Marx typically analysed the behaviour of capitalist firms producing a single product and involved in just one line of business, such as textile spinning or weaving. He did so because, in his day, that is how most firms worked. We’ve come a long way from that. Take the case of General Electric - a typical, modern diversified firm. General Electric is a conglomerate with a finger in all sorts of pies - though not, these days, electricity. To quote ‘Forbes’ It’s a “technology, media & financial services company, with products & services ranging from aircraft engines, power generation, water processing & security technology to medical imaging, business & consumer financing, media content & industrial products.” Where’s the industrial logic in that? There is none. So why diversify?

As a last resort neoclassical economists have invoked the mysterious notion of synergy as a force for diversification, rather like conjuring a rabbit from a hat. Synergy is said to mean that ‘two and two can make five.’ As we shall see, the results of mergers have just as often demonstrated that ‘two and two can make three.’

There is one theory of modern capitalism that can attempt to explain diversification in the form of a pure conglomerate like GE. That is the theory that treats the firm as a portfolio of assets. Portfolio theory begins with the homely saying that ‘you shouldn’t put all your eggs in one basket.’ Diversification is said to be about risk reduction.

The notion of reducing risk (rather than increasing profit) hardly seems an adequate theorisation of the aggressive and predatory irruption of big capital into new sectors in search of more and more surplus value. A Marxist has no problem in perceiving the unifying theme in financial services, aircraft engines, power generation, medical imaging and the media within GE. They are all intended to make money.

GE’s market capitalisation comes to $279 billion. Its sales are $172.6bn, profits $21.9bn and it has assets of $833.9bn. It employs 327,000 workers. (All these figures were bigger at the turn of the millennium. GE has had serious difficulties in recent years and the value of its assets has been in decline.) In many ways General Electric is typical of the biggest businesses of our age.

General Electric is in fact treated by top management as a portfolio of financial assets which generate surplus value. They don’t care whether they are making aircraft engines or security technology as long as they make money. Modern capitalists take a purely financial view of their firm’s operations. Not only that, they are increasingly intertwined with and dominated by financial institutions, financial instruments and financial considerations. This process is called financialisation. It’s been going on for the last thirty years or so. It’s an ugly word. The reality behind it is not pretty either.

What is financialisation?

Others have noted this modern trend. Some writers, in our view, have tried to put too much explanatory weight on the concept. For now we will offer the fairly neutral definition offered by Wikipedia. “Financialisation may be defined as: "the increasing dominance of the finance industry in the sum total of economic activity, of financial controllers in the management of corporations, of financial assets among total assets, of marketised securities and particularly equities among financial assets, of the stock market as a market for corporate control in determining corporate strategies...”

 “More popularly, however, financialisation is understood to mean the vastly expanded role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and international economies.”

This is not simply restating the view outlined by Lenin in his book, ‘Imperialism, the highest stage of capitalism’ (Progress Publishers, 1966) that capitalism in its monopoly stage is dominated by or merges with finance capital. The increasing importance of finance capital to modern capitalism remains a valid insight to this day. But we have moved beyond the period where finance capital simply battens itself upon the productive capitalist sector though it still does so, like the Old Man of the Sea on Sinbad the Sailor’s back. George Soros has observed, “The size of the financial sector is out of proportion to the rest of the economy. It has been growing excessively...ending in this super-bubble of the last 25 years.”

Capitalism has evolved to the stage where all management calculation is basically dominated by financial calculations. The importance of productive activity has been completely dissolved in the modern management mindset. In ‘The moral consequences of economic growth’ (Alfred A. Knopf, 2005) Benjamin M. Friedman summed up his analysis of the changes that have taken place, “I have the sense that in many of these firms the activity has become further and further divorced from actual economic activity.”

This is reflected in the background and training of top management. Thirty years ago the manager of an engineering firm would typically have come from an engineering background and would have a basic understanding of the problems and possibilities afforded by the technology handled by the firm. This is no longer considered necessary or desirable. Harvard Business School has concentrated over the past thirty years in turning out managers who have the mentality of accountants. They are completely unaware of the technology the firm uses. All they see is a balance sheet. More and more top managers have been trained as accountants or lawyers.

Money from money?

Marx dealt with two forms of circulation. In an economy of simple commodity production the commodity is exchanged for money only as a means of acquiring commodity of a different kind. The commodity producer sells in order to buy. Marx calls this the C – M – C circuit. He contrasts this with the intention of a capitalist who starts with money and exchanges it fleetingly for commodities (for instance means of production) only in order to end up with a larger sum of money. He intends to transform money into capital. This is the M – C – M’ circuit. Marx notes that the acquisition of commodities (even if only for an instant) is regarded by the capitalist as a nuisance. The capitalist’s ideal is to move from M – M’ without bothering with acquiring commodities at all. This strikes us as absurd but it is this absurdity to which capital aspires.

A new era?

A new era of capitalism was announced by Martin Wolf in 2007 (The new capitalism: how unfettered finance is fast reshaping the global economy. Financial Times 19.06.07

Wolf may be regarded as a guru of finance capital. The article is exceptionally wide-ranging and well-informed. However it is inevitably impressionistic and raises more questions than it resolves. Wolf is no Marxist. He is a Commander of the British Empire. His last book was entitled ‘Why globalization works.’ As we will see, he may be having second thoughts on that. We have certainly expressed our reservations in the past at the way in which the phrase ‘globalisation’ has been lazily bandied about to suggest the unfettered triumph of capitalist production relations throughout the world. (See http://www.marxist.com/globalisation-imperialism-economy110406.htm)

We agree with Martin Wolf when he argues that there is a new, or at least vastly more important, trend in modern capitalism. That trend is financialisation.

“First, finance has exploded. According to the McKinsey Global Institute, the ratio of global financial assets to annual world output has soared from 109 per cent in 1980 to 316 per cent in 2005. In 2005, the global stock of core financial assets had reached $140,000bn.”

This is true and important. But we need to know why finance has exploded in modern capitalism. Wolf himself does not have a complete explanation, though he associates its rise with neoliberalism and globalisation.

“Second, finance has become far more transactions-oriented. In 1980, bank deposits made up 42 per cent of all financial securities. By 2005, this had fallen to 27 per cent. The capital markets increasingly perform the intermediation functions of the banking system. The latter, in turn, has shifted from commercial banking, with its long-term lending to clients and durable relations with customers, towards investment banking.”

Again this is new and true. The reason for the present credit crunch is that banks no longer hang on to mortgages and other assets, and just count the money as it comes in. As we now know they bundled these assets on, including the toxic sub-prime mortgages, and passed these exotic securities on all round the world.  The other side of this game of passing the risk parcel is that innumerable financial intermediaries have sprung up taking a cut – agency fees – for every transaction. This is what Wolf calls financial intermediation - turning loans into securities.

The credit rating agencies such as Standard & Poor did not put any difficulties in the way of this securitisation. The reason is not hard to seek. Since they are actually employed by the financial institutions that issue the securities, they do not scrutinise the risk as carefully as they might. They know what side their bread is buttered on.

When considering finance capital, we naturally think of borrowing and lending as the principal activities and of interest as the ‘reward’ sought by finance capital. In fact as transactions are bundled up and sold on, many intermediaries in the financial sector make their main income from commissions on sales. In the 1987 film ‘Trading Places’ Eddie Murphy as a con man exchanges places with a trader in futures as part of a bet between two billionaire brothers as to whether heredity or environment is determinant in human behaviour. As they explain their business to Murphy, he sums it up, “I get it. You guys are bookies, right?” Traders in pork belly futures get their commission whether pork bellies go up or down in price, just as bookies get their cut no matter which horse wins the 3.30 at Lingfield. Huge sums are made in the City and Canary Wharf in activities that approximate to bookmaking.

Investment banking is basically a matter of mobilising other people’s money and hurling it at investment opportunities rather than the homely high street job of lending money out on mortgage and taking in deposits most of us associate with banking. "O brave new world, that hath such people in it," as Miranda says in Shakespeare's ‘The Tempest’.

Derivatives and fictitious capital

Wolf goes on, “Third, a host of complex new financial products have been derived from traditional bonds, equities, commodities and foreign exchange. Thus were born ‘derivatives’, of which options, futures and swaps are the best known. According to the International Swaps and Derivatives Association, by the end of 2006 the outstanding value of interest rate swaps, currency swaps and interest rate options had reached $286,000bn (about six times global gross product), up from a mere $3,450bn in 1990. These derivatives have transformed the opportunities for managing risk.”

Derivatives are so called because they are derived from another transaction. For instance a future contract may be a contract to buy a share in the wheat harvest of 2010. The crop, of course has not been sown, so the buyer is making a bet as to whether there will be a good harvest or not. Futures are contrasted to spot transactions, where the buyer takes delivery of the commodity at the time of buying. Derivatives are a form of what Marx called fictitious capital.

In the case of real capital, it is a real productive resource that participates in the equalisation of the profit rate. So the return is worked out on the capital invested. For fictitious capital it is the other way round. “The formation of a fictitious capital is called capitalisation. Every periodic income is capitalised by calculating it on the basis of the average rate of interest, as an income which would be realised by a capital loaned at this rate of interest. For example, if the annual income is £100 and the rate of interest 5%, then the £100 would represent the annual interest on £2,000, and the £2,000 is regarded as the capital-value of the legal title of ownership on the £100 annually. For the person who buys this title of ownership, the annual income of £100 represents indeed the interest on his capital invested at 5%. All connection with the actual expansion process of capital is thus completely lost, and the conception of capital as something with automatic self-expansion properties is thereby strengthened.” (Capital Vol III Chapter 29p. 597 Penguin, 1981)

Fictitious capital generates pieces of paper that entitle the bearer to an income stream. This revenue can only come from surplus value, from the unpaid labour of the working class. Yet the capital is fictitious because it’s just a piece of paper and hasn’t contributed a penny to the development of the capitalist world’s productive power.

Does a capitalist care whether through spending £1,000 he owns a share in a factory, a mass of real productive capital; or whether he owns a piece of paper? In either case ownership provides him with a steady income stream, a share of surplus value. And, in any case, a share in a factory does not really cause its owner to perceive that they have ownership of individual bricks and machine parts. So of course they don’t care. The capitalist’s indifference between real and fictitious capital is the objective basis in his cranium to calculate everything in money terms – in other words for the evolution of the mentality that produces financialisation, that regards all economic activities as simply profit opportunities to be assessed against each other.

As for managing risk, the supposed justification for this explosion of paper wealth, that has proved a cruel delusion. What this ‘globalisation’ of finance has achieved is a global spread of risk. It has turned localised risk into generalised systemic risk. Nice one!

Wolf continues, “Fourth, new players have emerged, notably the hedge funds and private equity funds. The number of hedge funds is estimated to have grown from a mere 610 in 1990 to 9,575 in the first quarter of 2007, with a value of about $1,600bn under management. Hedge funds perform the classic functions of speculators and arbitrageurs in contrast to traditional ‘long-only’ funds, such as mutual funds, which are invested in equities or bonds. Private equity fundraising reached record levels in 2006: data from Private Equity Intelligence show that 684 funds raised an aggregate $432bn in commitments.”

(We have discussed hedge funds and private equity funds elsewhere. http://www.marxist.com/hedge-funds-speculation-and-capitalism.htmhttp://www.marxist.com/private-equity-capitalist-mutation260207-6.htm)

Basically hedge funds are betting syndicates for very rich people. They are run by investment managers. They are private and unregulated. There were estimated to be 8,000, but there has been a big shake-out since the present financial crisis. Their claim to be able to outperform the market, which is what makes them so attractive to the rich, has been severely tested and many have disappeared. Never the less they were described in 2006 as economically “the eighth biggest country in the world.”

For the moment all we want to add is that when the mainstream banks slice and dice debts and pass them on as securities, they do not literally disappear from the earth, even if they no longer impinge on the consciousness of the bankers who transferred them. Someone buys them. There is therefore a secondary banking sector linked to the official banks. Hedge funds have been a central institution of secondary banking. But because they are linked to the regular banks and the rest of the capitalist economy by a thousand threads, they are bound to take a hit when the rest of the capitalist economy cops it. Hedge funds are famously secretive institutions, only invested in by the super-rich. It is the secondary, unregulated banking sector that has exploded over past recent years. It is the secondary banking sector that has collapsed. Now it is dragging the rest of finance capital, and of the whole capitalist system, into crisis.

But when shares go down, the owners sell and contribute to the catastrophe. In an article in the Financial Times (12.01.09) George Soros is reported to have told the US Congress that hedge funds would shrink during the present crisis by 50-75% from their $2,000bn (that’s $2trn) peak. The fundamental problem was that they were so heavily leveraged. Funds were reported as betting thirty times as much as their assets, boosted by cheap loans. The same paper reported that they have probably wound down their holdings of listed companies from $3,500bn in mid-2008 to $1,500bn by the end of the year. Clearly this is not just a disaster for the overpaid employees of hedge funds in Mayfair, for whom the reader may or may not shed a tender tear, but is disastrous for the future of those listed companies and their employees.

Back to Wolf’s analysis (The new capitalism: how unfettered finance is fast reshaping the global economy. Financial Times 19.06.07)

 “Fifth, the new capitalism is ever more global. The sum of the international financial assets and liabilities owned (and owed) by residents of high-income countries jumped from 50 per cent of aggregate GDP in 1970 to 100 per cent in the mid-1980s and about 330 per cent in 2004.

“What explains the growth in financial intermediation and the activity of the financial sector? The answers are much the same as for the globalisation of economic activity: liberalisation and technological advance....”

Liberalisation

Martin Wolf is quite right that liberalisation is a major factor in the financial explosion. Before the 1970s monetary crisis the world’s financial affairs were governed by the Bretton Woods system of monetary management laid down at the end of the Second World War. This was basically a fixed exchange rate regime. We have to say that this tightly regulated system of financial management presided over much more spectacular results in real economic performance than anything that has happened since, when the ‘animal spirits’ of the entrepreneurs have been allowed free rein. Exchange rates were fixed and restrictions on capital movements were universal. In Britain and other capitalist countries exchange controls strictly limited the movement of capital before 1979. This in turn restricted the scope of speculation. Keynes’ remarks in ‘The General Theory of Employment, Interest and Money’ (Cambridge University Press 1973 p. 159) seem borne out. “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

Thatcher was the first leader of a major capitalist country to scrap exchange controls. Now they are a thing of the past in the advanced capitalist countries. (They were sensibly reintroduced in Malaysia in 1998 to immunise the country from the regional financial crisis that started in 1997. India and China still have exchange controls.).

Since the collapse of the Bretton Woods settlement, we have seen an orgy of deregulation. (See http://www.socialist.net/neoliberalism.htm) In the USA the Glass-Steagall Act left over from Roosevelt’s New Deal strictly separated commercial and investment banking. All the other domestic banking systems were rigidly regulated. In London the ‘big bang’ of 1986 heralded the end of cosy regulated City establishment. Instead we saw capitalism red in tooth and claw in London competing with New York for the position of financial capital of the world.

Fixed and floating exchange rates

In a more recent article, Martin Wolf links the explosion of currency reserves as a destabilising element in the world capitalist system with the floating exchange rate regime. “Between January 2000 and April 2007, the stock of global foreign currency reserves rose by $5,200bn. Thus three-quarters of all the foreign currency reserves accumulated since the beginning of time have been piled up in this decade.” (Financial Times 09.10.08) Under fixed exchange rates monetary flows, to pay for flows of goods and services in the opposite direction, were in effect self-liquidating in that they disappeared into the receiving country’s reserves. Under a floating exchange rate regime, national banks do not in principle have to maintain foreign exchange reserves to back the currency. So they can multiply without number and be acquired by speculators.

Liberalisation was inevitable as capitalism after 1971 entered an era of floating exchange rates. Capital movements were no longer just the counterpart of trade in goods between countries. Capital was set free! Capital movements soon dominated the movement of goods by a factor of 100:1. It was these capital flows that determined exchange rates, not the balance of payments of a country. Capital outflow could bring any government not prepared to do the bidding of international capital to heel. (For more on the implications of exchange rate regimes on the accumulation of capital, see http://www.socialist.net/the-world-economic-crisis-and-the-%E2%80%98emerging-economies%E2%80%99.htm)

Computers in trading

As to technology, it has helped to transform the financial environment. Risk assessment was largely a personal matter till the building up and availability of banks of data on the creditworthiness of millions of citizens. Typically the borrower had to appear before a bank manager, of the kind typified by Captain Mainwaring in ‘Dad’s Army’, and explain why they needed the money. In the City cliques of blue-blooded bankers typically relied on trust between one another as the glue that held their financial transactions together. Risk is no longer monitored individually. Transactions are logged and risk assessed mathematically. Experian is a British firm with sinister banks of information on the ‘consumer preferences’ and credit history of virtually every citizen in the land. Nor is risk held at the bank with the loan. It is securitised and passed on, and agency fees are pocketed in the process. The illusion was allowed to develop that, in this manner, risk had disappeared. Out of sight, out of mind. As explained earlier, rather than being localised, risk is being packed into the foundations of the global financial system. It is made systemic.

Secondly banks of computers are routinely used to develop the complex programmes and predictions evolved from advanced mathematics with the noble aim of making money through speculation. We deal later with the ‘efficient markets hypothesis.’ Briefly markets are assumed to be ‘efficient’, in the sense that they process all available information.

One implication of the theory is that, 'you can’t beat the markets' – not consistently at any rate. This, of course, does not prevent capitalists expending vast amounts of blood and treasure in an attempt precisely to beat the markets. One such model is called the Black-Scholes options-pricing mechanism. Perry Mehrling – in ‘Fischer Black and the Revolutionary Idea of Finance’ (John Wiley, 2005) – notes that, despite the occult quality of these mathematical endeavours, there is no evidence that this model ‘added value’ to their assets. But the myth lives on.

Here’s a note from Scientific American (December 2008 p. 21) on why these programmes failed. “As Benoit Mandelbrot...wrote in Scientific American in 1999, established modeling techniques presume falsely that radically large market shifts are unlikely and that all price changes are statistically independent; today’s fluctuations have nothing to do with tomorrow’s – and one bank’s portfolio is unrelated to the next’s. Here is where rocket science and reality diverge.”

Wolf concludes, (The new capitalism: how unfettered finance is fast reshaping the global economy. Financial Times 19.06.07)

 “Yet there is also a shorter-term explanation for the explosive recent growth in finance: today's global savings and liquidity gluts. Low interest rates and the accumulation of liquid assets, not least by central banks around the world, have fuelled financial engineering and leverage. How much of the recent growth of the financial system is due to these relatively short-term developments and how much to longer-term structural features will be known only when the easy conditions end, as they will.”

Since he wrote the article Martin Wolf has come to see how much of the inexorable progress he outlined was a pure, unsustainable financial bubble. But the article was the conventional wisdom little more than a year ago.

“What then have been the consequences of this vast expansion in financial activity, much of it across international borders?

“Among the results are that households can hold a wider array of assets and also borrow more easily, so smoothing out their consumption over lifetimes. Between 1994 and 2005, for example, the liabilities of UK households jumped from 108 per cent of GDP to 159 per cent. In the US, they soared from 92 per cent to 135 per cent. Even in conservative Italy, liabilities rose from 32 per cent to 59 per cent of GDP.”

The notion that this amounts to ‘smoothing consumption over one’s lifetime’ is far-fetched. What is really going on with these spiraling liabilities is people getting head over heels in debt.

Mergers and acquisitions

“Similarly, it is ever easier for companies to be taken over by, or merge with, other companies. The total value of global mergers and acquisitions in 2006 was $3,861bn, the highest figure on record, with 33,141 individual transactions. As recently as 1995, in contrast, the value of mergers and acquisitions was a mere $850bn, with just 9,251 deals.”

In the first place a merger typically does not raise a penny for new investment. Vast sums of money are indeed mobilised, but for the sole purpose of changing the ownership of assets, not for increasing their productive power. Secondly we note that all surveys show that mergers and takeovers are usually unsuccessful in improving real economic performance. Put bluntly, the merger movement is a huge waste of energy and resources, and the fact that financial mobilisation makes mergers possible on an ever larger scale cannot be regarded as any form of ‘progress.’ Can capitalist dinosaurs spending all their energy eating one another be regarded as progress?

After his breathless exposition, Wolf injects a note of caution. “Pessimists would argue that monetary conditions have been so benign for so long that huge risks are being built up, unidentified and uncontrolled, within the system. They would also argue that the new global financial capitalism remains untested.”

The pessimists were right.

Working class households

Let us look at the development of financialisation, starting with the household sector. In the nineteenth century workers did not use banks. Skilled workers had a strong savings ethos. But life was precarious. They were only one wage packet away from destitution. A host of voluntary savings societies catered to their need. None of these funds flowed into or out of the banking system. Banks were certainly missing a trick to make money out of workers’ savings. The Bank of England’s smallest note issued was £5, the equivalent of several weeks’ wages for any worker.

For a nineteenth century worker, the unskilled in particular, wages were usually spent as soon as they were received. For workers of that time surviving on a subsistence wage, the only ‘provision’ for being looked after in old age was to submit themselves to the Poorhouses, the ‘poor law Bastilles’, unless they could rely on the charity of others in their family who were better off.

 The banks made their money elsewhere. The banks’ obsession with the finance of world trade, and the consequent ignoring not only of workers’ saving needs, but also of the requirements of capitalist manufacturing as we shall see, was typically part of the process by which British capitalism lost its pre-eminence. Economic historians have declared that the banks did not ‘fail.’ In the light of the relative decline of British capitalism this seems a metaphysical proposition. Certainly British capitalism, of which the banks were a central part, failed in the competitive struggle against rival capitalist powers.

In the modern era each individual is perceived by the banking system as “a two legged cost and profit centre,” as Robin Blackburn puts it. (New Left Review The subprime crisis April 2008 p. 84) Workers are expected to go into debt if they go to university. These loans are commodified and sold on. Workers are expected to go into debt to buy a house. In Britain there is little other option for most people. Wages are becoming a form of loanable funds, a site for profit-making by the financial institutions.

Now working class people see their wages as subject to all kinds of exactions and financial flows. The credit card, let it be remembered is, despite our universal reliance upon it, a relatively recent invention. More and more ways of borrowing are being opened up to ‘the consumer.’ Historically the household sector has always been in net surplus. No longer. In recent years both the British and US household sectors have slid into deficit as the burden of debt upon families has soared.

Every aspect of consumption has been financialised. Apart from the attempt to get consumers in hock through mortgages and credit cards on every aspect of their private spending, this principal percolates into as many aspects of our collective consumption as it will fit.

• State old age pensions were introduced in this country in 1908 as an unfunded system. How could it possibly have been otherwise? As a politician, Lloyd George could not have been expected to levy national insurance payments from voters and start handing out pensions decades later when the pot had filled up. Apart from anything else, this would have been electoral suicide. The point is made to illustrate the wider principle that, even when people are told that their benefits are matched by their contributions, the reality is that this year’s pensions are paid from the current national insurance fund.

• Workers are told to save for their old age. In some cases this is a complete illusion. Pensions, including private pensions, are paid for from current national income, just as this year’s apples are plucked from this year’s apple trees. Payments from pension funds are a claim on current national income, though the assets piled up are presented as saving for a distant future. Most of this monetary flow out of the funds is not real investment in the sense of increasing the productive capacity of the nation. It chases yet more paper assets. But these huge funds mean a huge increase in institutional finance. Pension funds and insurance companies are major players in financial markets. These funds need fund managers. Fund managers require fees. We shall see later what effect all this has on stock markets.

• In relation to the health service, Aneurin Bevan was emphatic that the NHS should be funded from general taxation. The introduction of the Private Finance Initiative, along with other ‘reforms’ aimed at creating a market in the health service where none existed, have transformed the situation. What is significant about PFI is that the task of providing the infrastructure of the NHS such as hospitals is compulsorily handed over to the financial sector by the simple expedient of forbidding the public sector the right to borrow, as it had done for fifty years before. Since the private consortium owns the buildings they also provide the health service as a private profit-making business. Two features of the mentality of capitalism in the age of financialisation pop up. The first is that no management expertise in providing health care is regarded as necessary. An accountant will do just as well, or even better. The second is that a service based on current spending, mainly on wages, is turned into a series of financial flows.
• Higher education: when grants were replaced by loans and students had to pay fees, higher education became commodified. Another stage in the endless life cycle of workers accumulating debt and paying it off was created. And of course they are using PFI to fund school building. In doing so they have exposed education, the health and other elements of the essential infrastructure of our society to the vagaries of the banking crisis. The banks, central to the whole project, have just turned the finance tap off. Will PFI survive? Early signs are that New Labour will guarantee the contracts, thus removing any last fiction that PFI is about switching risk to the private sector. Just guaranteed profits for them – in boom or in slump. Anything is better than slaughtering the sacred cows that show the government’s commitment to ‘pro-business’ policies.

Middle class savings

The Victorian middle class did save, but their savings did not serve to grease the wheels of industrial investment. Famously they would put their money into railway bonds and state and municipal bonds in exotic countries. (It is argued that British capitalism did benefit indirectly from this early trend to ‘globalisation.’ Railways being pushed into the interiors of far-away places opened them up as markets for dominant British manufactures.) The British middle class also bought government securities (consols), but seldom bought into shares of any kind. Banks were also geared to financing world trade by dealing in bills of exchange and other trade-related paper and domestic monetary and credit circulation, rather than financing industrial investment.

Government

The government sector was comparatively small in the nineteenth century. Throughout most of the twentieth century state spending rose as a proportion of national income, and the national debt ballooned on account of two world wars. The welfare state, beginning with old age pensions and the National Insurance Act of 1911, was based on spending out of current government income from values generated by current working people, rather than generating the illusion that NI, pensions and other transfer payments were a form of saving for the future.

The corporate sector

 Nor did banks lend long term to industry at least in Britain and the USA. They still don’t. More than 90% of investment funds in those countries are internally generated, that is to say they come from profits ploughed back. Yet industry is more and more dependent on finance, and finance more and more dependent on industry. Every major car firm now has its own hire purchase company, such as the General Motors Acceptance Corporation and the Ford Motor Credit Company. Before these were set up, a car buyer would have had to save up, or try their chance for a bank loan. These credit institutions are more than just a convenience to these car companies. They illustrate the way that production has been almost erased as a separate activity in a welter of financial calculation at the top of a big corporation. The crisis of these HP companies is an important part of the present acute crisis in the world motor industry.

Anglo-American capitalism versus the ‘bank’ model

There are undoubted differences between different capitalist nation states. These differences are products of their different history and evolution. We are going to refer to these different types as ‘models.’ The reader should not get the impression that the ruling class, tiring of the failure of their own model of capitalism, can select another from off the shelf. They are also victims of historical processes, are trapped in the form of capitalism that has evolved and, like the captain of the ship, will go down with their system.

One of the differences between Anglo-American capitalism and the German type concerns the interaction between production and finance capital. Historically, the ‘stock exchange’ capitalism of Britain and the USA has been contrasted to the ‘bank’ model typified by Germany, and later in a modified form by Japan and countries such as Korea.

German capitalism of his time was the model for Hilferding in his classic ‘Finance Capital.’ (Routledge and Kegan Paul, 1981) It should be noted that Lenin in ‘Imperialism, the highest stage of capitalism’ (Progress Publishers 1966) gave a broader sociological definition of finance capital than Hilferding’s strict reliance on the practices of German banks. After all Lenin used and adapted the Liberal-radical Hobson’s analysis in his treatment of British imperialism. Likewise he tended to speak of the ‘fusion of financial and productive capital’ in preference to Hilferding’s formulation of the ‘domination of finance capital.’

The specific phenomena incorporated into Hilferding’s theory are often seen as of two-fold significance: first they have been seen as part of the launching of German capitalism as a major competitor nation on the world economy. Whereas British capitalism evolved ‘organically’ from petty artisan production, German capitalism could only compete on the world market at the time it emerged as big business. This required large amounts of fixed capital. This in turn meant that industrial capital could not be financed by private capitalists, as was generally the case with early British capitalism, but firms had to have recourse to borrowing. This gave the banks a key role. Secondly this teutonic form of capitalism persisted till quite recently in that banks lend long term and develop an active interest in monitoring their investments in manufacturing firms. This in turn meant that capitalism could develop long term perspectives, as opposed to the chronic ‘short termism’ characteristic of Anglo-American capitalism. So the structure of German capitalism was a part of its combined and uneven development. Conventional economic historians call this the Gerschenkron thesis, but Marxists will recognise it comes from Leon Trotsky.

The stock exchange

The stock exchange is not a major source of investment finance for most capitalist firms in most capitalist countries. Of course a company can issue new shares as a means of raising funds. But as Lazonick has pointed out, many executives have been more concerned with stock repurchases, that is withdrawing their shares from the exchanges. Buying a second hand share of a car company in the bourse is no more advantage to the motor company than buying a second hand car.

So why is the share price important? It is important because the share is the modern form by which capitalists own the means of production. The dividend and hoped for increase in the price are the rewards of being a capitalist. The shareholders are the people the managers have to butter up. The share price is therefore a central determinant of the behaviour of those who run the firm.

We can look at the options for different forms of capitalism in terms presented by organisational theorists such as Albert Hirschman (‘Exit, Voice and Loyalty,’ Harvard University Press, 1970). He looked at the likely reactions to unsatisfactory prospects in life as a choice between ‘voice’ and ‘exit.’

In Britain and the USA the stock exchange is actually dominated by these institutional investors. Personally owned shares are only a tiny minority of those traded. The fund managers have their own techniques. If they perceive failure, in terms of the price of a share in their portfolio heading south, they just sell.  Here the instant reaction from the institutional investor is to ‘exit,’ showing no ‘loyalty’ whatsoever – any more than a gambler would to a horse that had fallen at the first fence.

The predominance of institutional investors in British and US capitalism in particular has meant that managers are well aware that any adverse signal provided by their share price is likely to trigger a wave of selling. They therefore propitiate the markets by taking decisions that keep the share price high, often at the expense of long term investment decisions. So the dominance of institutional investors in the stock market enforces short term decision making inside the firms. The Anglo-American disease of short termism is accentuated by financialisation, where the fund managers of dominant institutional investors measure performance in nano-seconds and react in like time scales.

In the case of traditional German capitalism (now being undermined by the process of financialisation) the principal bank of a firm would show concern for the poor performance of a firm it had lent money to. Since its money was necessarily tied up in the fixed capital of the firm for a considerable period of time, their natural reaction would be to try to turn the firm around. In other words they would resort to ‘voice’ as a first resort, involving themselves in its future.

The German and Japanese forms of capitalism rest on committed, long term relationships between capitalist institutions. Anglo-American capitalism relies on short term, pure market relationships between firms. It assumes a blind faith in market solutions. This is based on the equally blind faith of neoclassical economics on the ‘efficient markets hypothesis.’ Most neoclassical economists hold to the theory that markets are ‘efficient’, that is that they process all information available.

Share prices

How does this fit in with the price of a share – a piece of paper? Share prices are subject to irrational factors, but at bottom the share price reflects expected future profitability. So it is supposed to tell us everything that people (‘markets’) know about the future prospects of that firm. After all, what would be the point of following the movement of markets if they just reflected the hysteria of market participants? But market actors never know for definite what the future will bring. The dot.com bubble at the end of the last millennium just ‘informed’ us that share prices were going crazy because the people who were buying them were going crazy. The ‘information’ the observer was likely to derive from the share markets was to go and do likewise - advice to lose your shirt. Is that efficient?

The efficient markets hypothesis, rules out the possibility of bubbles forming in markets. Bubbles are created because markets are going ‘the wrong way.’ Since the hypothesis cannot explain real world phenomena, it is plainly wrong. No wonder one of the most influential analyses of financial markets in recent years is entitled ‘Irrational Exuberance’ by Robert J. Shiller (Broadway Books, 2000) – going back to hysteria as an explanation of share markets’ behaviour. Really this is no explanation at all.

Managers, shareholders and share options

This neoclassical commitment to laissez faire and to the infallibility of the ‘information’ provided by share prices has also been used to incentivise managers and get them to do what the inert shareholders want, through the share price mechanism itself. Since there is no doubt that the vast majority of modern shareholders are absentees with no managerial function, how should they achieve this? This is what is known as an agency problem: how do you get your agent to do what you want, not what he wants, given that the agent actually does the work?

The solution was said to lie in share options for directors. This is supposed to align the interests of directors with those of shareholders. Managers, like the passive institutional shareholders, have a material interest in being obsessed with the share price – the source of the vast bulk of their income. Their salary is small beer by comparison. The executive also becomes a part owner and shares an interest in ‘maximising shareholder value.’ Here’s how. An option is the right to buy company shares at a particular time at a particular price. Clearly the director will not exercise that right unless the actual market price is above the price at which he can exercise the option. It is argued that the director will therefore work and sweat to drive share prices up, which is what the shareholders want.

Managerial guru Peter Drucker has describes directors’ share options as “an encouragement to loot the corporation.” And so it has proved to be. It is pure naivety to suppose that the only factor driving share prices is the effort of the managers. In a bull market all shares tend to go up, whether management are performing well or badly. It is evident that the share price is not an indicator of managerial achievement. In fact the share price is not the sole factor on the radar of shareholders. They are also interested in dividends. Share options may actually provide the perverse incentive for directors to sacrifice dividends to share price.

Warren Buffet (currently the richest man in the world) sums up. “Once granted, an option is blind to individual performance...A management Rip Van Winkle, ready to doze for ten years, could not wish for a better ‘incentive’ system.”

William Lazonick gives a graphic description of the catastrophic consequences of stock repossessions motivated by executives’ share options in the Financial Times, 25.09.08. “During the stock market boom of the 1980s and 1990s the argument that “maximising shareholder value” results in superior economic performance dominated corporate governance debates... Traditionally companies distributed cash to shareholders through dividends. Increasingly, however, the payouts of US companies have taken the form of stock repurchases – total repurchases surpassed total dividends in 1997... executives have become enamoured by stock repurchases. Their abundant stock options give them an incentive to do buy-backs to boost stock prices even if this undermines long-term value.”

“The adverse impact of these decisions goes beyond the unseemly explosion in executive pay…

“In November 2007, the $7.5bn equity investment that Citigroup secured from the Abu Dhabi Investment Authority was almost as much as it spent on buy-backs in 2006 and 2007. Merrill Lynch did more than $14bn in repurchases in those two years, but by January 2008 had given up a 12.7 per cent equity stake to raise $9bn from foreign investors. Morgan Stanley, which did over $7bn in buy-backs in 2006-07, traded a 9.9 per cent equity stake with China’s sovereign wealth fund for $5bn. It has now agreed to a takeover. Lehman Brothers, which repurchased more than $5bn in 2006-07, is now bankrupt.” Not to put too fine as point upon it, the executives drove firms central to the functioning of the whole capitalist system into the ground in pursuit of their own selfish and short-sighted interests.

So much for maximising shareholder value.

Patterns of share ownership

The USA from the nineteenth century had a quite wide stratum of the population holding shares. It was a regular ‘property owning democracy’. The aspiration to own shares was seen as part of ‘making it’ and ‘sharing in the American dream’. On continental Europe, things were quite different. Not only was share ownership quite restricted and narrowly spread. German firms often had complex different classes of shares with different voting rights so that families could maintain control, while raising external finance. Often shares were actually owned by a bank, which thus had a stake in the long term success of the manufacturing firm and invested long term in its future. This system produced Germany as a pre-eminent European manufacturing nation with some of the finest engineering companies in the world.

The truth is that financialisation is a process going on all over the world, dissolving all these ‘social structures of accumulation,’ models or different ways of doing capitalism at different paces. Long term calculation and capitalist planning are inevitably victims of this process.

It is said that the first economic ‘law’ propounded was Gresham’s law of the currency. This states that bad money drives out good. This means that if some currency is solid silver and other coins are debased, everybody will spend the debased currency as quickly as possible and hang on to the good coin. An analogous process to Gresham’s law seems to apply to forms of capitalism. Short term financial calculation invariably wins out over engineering excellence. Capitalists can’t resist the lure of short term gains, even at the expense of their own future. In Germany capitalism is being hollowed out by capital’s drive to the east in search of lower wages in the former Stalinist countries – countries where the traditional German way of doing capitalism has never taken root.

What about the banks and other capitalist financial institutions pure and simple? This sector is sometimes called FIRE (standing for finance, insurance and real estate). In the 1960s finance drew off about 15% of total surplus value. Now they help themselves to almost 40%. Do the non-financial corporations resent this? If they do, there is no evidence that they can do anything about the fact.

How finance helps capital to circulate and multiply

In Capital Volume II, Marx deals with the circulation process of capital. He analyses the cost of the banking service of the time to the production capitalists as a ‘faux frais’ of capitalist production and thus a dead weight serving to snatch a portion of the total surplus value. So why should manufacturing capitalists use the services of banks? The profit of a capitalist firm is measured in terms of the time it takes to ‘earn’ it. The quicker, the better. By allowing capital to turn over more quickly and to circulate much quicker the banking system allows capitalists to achieve a much greater annual quantity of surplus value and thus a higher rate of profit.

In this the banks are different from the transport capitalists, who also accelerate the circulation process of capital by moving goods around. In the case of transport the activity is also productive of surplus value. Coal is no use to anyone at the pithead. It needs to be at the power station or on the hearth, and moving it to where it is needed is a productive activity.

Our point however is that finance capital is not directly productive of surplus value. In fact their profits are drawn from the productive sectors of the capitalist system. Never the less the activity of finance capital can make the extraction of surplus value more effective, increase the annual mass and rate of profits of productive capitalist firms, and so of the system as a whole.

It is not a question of asking, as a neoclassical economist would do, whether this is a more efficient arrangement. For Marxists it is a question of understanding that financialisation is the evolutionary trajectory of modern capitalism.

Finance capital does not produce surplus value – it consumes it

As part of a debate as to the validity of Marx’s tendency for the rate of profit as an explanation of capitalist crisis, the following passage uses Fred Moseley’s attempt to gauge the impact of finance as unproductive activity (unproductive in the sense that it does not directly produce surplus value) and its effect on the capitalist system as a whole. It can be found at http://www.marxist.com/unproductive-labour1981.htm.

The difference between productive and unproductive labour is crucial for Marxist economic analysis. By productive labour Marx means labour that produces surplus value, whether or not it produces material products. So a programmer who writes a computer programme or a chef who cooks a meal can be regarded as productive, providing they perform their tasks in order to produce surplus value for the boss.

What happens to this surplus value? Part is accumulated while the rest is spent on unproductive expenditures (“luxuries”). Workers in luxury industries produce surplus value for their boss, of course. But the unproductive sector, including the workers who make their living there, is subsidised from the surplus value raised in the capitalist economy as a whole.

What sort of unproductive expenditures are there? What has been happening to them since the Second World War? These issues are investigated in Fred Moseley’s The falling rate of profit in the postwar United States economy, Macmillan 1991). Moseley argues that the runaway rise in unproductive expenditures has been the second great factor levering profit rates down. At the time of writing, for instance, there are four million workers in the shop and distribution sector in Britain compared with 3 ½ million employed in industry.

Moseley sums up his results for the USA:  “Commercial labour... accounted for almost two thirds of the total increase of unproductive labour. The other two types of unproductive labour, financial labour and supervisory labour, each accounted for approximately half the remaining increase of unproductive labour.” (Moseley, p.150-151).

“Financial labour” (in the Finance, Insurance and Real Estate industry) “increased 173% from 1950 to 1989, while productive labour increased only 44%, so the ratio of financial labour to productive labour increased 91%”. (Moseley, p.133-134)

Moseley argues, and we agree, the present epoch of capitalism is characterised by a huge increase in unproductive expenditure. He finds this a dead weight on the system, acting as an involuntary levy upon the profits of individual capitalists. And he shows unproductive spending exploding out of control over the past fifty years. He assesses this effect as significant as the rise in the organic composition of capitalism in causing the secular decline of profits since the War.

How will the distinction between productive and unproductive labour affect our analysis of the economy? National income accounting typically lumps all workers together. For bourgeois economics, there is no notion of productive and unproductive labour. But Marxists argue that some are producing surplus value, while the unproductive are being supported from a part of surplus value (that does not mean that they don’t work hard or are “parasites”, of course)...

So the paradoxical effect of the drive to financialisation is that it raises the annual rate of profit for an individual capitalist corporation. But, taken as a whole, this financial edifice increases the unproductive sector and thus reduces the rate of profit for the capitalist system.

Cyclical or secular trend?

Is the process of financialisation a secular one or is it subject to the boom-slump cycle? The present crisis is producing an enormous destruction of paper values. This painful process is called ‘deleveraging.’ As we pointed out earlier George Soros has seen financialisation as the blowing of a ‘super-bubble.’ Bubbles, and super-bubbles, burst. What is the point of writing this essay if the process we are examining is coming to an end?

There was a massive destruction of fictitious capital during the Great Depression of the 1930s. This led economic commentators to assume that the age of the domination of finance capital had come to an end. Here is Paul Sweezy. “The dominance of financial over industrial capital, which for a while was widely interpreted as a more or less permanent state of affairs, is thus seen  to have been a temporary stage of capitalist production, a stage which was characterized above all by the process of forming trusts, combinations and huge corporations.” (Sweezy – The decline of the investment banker Antioch Review 1.1 (Spring 1941) p. 67) This assumption must have seemed quite reasonable at the time. But of course the post-War period, specially the last thirty years, have seen a reflorescence of finance.

We are not arguing that financialisation is a return to any former stage of capitalist development whether real or imagined. It is a new phenomenon. It represents a new feature of capitalism that has become evident over the past thirty years or so. As Michael Perelman puts it, “A Wall Street perspective began to pervade the industrial sector.” He concludes, “This process became so thorough that the distinction between finance and industry became almost meaningless.” (Railroading economics, Monthly Review Press, 2006, p. 181)

Capital – real and fictitious

The nearest analogy to the way financialisation creeps up on capitalism is that of growth of the organic composition of capital. This measures the proportion of dead to living labour in the production process. The increasing organic composition of capital, the accumulation of more and more constant capital, of plant and machinery, behind the elbow of each worker is a basic tendency of capitalist progress. It is also the basic determinant of the tendency for the rate of profit to fall. This is the case since only living labour yields surplus value, yet the tendency is for the proportion of living labour to fall relative to dead labour in the capitalist’s outlay.

However the rise in the organic composition of capital is not a constant tendency as capitalism develops. As capitalism goes into crisis, one of the most important ways the system purges itself during a slump is through the destruction of capital. This provides the basic for a revival in the rate of profit at a later stage. This destruction of capital does not just refer to physical destruction in the form of rusting and rotting through lack of use. It principally means the destruction of the values of capital. As society goes through a period of overproduction many capital goods are sold off cheap. A crisis is very often a period where inflationary pressures are reduced and many goods actually fall in price owing to the lack of effective demand.

And, of course, the destruction of capital is not just the destruction of material means of production, of real capital or of its devalorisation in a crisis. The whole house of cards of credit comes tumbling down. What is destroyed above all is fictitious capital, of paper claims to a share of surplus value.

This is what we saw on a vast scale in the great Depression of the 1930s. Commentators such as Sweezy confidently predicted that the speculative madness, as they later saw the 1920s boom to have been, had been brought low. And for many years it seemed so. The great post-War boom after 1948 was soundly based on production. Finance capital remained a lowly handmaiden to productive capital for many years.

There already is, and will continue to be in the next few years, a great bonfire of the financial assets and the fruits of the recent speculative madness. But, as with the organic composition of capital, capitalism will not return to the primitive state of the technology of Watt and Arkwright after a recession. Though massive amounts of capital have been destroyed the historic tendency of the organic composition of capital is to rise.

In the same way masses of finance capital will be destroyed. Yet the tendency to financialisation, written in to the DNA of modern capitalism, will not disappear. It will dog modern capitalism to its death.

Financialisation and crisis

In the past, crises in production and profit-making have led to a crisis in the financial system. As we commented in an article on the 1929 Wall Street Crash, “It would be a mistake to get dragged too deep into the 'explanations' offered by the wizards of high finance. The difficulty with all these lines of reasoning, however, is the speed with which the collapse of production took place, and the fact that it began well before the stock market crash. Industrial production fell from 127 in June to 122 in September, 117 in October, 106 in November, and 99 in December. Specifically, automobile production declined from 660,000 units in March 1929 to 440,000 in August, 416,000 in September, 319,000 in October, 169,500 in November, and 92,500 in December.” ( See http://www.marxist.com/1929-can-it-happen-again.htm )

In addition to financial crises triggered by crisis in production, Marx noted in a footnote to Capital, “The monetary crisis defined in the text as a particular phase of every general industrial and commercial crisis, must be clearly distinguished from the special sort of crisis, also called a monetary crisis, which may appear independently of the rest and only affects industry and commerce by its backwash. The pivot of these crises is to be found in money capital and their immediate sphere of impact is therefore banking, the stock exchange and finance.” (Capital Volume I, p. 236, Penguin 1976)

These ‘pure’ financial crises arise because capitalism is an anarchic system and the only link between the different capitalist firms united in a gigantic world wide division of labour is the nexus of money. These crises can, as Marx explains, do great collateral damage to the ‘real economy,’ but will in time burn themselves out. Financial crisis comes together with a general crisis of the capitalist system, with devastating results as we see now (in 2009) when the general conditions for crisis have been prepared. As Michael Roberts has pointd out, this confluence came as a result of the fall in the rate of profit that became evident in 2007. (http://www.socialist.net/crisis-worst-since-1930s.htm) 

The tendency of the rate of profit to fall was described by Marx as “the most fundamental law of political economy.” It was and is also “a two-fold law” since as the rate of profit declines over the trade cycle, the mass of profit continues to rise. This phenomenon of narrowing margins together with plenty of money about inevitably produces  waves of speculation as the boom overheats and turns to bust. None of the speculators, of course, are aware of the material basis of their actions. But that has been the pattern of capitalist development since the system came into existence. 

What seems to have triggered the recesssion of 2001 was the collapse of the dot.com bubble. Likewise the immediate cause of the recession commencing in 2007 was the sub-prime mortgage crisis, which in turn led to the credit crunch. The sub-prime mortgage crisis was the issue that led to the pricking of the huge house price bubble. In other words the classic process of general industrial and commercial crisis leading to a crisis in banking, the stock exchange and finance seems to have been reversed. In view of the increased importance of finance and the reduction of all decision-making to financial decision-making in modern capitalism, that is not completely surprising. But what is its significance? Modern capitalism is over-balanced by a much greater weight of finance capital and financial calculation upon its back. Is there any wonder that from time to time this weight tips the whole system over?

Classical Marxism has traditionally analysed crisis as emerging naturally and inevitably from the tendency for the rate of profit to fall.This process is studied in detail in ‘The Marxist theory of crisis.’ ( http://www.socialist.net/marxist-theory-crisis.htm) It is a contradictory process, where the basic tendency produces its own counteracting tendencies in a dialectical manner. As Marx points out, "The real crisis can only be deduced from the real movement of capitalist production, competition and credit." (‘Theories of surplus value Volume II’ p. 512 Lawrence & Wishart, 1969) Movements in the rate of profit have their effect on the financial sector. This is particularly the case in the modern era when the very predominance of finance capital and the sheer scale of fictitious capital mean that bubbles are constantly being blown. Bubbles tend to begin as profits revive after a downturn. They wax fat in the good years. As crisis impends, capital panics and takes flight. The bursting of the bubbles seems an accidental affair, but accident is the manifestation of necessity. Financialisation means that the capitalist crisis appears as a financial crisis. In other words financialisation adds another complicating factor in our analysis, but does not fundamentally change the overall path of capitalist development.

Capitalism remains the same in its central features. It is the giant obstacle to workers maintaining and improving their living standards. More than ever it needs to be overthrown and replaced by socialism.