By James H. Nolt
I have criticized many fundamental conceptual errors of mainstream economics throughout this blog, but many of them converge on its failure to conceive the role of time. I am not the only critic of economics to notice this deficit. For example, Steve Keen includes an excellent chapter in his book, Debunking Economics, on the implications of the bizarre attitude toward time in modern textbook economics. However, I go a step further than Keen and other critics by introducing a solution that investigates the strategic dynamics of private power.
A critical error at the core of neoclassical economic thought is treating every economic transaction the same, as an exchange of value for value. Actually there are fundamentally different forms of economic transaction that are best distinguished by the time element. The textbook model of exchange occurs at a moment of time: for example, a barter trade of a horse for two cows or a money transaction of a cow for a few gold coins. This could be called simply an exchange or (emphasizing the time element) a spot trade. It does not entangle the traders beyond the one-time transaction.
Karl Marx expounded the richest analysis of another form of economic transaction: the hiring of labor by a capitalist. Even Adam Smith admits that this transaction involves relations of private power. It also entangles the participants over time. It is fundamentally different than the mere exchange of value for value. Marx highlights this by distinguishing labor power from labor. Labor power is the capacity to labor, which the worker sells to the capitalist as an exchange of value for value. But the struggle over the value of labor power is separate from the subsequent process of labor itself, during which the capitalist endeavors to extract as much surplus value as possible to maximize profits. This distinction between hiring and working is what implicates labor and capital in an ongoing relationship over time.
Investment by capitalists is another crucial economic activity that extends over time. Capitalists purchase productive equipment and hire labor to produce goods that will be sold in the future. Investors buy assets in anticipation of enhanced future value. Both reference an uncertain future. Investment is always a bet, a wager, about future conditions. It should not be treated the same as a spot transaction that references only present values.
Finally, I often emphasize the credit relationship. Credit involves the exchange of value for a promise to return something of value in the future. It necessarily entangles the two parties, the debtor and creditor, in a relationship for the duration of the credit contract. During that time, the two have opposing interests and conflicting policy preferences on a variety of economic issues, especially the value of currency, which also defines the value of debt obligations denominated in that currency. Inflation benefits debtors and hurts creditors. Price deflation has the opposite effect.
Economics treats the spot trade as the archetype for all these others because it represents “the market” as a realm of freedom and equality. Exchange is a voluntary activity. Both sides must agree on the price for an exchange to occur. It seems fair. Of course, even simple exchange may not be fair if one side has greater pricing power or asymmetric information advantage. Even textbook economics admits this, though these are treated as aberrations rather than the ubiquitous conditions they are.
On the other hand, all the transactions that involve time and bets about the future even more directly enter my world of polarized political economy. Since the future is uncertain, bets about the future always polarize investors into rival bear and bull camps. The bear-bull polarization is both absolute and relative. The absolute case is most obvious. Since the price of anything can only go in two directions, up or down, bulls bet on price increases and bears on decreases. Asset sellers generally expect the price has peaked; they are bears, whereas buyers are bulls. They would not buy without expecting further increase. Both cannot be right. The bear-bull polarization necessarily involves winners and losers. Bets can become more sophisticated and complicated using leverage, short sales, and derivatives.
But there is also a relative difference between bears and bulls that emerges through the process of competition. This is broadly relevant for real investment in productive businesses, not just financial assets. Consider an industry where there are two firms, one large and well established, and the other smaller and fast growing, with some competitive advantages in marketing, production technology, lower costs, or better product design. Almost certainly, a fast-growing competitor must rely on greater debt leverage to fuel its growth. As long as credit conditions favor bullish growth, it prospers and gains market share. However, if credit tightens and interest rates rise, the greater relative indebtedness of the faster-growing firm puts it at a disadvantage to its slower-growing, less debt-dependent competitor, who is relatively bearish. Worst case, in a financial crash, the smaller firm, even if more efficient, could go bankrupt while its stodgy adversary survives.
Economists have used all sorts of false assumptions to overcome the limitations of their foundations, based on a static equilibrium theory. One such dodge is the concept of “rational expectations.” The idea is that current prices reflect the collective best estimate of the future, so that even if the collective wisdom is eventually proved wrong, it was the best possible estimate at the time it was made. This is one of the many cases where I criticize economists for wallowing in the “dull gray averages” and ignoring polarization. Yet investor views do not converge; they are diverse, especially when there are asymmetries in power and information between bears and bulls. The largest and most powerful players always have an advantage, too, because they at least know their own positions and intent, which may be sufficient to move markets in their favored direction.
Credit power, as I have discussed, has been highly centralized throughout history in part because only the most powerful players can create a bond market adequate to deal with large mercantile and sovereign creditors. One of the reasons I am a fan of the TV series Game of Thrones is its sophisticated treatment of strategy and the role of credit in war. The author, George R. R. Martin, modeled his “Iron Bank” in part on the role that rival Italian financiers played supporting opposing sides during the Hundred Years’ War, even influencing strategy to favor profitable plunder over expensive and risky battles. Centralized credit power also means centralized control over the single more potent lever affecting the direction of prices: the expansion or contraction of credit. Economists emphasize government control over price levels using monetary and fiscal power, but entirely ignore the much longer and often more potent history of private influence over prices via the credit system.
Adding the element of time adds uncertainty, but uncertainty is not randomly distributed. Those with power to act strategically have more chance to shape the future in accord with their strategic intent, though countervailing forces ensure that this power is never absolute or unchecked.
James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.
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