important the a coherent theory of distribution and prices, as evidenced monetary information can become. by the transformation problem. [This is a naive view of 21:4/o Industrial production structures are inert, while the reasons why Marx was not accepted.] monetary flows are very mobile. Refers to German 24:1 That is why the shift from value to utility puts em- [Bac88]¨ as source. Here G puts his finger on an impor- phasis from production to exchange and puts class issues tant contradiction. I do not recall Marx discussing this. into background.

21.2.3 The Circuits of Exchange, Produc- 21.2.2 Going Beyond a Functional Ap- tion, and Credit proach to Money 24:2 Says these are three different circuits. 22:1 sumarizes mainstream view on money. 24:3–26:0 Exchange. 22:2 G’s position: Money more than just another good, 24:3/o In the absence of money it would be barter. it is above all a social institution subject to change and Barter requires double coincidence of wants. (He does regulation. [There is this nice Marx quote that it is both not say it requires realization of value also, and these two (this is like the wave-particle duality), and G’s formula- cannot be reconciled.) “Moreover, each good has to be tion leaves it open that it is both, but then he forgets it priced in terms of all other goods with which it can be again.] traded.” This is the expanded form of value. Why is this a Money not an exogenous stock but an endogenous flow. disadvantage? Because it cannot lead to a consensus. At Money is anything but neutral vis-a-vis volumes of pro- least G does not imagine a barter economy in which every duction or terms of exchange. good has a price, like the Neoclassicals do. 22:3 Closer look at what lies behind the functions of 25:1 Insertion of money into exchange makes dou- money. [What comes now is, surprisingly, Chapter Three ble coincidence unnecessary. Therefore lower transac- of Capital. A little incongruous with the rest of the book.] tion costs. Marx again says it does not merely lower the 21.2. ECONOMIC ACTIVITIES AS MONETARY CIRCUITS 93 transaction costs but without money the transactions are on demand. so contradictory that they are virtually impossible. 28:3 financial intermediaries to reconcile differing in- 25:2 Money imposes its own restriction in form of a terests between lenders and borrowers regarding length, monetary constraint. Here G fully agrees with Marx. The size, and collateral of a loan. introduction of money introduces its own contradictions 29:1 A second institution is financial markets. Credi- (perhaps one should better say: the contradictions which tors can sell their claims before maturity. it tries to solve re-appear in a different form) namely that 29:2 different interest rates for different risks and ma- money can be held and therefore someone cannot sell: turities. Say’s law does not hold. 29:3 financial institutions are not just another industry 25:3 Imbalances of demand and supply may not be but they have strategic importance. self-correcting due to the monetary mechanism, compare xviii:2. Very important point, which is not in Marx. But this is not a function of money per se, but this may be the 21.2.4 Credit Money and the Strategic Role side effect of certain implementations of money. of Banks 25:4/o Also something which is not in Marx, because 29:3/o To get neutrality of money and exogeneity of it would be in the book about competition: antagonism money stock money must be a separate good (commod- between buyer and seller regarding the price is regulated ity money). by market power. 30:1 But today we have credit money, which is often 26:1–27:2 Monetary Production Circuits not understood. Therefore this Section will say what it is 26:1 Starts with a general Marxian framework. and how it differs from what money is understood to be in 26:2 Neoclassical production function only looks at the standard theory. productive capital, therefore misses the accumulation aspect of the circuit. [He says: in M–C–C–M the neoclassi- Question 33 Guttmann gives 7 aspects in which credit cals miss M–C and C–M. Marx says by contrast: the C–C money differs from money as described by mainstream itself has a double character: production of value and pro- theory. What are these? duction of surplus value.] 26:3 aside: neoclassicals also ignore the labor manage- 30:2 (1) Money is not a good. He says, if money were ment relationship. Important reminder that one has to look just another good, we would have barter economy and not at the production process. a monetary economy. Even gold coins were tokens and as 26:4/o Possibility of crises from exchange circuit turn such strictly speaking credit money. into necessity here, because of strong incentives to in- Foley in [Fol87b] says that credit money can be defined crease production beyond demand. in a gold system and in a fiat money system. This only 27:1 Here is something akin to Keynes’s animal spirits affects the top of the pyramid, everything else remains and Mynski perhaps? Crises coming from investors. Also equal. high interest rates can prevent production. 30:3 While money has not been a commodity dur- 27:2 Time constraints, mistakes cannot be undone. ing recent historic times, we have recently been under a 27:3–29:3 Credit Circuits regime of commodity money. [Does not give resolution 27:3 Definition. Does not bring Marx’s basic observa- of this riddle.] The so-called gold standard was suppos- tion that a capitalist must do two things, he must own the edly backed by gold. Drawbacks: at the first sign of trou- capital and he must operate it, and these functions can be ble, banks would become subject of panic runs. Gold flow split up. Therefore interest rate. between nations would easily destabilize their respective But where does credit come from? Marx sees 2 sources: economies. (1) the production process periodically sets funds free 30:4/o (2) Money must originate outside the market which are temporarily idle. (2) reserve assets can be place. Buyers of goods are not allowed to issue money. pooled. Also private savings, and fictitious capital. Only banks are allowed to issue it, because they don’t buy 27:4/o Benefits of credit. Neglects to say that it is a goods. Credit money is credit. If you pay credit money tool to overcome contradictions which re-generates these for something, the seller actually extends a line of credit contradictions. Perhaps 28:2 can be considered such. to the buyer. By continuously issuing tokens, buyers could 28:1 neoclassical theory says credit is stabilizing, permanently postpone final payment (seigniorage). Keynes refuted this. 31:1 This is why the privilege of money creations has 28:2 Interdependence and conflict between creditor and been confined to banks which do not buy and sell [and debtor. Creditors do private ex-ante validation. This is they can create money only as an ensemble, not individu- different than just saying: money is created automatically ally]. 94 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

31:2 (3) Monetary payments are triangular transac- 32:3 (5) Central Bank does not control the money sup- tions. What comes now reminds me of Foley’s Palgrave ply. G introduces the Central bank as a check clearing entry [Fol87b]. G says: the check represents a promise to house with additional power of setting reserve require- pay by a third agent. I see it rather as follows: the check ments on bank deposits. Now 4 additional functions of is my promise to pay, and since I have an overdraft ac- the Central Bank: (a) issues its own credit money in the count with my bank, the bank automatically endorses this form of paper currency. (b) “operates the nation’s pay- promise to pay, i.e., it substitutes its creditworthiness for ments system so as to maintain the automatic convertibil- my creditworthiness. It makes sense to assume that we ity of all tokens circulating as credit money, including the are in an overdraft economy in order to understand things. exchange of currencies with foreign moneys. This con- This is also G’s understanding when he writes: “Payments vertibility is precisely what enables private bank money to by check turn the buyer into a debtor of the bank and the become a socially accepted medium of exchange.” Which seller into a creditor of the bank.” other convertibility? It seems he means checks. (c) Acts Basically the idea of credit money is: everyone pays as fiscal agent of the state, trades large amounts of secu- with promises to pay, and can make good on his promises rities to maintain an orderly market for government debt. to pay when he receives promises to pay by others. But (d) Only agent in the economy which can write checks overall the system is set up in such a way that the total drawn on itself. In this way it can extend credit at will. volume of promises to pay cannot get out of hand, and 32:4/o Combined this allows the bank to do monetary those who individually do not honor their promises to pay policy. It can manipulate the amount of reserves in the will be disciplined. banking system, add reserves through the discount win- The bank gets to know me and knows whether it can dow and open market operations. In this way it can ac- trust me by granting me overdraft privileges, or if it has celerate or slow down the money creation process by the to insist that I first deposit a full collateral for the loans banks. I am about to receive. [Again, this is Lipietz’s value in 33:1 This does not mean it can control the money sup- process!] ply: (a) controls excess reserves but not the willingness of G only describes the formal triangulation, and omits banks to lend. (b) Banks may also borrow from each other that it is a triangulation in which a less reliable lender pays to increase their reserves. Within the US this is within the his debts with an IOU of a more reliable lender. reach of the Fed, but loans from foreign banks holding G says: these debts are settled as soon as the bank Eurodollars is an injection outside the reach of any mon- deducts the amount due from the buyer’s account and etary authority. (c) Banks cannot determine the public’s credits it to the seller’s account. But this is only one part demand for bank loans. of the settlement of the debt; the other part is that the bank 33:2 (6) Banks are more than just intermediaries. Mis- must make sure that I have enough money in my account. taken mainstream view that banks collect savings and fi- 31:3 If the seller does not have an account with the nance investments, which would require that savings are same bank, then it goes through the Federal reserve sys- there before the investments can be financed. tem, which runs a check clearing mechanism. 33:3 This is an illusion; when banks make loans, they 31:4 Therefore now there are two triangular transac- do not simply transfer liquidity but create new liquidity. tions involved. (This is called the monetizing of debt, i.e., an agency 32:1 (4) Money creation is tied to bank lending. This whose debt functions as money trades the debt in for its goes to the stock of money. It looks as if I can just create own debt.) money by writing a check. But I am limited in writing this check because I have to settle my debt with the bank. 34:1 One cannot understand this with methodological And the bank, in extending credit to me and others, con- individualism, but one should also not aggregate banks trols the total amount of credit it extends. (Those who do and the industrial sector into a single sector, a mistake not have overdraft privileges must first fully collateralize commonly found in macroeconomic models. their credits by first paying the deposits in. This is how 34:2 Firms create a surplus. [The obvious thing to say participants can establish a track record, prove their cred- now would be: banks create the money in order to re- itworthiness.) alize the surplus. G does not quite say that. He says:] Federal reserve requirements put a limit on this total Banks supply firms with the means of payment to carry amount of credit granted. out their production plans [firms do not need means of 32:2 Explanation of money multiplier (G does have a payment for production!] in return of this they obtain a money multiplier, it is not a divisor as in post-Keynesian share of the firm’s income gain. [This is not only done theory). by banks but by all interest-bearing capital. Here G confuses distributional aspects with circulation technicalities. Question 34 Enumerate the functions of a Central Bank. Ownership of capital is needed for production; G (and 21.3. THE CYCLICAL GROWTH PATTERN OF CAPITAL ACCUMULATION 95 the post-Keynesians) confuse this with access to means reasons: holding of cash to benefit from anticipated price of purchase, which is socialized by the banks. For Marx, movements of financial assets (speculative motive), and the socialization of capital by the credit system was some- debtors need money to honor their debt obligations (but thing to be explained. G takes it for granted.] the financial capitalists are creditors, aren’t they? I think 34:3 (7) Money flows in the form of a circuit. he means that the system with financial capital generates Firms need bank loans because the workers do not this additional money demand on the side of the industrial spend all their wages. Foley has a different explanation capitalists? But banks are both debtors and creditors, and here. so are mutual funds? No, they do not issue debts. (5) inter- 35:1 “As long as workers spend their money wages on est is not the same as profit, it is a portion of profit due to consumption goods or invest their savings in corporate se- demand and supply of loanable funds. G does not commit curities, firms receive their original wage payments back himself to where the profit comes from. (6) 39:5 Prices of and can use those funds to repay their bank loans.” industrial output are cost plus markup on cost, i.e., profits I see several things wrong with this. I would say, even are determined by cost, while with prices of securities it if the workers do not save anything, the expenditures of is the other way round, there cost is determined by profit, their wages cannot generate enough purchasing power for because it is capitalized expected income. It also fluctu- the firms. And that is independent of the composition of ates much more. the output. The argument is given in Foley. Then with them buying corporate securities: firms can- 21.2.6 Finance Capital and Fictitious Capi- not repay their bank loans because they must pay interest tal on the bank loans. Circuit theorists say: money is endogenous, because 40:1 Volatility of security prices and speculative waves. it arises in the wake of bank credit, and money is non- 40:2–3 Interdependence and relative autonomy be- neutral, because it is needed for growth. tween industrial and financial capital. 35:3 (8) Interest rates do affect investment behavior. If 41:1 This lead to the merging of the two in some coun- circuit theorists say it doesn’t, this shows that circuit the- tries like Germany; Hilferding thought this was the gen- ory has some flaws. Don’t want to get into this now. eral trend. 41:2 But there are also incentives to keep the two sep- Question 35 After a monetary system based on the gold arate, and basing financial capital on the money-dealing standard nowadays a monetary system based on credit activities of the banks. money has emerged. How does this system work? How can credit function as money? How has it been theorized? Question 36 Define fictitious capital. What are its main (E.g., Lipietz’s capital as process, or the post-Keynesian forms today? money as a flow). Which are the economic implications of a credit money system as compared to the gold standard? Then he starts talking about fictitious capital, although I don’t quite see the connection. Somewhere I want to look at [Lor85], I have it. 21.2.5 The Bifurcation of Money Capital: Three main forms of fictitious capital: equities, government debt, and credit money. Industrial Versus Financial 42:3–43:1 Recent explosive growth of fictitious capi- 37:2 interesting, from the flow of funds accounts: finan- tal is a major force in the structural transformation of the cial capital grows faster and also turns over faster than economy. industrial capital. 37:3/o but the financial sector is disregarded in mainstream economics, because it is considered just another 21.3 The Cyclical Growth pattern of service. Capital Accumulation 38:2–39 Six differences between financial and industrial economy: (1) M–M’ versus M–C–M’ (2) financial 44:1 Capitalist competition forces everyone to either be capital is quite liquid, I think this means, people can cutting-edge or to decline, and credit system reinforces sell it before it has finished its turnover. (3) profits are this. more predictable because contractually determined (4) Then he says it is automatically cyclical, because in- different money demand function: industrial capital needs vestors must invest now in order to get profits later. Self- money for transaction purposes, insurance for unforeseen reinforcing tendencies in there. mishaps, and cash advances to start investment projects. Then he distinguishes between business cycles and long Financial capital wants to hold money for two additional cycles. 96 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

21.3.1 3.1 Business Cycle Dynamics But then again this inelasticity may have been an advantage: if a commodity in a less fixed supply were to func- Basic reason for onset of downturn is that profit rates fall tion of money, then too much of that commodity would after investment boom. Does he say this? Is this right? have been produced? Shouldn’t he say, investment overshoots because it adds What he says on 88:0 are just manifestations of the to the boom? And where are Marx’s basic contradictions metallic barrier. It could not make the jump from means of bursting out into the open? circulation to means of payment when the economy over- Then regulation theory, and some good points about heated. This also restricted the role of the central bank as logn waves. a lender of last resort. [Of course this lender of last resort thing is also not a way out; when businesses come to rely 21.4 Transition from Commodity on that, it invites irresponsibler behavior, as Minsky said. The Fed sometimes must refuse to bail out somebody.] Money to Credit Money [Advantages of gold: wide acceptance as medium of circulation and store of value. Gold in form of jewelry 21.5 Postwar Monetary Regime and was not so easy to steal.] 88:1 Explanation of gold standard seems to be the old its Inflationary Bias Ricardian error: with domestic money supply thus reduced, price deflation. It was Ricasrdo’s absurdity that he 21.5.1 5.1 Advantages of Elastic Money believed in the quantity theory even during times of gold 87:2 Says we never used commodity money. Reasoning standard. Perhaps G does not mean it that way? My think- (a) Commodity money gives rise to a barter economy, ing here is: the net outflow of gold means a curtailment of (which is not true: commodity money is where money credit and therefore a recession and therefore fewer im- is a commodity). (b) even during the gold standard we ports and a falling of prices. had a monetary economy. Creation of money tokens has always been restricted to the banking system. But here I Question 37 Which two prerequisites necessary for the would say, people could take their gold to the mint and functioning of the specie flow mechanism were under- get it minted without charge. This is as close as you can mined in the transition from competitive to monopoly reg- get to people producing their own money by producing ulation and the increasing integration of the world econ- gold. Besides, means of circulation is not the principal omy? function of money. The principal function is measure of value. I guess nowadays this means: not only does the 88:2 Two hidden prerequisites to specie flow mecha- government obligate itself to buy gold at a fixed price (it nism: (1) responsiveness of prices to (now I would not say also buys agricultural surplus at a fixed price), but it does variations in the money supply, but variations in supply not sterilize this operation, i.e., it creates more reserves by and demand of credit?) You need competitive economy, this purchase, because the central bank and not the trea- not oligopolistic. sury pays for it? 87:3/o Limitations of the metallic standard system: (1) (2) Volume of external trade must be price elastic (I total volume of gold is a barrier to credit supply and ca- would say income elastic is perhaps enough). With in- pacity expansion. The issue of tokens in a cyclical expan- creasing international interconnectedness this is no longer sion could not be sustained when the expansion slowed the case; can only be the case if external trade is not very down and led to regular crashes. But is that not an expla- relevant. nation of crises through the surface? 88:3 Due to its flaws the demise of the gold standard I would explain these limitations this way: money is a was inevitable. There are now two forms of credit money: complex of several functions: it is measure of value and state issued currency, and demand deposits issued by com- means of circulation and money. The commodity gold is mercial banks in the wake of credit extension and out of very good as a measure of value. As a means of circula- excess reserves. tion you don’t need the gold material itself; you only need 88:4 Money is not exogenous but endogenous. Not it as money (hoard, means of payment, world money). stock but flow, because it must originate outside the mar- But the function of money is mainly needed for capital, ket place and must first be transferred to its users through and here it is much too variable and cannot be accommo- the extension of credit. I.e., it depends on developed credit dated by the influx of new gold. Its variability is indicated circuits! by the post-Keynesian theory of endogenous money and 89:1 This endogenous flow characteristic makes it overdraft regimes. much more elastic. 21.5. POSTWAR MONETARY REGIME AND ITS INFLATIONARY BIAS 97

21.5.2 State Management of Credit Money: 92:1 Three different policies: (1) anything impacting Monetary Policy on the allocation of credit: credit controls and interest rates, (2) regulations to promote “safer” banking, and (3) 89:2 State has to maintain purchasing power of tokens. central bank interventions as lenders of last resort. 89:3 Convertibility between demand deposits and cash 92:2–93:2 Examples of (1) is guaranteed by the banks’ permission to keep their re- 93:3–94:0 Evaluation. Sometimes credit policy helped serves either in cash or in deposits at the Fed. [How much the overall monetary policy objectives (low yields of govt. was the role of the Fed as a clearing house involved in securities during WWII, “operation twist” 1961). G is this? I guess clearing house is the first role of the Fed; the bringing here examples where low interest rates are in Fed is a clearing house which is also a bank and whose keeping with the policy objectives. deposits are legally higher up in the hierarchy than the de- But contradiction between the goal of low interest rates posits with other banks; indeed the deposits with the Fed and the goal of price stability in Korean War and in events are by decree as high up as cash. Is that the definition of a leading to 1979. central bank?] 94:2–8 Examples of (2) Moreover Fed also maintains convertibility of money 94:9–95:1 additional remarks. against foreign currencies. 95:2–5 Examples of (3) 89:4/o Good about fractional banking money creation: no individual bank can create extra money. It must be 21.5.4 Credit Money in the Regime of Mo- the banks in conjunction with the customers applying for nopolistic Regulation loans and spending their money. Why are fractional reserves sufficient to keep the banks 95:6/o Monetarists think the central bank has a lot of con- liquid? Because of the banks holding the reserve funds of trol and can cause and avoid cyclical fluctuations. In all firms etc., and because of the check clearing system? Guttman’s view, these fluctuations come from an inher- Reserve funds is according to Marx one of the pillars of ently unstable economy. Monetary policy can affect the the credit system. form of crises. G emphasizes its “support functions.” 90:1 Monetary policy is manipoulation by the Fed of 96:1 Explanation of this support function. Starts out the ability of commercial banks to create money. There with the commonplace remark that lenders and borrowers are three different policy tools: share the risk together. More analytically, credit extension 90:2 Open market operatioins is private prevalidation of production activities. Using 90:3 discount window Lipetz’s terminology it would be an antevalidation, not a 90:4 reserve requiremnts. prevalidation. Now the central bank supports it by a social 90:5/o With these means the Fed controls the monetary pseudovalidation in the Brunhoff sense, which seems the base, but this should not be interpreted to mean that it same as the Lipietz sense (and it explains the term “pseu- controls the money supoply. dovalidation”): the central bank cannot guarantee that this 91:1 Because they do not control willingness of banks loan will be paid back, but it can inject liquidity into the to give credit or of private agents to apply for credit. In system which facilitates he success of these enterprises. boom periods, banks may meet high loan demands by 97:1 This framework allows us to investigate the Cen- attracting funds other than regulated deposit liabilities. traal bank’s role with respect to 3 areas: Therefore Fed cannot do much countercyclical monetary (1) transition from competitive to monopolistic pricing policy. in industry (relations between competing firms); 91:2 More generally? Or is it a specific mechanism? (2) Expanded role of government spending in the econ- Banks are profit maximizing, and there is a tradeoff be- omy. Active use of fiscal policy to manage aggregate de- tween safety and yield. mand. He says this is the relationship between capital and 91:3 Banks change the terms of this tradeoff in a dis- labor. tinctly procyclical fashion. In boom times, with general (3) Bretton-Woods: relationship among nations. euphoria, they are less cautious. All of those were crisis-prone relationships, regulated on the basis of mutually beneficial consensus and cooperation. 21.5.3 State Management of Credit Money: Financial Policy Monopolistic regulation of prices and wages 91:4/o Due to the ineffectiveness of monetary policy, 97:2 Accumulation regime in the US from Civil War to banks try to control credit directly. This is what G calls Great Depression linked the underlying value of a com- “financial policy.” modity, defined by the labor content, and its money price 98 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY” in a fairly direct fashion. Productivity gains usually led to 101:3 Additional aspects of postwar fiscal policy: re- reduced money prices. [But only if the productivity gains distribution of income from rich to poor. Subsidies for in- are higher than those in gold mining!] dustrial investment: accelerated depreciation, investment 97:3 What enforced this direct linkage? [This is Lipi- tax credits, and military contracts. Provision of infras- etz’s “coupling”] tructure. Reproduction of labor as productive resources: Active price competition: producers with a technolog- income maintenance programs, education, public health, icasl edge undersold their competitors. Price wars es- low income housing. pecially virulent when producers faced excess supplies, which occured regularly at the cyclical peak, and coin- International: Bretton Woods cided with widespread failures of overextended banks, therefore money supply falling to its metallic base. In- 102:1/o One of the elements was the concerted push for flated price structure collapsed. Regular depression-type liberalization of trade and capital flow culminating in crises 1873–8, 1884, 1893–6, 1907, 1920-1, 1929–37. GATT. Reinforced by decolonization and economic co- These deflations adjusted the price level to the new level operation between neighboring countries. of productivity. 103:1 Also Bretton Woods System. Benefits: 97:4/o However the monopolistic regulation gradually 103:2 Facilitated international transactions by restoring gained ground which replacerd price competition by prod- full convertibility at stable exchange rates by the by the uct differentiation and advertising, and markup prices. late 50s. 98:1 Also a different form of wage determination, with 103:3 IMF enforced adjustment programs in deficit the switch to unskilled workers, industrial unions, Wagner countries, so that their markets would be kept open. Act. UAW strike wave 1936/7 forced firms to implement 103:4 Cheap loans by World Bank facilitated develop- the Wagner Act, ushered in collective bargaining. 1948 ment. strike against GM ushered in 3-year contract with wages 103:5 Gold exchange standard gave the US seignior- tied to prodjctivity increases. age. Since the US had a trade surplus, it used its seignior- 98:2 No longer price competition but firms had to in- age for capital outflows in form of investment, but also novate in order to maintain high enough profits to attract military expenditures, and aid programs like the Marshall funds on the capital market. (This already presupposes Plan. These transfers served both sides. that firms become more dependent on external capital.) 98:3 Productivity gains no longer led to falling prices 21.5.5 Postwar Monetary Regime as a Debt but to higher wages. This reduced business fluctuations Economy considerably. Contradictory double nature of the wage as private cost and largest source of aggregate demand (Sec- 103:6/o Therefore the Fed’s support functions consisted tion 3.1) was managed in a more stable fashion. in helping other institutional transformations: monopolis- 98:4–99:1 This enhances stability, but only at the ex- tic regulation of prices and wages, deficit spending, and a pense of an inflationary bias. To theorize this he says in rapid expansion of world trade and capital flows. 99:1: gold has instrinsic value, but modern credit money 104:1/o Nice results, but also a debt economy charac- does not, its value is determined by its purchasing power. terized by credit-financed spending in excess of current [This seems circular. The value is based on monetary pol- income, and demand-driven acceleration of growth. Two icy!] important developments: 99:2 cites [Gut84] about inflation and labor content. 105:1 rapid spread after WWII of forward money con- 99:3/o Summary tracts: financial contracts in credit relations (what is that, I guess three year wage contracts are forward money contracts), collective bargaining agreements, long term, Keynesian Demand Management supply contracts (including the provision of trade cred- 101:1 Keynesian revolution institutionalized both in US its), pension plans, insurance policies, government spon- and Great Britain by their respective 1946 Employment sored income maintenance programs (social security, un- Acts. employment comp.) Predetermined otherwise uncertain 101:2 Since New Deal, US budget has contained auto- and conflict-prone income flows. matic fiscal stabilizers: progressive income taxes, unem- 105:2 Other development is shift from direct lending to ployment benefits, etc. In addition, these stabilizers were financial intermediation. (During 20s, half of loans went reinforced by discretionary fiscal policy. This was only through financial intermediaries, now 90% do). Lowers possible because the Fed could monetize part of the gov- transactions cost and more importantly helps overcome ernment’s debt (i.e., would have been impossible under the conflict of interest between creditors and debtors over gold standard). maturity, denomination, risk, and liquidity. 21.6. STAGFLATION AND FINANCIAL INSTABILITY 99

105:3 All this elasticity allowed current spending to be capital, consumer purchases of large ticket items, regular driven beyond current income. budget deficits, and America’s seigniorage benefit. Depreciation charges: does he mean firms used to be Industry self-financed, and the new capital expenditures were financed by loans? It seems so. 105:4/o Instead of financing internally, firms took up out- I am also still thinking about substitution effects into side capital. [Was this centralization?] Short term trade raw materials, [Bru81] credits [but this comes from the circulation requirements], This is predicated on the assumption that the economy debt, and equity. cannot grow unless there is new injection of purchasing 106:1/o Clear bias towards corporate debt. Until 1986 power (which not only Foley holds but also the Post Key- they could fully deduct interest. Debt less expensive than nesians). equity because less risky for lender. Higher debt-equity 119:2 Gradual going into debt was possible because of ratios boosted rate of profit at the expense of more brittle- very strong balance sheets: a massive debt reduction dur- ness when something goes wrong. ing the Great Depression, and rapid income growth and 107:1 Same thing. Additional point: stockholders of a forced savings during WWII. leveraged firm demand higher dividends because of higher risk. Total debt remained constant for a long time, but its 107:2/o (Including fn 14) Apparently firms did not do composition changed from public debt to private debt. [I depreciation accounting until 1920. guess this was so successful because the income growth G seems to have funny view of depreciation. on the real side was also extraordinarily strong and ex- 108:1 Accelerated depreciation helped investment. tended.] 108:2 but inflationary underdepreciation punished in- 120:1 Profit rates peak at 1966, then turn down. Invest- vestors. ment slump. Footnote cites [Kal71] for profit investment 108:3 Due to higher depreciation, they have to pay too link. high taxes, and I would also say too high dividends, and 120:2 Very interesting figures, how low real investment have not generated the cash flow necdessary to replace became as a percentage of GNP. Fell by 40% from late plant and equipment. I would call this an evaporation of 60s to late 70s. [Enough reason to leave such important capital stock into tax revenues and investor revenues. things not to the capitalists!] 108:4 Again has a funny view of depreciation. What it 120:3 Civil rights movement plus resistance against means is that the firms get more indebted again. Vietnam caused Johnson to defer the necessary tax hikes, 109:1 Statistics about this indebtedness (which can therefore overheating of economy. only go on so long). 1969/70 nature of inflation changes. Productivity was Another consequence Lipietz drew was investment no longer rising, but wage rises were institutionalized. crunch: they did not invest because they did not have the money. Also the esxoteric-exoteric dimension is missing in G. 21.6.2 Standard Inflation Theories 122:1 Traditional demand-pull inflation did not apply in Consumer Spending the 1970s, because government demand fell. Deficit Spending by Government Cost-push inflation. Downward stick prices due to unions and oligopolies. Credit between Financial Institutions 123:1 Tight monetary policy does not help if prices are External Debt sticky downward. It cannot force many prices down a little if one price rises somewhere. 21.6 Stagflation and Financial In- 123:2 Conflict Theory of Inflation. Battle over distributional shares of a shrinking pie. stability Accelerationist hypothesis (monetarists): money stock must grow at same rate as (or lower rate than?) output. 21.6.1 From Boom to Stagnation Rational expectations critique: goes even further. 119:1 Boom has several reasons: (1) Automatic moneti- 124:2 All these theories are insufficient. Now he brings zation of debt. Is this because there was a government critiques which I should type in together with the theories. deficit which is monetized? 125:2–126:0 We have to move beyond the traditional (2) Most important sources of spending in excess of explanations to be able to explain stagflation, and gives current income were: depreciation charges on invested reasons why the traditional explanations fail: 100 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

125:2 We cannot just assume full employment equilib- encourage speculation. Flight out of money into gold, rium on the real side; otherwise the only reason you can artwork, real estate. Massive selloffs of high inflation have rising prices with declining output is faulty govern- currencies in exchange markets. Inflation raises taxes ment policies (which is essentially what they end up say- (bracket creep, paper profits from historic cost accounting). ing) and encourages underground economy. 125:3/o One can also not explain it by price setting be- 132:1 Counter-reaction by monetary authority: not only havior, because price setters don’t take that long to react slower money growth but combat speculation. to forecasting errors. it must be institutional rigidities pre- 132:2 I guess now he is done with money. Stagnation venting prices from falling. and inflation two sides of same coin: agents want to maintain their income but they cause further stagnation. 21.6.3 Stagflation as a New Form of Struc- 132:3/o This is a more gradual crisis than the debt- tural Crises deflation spiral. Taking on more debt seems a feasible way out. 126:1 Stagflation lasted over a decade, and became worse with every cycle. 126:2 Stagnation increases inflation because of the high Question 38 Describe how stagflation functions, i.e., de- fixed cost component of output, and with lower output scribe the mechanisms how inflation and stagnation can you still have the same fixed cost. (2) Inflation shortens reinforce each other. But a debt-inflation spiral does not planning horizons of firms, therefore reduces investment, generally lead to a one-time crash; why not? hence stagnation. 126:3 Inflation cannot be explained as a monetary, and also not as a purely nonmonetary phenomenon. 127:1 Monetary aspect: monetary system allows firms 21.6.4 The Debt-Inflation Spiral and Credit to avoid deflationary adjustments. Crises no longer take form of depression, but of stagflation. Crunches 127:2/o Looks at exchange, production, credit, and 133:1 Inflation avoids crash by socializing losses. money circuits and sees how they become undermined. 128:1–129:0 Exchange: transfer gains in unequal ex- 133:2 But sooner or later it leads to credit crunches. change mean that some agents no longer can spend as In euphoric inflationary boom, creditors abandon long much as before in real terms. term credit in favor of short term capital gains from rapid 129:1–130:1 Production: nominally inflated profits, but price increases (energy, hard currencies of low-inflation not enough funds for replacement of fixed capital. Share- nations, real estate). holders lose confidence in financial statements. 133:3–134:3 Generates credit crunch soon thereafter: 130:2–131:1 Credit: Firms need more credit because 133:4 Highly indebted borrowers can no longer main- inflation evaporates internal fianncing away, but this tain their spending. Firm profit rates are eroded exactly makes firms more vulnerable. Falling asset prices along then, in late stages of boom. with rising materials prices. Eventually creditors protect 134:1 Borrowers no longer have option to go to short- themselves by tightening their credit terms, and share- term debts due to yield curve inversion which has been holders demand higher dividend because of of their higher feature of every credit crunch since 1966. exposure. This leads to a spectacular rise in the cost of do- 134:2 Yield curve reversal squeezes financial interme- ing business which led firms to cut back investment. diaries, or if their rates are regulated leads to massive dis- 131:2–4 Money: inflation affects each of the functions intermediation. of money. 134:3 All this leads to declining demand, prices no Store of value suffers, means of debt settlement (infla- longer rise, and speculation on these price increases col- tion reduced the effective debt of debtors—but why did lapses, which intensifies the crunch. the interest rate not compensate for this?), standard of prices due to growing uncertainty of future prices, and in 134:4 Therefore stagflation has cyclical character. hyperinflation even its function as medium of exchange 134:5 but progressively higher inflation and higher debt suffers. levels. Plus deteriorating accumulation conditions. 131:5/o Consequences of this erosion of the functions 135:1/o Long-term erosion of industry’s productive ap- of money: decline of savings, rise in credit demand led paratus main reason for rising cost and falling profit rates, to a rise in interest rates. Disintermediation due to de- on top of weaker balance sheets. Until lenders drastically posit rate ceilings. Unstable prices harm investment and tighten their credit terms, as in Great Recession 1979–82. 21.7. THE DISINTEGRATION OF THE POSTWAR MONETARY REGIME 101

21.7 The Disintegration of the Post- strains international cooperation. Danger of run on gold war Monetary Regime stock was exaggerated in the early years. 64–68 Holding action with increasing capital controls: thought victory in 137:1 Stagflation is not just a recession (short-lived ad- Vietnam War was around the corner. After 68: US does justment) but a structural crisis, which usually occurs only not care about it any more and is prepared to shut off gold in the downswing phase of a long wave, when overpro- convertibility. Block says SDR in 68 was diversionary duction and overextension have become sufficiently dom- tactic; apparently US did not want to go to multilateral inant. Breakdown of hitherto effective modes of accumu- monetary system. lation. 139:6 1959 Robert Triffin dilemma: dollar deficit was 137:2 Chapter shows how stagflation destroyed pillars necessary for world trade, but this would increase dan- of regime one by one. ger of run against dollar. The alternative, a return to BoP surplus, would reduce global liquidity. Therefore the way out would have to be international reserve unit, like 21.7.1 Collapse of Bretton Woods Keynes’s Bancor. Footnote 3 refers to [Tri60]. [Eichen- 137:3/o B-W fas first component to break down. Disinte- green [Eic92] says that this was also an issue during time gration began when dollar was no longer convertible into between WWI and WWII.] gold. 139:7/o Good elaboration on Triffin dilemma: “just as 138:1 Gold has notoriously inelastic supply; gold pro- individual buyers cannot settle their debts by simply is- duction lagged behind expansion of international trade. suing their own money, ... ” National currencies are by Gold’s share in total world money declined from 68% in nature inadequate as world money, but the country which 1951 to 41.3% in 12970, but is still rathee high. issues this money has seigniorage benefits. 138:2 Also distribution deteriorated: US gold reserves 140:1 This seigniorage is even more pronounced when cut in half between 1951 and 1970, which was from dollars become de facto inconvertible into gold. But sys- 68.3% of noncommunist gold reserves to 29.9%. Cur- tem can only persist if foreigners have trust in dollar. rency reserves of capitalist world convertible into US gold 140:2 National currency typically emerges as world rose from half of gold stock in 1951 to four times gold currency when issuer is the dominant power. But issuer stock in 1970. cannot remain dominant, because the stronger competi- 138:3–139:5 First dollar crisis: Return to European tive discipline exerted on the competitors allows them to convertibility in 1958 made Europeans less dependent on catch up. Factors enabling this catching-up process are (1) dollar, they exchanged their dollars for gold. At same time they have lower wages (2) they have newer, more efficient European Union triggered massive dollar investments. capital stock (3) their currencies are undervalued because Expectations of imminent dollar devaluation caused gold fixed exchange rate regime retards adjustment. G thinks price on open market to rise from $35 to $40. Counter- US should have devalued dollar in 1961. But US did not measures were have to because of seigniorage. 140:3 alternatively they could have reduced their bal- Gold pool to feed gold to private market and keep its ance of payment deficits by fiscal or monetary restraint; • price low. [This is another instance of privatization but they did not because of Vietnam and Johnson’s Great of socially held wealth.] society, which purported to prove that Vietnam did not cost the US anything. Treasury bonds denominated in other currencies • 140:4 The US vulnerability of having an overval- (“Roosa bonds”) ued dollar which was no longer convertible against gold Currency “swap lines” between Fed and other central turned into an acute crisis in 1968 when a sudden start of • banks, and Fed used foreign currencies to relieve the inflation (I think which was due to the “wage explosion”) dollar glut. without a rise in the interest rate caused a run agaisnt the dollar. 1961 operation twist. 141:1–3 Measures taken in that context: • 1964 US introduced capital controls to slow dollar controls on direct foreign investment by US firms • outflows. • gold pool replaced by two-tier system where private But a more fundamental adjustment would have been • gold price differs from official one needed. Compare here [Blo77, chapter 7, p. 164], who sees 3 25 percent gold coverage requirement for US money phases of US policies: 58–64 speculation requires and • supply was eliminated. 102 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

141:4/o March 68 also creation of SDR’s, but this was 21.7.2 Flexible Exchange Rates as Source of 10 years after Triffin’s speech, at a time when there was Global Instability no liquidity needs but the world was awash with dollar liquidity. 143:3/o Monetarists had long advocated flexible exchange 141:5, Late in 1968 Johnson finally increased taxes. reates, because this would give greater stability, allow This triggered a recession and strenghtened the dollar. states to pursue their individual monetary policies, and al- Newly elected Nixon adopted strongly reflationary poli- low trade imbalances to be quickly evened out. cies, therefore soon new downward pressure on dollar. 144:1 Reality was different: market-determined ex- 141:6/o During tighter credit US banks borrowed heav- change rates did not balance trade deficits; huge increases ily from Euromarket which eased the dollar glut, and of speculative currency flows prevented national central when credit eased again these loans were paid back, this banks from pursuing their desired monetary policies. constituted a huge outflow of dollars. 144:3 It did not work because international flows were 142:1 Nixon administration had policy of benign ne- no longer price elastic enough. glect towards dollar outflows. This forced the other cen- 144:4 This inelasticity led to J-curve. tral banks to absorb huge amounts of dollars into their 144:5 J-curve led to overshooting of exchange rate ad- reserves. Their dollar purchases have same effect as ex- justments up- or downward. pansionary open market operations in their own countries. 144:6/o Also competitive devaluations reduced effec- They could not counteract this by higher interest rates, be- tivity of individual devaluations. cause those higher interest rates would have attracted even 145:12 Hot money strong enough to defeat any cur- more dollars. This is “export of inflation.” rency. I guess it is too much to be sterilized, i.e., if they buy foreign exchange they might in theory sell their own gov- 21.7.3 Dollar Devaluation and Global ernment bonds at the same time in order to offset the effect Stagflation of their purchases on the money supply. 142:2 August 15, 1971 Nixon’s NEP 21.8 The Legacy of Reaganomics severed the dollar’s link with gold • import surcharge 21.9 The Dilemmas of Monetary • wage and price controls Policy • Continued the nationalistic turn which had been started with “benign neglect.” Nixon used dollar problem to the 21.10 Financial Fragility and the advantage of US: it was a bargaining chip to pressure Eu- Lender of Last Resort rope and Japan into trade concessions, and it converted the inevitable dollar devaluation from a sign of weakness into a show of American power. 21.11 Regulatory Overhaul and the 142:3/o This solved the problem of the dollar’s incon- Restructuring of US Banks vertibility but not that of its overvaluation. Smithsonian agreement December 1971: 258:1 Bank failures in the 1980s, which nearly bankrupted the FDIC fund, are symptoms of deeper struc- simultaneous currency revaluations against dollar at tural problems. Banks collect savings and redistribute • varying rates (7.5 percent for lira to 17 percent for them as investment. This sounds like a purely interme- yen) diary function; but in addition they create the new pur- widening the band of fixed exchange rates chasing power necessary for the economy to grow. Weak • banks are like a weak heart. devaluation of dollar against gold by 8 percent. • 258:2 Traditional functions of banks (taking deposits 143:1 This did not calm foreign-exchange markets. and making loans) met fierce competition from less regu- Due to uncertainty over future role of dollar, banks and lated institutions. multinational corporations diversified their currency hold- 258:3/o Elimination of interest rate ceilings on deposits ings. Currency speculation became institutionalized. Cur- made it more expensive for banks to attract funds. With rency trade quadrupled between 1970 and 1973. more expensive liabilities they had to look for higher 143:2 1972/3 starting with British pound, then Swiss yielding assets. And since the Federal government at that franc, then dollar devaluation 10%, then a joint European time was bailing out failing banks, the drive towards im- float against the dollar. prudent investment decisions was irresistible. 21.11. REGULATORY OVERHAUL AND THE RESTRUCTURING OF US BANKS 103

259:1 But their maneuvering room was restricted by and borrowers no longer need the services of the banks. outmoded regulation. The banks tried to circumvent this Mutual funds can judge credit worthiness by 10-K forms. regulation and by this weakened the regulation. 263:1 Securities are judged by an army of market ana- 259:2 1990/1 Bush administration tried a banking over- lysts. Their sentiments are subject to strong fluctuations, haul, but legislators made it too narrow. therefore availability of securities varies more than that of 259:3/o Survey of Chapter bank loans. This is a disadvantage. But bank loans require an intrusive relationship with the bank, and the bank cashes in the yield spread. 21.11.1 11.1 Slow Death of Traditional 263:2/o therefore movement from banks to security Commercial Banking markets. In 1960s top-notch corporations discovered the usefulness of commercial paper. Sum of commercial pa- 260:1 Between 1987 and 1991, more than 900 banks pers is today almost equal to sum of bank loans. In 1970s failed due to bad debt losses to developing countries, growth of corporate bonds, in 1980 junk bonds. farmers, oil drillers, real estate developers, and takeover 264:1 Reactions of banks to this loss of business: artists. With lower interest rates, situation is a little better 264:2 CD’s introduced by citibank in 1961 to compete now but is not yet over. with commercial paper. 260:2 Weakness of the banking system caused banks to 264:3 Banks no longer passively waited for depositors have a very large interest rate spread, and that choked off but issued CD’s etc. This increased volatility. credit to the economy. 264:4/o by doing business abroad in dollars. In this 260:3/o Banks lost market share to other institutions, way the multinationals did not have to borrow in a given and US banks also to foreign banks. country. 261:1–262:0 Important about the structure of Amer- 265:1 Also began to search for more lending opportu- ica’s credit system: nities. 261:1 Until not so long ago, America’s credit system 265:2 1978 money market mutual funds. Congress had three pillars: commercial banks (liquid deposits, short eliminated interest rate ceilings so that banks could com- term loans to businesses), insurance companies (illiquid pete with these funds. liabilities and predictable outflows, long term loans to 265:3/o Since banks were still insured, this led to spec- businesses), and investment banks (organizing financial ulation. markets). These three pillars were separated from each 266:1 Doubtful if banks can compete in long run. other, and other financial institutions filled niches. 261:2 special (or even dominant) role of commercial banks in this structure. Bank liabilities are safe repos- 21.11.2 Financial Innovation and Regula- itories for savings of households, and they give busi- tory Evasion nesses access to the nation’s payments system. Bank as- Question 39 Which combination of privileges and regu- sets are loans to businesses based on specific knowledge latory constraints allowed US banks to make money in the which markets cannot provide, and therefore banks at- 1950s and 60s? How did this system unravel in the 1970s? tracted funds and were shielded from competition of di- What did the banks do to cope with the situation? Discuss rect lenders. the larger economic implications of this breakdown of the 261:3/o Necessity of the banks’ intermediating func- monetary system, and give policy recommendations. tions: their household depositors needed small, secure and liquid deposits, and businesses needed large, illiquid and To answer this question. Privileges: money creation, risky loans. Banks bridged this gap in part by their own access to the nation’s payments system, access to the dis- capital, and benefited from an interest rate spread. They count window, and FDIC. See 262:0. Regulatory con- were regulated (minimum reserve requirement) and privi- straint: regulation Q, separation from investment bank- leged (monopoly on money creation, which brought with ing, no interstate banking, standards for assets, reserve re- itself access to the nation’s payments system, Federal De- quirements. The reason for the breakdown are not terribly posit insurance, and access to the discount window). clear. G writes about this in Chapter 7. Increasing indebt- 262:1 But this separation could not be maintained. Mu- edness and inflation, and the banks gradually escaped the tual funds and pension funds became challenger of banks. control of the Federal Reserve. Their profits come from fees and not from interest rate 266:2 First line of defense: attract costlier funds and spreads, therefore they are less vulnerable to interest rate lend to riskier borrowers. Second: Accelerate develop- fluctuations. [This is interesting, this is exactly the rigidity ment of new financial instruments and servies. Third: at- of the exoteric relations]. tack existing regulatory restrictions (with the expressed 262:2/o Due to computerization of information, lenders objective of weakening them or escaping their reach). 104 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

This is risky, led to losses, makes regulatory reform 273:2/o Securitization of the banks’ credit card credits, more urgent and more difficult. installment loans, and computer leases. Banks are sell- 266:3–275:0 Innovations. ing their best, most marketable loans. This makes them 266:4–267:2 Deposit brokerage (securities firms like weaker, because they no longer have those assets to fall Merryl Lynch broker large deposits to highest bidder) al- back on. lowed flimsy banks to attract large deposits by paying a 275:1 These innovations help individual banks but little more than the others, exacerbates the moral hazard overall had marginal impact, not a substitute to taking de- problem of the FDIC and made the bank failures much posits and making loans. 1980/82 only partial deregula- more costly. tion; ban on interstate banking and separation of commer- To me this seems to be a financial innovation which sys- cial and investment banking were still intact. Competitive tematiclly misuses the FDIC. They did not do this earlier, disadvantage compared to more integrated European and because it increases competition between banks, gives a Japanese banks. cut to the broker, and they must have known that in the 275:2 McFadden Act of 1927 prohibited interstate long run this would abolish the FDIC and therefore the ba- banking. Large number of small community banks op- sis of their operation. But now they don’t care any more. erated as local monopolies. Based on populist rejection of 267:3–269:2 Repurchase agreements. Dealers buy se- large banks. curities from banks and have the option, if they want to, 275:3/o Although this law had not yet been repealed at to re-sell these same securities a few days later at a higher the time of the writing of this book (it is repealed now, see price. It seems often they do not have to pay for them in [Kan96]), the banks found ways around it. cash, do they have to make a partial payment? The bank 276:1 Formation of bank holding companies. just holds the security and gives the dealer credit for it. 276:2 Formation of limited service banks, which do not How is this profitable? Usually the securities are re- legally quialify as banks since they do not both take in purchased, and the banks get the price difference. Other- demand deposits and make commercial loans. This seems wise, if the open market price of the security goes up, the to be contingent on the formulation of the McFadden Act. dealer can sell the security on the open market and pay off 276:3 ATM networks the bank and get the difference. 276:4/o Multi-state compacts involving smaller states One can pyramid repos if the dealer uses this security excluding the giants New York and California. while he is holding it in his possession as a collateral for 277:1 Failing thrifts could be taken over by out-of-state a loan? banks. It is a lottery based on price movements which may give 277:2 Result: new tier of superregional banks pros- large short-term yields if there is a change in the interest pered. rate. 277:3/o but the money center banks who make loans to 269:3–271:4 Mortgage-backed securities, collecting large corporations suffered from competition abroad and similar mortgage into a package and making this a secu- competition by investment banks, which allowed the cor- rity. Extended greatly, because thism meant banks could porations to raise money on capital markets. make their mortgages liquid. One risk is prepayment. An- 278:1 Hard lobbying to repeal 1933 Glass Steagall Act other risk is: supply of these securities fluctuates a great which kept commercial and investment banks separate. In deal, because it depends on whether banks want to securi- 1980s, investment banks had 26% after-tax return, com- tize their mortgages or not. mercial banks only 12.2% These are all efforts to get banks out of their special 278:2/o They specializend in services falling outside position they are in: their business loans cannot be sold Glass-Steagall. Mosat successful with new types of loeans but their mortgages can be sold. which limit customer exposure to the increasingly large 271:5–275:0 Off-balance-sheet committments swings in interest- and exchange rates. 273:1 If it is a purchase, then the security is his prop- 279:1 Apparently regulators gave commercial banks erty, and he can use this security as a collateral to get loans permission to do investment banking in various limited go buy other stuff. If it is only the loan of a security, then ways. he cannot do this. Also if he goes bankrupt, if it is a loan, then the bank which loans it to him, the bank has first right to this se- 21.11.3 Bank Reform: a Difficult Balancing curity. But if it is sold, then it belongs to the person who Act went bankrupt, as also his other belongings, and he owes the bank money, which comes out of that person’s assets 279:2 The existing regulation was put in place over 50 along with all other creditors. years ago. Computerization made geographic restriction 21.11. REGULATORY OVERHAUL AND THE RESTRUCTURING OF US BANKS 105 on bank branches or the artificial separation of commer- agreement about structure and operations of financial ser- cial and investment banking obsolete. vices industry. [Regarding branch banking there is the argument in fa- Now a number of issues to be addressed by bank re- vor of restricting the mobility of capital, not just across form: state boundaries, but geographically. Local capitalism de- 281:2 1) Push for nationwide banking. sirable because labor power is local too. Abolition of local G goes back and forth between esoteric and exoteric. capitalism is globalization, which is a defense against the Says nothing about pros and cons of local or regional cap- falling rate of profit. But it throws everyone in a com- italism. But he says: banks are too small, internationally pletely uncontrollable context.] they have grown much bigger. [Did the separation of commercial and investment Second argument: regional banking makes banks de- banking ever make sense? I guess Glass-Steagall was a pend on the regional economy. [But if the fate of the banks reaction in the 1930s to shady practices due to the con- is de-linked from the fate of the regional economy, then flict of interest between the bank as a lender and the bank banks would take money out where the economy is bad, as an equity holder. Economic rational was perhaps also which is procyclical.] to cushion the cheap recycling of deposits into loans to 282:1 He brings the argument for local banking only small businesses from the stock market, i.e., fictitious cap- as a report: this is how they lobbied. One problem with ital. See 282:3. Instead of saying this separation no longer the present system is that there are too many banks below makes sense, he should say: it is no longer sustainable by optimal efficiency. I.e., you cannot have local banks and competition. This is his confusion of exoteric and eso- optimal competition. Drawback of local capitlism is that teric.] it leads to monopolies. Present situation of peacemeal deregulation by loop- Against local banking: consumers deposit their money holes and circumvention is undesirable. Prospect of hav- no longer in bank accounts but in money market funds. ing to bail out the FDIC scared Congress into action: 282:2 2) Integration of commercial and investment February 1991 treasury offered its long awaited plan for banking. Why is there such division? To avoid the conflict comprehensive bank reform. of interest when banks relate to companies both as cred- 279:3/o Objectives of the treasury plan: itors and as investors, and abusive market manipulation, Removing the geographical restrictions on banking. practices that had contributed to the stock market crash Well capitalized banks could set up securities, mutual of 1929. Therefore G wants tight firewalls between the fund and insurance affiliates, provided those were sepa- departments. rately capitalized. 283:1–2 Practical difficulties because culture is quite Strengthen bank capital as a cushion against bad debt different. In commercial banks thorough study of the losses. [this function is completely missing in Panico] by creditworthiness of the customer and hierarchical report- removing separation between industrial and banking cap- ing. In investment quick decisions, risk taking, commis- ital. Hope of huge capital inflows, since banks themselves sions. Banks would have to change their compensation were undercapitalized. schemes, this will anger their employees. Encouragement of capitalization by having less regula- 283:3 3) Possible fusion of commerce and banking. Ex- tion on well capitalized banks, and having insurance pre- ists in Germany and Japan. Why does G want this? Would miums depend on capitalization levels. make it easier to get capital inflows into banking; would FDIC limiting insurance to a fixed amount per institu- allow banks to diversify out of deposit-taking and loan- tion (per customer?) and eliminating insurance for bro- making at a time when technological change threatens to kered deposits. make these traditional intermediation activities of banks Bank supervision would be tightened and streamlined. obsolete. 280:1 Lobbying pressure against this: small banks [I don’t quite believe this. Small businesses will never against nationwide banking; insurance companies resisted have access to the capital markets.] intrusion of banks into their own hitherto protected mar- That would be a way to facilitate the inevitable shrink- kets. All bankers opposed limitations on deposit insur- age of the US banking industry. ance. Even the security firms, who would be allowed to [I guess the rationale is: the normal way of just letting own banks now, lobbied against it. No lobbying in favor firms go bankrupt is not desirable, because it interrupts of it, general public cared little about it. the credit flows in the economy. It is like having a weak 280:2/o How it failed in congress. heart. And the other solution, letting the state take over 281:1 Deeper reasons for this failure: unpredictabil- firms which are structurally unprofitable, is impossible for ity of such far-reaching reform, banking system is alredy political reasons.] fragile and might be further weakened. Theoretical dis- 204:2 4. Creation of Core banks. Banks which offer 106 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

insured deposits, maybe with limit on return they can pay, 287:4/1 (1) Traditional functions of commercial bank- and give loans to small businesses, are subsidiaries in big- ing remain essential; households want a safe place for ger financial holding companies, kept strictly separate in their savings; majority of businesses are too small to issue terms of product offering, capitalization, accounting, Re- securities. Community banks that specialize in loans to strictions on intracompany dealings. (How do you enforce businesses, ranging from sole proprietorships to medium- this?) sized corporations have continued to do well. Most im- Arguments pro: will be conservatively managed, would portant reason: they create money! hardly ever fail. Reduce government’s bailout costs. Op- 288:1 Recent deregulation has exacerbated the prob- ponents: this would be the beginning of governmental lems. Deregulation of thrifts led to the savings and loan credit allocation. Due to their restrictions, such banks scandal, and partial deregulation of the banks (removal of could not compete with other financial institutions. De- interest rate ceilings) has contributed to their problems. positors would go to higher-paying money-market mutual 288:2 Precedent was wave of deregulation and innova- funds or something like that. He calls it disintermediation, tion in the 1920s followed by the crash of 1929, then strict but I don’t think it is this? Therefore core banks may not regulation in 1930s, which gave us 4 decades of financial have enough money to loan. stability and steady growth. Bailout costs would be reduced, but also the FDIC 288:3 G’s critique of core bank proposal, which has would have many fewer deposits to assess. both regulated and unregulated banks side by side: Parent They have increased overhead because they must main- companies may channel funds surrepetitiously from the tain two banking institutions instead of one. insured core bank to the other affiliate in trouble. regula- Would not be less risky than the uninsured banks, be- tors may not resist bailing out uninsured wholesale banks. cause small loans are not less risky than big loans. Critique of regulation Q: it was too rigid, it should be Litan’s proposal to confine assets to default-free gov- tied to the T-bill rate. ernment securities seems illogical to me: who would then Nationwide branch banking should be allowed, but give loans to small businesses? commercial banks should be restricted by and large to Larger uninsured wholesale banks would be too big to deposit-taking and loanmaking. fail. 288:4/o Wants to reconstitute RFC (reconstruction fi- 285:4 5) Restoration of market discipline Treasure plan nance company?) allowing capital infusion for undercap- wants depositors to check the soundness of the banks. G italized banks, which would be cheaper than bailing out says this is unrealistic, and will not lead to rational eval- failed banks (but which would distort incentives) and tax uations but to panics. Besides, tighter market discipline incentives to direct bank credit into desirable directions. would also result in more bank failures, and the govern- 289:1 New regulation also has to take account of the ment does not seem prepared to pay for that. globally integrated nature of modern financial capital. Precedents: 1975, following collapse of Herstatt and 21.11.4 Financial Capital and Economic Franklin National, the Basel concordat between central Development bankers defined intervention responsibilities when Euro- market subsidiaries of transnational banks fail. Cooke 263:1 In the absence of a thorough banking overhaul, committee serves as global intelligence network for cen- banks continue to be squeezed by (a) price deregulation tral bankers. 1982 framework for supervision of Euromar- but (b) continued product line restrictions. Must pay more ket banks; cooperation of central banks in order to reduce for deposits, but must lend their money and therefore must price volatility in foreign exchange markets, and to man- seek out riskier borrowers. age the LDC debt crisis. Reaction of the banks was bank mergers, often of banks 289:2 Ultimately an international regulatory framework competing in same geographic areas. Encouraged by the will be needed. Recently increased activity towards creat- regulators, and usually followed by massive branch clo- ing such a framework. sures and layoffs. 286:3/o Also higher fees, larger yield spreads, more dif- 289:3 1988 Basel agreement imposes uniform ficulties of local businesses to get credit. • capital-asset ratio of 8% on banks of 12 industrial 287:1 Mergers solved the problem of excess capacity nations. but not the other structural problems. 287:2 Two options: either re-establish a tight regulatory 289:4 More recently bilateral agreements US–Japan framework, or continue deregulation. • and US—EEC for “reciprocal access by their finan- 287:3 Two reasons why one might want to reverse the cial institutions to each other’s domestic credit sys- general trend and re-regulate: tem.” 21.12. DEAL MANIA AND FICTITIOUS CAPITAL 107

289:5 Pending: harmonization of national rules for 292:1 Benefits of this reliance on the stock market: • stock and bond markets. corporate managers have greater autonomy, more flexible, better entrepreneurship. Many more small companies 289:6 BCCI scandal caused intensification of inter- • have gone public here than there. Highly developed ven- national regulation of Euromarket (giving for in- ture capital to fund startups. stance German government the authority to regulate Downside: stock markets are a much more volatile the dollar deposits of German banks). Next step source of funds than long term liaison with a commer- would be regulation by a single international agency cial bank, which encourages speculation and short time such as the BIS (Bank for International Settlements). horizons. Then leadover to Chapter 12 So far the reregulation options. 290:1 Full scale deregulation option, i.e., Treasury proposal, which phases out existing geographic branching, 21.12 Deal Mania and Fictitious product line, and ownership restrictions. Strongest argument in favor: helps improve international competitive- Capital ness of American banks, which right now cannot compete Speculators may do no harm as bubbles on a with the more integrated European and Japanese banks. steady stream of enterprise. But the position is 290:2 Another argument in favor is the success of such serious when enterprise becomes the bubble on universal banking in Germany and Japan. Fusion between a whirlpool of speculation. When the capital financial capital and industrial capital: cross-ownership, development of a country becomes a by-product interlocking directorates, joint strategic planning, steady of the activities of a casino, the job is likely to supplies of lang-term funds, banks actively involved in be ill-done. mnagement, investmant, product development decisions of industrial coprorations. 293:1 Keynes’s quote about speculation at beginning of 290:3/o This produces “informed and patient capital.” chapter was never as relevant as during 1980s. After 1982, Banks have vested interest in long-term success of their stock market was fastest growing activity in the economy. corporate clients, are inclined to help their clients through G says it comes from deregulation and financial innova- hard times. This allows corporations to take on much tion. more debt (which is cheaper than equity capital) with- Why not earlier? Because it required computers? Or out incurring default risk. Although highly leveraged, few because long economic stability made speculators more German or Japoanese firms go bankrupt. daring? Or because opportunities for making profits in Managers can take longer-term perspectives in invest- production were disappearing? ment decisions and product development. 293:2/o Stock market activity is unproductive shuffling 291:1 Similar structure prevailed in the US in the 50 of paper. This huge trading overhead is not needed by years preceding the Great Depression (J.P. Morgan was the economy; on the contrary, stock market has diverted a leading bank). But 1933 Glass-Steagall Act prohibited resources from real economy whose investment has re- banks from engaging in securities business. mained relatively stagnant. Productivity growth has con- 291:2 Consequences: formerly cooperative bank cor- tinued to lack. porate relations became adversarial. Being collateralized Here G addresses the disproportionality between real lenders without owning equity capital, banks often feel capital and fictitious capital, which was also a concern they have little to lose from pulling the plug on delinquent of Marx’s in Capital III. He also looks at the macro- borrowers. Bankers lend to assets rather than to compa- implications of individual profit-seeking behavior, implic- nies; would rather fund tangible structures than intangible itly making Marx’s distinction between surface and core. technologies; prefer dealing with borrowers that have already succeeded rather than those that might succeed in 294:1 Overview of chapter. the future. As short-term lenders they have no stake in the long-term success of their borrowers. This reinforces the 21.12.1 Dominance of Fictitious Capital short-term and risk-averse investment horizons of industrial managers. 294:2 An economy can only grow if it puts resources into 291:3/o Therefore in the US firms are more dependent education and investment instead of consuming them. on the stock market. Disciplining of managers is done 294:3–4 Growing economy needs injection or bor- by disgruntled shareholders or by takeovers; whereas in rowed funds (either by firms, or by consumer loans which Germany and Japan it is done in boardroom sessions with benefit the firms indirectly). This is Foley’s insufficiency the banks. of demand 108 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

294:4/o Neoclassical theory recognizes this support ble because Fed appeased the main creditors, the banks, function of credit; it views the credit system as a mech- by favoring private bank money over state issued cur- anism which channels savings into investment. It views rency. But with arrival of stagflation in 1970s, banks banks as financial intermediaries, which reduce risk or could no longer survive on these low interest rates. Banks transform maturity times. It also views creation of money revolted in the form of regulation-evading innovations, as financial intermediation. Cite [GS60] as example of speculation against dollar, or disintermediation and loan- this theory. rationing during recurring credit crunches, and forced the Fed to abandon its low interest rate policy. G does not say Question 40 Neoclassical theory views the credit system here where this stagflation comes from Lipietz says it is a as a mechanism which channels savings into investment. consequence of falling rate of profit. It views banks as financial intermediaries, which reduce 297:1 Deregulation of interest rates in 1979 gave a last- risk or transform maturity times. It also views creation of ing hike to interest rates, and gradual decline of nominal money as financial intermediation. What is Guttmann’s interest rates after 1982 in response to disinflation also critique of this view? boosted security prices. Therefore funds moved increasingly from industrial capital to financial capital. 295:1 Creation of money is more than financial inter- 298:1 Combined with a high interest rate Reagan also mediation; it is a creation of new capital. G does not use had an anti-union policy; therefore income was redis- the term “fictitious capital” here but I think this is what he tributed from workers to capitalists to rentiers (see table means. Refers to Sections 2.4 and 2.5. 12.2). Undermined social fabric and changed output mix 295:2 Financial capital and industrial capital have an from basic needs to luxury products. Middle class Ameri- ambiguous relation. On the one hand, financial capital cans had to work longer hours, save less and borrow more. supports industrial investment, and on the other it com- Industrial investment remained stagnant because cost of petes with it and reduces its net return. These two aspects capital was so high. Since consumers, businesses, and need not clash. Under normal conditions, returns on fi- government all had to take on more debt to finance even nancial capital are below those of industrial capital; in- moderate spending growth, the dominant position of fi- dustrial capital will take up loans only if it ends up with a nancial capital and the condition of high interest rates was net gain. But there can be a clash if financial investments reproduced. Gradual Credit Crunch has unfolded over last can be more attractive than industrial investments, and/or few years. debt servicing outpaces profit growth. This is the situation today. 298:2 Pitfalls for the creditors, the beneficiaries: high 295:3/o Keynes’s approach to financial capital: (1) sav- interest cost weakened debtors to the point of default. ing does not depend on interest rate but on income; (2) Growing loan losses on debts to LDC’s, farmers, energy Over time, capital becomes more plentiful, its owners producers, real estate developers, and leveraged buyouts can no longer exploit its scarcity value and interest rates (10.2). This has tied up large portions of interest-bearing would decrease (euthanasia of the rentier). This seems to capital in debt rescheduling. Bank lending has lost mar- be G’s take on the falling rate of profit. ket share to more attractive sources of interest (mortgage 296:1 Keynes was right with (1): the historically high brokers, installment credit offered by retailers and auto- interest rates in 1980s did not increase savings. But he mobile firms, commercial paper, junk bonds). was wrong with (2): rentier aspect of capitalism has risen 298:3/o Revival of finance in 1980 was not due to instead of declining. Holdings of financial assets relative interest-bearing loaned capital but to rapid growth of fic- to GNP grew dramatically over the last decade. titious capital (2.6). Footnote 5 explains how to capitalize 296:2 Why did capital not become relatively plentiful? a return. About fictitious capital he writes: “dissociation [I can’t believe G adopts this framework.] G gives 3 rea- from any productive capital makes them less vulnerable sons: (1) Affluence incites more and more frivilous con- to the vicissitudes of industry. These advantages encour- sumption in industrialized nations, which was met with age speculative position-taking in financial markets, with capital intensive mass production. (2) Rapid population trading profits the principal income form of fictitious cap- growth in developing world requires massive infrastruc- ital.” ture investments, which absorb a great deal of capital all 299:1 Interesting claim: although financial speculation at once. (3) Also government spending switched from di- has always existed, fictitious capital has become “insti- rect employment to reliance on government contracts with tutionalized” part of our economic system only with the industry. This guarantees high returns and therefore en- monetary reforms of 1930s: bank money creation ex ni- courages capital-consuming production methods (8.1). hilo is itself a source of fictitious capital. G says this is 296:3/o Attempts to implement a pro-debtor low inter- also the reason why bank money has no intrinsic value. est rate policy were abandoned in 1979. Had been possi- 299:2 Major extension of linkage between credit money 21.12. DEAL MANIA AND FICTITIOUS CAPITAL 109 and fictitious capital in late 1950s when British banks de- 303:1 Autonomy of fictitious capital is only relative. It cided to accept Soviet dollar deposits. Eurodollar money is ultimately based on performance of industrial capital. creation has potentially infinite multiplier, only restricted Speculative bubbles must burst eventually. Speculation it- to leakages if an interbank loan is made to a bank in the self is also detrimental: its short term focus conflicts with original country of issue or when borrowers convert their the long term horizon required in industrial investments. Euroloans into local currency. [I guess if they do not, this Speculation also absorbs funds. means they invest it in fictitious capital. Does he say that 303:2 Another linkage is: speculation-driven bull mar- this money multiplier gives an artificial source of demand kets usually accompanied by merger waves, especially in for this fictitious capital?] initial phase of the bull market when equities are still un- 300:1 Very important: a major sphere of investment of dervalued from preceding crash. this fictitious capital is currency speculation! [The fact 303:3/o Financial institutions are interested in bull mar- that futures positions can be easily unwound is not the kets (which give them many profit opportunites) and feed reason why they are so profitable. The reason is that one them. One way is to allow stocks as collateral for buying always knows in which direction the currency is going!] more stocks. 300:2 Another is government securities. He says it is a 304:1 This of course exacerbates downturns. If an in- source of fictitious capital, to me it seems to be a sphere vestor borrows $9 to buy a stock for $10, then a ten per- of investment for fictitious capital, a form fictitious capi- cent price reduction in that stock is a 100 percent loss for tal may take. (G uses the word “form” in the next para- him. graph.) Although there is no default risk, “its market can be quite risky.” Reagan bloated the supply so much that primary dealers were overwhelmed, allowing secondary 21.12.3 Stock Market Boom and Merger dealers. See 11.2 what they did! Solomon Brother, a pri- Wave mary dealer, found guilty of rigging bids. 304:1 Stock market weak in the 1970s. Why? Firms 300:3/o Less obvious form is: creation of accounting showed record earnings in the books which were fictitious profits to hide or transfer economic losses. [I guess they gains created by historic cost accounting of depreciation are playing the game of doubling the stakes and since and inventories (see Figure 5.1), and share holders lost credit money is so elastic it can accommodate this. It confidence in accuracy of financial statements. [That is a seems credit money in its present incarnation is much too funny explanation.] elastic for the demands of industry! Is this a factor with 304:3 Another reason for poor performance was rising computerized money?] interest rates in wake of accelerating inflation. [But real 301:1 Why fictitious capital so dominant now? Contin- interest rates were not very high!] High interest rates de- ued stagnation of industry, which became more exposed press stock market for 3 reasons: (1) funds get diverted in disinflation in early 80s. Industry did not invest in plant from stock market to bond market as yields there be- and equipment but in financial instruments. Before 1979, come comparatively more attractive. (2) interest costs speculation was cyclical, and now it became permanent take greater bite out of corporate profits. (3) basis for cap- and deeply embedded in structure of economy. italization of anticipated income flows is raised [but is that 301:2 Growing trend of securitizing of loans. One way not the same as (1)?] for banks to earn higher returns. 304:4/o Zenith of this stock market erosion was the 301:3/o principal engine for fictitious capital was stock Great Recession 1979–82, when inflation peaked at 14% market. and key interest rates rose above 20%. This forced corporations to cut costs and improve their balance sheets. Col- 21.12.2 The Cyclical Nature of Corporate lapse of inflation eliminated much of the accounting bias Stock in financial statements; disinflation and reduced credit demands led to gradual decline in interest rates after 1982. 302:1 Defines common stock. 305:1 Second major factor in bull market of 1980s was 302:2 Fluctuations in stock market prices overstate a shift in US economic policy; income taxes for wealthy cyclicals fluctuations. Footnote cites [Sor87] [but also Americans were lowered, capital gains tax was reduced, Marx said this]. and after tax profits increased through as variety of tax re- 302:3/o Linkage between stock market and real econ- ductions and credits. At the same time key industries were omy: rising stock prices make it easier for firms to issue stimulated by massive military spending. Industries had new shares and borrow more; capital gains in the stock lots of cash, but capacity utilization was low. Therefore market may be significant in determining the level of con- this cash went into financial transactions [he apparently sumer spending; both linkages are procyclical. means it was invested in fictitious capital]. 110 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

305:2/o also ideological: counterrevolution against the takeovers. Investors no longer looked at long term earn- liberal legacy of New Deal and Great Society. Free mar- ings but on value which company would have if it were ket and individualism, get rich quick mentality. Financial dismembered and its parts sold off. speculation. Emphasis on current eranings among share- 311:2 First setback to this euphoria was the uncover- holders and managers. Dominance of Finance in business ing of massive swindling by Drexel (Dennis Lewine, Ivan education. Extremely high salaries for brokers and invest- Boesky). ment bankers. 311 Balance of merger wave: on the one hand con- 306:1 Final ingredient in stock market boom was mas- solidation and restructuring of key sectors, on the other sive industrial deregulation in telecommunication, energy, massive replacement of equities with costly debt is wor- transportation, and finance. Basic manufacturing sectors: risome, and led to a wave of bankruptcies during 1991/2 oil, steel, rubber, automobiles, machine tools, chemicals recession. Workers were laid off, undermining employee face large excess capacities and intensified competition morale and increasing stress. Also the poison pills were when the dollar rose by more than 60 percent between damaging. 81 and 85. Rapid technological change: electronics, information processing, factory automation, biogenetics re- 21.12.4 Computerization of Securities quire costly and risky investments on a large scale. All this encouraged greater concentration in affected indus- Trading tries. 312:1 Wall Street perfect target for computerization. 306:2 This restructuring took the form of mergers and Nowhere else is fast and accurate information so impor- takeovers. Despite the many government goodies to in- tant. Few products are as intangible; they can be sent dustry, government did not formulate a coherent indus- through wires. trial policy. Stock prices were undervalued, and Reagan’s 312:2 Computers were used in two areas: (1) on hands-off attitude with respect to antitrust laws and super- traders’ desk they supplied price information from many vision of financial markets promoted this too. different markets, allowed investors to identify trading op- 306:3/o Some mergers were gigantic, triggerd other portunities in seconds. (2) enabled the stock exchanges mergers in same industry as firms struggled to protect themselves to handle surging trading volumes and linking themselves against their now much larger competitors. the trading flow more tightly to brokerage houses. Degree of concentration rose rapidly and dramatically. Global integration (possibility of executing huge trades 307:1 1984, a new type of takeover activity emerged, in a matter of seconds across the globe) comes from both which was the corporate raiders: hostile takeovers of un- aspects. This added considerably to the global integration dervalued and lingering firms. of financial markets. 307:2/o mechanics of an attack on a company. 312:3/o Program trading was second generation: in- 308:1 Also the institutional investors helped it, because stead of solving already existing problems, computers raiders needed only the support of a few investors to gain found their own function. control. 313:1–4 enumerates kinds of program trading which 308:2 Most important cause for success was their fi- became popular in mid-80s and comprise about 10% of nancial backing; since due to deregulation of brokerage trading today. commissions, securities industry had a steady decline of 313:5 Pros and cons of program trading. earnings. 308:3/o Principal instrument to finance takeovers were 21.12.5 Stock market Collapse [1987] and junk bonds: risky long term bonds paying 3–5 percent its Effects above treasury bonds. 309:1/o Counterstrategies by firms: buying up their 314:1 In August 1987 Stock market was clearly overval- own shares; spinning off assets; saving costs through lay- ued. offs; introducing poison pills such as huge severance pay- 314:2 First sign of trouble was 1986 insider-trading ments to top managers in case of dismissal, or two-third scandal. majorities among shareholders, or leveraged buyouts (go- 314:3 But stock market got over it; between Jan–Sept ing private with borrowed money). 1987 it exploded from 1920 to 2720. 311:1 This takeover activity boosted share prices, be- 314:4/o September 1985 Plaza agreement to devalue cause the supply of stocks shrank by an estimated 400 bil- dollar created problems: (1) reawakened inflation fears; lion between 1982 and 87. (2) private capital inflows into US slowed down; (3) dollar Restructuring efforts by firms to defend themselves also devaluatio ntheratened to get out of hand since specula- pushed up stock prices. And speculation on possible tors dumped dollars expecting further decline. Therefore 21.14. THE INTERNATIONAL MONETARY SYSTEM IN FLUX 111

February 1897 Louvre agreement decided to stabilize the 323:3/o Congress has not made the switch from Pen- dollar. See Chapter 8.4. tagon, entitlements, and socialization of private losses 315:1 Dollar was stabilized but it turned out in 1987 (thrifts) to productive investment in our infrastructure and that the prededing devaluation had not improved US trade labor force. Success of this readjustment will depend on deficit. Exports began to revive, but imports rose as well, competition of other countries, since we compete with and deficit became worse month after month. Therefore them for scarce capital and whether they want to absorb downward pressure on dollar, therefore Fed sharply raised our trade surplus. interest rates. 324:1 Globalisation of capitalism has increased its pace 315:2 Events preceding crash. and scope. Qualitatively new global economy. 315:3 What happened on crash day, October 19. 324:2 Unique features of the global economy: contract 315:4/o October 20. enforcement and stabiilization policies depend on volun- 316:1 immediate aftermath of crash. tary agreement between diffferent nations. 316:2 Why crash only had limited effect on growth. (b) foreign trade involves an second transaction, the 317:1 Nevertheless significance of crash should not be currency conversion. downplayed. (c) globasl economy must have a mechanism for sym- 317:2 US regulators understood how close crash came metric adjustments and even dvelopment if it is to grow to meltdown, looked at it seriously. properly. 317:3 Although markets of commodity futures and 324:3 International monetary system is central. stocks are tightly linked, they are regulated by different agencies (Commodity Futures Trading Commission and SEC), which have their disagreements. And it is also non- 21.14 The International Monetary trivial to decide which kind of regulation is needed. 317:3/o Negative effects of stock market crash on in- System in Flux dustry. Industry has been buying back equities and incur- 353:1–3 Monetary international relations are logically ring more long term debt, and the crash exacrebated this. prior to other international relations (tariffs, attempts to 318:1 Junk bond market collapesed in aftermath of stabilize prices). crash. 353:4/o Signs that today’s monetary system is out of 318:2/o Also LBO’s (leveraged buyouts) no longer whack: worked out. SEC required more disclosure, which dis- couraged them even more. Richest nation of the world absorbs most of the world’s 319:1 Securities firms had to retrench since individual savings and the poorest nations are exporters of capital investors withdrew from market and also underwriting of Balance-of-payment disequilibria are not corrected by new issues and mergers shrank. market forces, or the adjustment burden is placed on 319:2–320:0 But deeper structural reforms are neces- weakest economiers. sary. Global growth that is based on large US budget and High variablilities of exchange rates is good for specu- trade deficits is unsustainable. lators but constrains policy-makers and trade. 354:1 Key features: competing forms of world money, flexible exchange rates subject to intermittent manipula- 21.13 The Challenges of Global In- tions by central banks, capital transfers go through a private and largely unregulated banking network. tegration It is a nonsystem, a transitional system. 354:2 for figuring out what system will work best, we 323:1 Until recently, US had a relatively closed economy, need (1) theoretical understanding of money and (2) his- which dominated the rest of the world. This gave it a great toric assessment of previous institutional arrangements. deal of independence. Today it is more open, no longer 354:3 Summary of chapter. dominant. We consume more than we produce. This has restricted our poilicy options. 323:2 We have become the world’s largest debtor na- 21.14.1 Gold: True Form of World Money tion. Cannot count on willingness of foreign savers to fi- or “Barbarous Relic”? nance our twin deficits for ever. Annual interest payments on foreign liabilities approach 1 percent of GNP, which is 354:4 Control over money was always important ingredi- nearly half our average growth capacity each year. This ent of political power. [But the flip side is also: you need debt was not for productive investments. but excess con- a powerful coercive apparatus to enforce the rules of the sumption and bloated military apparatus. game.] 112 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

354:5 Government control over money has always nations to service their foreign debts. This collapsed Au- meant: preventing private agents from being able to issue gust 1914, a few weeks after beginning of WWI. their own money. 360:1 How British Hegemony led to its own downfall; 355:1 Private issue of money usually had the result that not very clear. they issued too much of it, and therefore this role falls to 360:2 Gold standard began to emerge in 1819, fully es- government. tablished 1879, functioned well until 1914. Has two ad- 355:2 historical examples. vantages: fixes exchange rates, and has automatic adjust- 355:3/o Powers needed stable money to come into be- ment mechanism for equilibrating trade balances. ing, and then they often misused their seigniorage, leading 360:3–361:0 Explains better these two functions. Ex- to the demise of the empire. planation of the specie-flow mechanism. 356:1 Their emphasis on purity of money caused them 361:1 Drawbacks: fixed exchange rates were often too to lead wars of conquest to get at the gold stocks of other rigid and could not adjust properly to changes in “rela- countries. tive competitiveness” of different countries. Adjustment They also needed slaves to work in the gold mines. mechanism was too harsh. 356:2/o After 476 AD fall of Rome, Constantinople’s 361:2 Gold standard also suffered from inherently lim- gold coins (bezant) were at top of pyramid throughout ited supply of the money-commodity. British pound was middle ages. used to supplement gold. 690 the Islamic Caliphate established dinar and im- 361:3/o Gold exchange standard in interwar years short posed silver bloc for countries and trade routes under its lived. Pound was overvalued. control. 362:1 US replaced Britain as main creditor, but they did 357:1 Ater sack of Constantinople by crusaders 1203 not give up their protectionism. period of instability. 362:2 Bretton Woods unique opportunity to build a new 357:2 1400s new sources of gold in Central Bohemia system. and Transylvania, but this was insufficient. Capture of 362:3/o IMF administers a complex set of rules. First Constantinople by Ottomans in 1453 cut off traditional time ever management of international monetary relations trade routes from East. This spurred naval expeditions to no longer the domain of governments. open alternative routes. 363:1 Adjustable peg remedied the lack of flexibility of Plundering first from Africaln gold coast, then Incas, the gold standard. Aztecs (16th century), Columbia 17th, Brazil 18th. 363:2 Dollar became key currency, as good as gold. Spain wasted its riches and lost its hegemonic power Military committmens, Marshall Plan, and capital exports within a century, the influx of precious metals benefited transferred dollars overseas in ways that reinforced US emerging capitalism. hegemony. 357:4/o rising prices and large gold hoards with gold- 363:3 Structural shortcomings of Bretton-Woods sys- smiths led to circulation of certificates of deposit. tem: limited supply of gold, eventual inconvertibility of 358:1 These goldsmiths issued more certificates than key currency, there is no market remedy to the overvalua- they had in store, injecting liquidity. Their occasional fail- tion of key currency, issuer of key currency has a steadily ures induced recessions. widening balance of ayent deficit. 358:2 then Dutch banks, which benefited from free It is not an accident that all three gold-exchange stan- coinage. dards fell apart in a similar manner. 358:3/o Confluence of merchant capital, artisan pro- 1971 gold ceased being the anchor of the international duction, and gold-based banks laid the basis for industrial monetary system. revolution. 358:3/o After Napoleonic wars dominance of British, 21.14.2 National Currencies as Interna- they put pound on pure gold standard and abandoned pro- tional Mediums of Exchange tectionism. 359:1 Britain imposed free trade on other nations; by 363:4/o Since 1971, dollar has functioned as world money mid 1900s gold in short supply. 1848 Californai gold rush, without gold convertibility. Paper money as world cur- 1850s also Alaska. rency seems to have many advantages over the gold ex- 359:2 British capitalists spent 40% of their investment change standard: paper is a more practical medium of abroad. Pound became world currency, one country after exchange, because easier to divide, transport, and store. another adopted gold standard. Germany 1871, France Also more practical as reserve assets, because foreign- and Belgium, Switzerland, Italy 1878, US 1879. exchange reserve assets are usually held in the form of 359:3/o England ran large trade deficit, allowing other interest-yielding deposits. Also does not have the supply 21.14. THE INTERNATIONAL MONETARY SYSTEM IN FLUX 113 constraints of gold: originates in the banking system in this is an effective sanction against over-imports. the country of issue and is then transferred abroad through 365:1 repeats. Footnote 14 speaks of sterilization, i.e., net outflows of funds from that country. As long as issuer counteracting the rserve inflow byu simultaneous open of key currency rund BoP deficit, it supplies the rest of market sales. G says the central bank might do this “at the world with additional liquidity. Also removal of gold times” and it is clear that this can only be done on a tem- gives more flexibilty in the adjustment of exchange rates porary basis, because the Fed does not have an unlimited to reflect underlying macroeconomic changes. amount of securities to sell. This also suggests that it is 364:1 But system based on key currencies also has fun- easier for the country issuing the key currency to run a damenta weaknesses. “Those currencies are by their very budget deficit. G also speaks of “aggregate demand”, and constitution incapable of effectively fulfilling all of the it is clear that the mechanism he is speaking about is only various functions of money on the global level.” possible if aggregate demand is insufficient. 364:2 Fundamental rule: buyer cannot pay for his pur- 365:2 This international mechanism differs from the chases with his own credit. In footnote 13 on p. 516, domestic check-clearing mechanism because all produc- Guttmann refers to [Gut85, pp. 3–4] for more details on tion takes place within national boundaries and must be this. Is this the same as [Gut88]? Guttmann says in 364:2 paid for by national currencies. But the country issu- how this is enforced in the country (banks are not allowed ing world money is exempt from this: it can buy foreign to engage in ordinary business), and in 364:3–365:2 how things with its own money. this is enforced internationally, but he says at the end of 365:3–366:3 Advantages of this seigniorage: 365:2 that the issuer of the key currency is exempt from 365:4 if this country imports or exports capital, the this rule. money it spends flows right back into the economy, be- Rest of 364:2 is nutshell definition of credit money: cause the recipient of the dollars holds on to them (in the credit money is someone’s promise to pay. This gives form of treasury bills etc.). the problem that sellers who accept this give the buyer 365:5/o Since this country usually has trade surplus, it a loan of indefinite maturity. In domestic system this can and must export capital, which gives additional profits problem is resolved as follows: This credit cannot be the for its capitalists. buyer’s own credit or the credit of anybody but must be the 366:1 Therefore the key currency country becomes the buyer’s bank’s promise to pay. This is more secure than world banker with long term assets and short term liabili- the promise to pay by some ordinary economic agent, be- ties. Yield spread has been called “external seigniorage.” cause (a) banks are located outside the market place for 366:2 this can go on indefinitely “as long as foreigners goods, and (b) their promise to pay are “enforced” by the are willing to hold new supplies of the key currency in Fed’s clearinghouse function between banks: when the reserve.” G does not say here that this willingness will seller deposits the check, the Fed transfers the money to necessarily be undermined over time, and that at that time the seller’s bank (by debiting the buyer’s and crediting the not only the new supplies but also the refinancing of the seller’s bank). old supplies will be problematic. I think this is a better explanation than that given in 366:3 Key currency issuer can have more stimulative [Fol87b] why the “pyramid” described there works: Fo- monetary policy than other countries. ley merely says that the credit must be the credit of some 366:4/o Responsibilities and costs of seigniorage: Must more “trusted” institution, the bank, and the bank uses maintain stable value of its currency. Fed policy reversal credit from an even more trusted institution, the central in October 1979 shows how painful this can be for do- bank. Guttmann’s explanation says why the banks are so mestic economy. Must avoid flooding the world with its “trusted” and what the central bank is doing to make them money, as Johnson did with his “guns and butter” policy so trusted. in late 60s, or Nixon and Carter’s reflation/devaluation 364:3 There is also a somewhat different enforcement strategies in 70s. After becoming a net debtor nation in mechanism in an international payments without gold, 1985, there is the moral hazard of wanting to devalue the in which central banks ensure convertibility “by tranding currency in order to depreciate the debt. G claims that this foreign currencies as financial claims” (last line in 364:4). will eventually destroy the key currency role. The importing country cannot pay for the imports with 367:1 also the unit of account problem: if not anchored its own currency but it must buy foreign exchange; the in gold, price level is indeterminate. money spent in this way is lost for the domestic circula- 367:2 Neoclassical economists sidestep this issue. tion. 367:3 Capital movements are not temporary adjustment 364:4 Therefore aggregate purchasing power falls with flows, but they become stronger and stronger and are more imports (and capital exports) and rises with exports (and important than flows of goods. capital imports). G does not say it in so many words but 367:4/o People want to hold the key currency in order to 114 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY” be safe and liquid (international counterpart of Keynes’s 21.15 Supranational Credit Money liquidity premium). NC economists ignore this effect. 368:1 NC theory usually looks at single country in re- 21.15.1 The Bancor Plan of Keynes lation to rest of world instead of looking at the system as 385:1 Why it is so difficult to keep the current system: a whole. G7 nations do not follow up their “managed float” with 368:2 The flaws of this system—volatile foreign- increased policy coordination. echange markets, destabilizing capital flows, persistent 385:2 Why a commodity money (either gold or bun- imbalances in BoP—have contributed to synchronization dle of commodities) cannot be world money: supply of of business cycles, impossibilty of long-range planning. money commodity inelastic and uncertain, the producers of this commodity have an outright advantage. G says credit money and commodity money are incompatible. 21.14.3 The Instability of Our Multicur- 385:3/o Supranational Credit Money SNCM is next rency System logical step, most adequate form of money for present stage of globalism. 368:3/o Indeterminacy of numeraire is a problem because 386:1 But barring a catastrophe it is unlikely that the markets are often irrational. nations will give up their sovereignty and create a SNCM. 386:2 Also the technical question what kind of SNCM? 369:1–4 Laws governing exchange rates: 386:3 Fortunately, we have already experiences: Ban- 369:2 In long run they reflect a country’s competitive- cor, SDR’s, and ECU. ness. 369:3 Around this secular trend distinct cycles of 4–7 21.15.2 The Bancor Plan of Keynes years due to overshooting and adjustment in goods and asset markets. 386:4/o Radical ideas by someone who had a profound 369:4 much shorter-term price fluctuations due to ex- knowledge of international monetary affairs. pectations and speculation. 387:1 all transactions between countries should be 369:5 Despite this logic, they are very volatile which is routed through International Clearing Union, with new costly. currency unit called bancor. 387:2 Comprehensive exchange controls: all foreign 369:6/o Protections against this are not perfect and have exchange transactions have to go through the central bank. their own costs. Trade and long-term capital investment should receive 370:1/o Unwinding hedges to limit losses and the licenses automatically, and short term capital movements “leading and lagging” of multinationals are pro-cyclical. for speculation and flight purposes would not be ap- 371:1–2 Volume of currency trading has greatly in- proved. creased. Gives numbers. 387:3 Among each other, central banks would buy and 371:3/o this adds liquidity but technical trading adds sell foreign currencies only through debits and credits of volatility and it diverts resources from productive activity. bancors at the clearing union. 372:1 Present international monetary system lacks ef- 387:4/o Clearing Union works on overdraft principle: fective mechanism to correct trade balances. each country has a line of credit, and net of all credits and debits is zero. 372:2 Gold standard: specie flows from deficit to 388:1 Bancor represents a weight of gold. National cur- surplus countries forced both into countervailing adjust- rencies have an exchange rate with respect to bancor. ments. [How does a gold inflow force to countervailing Central banks can still ship gold to each other to make adjustments?] payments, i.e., the country shipping the gold will get a Bretton Woods: threat that the country had to devalue, credit and the country receiving the gold a debit in their was considered sign of weakness. bancor account. Countries can also pay gold to the clear- 372:3–373:2 Today no such discipline: (1) the coun- ing Union. try whose currency acts as world money does not have to But convertibility does not go the other way: no coun- adjust, rather it should run deficits. (2) Surplus countries try can demand gold instead of bancors. However if the do not have to adjust, they can re-lend their surplusses (3) Clearing Union has too much gold it can distribute it to Debtor nations with access to capital markets do not have the credit countries in proportion to their credits and this to adjust. They can also let their currencies plunge instead diminish those credits. of adjusting?? Will that not lead to adjustment? (4) Euro 388:2 Not only deficit but also surplus countries have network is prone to credit overestension. to use policies to address their imbalances if these imbal- 21.16. TOWARDS A TRUE FORM OF WORLD MONEY 115 ances become too large. Deficit countries: modest or large 21.15.3 Special Drawing Rights currency devaluations, restrictions on capital exports, sur- render of gold reserves, austerity measures or outright de- 21.15.4 European Currency Units fault. Surplus countries: reflating the economy (lower in- 21.15.5 Economic and Monetary Union in terest rates, higher wages), currency revaluation, removal of trade barriers, loans to lesser developed countries. Both Europe have to pay fees which rise with their imbalances. But if 21.15.6 Europe’s Currency Crisis of 1992 the surplus countries lend their surplus to deficit countries, then they don’t have to pay these fees. 21.15.7 The Uncertain Prospect of the Union Treaty 21.16 Towards a True Form of

388:3/o Clearing Union also collects levies for a vari- World Money ety of new multilateral agencies: Relief and Reconstruc- tion Authority to rebuild war-damaged economies, Com- 21.16.1 Finding a Viable Form of World modity Council holding stocks of commodities, Board for Money International Investment to transfer capital to developing countries, and International Economic Board to maintain 21.16.2 The Issue of Supranational Credit stability of world prices and control business cycle. Money 431:2 SNCM carries out all the functions of money and not just be an international reserve asset with which to settle official international debt (is the emphasis on “official”?) as is the case with SDR’s or the current ECU’s. 389:1 Advantages of Bancor Plan as G sees them. Since it is too early for a world wide currency union, SNCM coexist with national currencies. SNCM does all international transactions, and national currencies are confined to domestic circulation within their respective countries of issue. 389:2 Nevertheless Bancor Plan was defeated. Why? 431:3/o Important theoretical issues: (1) separation of Notion of an overdraft facility was alien to US. US ex- international and national spheres is already in existence pected to have strongest currency and to be main supplier today since although trades are made individually the ex- of international credit. It did not want to have the obliga- change rate is determined on a nation by nation basis. tions the Bancor plan would have put on it (dollar revalua- Since SNCM is credited to nations as a whole, it does tion and other corrective measures). Also currency depre- not circulate in the hands of individuals. It is credit ciation of others was a threat to US exports, therefore they money, and as credit money it must be issued outside wanted stability of exchange rates more than liquidity. the market. Instead of being a net asset with purchasing power, it must be a simultaneous asset and liability. [I guess this means: the only way to get cash is to incur a debt, and to obligate oneself to pay back this debt. In this way, there is no seigniorage.] 432:1 Mechanics how it works. 390:1 Along with the bancor plan the US also quashed 432:2/o Creation of liquidity can be noninflationary, be- the ITO plan, which would have gone beyond tariffs and cause the individual produces new values and then sells quota to domestic policies which give unfair trade advan- this new value to get the mone yback with interest. But tages (export subsidies, cartels, price discrimination) and G says, internationally there is not production, therefore would put pressure on trade surplus countries. there cannot be creation of liquiditly. The sum total of world liquidity must stay constant. [He is using it as an automatic mechanism which coordinates the monetary policies of all the member nations, and makes sure that the purchasing power cxreated in one country is cancelled by 390:2–391:0 This too never materialized, instead a destruction of purchasing power in theother. Does this GATT. mean: automatic sterilization of all international trade?] 116 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY”

433:1 That is what distinguishes it from Bancors, and would have much greater powers as the sole issuer of SDR’s and ECU’s. world money. 433:2 Bancor allows deficit countries to draw from the 439:1 Because of the sensitivity of the issue, he pro- accumulated surplus of the surplus countries, i.e., it is a poses general rules, which apply to each country. loan to the deficit country, which can circulate as money, 439:2 Deficit reduction by debtor nations has to go hand because it is guaranteed by the international bank issuing in hand with surplus reduction by creditor nations. This the bancor. would allow global demand to remain higher. 433:3 SDR’s are ECU’s are simulteneous assets and li- 439:3/o Finally comes out with it: surplus countries abilities, but [presumably since they are backed by previ- may be subject to a graduated surtax on excessive surplus ously created national currencies] they already represent reserves. revenue with purchasing power. 440:1 In addition to those rules, there should also the 433:4/o Explains it again: it is not means for settlement the discretionary power to override those rules. after the fact, but I don’t quite get it. 434:1 3 criteria for SNCM: Does not function as money 21.16.5 Global capital transfers in the hands of individual buyers, can only be issued to a particular country in exchange for an equivalent reduction 443:1 There has been a net outflow of capital out of the in domestic purchasing power, and its issue covers all for- poorer countries and a huge inflow into the US. This per- eign transactions, not just the net balances. verse flow of capital has to be reversed. 441:1 Issue is that they export only a few commodities with highly volatile world market prices, but need lots of 21.16.3 16.3 The International Payments imports. System 441:2 Therefore IMA, instead of loaning funds to the 434:2 Description with Figure 16.1, additional details in central banks, it should purchase productive capital goods [Gut88, pp. 270–82]. directly and invest them in the deficit countries. [Certainly the capitalists will not like this: a nationalized bank making investment decisions. But maybe this is the interna- 21.16.4 16.4 Deficit Financing and Adjust- tional counterpart of government taking over unprofitable ment Policy spheres of investment.] 441:3 Advantage over private Euromarket recycling. 434:3/o How to handle chronic deficits is important. 441:4 Surplus countries will leave excess funds in the Keynes’s Bancor proposal wanted to leave the global safe hands of the IMA instead of putting them in the un- redistribution of funds from surplus countries to deficit secured eurocurrency deposits. countries to the automatic rule of a global authority, rather 441:5 Since invested in productive entrprises, instead of than the profit motive of private banks, or the politicized import of luxury goods or purchases of arms, they will be foreign assistance of governments. The SNCM follows more likely to be self-liquidating. [That is where I would this principle. question it.] 435:1/o Split up IMA in two departments: M.D. (mon- 441:6 Since it not profit motive, it is more flexible to etary department as just discussed) and F.D. (Finance De- adjust its credit terms to the needs of the borrower [that partment). Surplus countries can loan their excess funds could be abused by the borrower]. to the F.D. which then loans it to the deficit countries. 441:7 Net loans to each country will be limited. 436:1 Symmetry of this [I guess what he wants to stress 44:8/o Summary here is that this involves not money creation because those debts have to be paid back.] 436:2 Surplus countries do not have to lend to individ- 21.16.6 16.6 Exchange Rates ual countries, so they are less exposed to risk. It is not 442:1/o Since national currencies are no longer traded profit driven, therefore not prone to the cycles of overex- against each other, they don’t have exchange rates against tension and retrenchment, and it is not as skimpy and each other, but only an absolute price in terms of SNCM. heavily politicized and does not come with strings at- 443:1/o But there are possibilities to adjustment of the tached as the official foreign aid programs. exchange rates, which should not be confined to deficit 436:3 If there is a danger that those loans cannot be countries. Trade among industrial countries is essentially repaid, the IMA has to impose austerity measures. balanced, while allowing LDC’s to run adequate deficits. 436:4/o IMA would enforce adjustments more gradually, before debt levels have gotten out of hand, would Question 41 Guttmann argues that the present interna- coordinate the balancing efforts of debtors and creditors, tional monetary system has some immanent flaws which 21.17. UNITED STATES AT THE CROSSROADS 117 can only be remedied by a true supranational credit 21.17.1 17.1 The end of American Hege- money. What are these flaws? Describe the attempts to mony create a supranational credit money and their limitations. Lynn Turgeon Book Review

Review of [Gut94] on Pen-l July 22, 1994, by Lynn Tur- 21.17 United States at the Cross- geon: Robert Guttmann’s pathbreaking critique of contem- roads porary international monetary policy attempts to explain capitalism’s long-run tendencies and sources of instabil- 455:1 World monetary system has been based on the dol- ity. Building on the works of Karl Marx and John May- lar. This implies that Americans had to supply the rest of nard Keynes, G contends that both were essentially mon- the world with adequate global liquidity. Lender of last etary economists. As critics of standard equilibrium the- resort obligation, dominant US role in funding the IMF ory, Marx and Keynes based their heterodox alternatives or in managing the LDC debt crisis. But the seigniorage “on presenting money as the unifying force that integrates benefits have been an advantage. US has been able to run otherwise separate and disparate activities into a coherent continuous balance of payments deficits. whole capable of reproducing itself in expanding fashion 455:2 The dollar’s international role gradually eroded ... Both economists understood the standard treatment of since 1971. Symptoms: Series of devaluations; long-term money to be the Achilles’ heel at which to aim their at- loss of market share to other key currencies. ”Trend is tacks against orthodox economists.” direct result of America’s worsening economic position Traditionally economists have considered Marx and over the past 25 years.” Dollar will cease to be primary Keynes as rivals, and it is certainly true that Keynes had world currency. little use for the Classical writings of Marx. This antag- 455:3/o This may take the form of the adoption of su- onism between the two major heterodox economists of pernational credit money. But even without it, he predicts the 19th and 20th century, respectively, was exacerbated it will be the case by the turn of the millenium. In either by Stalin and dogmatic Marxists, who felt that Keynesian case the US will lose their seigniorage benefits. economics was an alternative to their hoped-for crisis of 456:1 This is not a smooth process (euphemism for the advanced capitalist system. On the other hand, most crises): Sharp devaluations of the dollar in 1973/4 and Keynesians, with the exception of Joan Robinson, have 1978/9 destabilized commodity markets, forced interest refused to take Marx seriously. rates higher, and set off global recessions. Efforts to stabi- G does for international banking what William Greider lize the dollar in 1987 Louvre agreement helped to trigger [Gre88] did for United States monetary policy, with ex- world wide collapse of stock prices. Further likely dis- tensive probing of the world history of money. But he is ruptions: massive flight out of the dollar. Deepening of equally at home with contemporary affairs, such as the re- global debt crisis In the absence of an effective interna- cent breakdown of the European Monetary System. He tional lender of last resort. Intensifying trade wars. Syn- is rightly critical of the monetarist biases of the Proposed chronized world wide downturn. Union Treaty coming out of Maastricht: “The abandon- 456:2 Even absent these crises, America will soon face ment of debt monetization is in line with standard Mon- the same kind of external constraints as anyone else. It etarist thinking. The influence of that theory within the will not be able to borrow as easily, and since surpluses Delors Committee, which drew up the plan for economic elsewhere will no longer be held in dollars, also interest and monetary union, can also be seen from its emphasis payments will not come out of seigniorage, but out of ac- on price stability as the primary policy objective and its tual income. [The question how these seigniorage benefits lack of attention to the structural origins of inflation. In entered the economy, whether it was capital investment, this quantitativist notion, price stability is seen to depend imports, or interest payments, seems to me an important on prudent management of the ECU money supply by the one.] It is beteen 1 and 2% of GNP (i.e., half of current Eurofed. The focus of attention thus shifts from the cur- annual growth capacity). rency to the monetary institution, justifying the notorious 456:4 Therefore we must find ways for for the US to anti-inflationary Bundesbank as the model to copy. This expand more rapidly; overcome institutional barriers to particular bias raises some troubling questions about the growth: slow productivity growth; inadequate investment future monetary union.” (p. 425) spending; bias towards the sort term; paralyzed policy- The deregulation of capital movements in the Eco- making; nomic Community since 1991 – during the first phase of 456:5–457:1 Overview of Chapter. the transition – “may have been a serious mistake,” ac- 118 CHAPTER 21. GUTTMANN’S “HOW CREDIT MONEY SHAPES THE ECONOMY” cording to G. If this reviewer has any reservations about G’s conclu- In his conclusion, G develops a plan for a truly supra- sions, it is his assumption that our chief rivals (Japan and national form of credit-money (SNCM). He builds on Germany) are still “closing the gap.” Granted that the ad- Keynes’ Bancor Plan which was ultimately pushed aside vanced capitalist system seems to be in trouble, the recent by the U.S. delegation at Bretton Woods. This plan was hegemonic success of the United States economy rela- based on comprehensive exchange controls on both ends tive to Japan and Germany has to be explained. In my of capital movement to make them more effective. One view, Germany continues to be handicapped by the “no- of his goals was “to distinguish between trade or produc- torious” Bundesbank, which has already been responsi- tive investment, both of which would receive licenses au- blefor bringing down four postwar German governments. tomatically, and unproductive movements of capital for The Japanese, on the other hand, seem to be constricted by speculation or flight purposes,which would not be ap- continually tight fiscal policy, or a reluctanceto engage in proved.” deficit financing to get them our of their doldrums. Lynn The Bancor would have largely eliminated the role of Turgeon gold, which had a comparatively inelastic supply and was responsible for the deflationary biases of the international gold standard. As the nation with the largest expected foreign trade surplus after the war, the United States dollar would have been subject to constant revaluations. Thus, the delegation headed by Harry Dexter White rejected Keynes’ proposal in favor of a gold-backed dollar, the so- called “gold exchange standard,” under which the United States would reap the benefits of seigniorage and turn its huge postwar gold hoard into a source of global liquidity. G also consider the limitations of the Special Drawing Rights (SDRs) first issued by the IMF in 1969 as a substitute for gold and dollars, and the European Currency Units (ECUs) of the Common Market as first steps towards a truly stateless money managed by an international monetary authority. Because the SDRs cannot be held by private parties, and because their further creation has been subject to the approval of the U.S. Congress since 1982, a new form of world fiat money is still far from being realized. Michel Camdessus, the IMF’s current Managing Direc- tor, would like to create enough SDRs to cover 10 percent of the total growth in demand for government financial liquidity, according to Pete Passell (The New York Times, July 7, 1994, p. D-2). For well over a year, Camdessus has proposed, in the name of rough equity, the issuance of SDRs for the countries of Eastern Europe which have only recently joined the club and therefore failed to share in the earlier creation of SDRs. G views international monetary history as a gradual transition from commodity-money (as in Marx’s time) to credit-money, and finally to a new supranational credit- money. With NSCM, there would be no need for nations such as the United States benefitting from seigniorage. There would be no need for the richest nation, the United States, to become a huge importer of foreign capital, some of which comes from the poorer countries. There would be no need for politically motivated foreign aid programs or the writing off of debt. With the ending of the Cold War, this would now seem to be more possible. Chapter 22

De Grauwe’s Textbook on Monetary Integration [DG97]

De Grauwe has also written a book called International 9:2 If the countries are in a currency union, they can’t Money, [DG96]. use this instrument. This is the cost of a currency union. 9:3 Can it be solved by other instruments? If Germany raises taxes and transfers the tax revenues to France, this 22.1 Costs of Common Currency would solve it too. 9:4–10 Of course such a thing will not happen between Introduction sovereign nations, but it does happen between regions of Survey of “theory of optimum currency areas.” He is crit- same nation. Either automatically, because government ical of it, but first brings the theory as it stands. expenditures are spent uniformly over the whole country while tax revenues may vary by region. or explicitly, see German Finanzausgleich. 22.1.1 Shifts in Demand (Mundell) 11:1 Fiscal transfers can only solve the problem if the The AD/AS curves he is using here are not based on the shocks are temporary. Bastard-Keynesian IS-LM effect described in footnote 4, 11:2–3 Implication: monetary union is optimal if there but on substitution between foreign goods and domestic is wage flexibility or mobility of labor or if fiscal transfers goods. can be organized. If there is an increase of demand for German as opposed to French goods, then prices and output rise in Ger- Question 42 Assume there is an increase of demand for many and decline in France. German as opposed to French goods. Describe what hap- This will cause a (current) BoP deficit in France and pens under different policy scenarios. How does a discus- surplus in Germany. Why? the current account surplus is sion of various possibilities lead DeGrauwe to the con- domestic output minus domestic spending, and spending clusion that monetary union must be followed by fiscal in France will not decline as much as output (because of union? unemployment benefits etc.) 7:3 What is next step (barring currency revaluation/devaluation)? 7:5–8:1 (a) if wages are flexible, they will fall in France and rise in Germany. 22.1.2 Different inflation/unemployment 8:2 (b) is labor is mobile, workers will migrate from preferences France to Germany. 8:3 but if neither is the case, i.e., wages will not de- This really means: different strengths of the labor move- cline in France, then there will be an inflationary trend in ments. Germany. This assumes a stable Phillips curve: if the countries are 8:4 Policy dilemma: if Germany resists inflation, then on points of their Phillips curve with different inflation it will have continuing current account surplus. rates, after the monetary union they must choose points 8:5–9:1 Way out is revaluation of mark against franc— where their inflation rates are equal (which may be less says Mundell. De Grauwe says, this is too good to be true. preferred points for both countries).

119 120 CHAPTER 22. DE GRAUWE’S TEXTBOOK ON EUROPEAN MONETARY INTEGRATION

22.1.3 Differences in Labor Market Institu- industry trade, based on economies of scale and product tions differentiation. Therefore countries buy and sell to each other the same categories of products. France sells cars to If there is a supply price shock (oil price increase) and and buys cars from Germany. Therefore a demand shock labor unions are centralized, they will press for moderate for cars will affect both countries equally, they will be wage increases because they do not want to cause infla- symmetric. tion. 21:3– Paul Krugman: Economies of scale will lead to If labor unions are decentralized, then each union will regional integration of industrial activity: perhaps cars try to get raises for its membership, hoping the other will be built in Germany and Italy only. Therefore shocks unions will not follow suit. will be asymmetric. If labor unions are very decentralized so that they deal 23:1–24:0 De Grauwe: the regions of concentration with single firms, they can again not press for so high will not be national boundaries: perhaps cars will be pro- wage increases because otherwise their firm goes out of duced in Northern Italy and South Germany. This makes business. the effect of shocks more symmetric again. The figure on p. 16 shows this inverted U: change in misery index (inflation rate plus unemployment rate) is 24:1–2 Empirical evidence supports this. highest when centralization index of labor unions is in the middle. Apparently De Grauwe has made this argument in [DG90], and the data come from [CD88]? Asymmetric Shocks and the Nation State Therefore countries with different centraliation indices may get into difficulties when they form monetary union. There will be asymmetric shocks due to national bud- This is a very a-political treatment of labor unions. getary policies, national wage bargaining. Monetary union cannot persist if political union does not follow. 22.1.4 Different growth rates In order to avoid BoP deficits, the fast growing coun- Institutional differences in labor markets try must have lower inflation rate than the slow growing country, i.e., a deflationary opolicy whcih will then reduce They will diminish: differences in government policies growth. are one factor fostering these differences, and government If currency devaluation was an option, it would do the policies will be more equalized. trick.

Do differences in growth rates matter? 22.1.5 Different fiscal systems Countries use different mixtures of taxes, debt, and print- Contrary to what was said in Section 22.1.4, faster growing money to finance their goverment outlays. In a mone- ing countries do empirically not have more real deprecia- tary union, the printing-money part must be equal for all. tions than slower growth countries. (I assume “real” depreciation is one measured in purchasing power parity.) 28:1 Elegant explanation why not by Krugman: Eco- 22.1.6 Conclusion nomic growth implies development of new and better Changes in exchange rates are often less costly than other products, and the demand for those has higher income- policy alternatives, and in a monetary union these changes elasticity than that of the slow-growth countries. There- are no longer possible. fore exports of fast-growers have higher income elasticity But now lets look at the benefits of a currency union. than imports, i.e., they can grow without incurring trade deficits. 22.2 Critique 22.2.2 Nominal and real depreciation of 22.2.1 How relevant are differences be- currency tween countries? If one relinquishes one’s national currency one can no Is a demand shock concentrated on one country likely? longer change one’s exchange rate. But did one ever have 21:1–2 European Commission view: differential demand this power? Can nominal changes of the exchange rate shocks will occur less frequently. Trade is mostly intra- permanently alter the real exchange rates? 22.2. CRITIQUE 121

Devaluations to correct for asymmetric demand But then government is motivated to cheat: instead of shocks pursuing zero inflation it moves along thep ˙e = 0 Phillips curve so that inflation is really atp ˙1. Agents discover 29:4–30:1 After the devaluation in France: prices of im- e this and they change their expectated inflation top ˙ = p˙1. ported goods are higher, therefore all prices will be higher, Government, realizing this, moves to C. This leads to a therefore French workers will fight for a wage increase, migration along the contrct curve between the short term i.e., general price hikes until the benefits of currency de- Phillips curves and the government indifference curves, valuation have withered away. Change in real exchange until this contract curve hits the NARU. Now government rates was only temporary. is no longer motivated to cheat. 30:2– Effects in short run: government has to introduce 43:1–3 This equilibrium is not very attractive. But con- deflationary policies to curb the trade deficit. tinue with the above: 33:3 In long run, deflationary policies and devaluation 43:4–45 Final equilibrium inflation is lower with hard- have the same real effect, namely, lower real wages. Con- nosed than with wet government. And it is higher if the sistent with classical “money is a veil”: structural differ- NARU is higher. ences cannot be remedied by fiddling with money. A very nice discussion of the same issues is in [IL98, De Grauwe does not say it in so many words: Devalua- pp. 170–175], tion allows to lower real wages even if nominal wages are sticky. It is difficult for the labor movement to oppose de- Question 43 An influential recent strand of monetary valuation, because some workers will greatly benefit from theory claims that Central Banks are tempted to make a it in the short run. dishonest use of monetary policies. Explain how. What 32:4 Short term cost of devaluation is inflation, and of are the policy implications of this? outright deflationary policies is a decline in output. 32:5 But if devaluation is no longer possible due to Barro-Gordon in open economies monetary union, then this second route must be taken. Maybe the small currency areas are a means to divide Model can be extended to open economies if we assume and conquer the working class. purchasing power parity, i.e.,e ˙ = p˙1 p˙2. 33 Case study of devaluation in Belgium 1982 which − was successful. Credibility and Cost of Monetary Union If Italy announces credibly that it will tie its currency to Devaluations to correct for differencet policy prefer- the mark, then it moves from E to F. But if it cheats it ences goes to G etc and back to E. Previous analysis depended on Phillips curve not being 46:1 Fixing the exchange rate does not solve the prob- vertical. If it is vertical, then countries are at their natural lem, because a fixed exchange rate is only a little bit more rates of unemployment anyway. If Germany and Italy are credible than a target inflation rate. in a monetary union, then they are forced to equalize their 46:2 Other arrangements may be more credible: if Italy inflation rates. But this will have no other real effects, it abolishes the lire and adopts the mark as its money. This will not affect the NARU. allows Italy to borrow credibility from Germany. Currency boards are a less blatant way of doing the same thing. 22.2.3 Devaluation, time consistency, and 46:3 This is strong result in favor of monetary union: credibility large gains for Italy at no expense for Germany. 46:4 But this is only possible if Italy actually abolishes By following particular policies, governments play games its currency. with private sector. 47:1 The above thought experiment assumed that the central bank for the unified currency is the German central Geometric interpretation of Barro/Gordon bank. What if the new central bank also has Italians in it? Outcome unclear, since Germany would lose if the new 39:3–40:3 Phillips curves which only depend on unex- central bank seems to be less hard-nosed than the German pected inflation. one. 40:4–41:2 Indifference curves for government. 47:2 Devaluations a two-edged sword, some 41:3–43:0 If government announces that it wants to re- economists say don’t use it. duce inflation, it is credible, and it does not cheat, then 47:3 This advice goes too far: successful devaluations economy will go to A. in 1980s in Europe. 122 CHAPTER 22. DE GRAUWE’S TEXTBOOK ON EUROPEAN MONETARY INTEGRATION

22.2.4 Cost of monetary union and open- 55:2–56:5 But uncertainty can also be a source of prof- ness of countries its, and de Grauwe, who thinks proﬁts are a good thing, is confused by this. 48–49:2 Figure 2.15: If an open economy, i.e., an econ- 56:6–57:1 something similar about consumer surplus. omy that is integrated in the world economy, devalues, then both demand and supply curves shift more than if a closed economy does. Effect on Y is uncertain, but that 22.3.4 Exchange Rate Uncertainty and the on p is much larger for open economy. Since large price Price Mechanism ﬂuctuations are undesirable, open economies should not Under uncertainty one cannot make as good decisions. devalue. 58:2 uses USA as example. 49:3 Therefore currency union is good for open 58:4/o Increase in risk will increase real interest rate. economies. 59:1 Moral hazard: Borrowers have incentives to in- 49:4–50:1 Skip that. crease riskeness of their project. 59:2 Adverse selection: suppliers of low-risk invest- 22.2.5 Conclusion ment projects drop out of the market. 59:3 Both lead to an increase in systemic risk. This was much less pessimistic about monetary union 59:4 Some economists say elimination of exchange risk than Chapter 1. Nevertheless the following objections to will lead to increase of risk elsewhere. currency union still stand:

There are important differences between countries 22.3.5 Exchange Rate Uncertainty and Eco- • that will not disappear in a monetary union. nomic Growth

Exchange rates are indeed dangerous instruments in Looks interesting, no notes yet. • the hands of politicians. 22.3.6 Benefits of a Monetary Union and the But we should not throw away an instrument because it can be misused. Openness of Countries The more open the country, the higher the benefits. 66/67 Poole’s argument with respect to exchange rates. 22.3 Benefits of Common Currency

52:1 While costs are macroeconomic, benefits are microe- 22.3.7 Conclusion conomic. 22.4 Cost and Benefits Compared 22.3.1 Direct gains from elimination of 22.4.1 Cost and Benefits Compared transaction cost If country is open enough, benefits exceed costs. Currency exchange fees. Only true if national moneys are Monetarists say exchange rates are ineffective policy replaced by a common currency, not of national currencies instruments in the first place, therefore they favor currency have fixed exchange rates. unions more than Keynesians.

22.3.2 Direct gains from elimination of 22.4.2 Monetary union, wage rigidity, labor transaction cost mobility Reduces scope of price discrimination in national markets.

22.3.3 Welfare gains from less Uncertainty 54:2–55:1 These gains are obvious, but in the present section de Grauwe looks at them only as psychological gains. How they affect production cost will be discussed in next section. Bibliography

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