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Mainstream economics likes models, especially models that are nonsense.
Figure 1, below, shows a typical “circular flow” model of the economy such as you would find in mainstream economics texts by Mankiw (his is a bit more colorful and has some additional detail, but not anything material):
This model perpetuates several falsehoods (normative myths) that are central to mainstream economics, including at least:
- The politics-economics duality (government and money are exogenous to the economy)
- An economy in a state of equilibrium; and
- The loanable funds model of banking, where banks just intermediate between savers and borrowers (i.e., they don’t create money)
Figure 2 proposes an alternative, centrally controlled model that reflects our credit-money system:
In a credit-money system, all money begins as bank credit subject to the payment of interest (i.e., every dollar “borrowed” must be “repaid” as 1.x dollar). As a consequence, every sale of a commodity or service involves two distinct transactions: (1) the delivery of the commodity or service and (2) the exchange of money. Every exchange of money in our economy includes Finance as an intermediary; even all cash transactions are accomplished using central bank notes.
In Figure 2, I begin to distinguish between money and capital, which itself suggest disequilibrium. Specifically, money is exchanged for commodities and services outside of Finance, and capital is exchanged for financial assets. I consider capital to be money that accumulates and circulates within Finance (e.g., as deposits appearing in the accounting records of financial institutions), but it is also available for redemption as money for circulation outside of Finance, as long as it has not been used to purchase a financial asset. Regardless of whether the medium of exchange is money or capital, Finance (which includes the FIRE sector and the governmental agencies that support it) stands in the middle of every transaction.
Figure 3 attempts to translate the model of Figure 2 into a model of “the state of capital” by adding detail that is nowhere discussed in mainstream economics but is often touched upon, sometimes in different ways, in CasP as well as in the work of Thomas Piketty and Steve Keen.
The existence of two different mediums of exchange (money and capital), two different types of objects of exchange (commodities and financial assets), and the two different approaches to pricing them (cost-plus v. present valuation of future income), suggest two distinct economies (even two distinct poleis), which are shown here in Figure 3 as the “Political Economy” and the “Financial Economy.” I considered labeling each domain a “market,” but the market metaphor suggest freedom that does not exist in the state of capital. The key concept is that there are two distinct domains that are inter-dependent, but the domain of Finance/capital dominates.
The concept of differential accumulation is central to CasP and is represented at a macro level by Piketty’s R>G formulation, where R is the annual growth rate of capital (return on capital), and G is the annual growth rate of the political economy, aka GDP.
The “state of capital” is constructed to ensure R>G by imposing differential taxation, differential pricing and differential costs of capital/credit, all of which favor Finance. For example, for transactions involving commodities, any tax typically will be imposed on the buyer based on the purchase price. Conversely, for transactions involving financial assets, any tax typically will be imposed on the seller based on the difference between the seller’s cost basis and the sale price. Moreover, all capital losses incurred in the Financial Economy are applied as direct offsets against capital gains, whereas losses of property incurred in the Political Economy are, at best, subject to a limited deduction on income tax liability and not as an adjustment to gross income.
CasP researchers have discussed prices (especially the pricing of financial assets) at length, but something that I have not seen discussed before in CasP is the importance of the cost of capital (Financial Economy) and the cost of credit (Political Economy) to differential accumulation. For example, larger companies, whether size is measured by market cap or annual revenues, generally have lower costs of capital, i.e., it costs larger companies less to increase their power. The same dynamic plays out in the political economy, where the more money you have, the less credit costs you. Within each economy (or polis), relative capitalization/wealth creates self-perpetuating hierarchies, which in the Political Economy we call classes.
From this perspective, power manifests itself both as price (e.g., capitalization) and cost (e.g., cost of capital), where cost is one major determinant of price, another being growth rate (i.e., the discount rate or the rate of compounding). Indeed, I believe that the cost of capital/credit was the primary mechanism by which capital enforced differential accumulation until the 1980s, when it began goosing stock market returns by lowering the cost of capital/credit (which also reduced GDP growth).
I am going to stop for now, but there is more to say. For example, I have not discussed the concept of feedback that comes from “financialization” of a corporation, by which I mean the creation of a financial avatar known as a stock ticker or bond number.
I recognize that conceptualizing the state of capital as two economies or two poleis may seem like I am embracing the “real v. nominal” duality, but both domains, whatever you label them, are real, and the primary domain of capital controls everything else through setting the prices of purchases and the costs of capital/credit. Capitalism requires the complete enclosure of a society to render the “market” as nothing more than a company store in a company town.
One of the reasons I prefer to think of the twin domains of the state of capital as different poleis is because, as a political matter, they are. To access, the market/economy of the material world, you need access to the money that Finance creates through “loans.” This money is just “company scrip,” all of which flows back to Finance as capital plus interest. In the U.S., the “citizens” of the Financial polis represent maybe 10% of the total population of the U.S., most of whom blink in and out of existence in the Financial world as they live from paycheck to paycheck. In other words, the consumers of the Political Economy who are not also members of the Financial Economy are, in fact, consumed by the Financial Economy.
Any thoughts or comments? I have left a lot out, so I understand there may be some gaps in this particular presentation of my model, and, of course, I am sure I probably missed some things completely.
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Thanks, Scot. Here are a few questions/comments.
1.
In your outline, FINANCE = FIRE = Banks, insurance, real-estate. I understand why you think of banks as ‘Finance’: allegedly, they are the ones who create money. But why do you lump insurance and real estate together with them?
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You distinguish between the ‘financial economy’ and the ‘political economy’, but you recognize that capitalists, governments and the underlying population exist in both, and that each of their actions has simultaneous financial and political-economy ramifications. With this in mind, how is this bifurcation useful?
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CasP researchers have discussed prices (especially the pricing of financial assets) at length, but something that I have not seen discussed before in CasP is the importance of the cost of capital (Financial Economy) and the cost of credit (Political Economy) to differential accumulation. For example, larger companies, whether size is measured by market cap or annual revenues, generally have lower costs of capital, i.e., it costs larger companies less to increase their power.
Baines and Hager researched this process in their 2021 paper ‘The Great Debt Divergence and its Implications for the Covid-19 Crisis: Mapping Corporate Leverage as Power’.
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Thanks, Scot. Here are a few questions/comments. 1. In your outline, FINANCE = FIRE = Banks, insurance, real-estate. I understand why you think of banks as ‘Finance’: allegedly, they are the ones who create money. But why do you lump insurance and real estate together with them? 2. You distinguish between the ‘financial economy’ and the ‘political economy’, but you recognize that capitalists, governments and the underlying population exist in both, and that each of their actions has simultaneous financial and political-economy ramifications. With this in mind, how is this bifurcation useful? 3.
CasP researchers have discussed prices (especially the pricing of financial assets) at length, but something that I have not seen discussed before in CasP is the importance of the cost of capital (Financial Economy) and the cost of credit (Political Economy) to differential accumulation. For example, larger companies, whether size is measured by market cap or annual revenues, generally have lower costs of capital, i.e., it costs larger companies less to increase their power.
Baines and Hager researched this process in their 2021 paper ‘The Great Debt Divergence and its Implications for the Covid-19 Crisis: Mapping Corporate Leverage as Power’.
1. Including insurance and real estate within Finance more broadly is optional, but I think if you are trying to have a comprehensive understanding of capitalism and its history, insurance and real estate need to be included, even if they don’t have all the same indicia of pure finance. Due to the rents it can provide, real estate was the first “financial asset” (although it exists in the material world, as well). English capitalism came into being well before the Bank of England and credit money in 1692, and it was based entirely on real estate (e.g., making improvements to increase rents). Insurance was an important early development in capitalism, and is purely financial, although it does not create capital the way commercial banks or stock markets do.
2. The bifurcation is real. We have two different domains, each subject to a different rule set, where one domain controls the other. Refusing to accept that bifurcation prevents you from truly understanding how capital as power is manifested, distributed and applied throughout society in both domains. By having a “schematic” of how the two domains interact, you can identify key interfaces between the two domains and learn how they interact and function, both together and independently. Having a schematic also allows you to make changes to the system, hopefully for the good.
For example, the cost of capital/debt clearly was capital’s dominant control mechanism for most of capitalism’s existence. Every depression was due to the unavailability of credit, not strategic sabotage. All that has changed over the last 50 years, and CasP captures the new reality of the dominance of strategic sabotage and stock markets over debt and bond markets. But it is not like the cost of capital/debt control knob has disappeared, it is just being put to a different purpose: accelerating the dominance of the stock markets and especially larger firms. In the meantime, loosening credit standards has allowed the capitalist system writ large to supply labor with the same purchasing power without increasing wages.
This fundamental shift, which began under Reagan in the 1980s, could not have been accidental and can be reverse-engineered, with the right “schematic.” I am not saying my schematic is the correct one (and I have yet to fully describe it), but I think developing a schematic that reflects observable facts is a worthy goal.
3. I’ve read that paper previously, and agree, in hindsight, that it relates to the cost of capital. What I am saying is that the cost of capital (in the financial domain) and the cost of debt (in the political domain) are as central to “creordering” as the strategic sabotage used to set the prices of commodities.
Originally, I thought I could work the cost of capital/debt into your domains of strategic sabotage, but I realized that it is a distinct control mechanism, although not completely independent. The cost of capital appears to bound the creordering that can be achieved via the stock markets, i.e., cost of capital represents an asymptote of capitalist power, if it is set too high.
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Another reason I find the bifurcation of society into two domains (as opposed to two classes) is the fact that doing so seems to explain the success of liberalism as an ideology.
Those members of society who “live” in the financial/capital economy (or polis) do enjoy the self-ownership, equality and rights promised by liberalism. That’s just what happens when you have enough wealth that you don’t have to work for anybody else.
Further, many of the models, assertions and normative myths of mainstream economics actually apply in the markets of the financial/capital economy, which are far more free than those of the political/material economy.
All of this goes to the Double Truth doctrine of neoliberalism asserted by Philip Mirowski. Basically, there’s one truth/assertion for the masses (exoteric) and a completely different truth for the elites (esoteric). The most successful “double truth” is one that is based on a common statement understood differently. I asked Mirowski whether he has ever considered classical liberalism as having its own double truth doctrine, and he said he has not. I believe that neoliberalism’s “double truths” are not an innovation but built upon the foundation of the liberalism that went before.
The bifurcated model allows me to identify and explore those double truths (i.e., how can one statement simultaneously be true and false), which I prefer to think of as “normative myths” (assertions having both political magnitude and direction). The financial/capital economy/polis is a result of the normative myth (“false duality) of politics v. economics. Repeat something until it becomes policy then reality. The false duality of real v. nominal is likewise a normative myth, one meant to distract from the fact that the financial/capital economy is not an imperfect mirror of the political economy, it is the engine that drives the political economy. This particular myth simultaneously absolves the “false” economy while justifying austerity that rebuilds that economy. Equilibrium is another normative myth that the bifurcated model can also help explain.
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The existence of two different mediums of exchange (money and capital), two different types of objects of exchange (commodities and financial assets), and the two different approaches to pricing them (cost-plus v. present valuation of future income), suggest two distinct economies (even two distinct poleis), which are shown here in Figure 3 as the “Political Economy” and the “Financial Economy.” I considered labeling each domain a “market,” but the market metaphor suggest freedom that does not exist in the state of capital. The key concept is that there are two distinct domains that are inter-dependent, but the domain of Finance/capital dominates.
I think your grappling with these issues is interesting an potentially fruitful for research. But until we see how it is fruitful, a few more observations/questions.
(1) Two distinct economies? Yes and no. On the face of it, money is not the same as capital (although you can argue that, in the capitalist mode of power, money is capital with zero expected profit); commodities are different than financial assets (though you can argue that, in the capitalist mode of power, commodities are financial assets with a zero expected profit); and the pricing of commodities is different from the pricing of future income (although, in the capitalist mode of power, this difference disappears when commodities are sold to be delivered in the future, which suggests that the difference has to do with temporarily).
(2) Regardless of my reservations in (1) , there is the issue of parsimony. I’m just wondering which of your claims requires tucking the finance/political economy duality on top of CasP. At this point, it seems to me that all your claims here can be examined without this extra duality — though, I’d be happy to see your future research prove me wrong!
(3) FIRE. You argue that real-estate and insurance were crucial in the emergence of capitalism, which is true — but how is this relevant to Finance as an analytical category?
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(1) Two distinct economies? Yes and no. On the face of it, money is not the same as capital (although you can argue that, in the capitalist mode of power, money is capital with zero expected profit); commodities are different than financial assets (though you can argue that, in the capitalist mode of power, commodities are financial assets with a zero expected profit); and the pricing of commodities is different from the pricing of future income (although, in the capitalist mode of power, this difference disappears when commodities are sold to be delivered in the future, which suggests that the difference has to do with temporarily).
First, thank you for your time, observations and criticisms. I find the discussion helpful and I am encouraged by it.
As you can tell, I am struggling with how best to label the logical-legal domains I’ve identified. Is each domain an “economy,” a “polis” or just indicia of “class”? All I can say is that, within the U.S., these domains were created by a series of laws enacted over many decades since the U.S. Civil War, and they seem to have really emerged during the Reagan administration, most likely due to the tax reforms it enacted. Accordingly, even if you accept these domains as real and meaningful, they are not a precondition to capitalism itself. That said, they appear to be part of the capitalism we currently have, and understanding how these domains interact with each other may have explanatory power.
Regardless, I do see two distinct social orders emerging, and the differences go well beyond the boundaries of the domains as I’ve drawn them.
(2) Regardless of my reservations in (1) , there is the issue of parsimony. I’m just wondering which of your claims requires tucking the finance/political economy duality on top of CasP. At this point, it seems to me that all your claims here can be examined without this extra duality — though, I’d be happy to see your future research prove me wrong!
I developed the model in an effort to understand in a much more fine-tuned and nuanced way how power is created, manifested and applied.
At the end of the day, having a large market cap only gives a company so much power, and that power, whatever it is, does not transfer to the owners, nor does it usually extend much beyond the company’s ecosystem (suppliers, competitors and customers). Michael Porter’s “Five Forces Model,” which has been around since the 1980s, explains this aspect of capital as power better than CasP does, but it does not support CasP’s assertions regarding creorder.
One of the conclusions that my “extra duality” leads me to is that individual capitalists and firms are somewhat irrelevant. The fact that all capitalist wealth is really just one giant IOU from Finance places all the power of capital in Finance itself. You’ve called this “the state of capital,” and I have identified it as the “financial economy” or the “capital economy.” (This may explain why I have considered labeling the capital/financial domain as a polis, aka a state.)
In this sense, my model does not layer in an extra duality, it just gives more definition to CasP’s amorphous “state of capital.”
I also think there is value in abstracting the people (e.g., the “rulers” and the “ruled”) away and focusing on the system itself. Most capitalists are just cogs in the “state of capital,” and they are not even aware of that fact. They rule nothing, the holders of their “wealth” do.
(3) FIRE. You argue that real-estate and insurance were crucial in the emergence of capitalism, which is true — but how is this relevant to Finance as an analytical category?
That’s a good question. I am not wed to Finance as FIRE sector, but I have done more thinking on this matter than I’ve discussed so far.
Insurance and real estate should be considered as part of Finance (and the State of Capital) because both sectors create their own forms of “operational symbols” (i.e., policies and mortgages) that represent and affect entities in the political economy (material world). Just as a stock ticker extends Finance’s control over a previously unlisted corporation, so does a mortgage establish a means for controlling the underlying property. An insurance policy is more like a bet, but that’s also the essence of stock in a company that doesn’t issue dividends.
I prefer to think of this kind of “financialization” (the creation of financial symbols or avatars that represent a productive entity) in terms of a space-state control system (where those symbols are software sub-routines that are used to monitor output and provide feedback that guides the system under control.
Put more simply, the insurance and real estate sectors should be considered part of Finance/the State of Capital because each relies on the creation of economic claims to, or based on, existing legal rights. It is this additional layer of abstraction that is the hallmark of the State of Capital.
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Looking forward to seeing your ideas enable new research.
Me, too. That said, I think the research areas probably need to expand beyond political economy, and even with political economy, they need to pursue other paths, perhaps towards new “indices.”
One area for research is the law, which is where my strength resides (and I’ve been researching the history of the law as it relates to many CasP issues for over a decade). Markets and Finance would not exist, but for the law.
Another area, which you’ve mentioned previously, is accounting. I’ve actually started looking at the history of depreciation and amortization and accounting, generally, mostly trying to track down how/why the term “capital assets” came into usage (it certainly predates Smith, who gets a lot of blame from you and others).
A third area is modern finance. Someone or something was behind the investment in developing (100% wrong but widely used theories such as) CAPM, for example. I’ve actually spent a lot of time over the last decade studying this, as well, but a lot of the work y’all have done in CasP leads me to believe Finance discovered some connection between cost of capital, return on capital and GDP growth that changed everything, resulting in what we’ve seen in the world economy beginning probably as early as the 1960s.
“Research” in these first three areas does not necessarily look like what CasP normally does. Something that is closer to CasP’s home is attempting to understand the causal connection, if any, between (1) interest rates for corporate debt, (2) corporate profits (and growth rates) and (3) GDP growth. (The answer could be in CAPM itself, as the “risk free rate” is the benchmark against which all other interest rates are set.) While free resources like FRED have a lot of the data, they are unlikely to have all that is necessary to study this issue. I am currently developing some ideas on what research can be done by me in this area using the resources I have, and will post those up in the Research section of the forum. Maybe others will know better resources. Again, while I can do some basic data analysis, I am not a data analyst by any stretch.
P.S. I don’t know how familiar you are with the so-called Coase Theorem, but taken to its logical conclusion, it destroys our understanding of private property and would replace it with something else that vastly increases capital’s power. Basically, the Coase Theorem argues that the owner of any particular property ought to be he who can best exploit it economically, as that ensures the greatest utility for society as a whole. What is scary is that the Coase Theorem and other economic ideas such as Pareto Efficiency are central to the Law and Economics movement and have already begun reshaping the law in ways that always further advantage capital over everyone else.
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