Political Economy of Money and Finance

The classical theory of money and credit is characterised by the underlying assumption that natural harmony prevails in the operations of the market economy, a harmony that extends to the realm of money and credit. Two distinct traditions can be discerned within classical theory in this respect. On the one hand the quantity theory of money (or the currency school) emphasises the harmonious equilibration of the total quantity of commodity output and the total quantity of commodity money, provided no state or other interference has taken place with the domestic and international operations of the capitalist markets. In this view money is a secondary aspect of capitalist exchange, a Veil’ on real economic activities. Credit money created by banks could upset the presumed harmony, resulting in commodity price disturbances. Thus this tradition supported the introduction of the English Bank Act of 1844 in the hope that the tight quantitative regulation of credit money created by the Bank of England would eradicate capitalist market disturbances.

The labour theory of value is the cornerstone of Marx’s theoretical system in economics. Marx’s formulation of the theory stressed the historically specific character of the capitalist economy, while on the whole the classical school treated the market economy and capitalism as the natural order of economic life.¹ The neglect of the historical specificity of market relations and capitalism resulted in the ultimate failure of the classical school to discover the origin of the forms of value, money and capital. Section 2.1 of this chapter examines Marx’s theory of value and ascertains the logical foundations for the emergence of the form of money. The relation of money to the substance of value, that is, to socially necessary labour time, is also examined. Section 2.2 turns to the several functions performed by money in a capitalist economy. Finally, Section 2.3 considers the problem of the very early historical emergence of money and its implications for the relation between money and commodity exchange.

The concept of commercial credit, that is, the sale of commodities against promises to pay that are subsequently settled by the payment of money, was introduced in Chapter 2. Commercial credit emerges spontaneously and continuously across the surface of capitalist exchange. Equivalently, capitalist sellers and buyers typically become creditors and debtors in the normal course of capitalist accumulation. Commercial credit relations form the necessary background for the emergence of the capitalist credit system, as Chapter 4 explains in detail. In analytical and practical terms, moreover, commercial credit serves as the foundation for banking (or monetary) credit, the other major and distinct form of credit. Banking credit refers to the lending of money itself on condition of repayment plus interest, and is considerably more complex than commercial credit (though the two also overlap). Banking credit relations give a clear content to the capitalist categories of interest and interest-bearing capital, the latter being a special type of capital remunerated through the payment of interest.

The emergence of elementary forms of credit long preceded industrial capitalism. Forms of money lending and interest payment generally appeared in various precapitalist societies in the practice of usury. Centuries before capitalism became the dominant mode of production, rudimentary bills of exchange functioned as convenient means of economising on the costs (and reducing the risks) of sending money to distant places. After the sixteenth century, as mercantile capitalism reached maturity, bills of exchange (or commercial bills), which were the chief form of payment in the operations of foreign trade, were increasingly employed as an important means of facilitating commodity transactions among merchants in the domestic economy. Modern banks appeared in Western Europe as institutions of finance that gave credit by employing their own liabilities, such as customers’ deposits, in the discount of commercial bills. Unlike the money-lenders of old, the banks’ ability to extend credit was not limited by their own capital. The capitalist market economy penetrated the core of Western European society in the course of the protracted primitive accumulation of capital that took place during the mercantilist era, and it firmly established itself as the main arena of social reproduction during the English industrial revolution. Against this background the forms of credit further developed their organic connections with each other and with real accumulation, emerging finally as a credit system, an integral mechanism of the domestic economy. The representative paradigm of a capitalist credit system appeared in the age of liberal nineteenth-century capitalism in England.

The credit system mobilises idle money capital and enables circulating capital to expand and acquire elasticity. Social organisations constructed on joint-stock capital, on the other hand, mobilise idle money capital and facilitate the creation of large enterprises and the construction of enormous industrial fixed capital far exceeding the limited powers of individual capitals. For Marx (1894, p. 567), formation of joint-stock companies involves a ‘tremendous expansion of production, and enterprises which would be impossible for individual capitals’. Shares of joint-stock capitals are traded in the capital market.

In the work of the classical school the capitalist economy represents a natural and harmonious social order. For Marx, on the other hand, the capitalist economy is inherently unstable. Economic instability has several monetary and financial aspects. The following three levels can be identified in Marx’s analysis of monetary and financial stability.

Central banks possess and utilise an element of economic rationality in the anarchical world of capitalist finance and accumulation. Consequently they have long been the object of the reformist zeal of credit practitioners and political radicals. They have also been subjected to withering criticism by those who think that the inherent instability of capitalist accumulation originates in money and finance. This chapter argues that there are narrow limits to the effectiveness of central bank operations determined by capitalist accumulation. That is not to negate the element of conscious policy-making and the possibility of partial success of central bank operations. However the crisis-ridden character of the capitalist economy cannot be abolished by central banking, regardless of the experience of the central bankers and the erudition of their economic advisers.

From the end of the Second World War to the end of the 1960s the capitalist world economy enjoyed relatively stable growth. The profound instability of the interwar years, including the Great Depression of the 1930s, were not repeated, despite fears to the contrary immediately after the war. Although recessions occurred, for instance, in the US economy in 1953–4, 1957–8, 1960–1, 1966–7 and 1969–71, they were neither particularly severe nor persistent. Such recessions were often called ‘growth recessions’ since only the rate of growth and not the absolute level of real GDP declined. Economic growth was not merely stable but also rapid in historical terms. Annual output growth of the seven most advanced capitalist countries (the United States, France, Britain, West Germany, Italy, Japan and Canada) averaged an estimated 4.9 per cent in 1950–73, compared with 2.2 per cent in 1820–70, 2.5 per cent in 1870–1913 and 1.9 per cent in 1913–50 (Armstrong et al., 1984, p. 167). As a result the total output of these countries was almost three times as large in 1973 as it had been in 1950. Remarkably, throughout the high economic growth of this period prices remained relatively stable. There were isolated episodes of rapid inflation immediately after the war, but on the whole inflation remained subdued. Low inflation prevailed despite the predominant ideological belief that expansionary state economic policies could sustain effective demand. Annual consumer price inflation for the same seven countries was only 2.7 per cent in 1960–8, but it climbed to 5.5 per cent in 1968–73 and 9.8 per cent in 1973–79 (OECD, Historical Statistics, various issues).

John Maynard Keynes has been by far the most eminent economist of the twentieth century. When he was very young he was admitted into the most influential circles of economic theorising in Britain and the world, and soon began to shine in economic policy-making in the global arena. Keynes was first and foremost a monetary theorist who was not afraid to be polemical in defending the practical implications of his work. In the 1930s this fully paid-up member of the British intellectual and political elite launched a frontal assault (or so he thought) on economic orthodoxy. Elements of the tradition of Steuart, the banking school and Marx resurfaced in Keynes’ attack on the orthodoxy: the complexity of the functions of money in a capitalist economy, particularly the importance of money hoarding; the inherent tendency of capitalist accumulation to move towards disequilibrium and crisis; and the role of uncertainty and expectations about the future in shaping the path of capitalist accumulation. These elements taken together provided the rationale for Keynes’ support of government economic intervention, both fiscal and monetary.

Official postwar Keynesianism largely ignored Keynes’ original emphasis on uncertainty, the capitalist entrepreneur’s ‘animal spirits’ and the psychological elements of money holding. In Britain, where the radical milieu in which Keynes had moved remained much in evidence, it became common practice to differentiate between the economics of Keynes and official Keynesianism. Moreover the tradition of the banking school had also retained a strong influence in British policy-making and academic life. These strands of economic thought were instrumental to the emergence of post-Keynesianism.