Saturday, January 31, 2009

Marx before Minsky

Previously, I made the case that the financial meltdown was basically a delayed response to the severe neglect of investment in plant, equipment, and infrastructure. I also explained the cause of this neglect.

Here, I'm going to discuss the financial side of the crisis, which, while secondary, is still important.

This crisis has been nicely described as a Minsky moment, but it may just as well be described as a Marx moment. Marx's term fictitious capital and the more conventional discounted present value are not entirely different, but Marx's expression emphasizes the fact that the future is both unknown and unknowable.

As Keynes explained very well, the future takes on an appearance of being known, but this knowledge is not knowledge at all. It is merely an extrapolation of the past.

There was a time when the returns from holding General Motors stock would have seemed very predictable, almost as much as an investment with Bernie Madoff.

Anticipating Hyman Minsky, Marx realized that over time people would become less risk averse and the risk-corrected discounted present values would start to rise. Extrapolating, this trend would be expected to continue.

What I did, many years ago, in Karl Marx's Crises Theory: Labor, Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain that this psychological phenomenon would tend to delink prices from underlying values. Expensive corporate headquarters would be built into the overhead costs of business. At the same time, as such capital values accumulate, measures of invested capital will increase, pulling down the rate of profit. Hunting for yields to maintain profit rates will set off bubbles, further promoting an even more speculative environment. Over time, this speculative psychology will eliminate the limited coordinating powers of the market and set the stage for a future crisis.

When the crisis comes, much of the fictitious capital will disappear, bringing prices more in line with underlying values.

In a sense, this part of Marx's crisis theory is not that far from Hayek's, but I think that Hayek may have taken this from Marx without attribution.

All this sounds very Minskyian. Of course, Minsky knew his Marx, just as he knew his Keynes. And Keynes, though never really studied Marx by his own confession, was surrounded by people who did.


RCJ said...

I think that a certain fragility can be attributed to what you're focusing on but I tend to view the serious increases in debt (all sectors) as a percentage of GDP as more important. I think the increasing leverage coupled with Shiller's bubble psychology allowed us to construct a very fragile economic engine that eventually had to collapse... what happens next..

Michael Perelman said...

The leveraging that you describe is part of Marx's concept of fictitious capital, which relates to an investment based on future profits.

Sandwichman said...

Dilke gave what I think was an exemplary discussion of fictitious capital in "The Source and Remedy". What is remarkable and commendable in his account is the founding role of the state and of its financing of war in establishing the institutions that would subsequently blow commodity and capital bubbles.

War is the mother of all bubbles.

Michael Perelman said...

Tom, you would do the world a favor posting Dilke's work.