On interest and the Nov. 6 rate cuts

[Also first posted at the RPOC blog]


Among the non-Obama related news is a massive Bank of England cut in the cost of borrowing by 1.5 per cent and the European Central Bank's cut of .5 per cent. The cuts came alongside a gloomy International Monetary Fund report forecasting 2009 to be the first contraction of industrialized countries since WWII. Meanwhile, the Financial Times has continued to report that inflation is set to fall along with declining commodity prices.

The aim of an interest rate cut is both to loosen credit to allow for the continued daily functions of capital and hopefully to increase investment, which would then combat falling prices. But how should we understand the determinants of the rate of interest? Academic economists theorize the longer term tendencies of the interest rate more than day to day shifts. Neoclassical economists assume that the average rate of interest and the average (or general) rate of profit equate in equilibrium. Here, the sheer mobility of money capitalists and productive capitalists will tend to generate an equalization of returns. Marx however, disagreed.

Marx's thoughts on the rate of interest are somewhat scattered and fragmented. He did not however seem to believe that the rate of interest was determined by the same laws of motion which determined the general rate of profit, ie, the technical conditions of production. He says in volume III of Capital: "The prevailing average rate of interest in a country, as distinct from the constantly fluctuating market rate, cannot be determined by any law. There is no natural rate of interest, therefore in the sense that economists speak of a natural rate of profit and a natural rate of wages."

While there is no general theory of the average rate of interest, he does say a few things about it's determinants. He indicates that the average rate of interest will fall below the general rate of profit and above zero. For if the average rate of interest and the general rate of profit were equal, where would be the incentive on the part of any individual capitalist to go through the difficult and uncertain process of production; much easier would be to simply lend and collect. Thus there must be rewards to "profit of enterprise." Marx also notes that the average rate of interest depends to some extent on the supply and demand of money capital.

Additionally, it must be noted that the interest of money capitalists does not reflect any contribution to the production of value. Instead it is a deduction on "profit of enterprise" or industrial capital. That is, surplus value is divided between what productive capital keeps and what must be paid out to money capital in interest. This might be why he refers to them as "parasites" and "bandits". Again, Marx notes: "It is indeed only the separation of capitalists into money-capitalists and industrial capitalists that transforms a portion of the profit into interest, that generally creates the category of interest; and it is only the competition between these two kinds of capitalists which creates the rate of interest."

Regarding day to day fluctuations of interest and central bank policy, Marx seems to deny that monetary authorities take the role of prime mover: "An ignorant and mistaken legislation ... may intensify a money crisis. But no manner of bank legislation can abolish a crisis." This, in a post gold-standard era, is because of the central bank's perpetual struggle to both avoid the devaluation of commodities and maintain money as the reflection of social labor (on this point see David Harvey, Limits to Capital, 2006, p. 294). In a crisis, the contradiction of a central bank may be between devaluing money on the one hand via inflation that is caused by lowering interest rates, and allowing commodities to devalue in a recession or depression. Put more generally, the problem for Marx is the simultaneous management of "capital in its money form and capital in its commodity form." Currently we are seeing the inflation/devaluation strategy. In a period of falling inflation, especially in Europe, central banks are hoping the drastic rate cuts will both to loosen credit and prop up prices of goods so to better reflect their value. Savers on the other hand are rightly worried about the value of their currency.

Nosedives in fictitious and productive capitals Oct 24-25

[This is originally from my post at the Radical Perspectives on the Crisis blog, I thought I'd repost here too]


Recession fears manifested in plunging markets on Friday. Stock markets in Asia, Europe and finally the Dow Jones in the U.S. fell to five year lows. The Wall Street Journal fears there are no safe havens in the global economy left to hedge with.

Following Marx, I would argue that market falls and crashes are not destructions of value but rather are redistributions of value. What is destroyed is the title of ownership, which Marx called fictitious capital. If I own a $50 stock in a company, and the stock collapses to zero, I have simply transfered $50 to the company and received nothing. That is to say, stockholder ruin does not necessarily imply the destruction of real societal wealth. We can say there has been destruction of value only if the collapse generates the abandonment or depreciation of plants, machinery or other fixed investments.

The fallacy is thinking that a debt is a commodity with real value (despite the fact that it is traded on the market). Marx, in Volume III of Capital wrote that "unless this depreciation reflected an actual stoppage of production and of traffic on canals and railways, or a suspension of already initiated enterprises, or squandering capital in positively worthless ventures, the nation did not grow one cent poorer by the bursting of this soap bubble of nominal money-capital."

Of course, stoppages of production and traffic in the real economy have indeed been appearing across the globe. Data published on Friday revealed a significant drop in third quarter British output, the sharpest decline since 1990. Though a single quarter decline does not meet the technical definition of recession, there is virtual consensus that the country is in one. The Industrial and Commercial Bank of China announced a significant decline in third quarter profit growth. In expectations of declining demand, Chinese steel and aluminum industries have cut production by 20 and 18 per cent, respectively. Chinese car sales are expected to flatten. Despite Opec's production cut on Friday, oil prices continue to decline as fears of slowing demand growth mount.

In the US, amidst a 25 per cent drop in annual sales, Chrysler announced that by the year end it will lay off 25 per cent of its white collar workforce. Meanwhile merger talks with GM escalate.

Keynes and the liquidity preference

Will the Fed make another half point interest rate cut? If so, will finance react at all? Howard M Wachtel, an Economics professor at American University points to an important lesson from JM Keynes on the futility of monetary policy during a downturn:

Take one issue – interest rates. The U.S. Federal Reserve’s policy of lowering interest rates, from 5 and 1/4% in August 2007 to 2% in May 2008, was a grave mistake that could have been avoided if Keynes’ analysis had been part of the Fed’s policy making knowledge. The Fed’s error in interest rate policy was compounded when it followed interest rate reductions that did not work with large infusions of new money into the financial system.

Keynes taught us that when banks and other holders of vast sums of capital have what he called a “preference for liquidity” – a desire to hold cash and not invest it – lowering interest rates will not unlock this liquidity for investment. Instead any infusions of new money by the central bank into the system will simply be stashed away for two reasons: first, the mood of the financial market’s psychology is glum and not conducive to investment because rates of return are perceived to be too low. Second, new money injected will be held as cash in anticipation of a better day, so the new money will be seen as an arsenal to be held until markets improve.

Added to this is the character of this most recent bubble – inflated home prices and their accompanying high-risk financial instruments to insure these bad loans. Lowering interest rates simply poured fuel on the fire by keeping loan rates low, encouraging more imprudent lending and borrowing, and furthering the speculative bubble’s chain of bad debts.

This reasoning is counter-intuitive, but it fits the current paradox of lower interest rates and unprecedented chunks of cash interventions without their anticipated impact. The preference to hoard money by banks reinforced a psychological condition that was confirmed by the failure of the lower interest rates to have their intended effect. Credit markets in today’s language have frozen.

Keynes called this the liquidity trap – the most difficult position for an economy, one that characterized the Japanese economy in the 1990s, and threatens to engulf not only the U.S. but the global economy today.

It's still the mortgages stupid!

In those halcyon days when U.S. housing prices were rising, defaults didn't lead to systemic capitalist crises. In fact, they didn't impact much beyond the creditor and debtor in the contract. Creditors could appropriate your house and make a profit upon resell (hence the incentive for trumped-up loan applications, some of which inflated borrower incomes by up to 50 percent). And many debtors, even if they could make monthly payments, knew that creditors couldn't take any more than the home itself. As we know, everything changed when housing prices fell some 20 percent. Finance wonks tell us we can expect another 15 percent fall, which would double the amount of homeowners with loans greater than their home value. Any bailout or rescue plan that ignores this seems likely to fail.

Also scary is the so-called Alt-A mortgage threat. These mortgages are one notch less risky than subprime paper. And of course, they sound extremely enticing: borrowers were given an initial interest rate of 1 percent and were exempt from repaying the principal in the first several years. As is often the case, one day down the road, they will reset. Frédéric Lordon in the October issue of Le Monde Diplomatique describes the position of the average option adjustable rate mortgage (the Option-ARM category is just one breed of Alt-A):

The average Option-ARM borrower can expect to see repayments increase by 63% at a stroke. According to the financial services company Bloomberg, 16% of holders of Alt-A mortgages agreed since January 2006 are more than two months in arrears. Since there is a delay of between three and five years before the rate is reset, defaults can be expected to increase next year and continue until 2011.

Lordon also mentions that subprime loans totaled a mere $855bn where Alt-A mortgages amount to $1,713bn. I suppose this doesn't seem like much when leaders are desperately trying to avoid a financial collapse before Monday morning when stock markets open, but it's something to look out for in the coming months.

--

In other news two wonderful and brilliant friends put up a website called Radical Perspectives on the Crisis:
http://sites.google.com/site/radicalperspectivesonthecrisis/

It is extremely useful, please check it out!

AEA: Born in Sin

The American Economic Association, which publishes perhaps the world’s most prestigious and staid economics journal, generally omits all heterodox representation from its renowned mid-winter meetings, and prides itself on a political neutrality that disallows all but the most anodyne public positions, was in fact, founded by ardent state socialists. I found a 1955 essay by Joseph Dorfman published in the American Economic Review that reproduced the AEA’s 1885 founding statement of principles; they are astounding, especially when measured against the organization’s current incarnation:

1. We regard the state as an agency whose positive assistance is one of the indispensable conditions of human progress.
2. We believe that political economy as a science is still in an early state of its development. While we appreciate the work of former economists, we look not as much to speculation as to the historical and statistical study of actual conditions of economic life.
3. We hold that the conflict of labor and capital has brought into prominence a vast number of social problems, whose solution requires the united effort, each in its own sphere, of the church, of the state and of science
4. In the study of the industrial and commercial policy of governments we take no partisan attitude. We believe in a progressive development of economic conditions, which must be met by a corresponding development of legislative policy.

These principles didn’t emerge from thin air. The emphasis on the developmental state, on induction and history, and on class relations, can all be traced to late 19th century Germany, when there were close ties between American and German universities, particularly American Institutionalist economists and members of the German Historical School. The founding members of AEA were all German-trained economists, and the AEA itself was modeled after the Verein für Sozialpolitik, an institution originally run by members of the German Historical School which was intended to serve as an organ for social and economic reform and labor activism.

The German tradition is unmistakable in the writings of the American Institutionalists, though on the whole, the Americans were less hyper-nationalist (think: Schmoller, late Sombart), less radical (think: early Sombart) and by and large more sensitive to the category of the individual than their German counterparts (Schmoller famously deemed the state the “highest ethical power that controlled individual existence,” and the military “a school for the nation”). Perhaps the most provocative of the American lot was Richard T. Ely. He reiterated the credo and program of the AEA in 1887:

We hold that the doctrine of laissez-faire is unsafe in politics and unsound in morals, and that it suggests an inadequate explanation of the relations between the state and the citizens. In other words we believe in the existence of a system of social ethics; we do not believe that any man lives for himself alone, nor yet do we believe social classes are devoid of mutual obligations corresponding to their infinitely varied inter-relations. All have duties as well as rights, and, as Emerson said several years ago, it is time we heard more about duties and less about rights. We who have resolved to form an American Economic Association hope to do something towards the development of a system of social ethics.

Unfortunately, the influence of the German Historical School on American economic thought quickly dissipated, at least in mainstream publications like the AER. The statement of principles was dropped a few years after it was issued. John Bates Clark—another eminent German-trained founder of the AEA—and others eagerly adopted Stanley Jevons’ theory of marginal utility, after which they shifted their focus away from histories, institutions and statistics, and toward axiomatic systems designed to scrutinize the imaginary and infinitesimal increments of economic distinction between, say, eggs and tea. Ely was bitterly dismissed from Johns Hopkins University in 1892. His termination was orchestrated by Simon Newcomb, Ely’s conservative colleague. (Newcomb’s assault was essentially an angry repetition of that classic tenet, so deeply embedded in the history of economic methodology from J.S. Mill to Milton Friedman, regarding the proper scope of economics: Ely, Newcomb insisted, belabored questions concerning “what ought to be,” rather than limiting himself to the study of “things as they are.”) Afterwards, Newcomb helped transform the AEA into the professional organization it is today. Ely still has a distinguished lecture named after him that is given annually to the AEA, but the fiery normative agenda he defended was rubbished not long before he was put on trial for allegedly indoctrinating students with “socialistic” ideas.

Perhaps that’s what this blog does—its point seems to remain unclear. It can be a place to pick through the rubble of our social science ancestry and poke at the corpses. We’ll see.

Everything you’ve ever wanted to know about Adam Smith but were afraid to ask Maurice Dobb

I recently dusted off my copy of Maurice Dobb’s fantastic survey of economic doctrines, Theories of Value and Distribution since Adam Smith: Ideology and Economic Theory, and once again, found two Adam Smiths. More precisely, Dobb delineates two “distinct and rival traditions” in nineteenth-century economic thought with respect to the “order and mode of determination of phenomena of exchange and income-distribution.” The first tradition, derived from Adam Smith, is identified as the “supply-demand-cum-component-parts-of-price” school, and is said to descend though Malthus, John Stuart Mill, Walras, Jevons, the Austrian School, and Marshall. Late nineteenth-century versions emphasized demand-determination and the exchange process, and deemphasized costs of production and social and institutional relations, which meant that concepts including surplus and exploitation lost all analytic value. The second tradition, also derived from Smith, gives prominence to production conditions; in particular, the amount of labour spent in the production process is taken as the primary determinant of exchange-relations. According to Dobb, David Ricardo, who solidified this second tradition, regarded distribution as central, and was dissatisfied with Smith’s relegation of distribution to the arbitrary functions of the supply-demand relation. Instead, it was the conditions of production that determined the ratio of profit to wage, and consequently, commodity exchange-values. Dobb traces this line of thought through Marx and more recently, to the neo-Ricardians.

While this might be a reasonable way to divide economic thinking, Dobb effectively creates a false Adam Smith Problem. In my view, the two traditions are unified in Smith’s dialectic of natural price and market price, where the latter fluctuates irregularly around the former. (Natural price in Smith is similar to Ricardo’s ‘price of production’ and Quesnay’s ‘prix nécessaire’. Marx however reminds us in chapter 10 of volume III of Capital that none of them distinguish between price of production and value—an issue for another time.) Recognition of the importance of this dynamic—which later becomes central to Marx in three volumes of Capital and the Grundrisse—would circumvent the common accusation that the classicals somehow value production over exchange.

Natural commodity prices in Smith—revealed only as statistical ex post averages—are determined by natural wages multiplied by labour spent, the natural rent multiplied by the amount of land used, and the natural profit rate multiplied by the capital employed. Observable market prices then gravitate around natural prices by “dint of the operation of competition upon supplies and upon demand.” What’s the problem? Well, Smith doesn’t really determine a theory of natural wages or profit required to build this so-called ‘adding-up’ theory of value. Worse, his theory of rent is inside out, since it is circularly determined by the natural commodity price.

Dobb can be harsh. He insists that Smith’s offering of a labour theory of value exists only in his initial thought experiment set in that “early and rude state of society”, which precedes the accumulation of capital and the appropriation of land. And even there he maintains two labour theories of value: one where exchange value is regulated by the quantity of labour necessary to acquire or produce any commodity, the other where exchange value is regulated by the quantity of labour that the commodity can command or purchase on the market. Yes, this is a major confusion, and it is indeed the whole basis for Ricardo’s critique, but in a model void of appropriated land and accumulated capital is there any difference between the theories? (Example: a deer may be produced or acquired by a worker expending one day’s labour, making the labour embodied in that commodity, one day. Since profit and rent do not yet exist, we can then imagine that if supply and demand balance, the labour which can be purchased or commanded on the market by the deer-commodity is also one day.)

In any case, Dobb insists that once stock is accumulated and land is appropriated Smith abandons both labour theories for an ‘adding-up’ theory of value. While Smith relates an excellent description of the equalization of profits and wages under competitive conditions (rooted in the above-mentioned distinction between natural and market price), there does not seem to be any explanation as to the particular level they take. Thus the ‘adding-up’ theory is certainly not a labour theory of value, and since the actual levels of the component parts to be added themselves are not conceived, for Dobb, this theory is not a theory of value at all. Dobb flatly rejects commentators who implicitly or explicitly treat the labour theory of value as a kind of first approximation containing nothing essential that cannot be expressed in other terms.

Although he is at times hard on Smith, and in the end seems to eschew the quantitative use of labour-value magnitudes, Dobb maintains that the “labour-principle” makes an “important qualitative statement about the nature of the economic problem.” As such,

‘exploitation’ is neither something 'metaphysical' nor simply an ethical judgement (still less "just a noise") as has sometimes been depicted: it is a factual description of a socioeconomic relationship, as much as is Marc Bloch's apt characterization of Feudalism as a system where feudal lords “lived on the labour of other men”

While I think this quotation illustrates important “qualitative” aspects of the theory of value, it also gives up too much ground. Amid the influence of Cambridge political economy, and especially the work of Piero Sraffa, Dobb’s concession seems apposite. I would prefer to follow those modern ‘classicals’ who also maintain the quantitative aspect of value theory which proposes that the socially necessary labour-time in a given economic sphere, over a given period is expressed as the money value added to all produced commodities, and hence equals total wages plus total profits, or alternately, total capitalist revenues minus total costs of machinery and materials. I can’t resist quoting an example from Duncan Foley’s Adam’s Fallacy, which illustrates his interpretation of the basic hypothesis of the labour theory of value:

…the GDP of the U.S. economy in 2005 was about 12 trillion dollars, and the employed labor force of about 150 million persons worked an average of 1600 hours per year. The total labor time (making no correction for complex labor) comes to about 240 billion hours; thus each hour of labor produced on average about $50. Marx constantly uses this method of translating from labor time to its money equivalent throughout Capital. This “monetary expression of labor time” has the same units as a wage, dollars per hour, but it is not the same as the wage. The monetary expression of labor time tells us the whole money value added per hour of labor, but workers, as Marx’s theory will emphasize later, get only a part of this back in the form of wages. The average wage is typically only a fraction of the monetary expression of labor time.

I intended to conclude by commenting on some of Dobb’s other work—beyond Dobb the economist and Dobb the historian, there is also Dobb the public debater and labor educator who authored numerous popular pamphlets. Instead I digressed into the continuing imperative of value theory. Accordingly then, Ben Fine, in an essay from Capital & Class (No. 75, August, 2001) poses three central reasons why value theory, including both quantitative and qualitative aspects, must remain central to any political economy of capitalism. He’s very succinct, and all three points beg elaboration. I also think he’s correct:

First, it is the abstract basis on which to understand the social relations of capitalist commodity producing society. Second, it attaches complex forms, such as price and profit, to simple underlying determinants. Third, it addresses the dialectics of change and reproduction.

The Other Adam Smith Problem

The classic ‘Adam Smith Problem’ turns on the allegedly irreconcilable distinction between the self-interest central to the Wealth of Nations and the reciprocal altruism of the Theory of Moral Sentiments. After mild debate it is usually agreed that for Smith sympathy is but a form of self-interest. It turns out that the tension was just an illusion, and there was one, not two, Smiths all along. Duncan Foley, in Unholy Trinity, as well as in Barriers and Bounds to Rationality, hints at a more compelling and genuinely irreconcilable Adam Smith Problem.

Like the original, the new problem also contrasts two incompatible interpretations of Smith. The first interpretation presents Smith as a proto-neoclassical economist. In Whiggish fashion, a continuous line is drawn from Smith to Pareto to the static and efficient allocation of resources that defines modern microeconomic analysis. This vision of capitalism depicts a world defined more by unrestrained competition than unrestrained accumulation of capital. The second interpretation, emphasizing capital accumulation, is the complex systems theory reading. Here, the capitalist system, like other systems large and small is modeled as an organized but decentralized network constituted by scores of individual parts. And like other systems analyzed by complexity theorists, the capitalist system is taken to be adaptive, self-organizing, and unstable. Furthermore, these systems manifest emergent characteristics, which is to say that the micro properties of the individual components are not merely scaled down versions of the system itself. Differently put, changes in scale generate qualitative changes such that there is no one-to-one parallel between the whole and the sum of the parts. Emergence stands in direct contrast to the “isomorphic” relation between people and markets central to microeconomics. By contrast, when emergence is translated to classical political economy it implies a system generated by the unintended effects of the actions of individual capitalists, labourers and landlords. For example, individual capitalists endeavoring to maximize their own rate of profit may generate, once aggregated, a tendency toward the decline in the economy-wide average rate of profit.

In the complex-systems view, Smith’s advocacy of laissez-faire is rooted in the unintended effects generated by individual capitalist accumulation. Capital accumulation will widen the extent of the market, which Smith shows, in the third chapter of the Wealth, to be responsible for the growth of the division of labour (it should be noted that Smith was referring here to the growth of the social division of labour, which emphasizes the availability of different forms of employment. He was not referring to the detail division of labour which describes an increasingly rote division of tasks within one form of employment. Confusingly, it is the later which is described in the pin factory of chapter one). This then increases the productivity of labour, which lowers costs and increases incomes, extending the market and generating further increases in the division of labour in cyclical pattern. Capital accumulation is the original intention; the expansion of the market and the division of labour to the benefit of other capitalists is the unintended effect.

Whether or not this system of positive feedbacks benefits labour remains unclear. The Smithian process of economic development entails the growth of wealth followed by the growth in population, which in turn, may cut into any gains made by labour. While Smith insists on the concept of a subsistence wage, he also insists that subsistence must reflect socially and historically determined standards, leaving open the possibility of absolute gains to labour. In contrast, elsewhere in the Wealth, Smith points to the eventual ‘stationary state’ of capitalist economies where individual capitalists in tight competition with each other unintentionally drive the profit rate down and consequently drag down the wages of labour.

Before this inevitable heat death, the complex-systems depiction of Smith entails what neoclassicals would dub increasing returns to scale. However, Foley notes that widespread increasing returns to the application of capital and labour to land are fundamentally inconsistent with the assumptions underlying the general formulation of neoclassical competitive equilibrium. The evolutionary and dynamic Smith cannot be squared with the static general equilibrium Smith. One of the architects of general equilibrium theory, Kenneth Arrow recognized the other Adam Smith Problem in the Foreward to a book by Brian Author on Increasing Returns and Path Dependence in the Economy:

The concept of increasing returns has had a long but uneasy presence in economic analysis. The opening chapters of Adam Smith's Wealth of Nations put great emphasis on increasing returns to explain both specialization and economic growth. Yet the object of study moves quickly to a competitive system and a cost-of-production theory of value, which cannot be made rigorous except by assuming constant returns.

Instead of reading Smith as a theorist of optimal resource allocation as does Arrow, Foley reads him as a theorist of a capitalist development process which is complex, self-organizing and most importantly, non-equilibrium.

In this process, the trajectory of capitalist development remains uncertain. It is a determinant system in that connections between parts can be traced backward ex post, but it is not predetermined in that there is no way to predict the system’s evolution. Foley points to the kinds of questions this type of analysis grapples with, and those which it avoids:

We know that the wolf, for example, must maintain nutritional balance with her environment to live, but this observation does not allow us to predict her life cycle, where she will migrate, mate, or, eventually die. Smith’s vision of capitalist economic development is analogous: he can explain the metabolic processes, accumulation and competition, that support the evolution of the capitalist economy but not its history, the specific development of its technology, or its sociology.

Foley also admits to his political attraction to complex-systems theory. The following quotation might imply a hope for some kind of market socialism, which could explain his interest in Oskar Lange and the socialist calculation debate. Yet, that debate was defined by the static neoclassical conceptualization of optimality. Perhaps instead, complexity theory allows for a new way to parse through the old problems of democratic socialism:

Theory suggests that it is impossible to control complex, adaptive, self-organizing systems by directing the behavior of the individual entities that comprise them. Traditional conceptions of social policy, on the other hand, depend precisely on an ability to link individual behavior and aggregate outcomes. The methods of Classical political economy offer some hope of surmounting this apparent dilemma. We may be able to design systems that influence the self-organization of society as a complex, adaptive system in particular dimensions, even though we must give up any hope of stabilizing the actual evolution of the system in the hope of attaining once and for all such goals as justice and equality.

I would argue, in fact, that there is much to be gained from this shift in understanding. We avoid the Scylla of utopian fantasies of an end to the dialectical historical development of human societies, which, in the complex systems view, will continue indefinitely. But we also elude the Charybdis of conservative complacency in the face of the very real moral and social problems capitalist society creates and reproduces. What we need is a better understanding of the process of self-organization that are amenable to our influence.