CONFERENCE PANEL 1: MONEY AND BANKING
Prabhat Patnaik, Centre for Economic Studies and Planning, Jawaharlal Nehru University
Michael McDonald, Department of Political Science, Williams College
William Cohan, Journalist and Author of House of Cards: A tale of Hubris and Wretched Excess on Wall Street
For Patnaik, the “subprime crisis” is a manifestation of deeper crisis tendencies embedded in the structural dynamics of capitalism. In Patnaik’s account, the crisis of today’s financial capitalism is that it lacks a long-term exogenous force to fuel secular expansionary trends. With the colonial system no longer operating (the way it once did) and states politically constrained in their ability to engage in demand management, the capitalist system finds itself locked in a zero-growth limit-cycle. Today the global economy lurches from bubble to bubble, dependent on irrational exuberance to compensate for the stimulus once provided by exogenous forces.
At the core of Patnaik’s diagnosis of the current crisis is the tension between money as a medium of circulation and money as a store of wealth. While wealth is held in the form claims (money and financial assets) to physical assets whose prices can move independently of the value of their underlying assets, capitalism, as a demand constrained system, must hold the value of money vis-à-vis other commodities constant in order to avoid realization problems. The result is a contradictory impulse to increase the value of claims while suppressing the inflation of money wages. The negotiation of this tension for Patnaik is central to the history of capitalism and gives form to several features of capitalist economies that he draws out in his talk.
One of the features identified by Patnaik is the tendency toward the formation of bubbles. Patnaik points out that bubbles are a logical consequence of the growing volatility of financial assets relative to the stickiness of their underlying physical assets. Because the value of physical assets is constrained by the stickiness of wages, and financial assets less so, there is the potential for bubbles to form when the growth of money wages does not keep pace with the exuberance of financial markets. In fact, Patnaik’s short-hand definition of a bubble is a “boom without a change in money wages.” Again, for Patnaik this tendency toward bubbles is inherent in the money form, but amplified by the current ascendancy of financial markets.
Patnaik’s contention that the growth of capitalist economies depends on exogenous sources of stimulus is most closely related to his comments on the Schumpeterian notion that growth depends on gales of creative destruction, and cycles of boom and bust. Patnaik argues that the net-positive result of this boom-bust cycle is based on the assumption of full employment. Once this assumption is given up, however, there is no reason to believe that rising labor productivity will lead to growth. The fact that there clearly is growth in capitalism, for Patnaik, necessarily implies the existence of some external source of stimulus capable of breaking capitalist economies out of their limit cycles. To sustain secular growth trends the capitalist system must constantly devise, and divine new ways to reproduce the effect of exogenous stimulus. This is a challenge that remains unmet in the current conjuncture.
McDonald approached the themes of finance, crisis and intervention through an examination of Milton Friedman’s Capitalism and Freedom (1962) and A Monetary History of the United States (1971). According to McDonald, a close reading of these books reveals that Friedman was not the free market fundamentalist he claimed to be. What they show is that Friedman was more an advocate for the supremacy of finance than he was a believer in a night-watchmen state. Friedman’s libertarian ideology, in McDonald’s account, was a façade that concealed his support for state intervention in the service of financial markets.
In Monetary History, Friedman claims to provide proof that the Federal Reserve was responsible for the Great Depression by failing to adequately expand the money supply. But that’s not what the book actually argues. According to McDonald, Friedman believed the Depression was almost singularly about the collapse of the banks. Protecting the solvency of the banking system was priority number one for Friedman even if the actions required to do so meant that employment and growth would remain depressed. The way out of the Depression for Friedman was to bid up treasury instruments owned by banks. This endorsement of intervention to inflate the value of financial assets, for McDonald, obliterates the idea that Friedman was a market fundamentalist, and shows that his demonization of inflation was particular to goods and wages.
Because Monetary History fails to think through the connections between the state and finance, Friedman avoids directly confronting the ways in which financial markets depend on the state. Here McDonald’s analysis complements Patnaik’s by showing that even Friedman tacitly admits financial markets require external props to keep them growing.
McDonald’s analysis does more than reveal the contradictions and double standards that stem from Friedman’s commitment to the supremacy of finance. McDonald also describes how Friedman manages to blame the failures of finance on the state, while at the same time prescribing state action to resolve crises of insolvency. Though Friedman’s libertarianism may be a façade, it still does important ideological work by distributing blame and responsibility to the state. In Friedman’s account finance depends on the state, yet the state is also to blame and is denied credit when it comes to the rescue.
While Friedman prescribes technocratic solutions to financial crisis administered by the undemocratic Fed, he claims in Capitalism and Freedom to be a critic of “government” and a supporter of democratic institutions. Again, Friedman’s implicit support for a sort of technocratic sovereignty – on display today around the world today in various guises — reveals his true stripes.
Friedman’s tacit support of intervention in the service of finance’s supremacy, and scapegoating of the state, whilst relying on technocratic state institutions to enact policy, expose the contradictions of his analysis and belie his reputation as a libertarian.
The main question that Cohan set out answer was “why have there been so many financial crises in the last 25 years?” Cohan provides two distinct crisis theories in his talk. The first is that the crises of the past two decades are in large part products of perverse incentives. The second is a sort of product-life-cycle theory in which the final stage in the life of a popular financial innovation is crisis.
For Cohan the conversion of Wall Street investment banks from private partnerships to public companies beginning in the early 1970s created a culture on Wall Street in which people were “rewarded for taking big risks with other peoples money.” Not surprising, these perverse incentives encouraged unsound behavior in which crises were inevitable.
Opposing “partnership culture” with “public culture”, Cohan explained that in a partnership, firm partners have their own net worth on the line, and accordingly have strong personal incentives to be diligent in the management of risk. Going public, in Cohan’s words, “destroys” the incentive for prudence, and “bonus culture” replaces risk management.
The shift from a relatively large number of poorly capitalized private partnerships to a relatively small number of very well capitalized public companies has transformed Wall Street into a cartel “run for the benefit of the people that work there.”
Cohan’s depiction of financial crisis as a massive principle-agent problem runs the risk of reducing a diverse set of practices and processes to a matter of getting the incentives right. There appears to be little room in Cohan’s account for the structural dynamics highlighted by Patnaik, for instance.
Toward the end of his talk, Cohan did suggest a less incentive oriented theory of crisis. In this alternative theory, crisis is linked to innovation, but not in a Schumpeterian way. In Cohan’s account, the relation between crisis and innovation is zero-sum. It is a relationship in which a good idea is first mimicked and then reengineered into a platform for speculation before ending its product life-cycle in a bubble.