THE FRACTURE IN AMERICAN POLITICS

On a walk through Princeton's verdant grounds and lawns, amidst pleasant replicas of European architectural styles, from English Gothic to Italian Renaissance to Greek neo-classic, the great Italian monetary economist and historian arcello !e "ecco once e#plained to me how the cultural milieu at this academic esta$lishment in %ew England had $een shaped $y the German &ewish 'refugees' who had fled the horrors of %a(ism - until we passed, on our way to lunch at Graduate "ollege, the house where )l$ert Einstein resided 'in this friendly country and this li$eral atmosphere'* )s a graduate student from "am$ridge, England, I was welcomed with astounding hospitality $y mem$ers of the Economics !epartment +Peter ,enen even found time to read and comment on my Ph*!* thesis early draft-. in what seemed an )rcadian citadel of enlightenment* )ufklarung* It seems no coincidence to me that, apart from ,enen, illustrious economists like Paul ,rugman, ichael /oodford and now Professor 0hin +formerly at the %1 2ed. have 3oined the departmental staff* One such mem$er, until promoted to the "hair of the 2ederal Reserve, was Professor 4en 4ernanke, of course* )nd it is in this Princetonian conte#t that we need 'to situate' him* It is a conte#t that we may descri$e as 'Princeton Enlightenment' - right there in the heart of %ew England, a short distance from anhattan and /all 0treet, at the nerve centre of the capitalist world* I make this introduction $ecause it is vital to understanding what I call 'the fracture' in the )merican ruling elite $etween 'Progressives' who have a new vision of how a modern society should function and evolve from its capitalist origins, and those '"onservatives' who +in the words of 2! Roosevelt. would have us return 'to the days of horse and $uggy'* One of the chief 'ailments' +2reud would call them 'neuroses'. of capitalism is 'fear' - not least 'fear of stagnation', of that 'li5uidity trap' that ,eynes theorised and ,rugman reviewed +here http677www*$rookings*edu787media72iles7Programs7E074PE)79::;<=<$pea<papers79::;$<$pea<krug man<domin5ue(<rogoff*pdf . in relation to &apanese deflation and which is $rought a$out $y the e#istence of 'money', which ,eynes descri$ed as 'the $ridge $etween the present and the future'* It is this 'fear' that paralyses capitalist society - the fear of the future, the fear that the present +the capitalist esta$lished order. is in conflict with the future +the need of capital to allocate social resources only if they yield a 'profit' when this outcome is o$structed $y the antagonism of us 'workers', that is, $y all those who produce social wealth $ut have ne#t to no say in 'how', 'what' and 'how much' is produced.* Once again, it is in the conte#t of this capitalist 'fear' and the 'Rooseveltian Resolve' +4ernanke's phrase coined here http677www*piie*com7pu$lications7chapters<preview7>9:7?iie=;:@*pdf . that is needed to overcome it that we must $egin to analyse the conduct of monetary policy under the current leadership at the 2ed* ,eynes introduced 'uncertainty' to economics, 3ust as 2reud introduced 'neurosis' to psychology and civilisation* Ancertainty is what separates the capitalist present from its future6 and 'money' is the means of '$ridging' these two* &ust as 0chumpeter was initially wrong to $elieve that 'entrepreneur' and 'capitalist' were two 'separate' persons, so were ,eynes and ,alecki wrong to $elieve that $orrower's risk and lender's risk are two 'separate' entities6 - they are merely 'functions' of capital* It is false and meaningless to say that 'risk is the engine of capitalist growth'* "apital does not seek 'risk' - if that were so the entire earth would have $een laid waste $y now- "apital seeks 'safety' 'safe profits', to $e e#act* Bhe 'lending function' is that 'aspect' +4ild. of capital that seeks at least the return 'of' capitalC the '$orrowing function' is the one that knows that for capital even 'to preserve itself' it must go through the mortal danger of 'investment'* %o 'profit' without 'investment'* Bhe 'lender' is the present, and the $orrower represents the future* 4y the process of

lending 'money-as-capital' to the $orrower, the lender 'invests' in the future - $ecause without 'investment', without $eing perennially 'in circulation', capital cannot even 'preserve' itself, let alone 'grow' and '$e profita$le' +')ccumulate- )ccumulate- Bhat is oses and the prophets-'.* 0o there can $e no 'information asymmetries' $etween $orrowers and lenders - $ecause $oth are 'internal functions' of capital* Bherefore, 'risk' +$oth $orrowers' risk and lenders' risk. can determine only +through higher interest rates. the internal 'distri$ution of profit' $etween capitalists - $ut it cannot determine 'profit' itself- 'Risk' is the capitalist 'pro3ection' into the future - the 'e#pectation' of the likelihood of 'profit'* /hen this 'e#pectation' is $eset with and devoured $y 'uncertainty', we have a 'li5uidity trap', we have*** 'the (ero $ound' +see /oodford and Eggertsson, ' onetary Policy at the Dero 4ound' here http677www*scri$d****licy-at-Dero-4ound .* /hen the 'e#pected' profit is minimal, capital prefers to $ide its time and remain 'li5uid', 'ready-at-hand'* 4ut what is the 'ultimate source' of this 'uncertainty'E +2ahr et alii, 'Fessons for monetary policy strategy' at page G, here www*ec$*int7events7conferences7html7c$cG70ession<9<paper<2ahr< otto<Rostagno<0mets<Bristani* pdf. 2ew, if any, monetary economists will answer the 5uestion properly6 they will point to 'higher interest rates', 'higher uncertainty', or 'information asymmetries' +see 2 ishkin, '0pread of 2inancial Insta$ility' here www*kansascityfed*org7pu$licat7sympos79::?7pdf7s:?mishk*pdf .*

4ut in reality, the antagonistic reality of capitalist society, is that in order 'to valorise' itself and emerge from the cruci$le of the production process in the shape of 'products' that can $e sold to yield a 'profit', capital must first contend with 'us' - the workers, in the workplace and, increasingly, in 'the society of capital' at large* 0o we know that capital seeks Hto valouriseI itself as HsafelyI as possi$le J indeed, if this circle could $e s5uared, capital would HwishI to $e Hprofita$leI as HnaturallyI as trees $ear fruit- +- /hence comes the notion of Hfructiferous capitalI and of that more ignominious one, the /icksellian Hnatural rate of interestI- J or finally that most infamous of $ourgeois phantoms, Hthe natural rate of unemploymentI-. )nd when, in one fell swoop, two decades ago, one of the most $estial dictatorships this world has ever seen, the "hinese Polit$uro, decided to make Hthe great leap forwardI, all the prayers of capital seemed to $e answered J it was "hristmas all year round- Kere were a $illion potential HworkersI that could produce consumption goods to keep workers in advanced capitalist countries HpacifiedI and maintain nominal wages sta$le whilst the cost of wage goods for capitalists declined dramaticallyBhis was the $asis of the Great oderation* )gain, 2ahr at alii fail to mention this, and list the HeffectsI rather than Hthe ultimate sourceI6 HBhe period $efore the financial crisis, known as the great moderation, was the result of a num$er of factors that can $e grouped into6 a. structural change, e*g* $etter inventory management + c"onnel and Pere(-Luiros, =MMM. or financial innovation and $etter risk sharing +4lanchard and 0imon, =MM9., $. improved macro-economic policies, such as the esta$lishment of sta$ility-oriented monetary policies, and c. good luck, i*e* the a$sence of large shocks such as the oil price crises of 9:?N and 9:?:*99 Bhe relative importance of those factors has $een hotly de$ated, $ut all three factors are likely to have contri$uted to a reduction of volatility*9=I It is this paper $y 4lanchard and 0imon + http677www*$rookings*edu787media72iles7Programs7E074PE)7=MM9<9<$pea<papers7=MM9a<$pea<$lan chard*pdf . that 4ernanke mentions in the very first paragraph of his address launching the phrase Hthe Great oderationI +here http677www*federalreserve*gov7$oarddocs7speeches7=MMN7=MMNM==M7default*htm .6

HOne of the most striking features of the economic landscape over the past twenty years or so has $een a su$stantial decline in macroeconomic volatility* In a recent article, Olivier 4lanchard and &ohn 0imon +=MM9. documented that the varia$ility of 5uarterly growth in real output +as measured $y its standard deviation. has declined $y half since the mid-9:;Ms, while the varia$ility of 5uarterly inflation has declined $y a$out two thirds*9 0everal writers on the topic have du$$ed this remarka$le decline in the varia$ility of $oth output and inflation Othe Great oderationPI*

) remarka$le decline, indeed- 0o remarka$le that finally it seemed as if central $anks could $e given a Htechnical mandateI to target inflation simply $y means of small HcorrectionsI to the interest rates they set J and this could $e Hset in stoneI even in $ourgeois constitutions as part of Heconomic managementI without the need to $other a$out anything else* HBhe &ackson Kole "onsensusI +the last mantra spun out of Hthe Greenspan putI. was that Hasset pricesI are not and cannot $e the concern of central $anks J Hprice sta$ilityI alone will suffice, and Hthe marketI will take care of the allocation of capital to various investments* Bhe entire wave of Hfinancial deregulation and li$eralisationI that culminated with the repeal of the Glass-0teagall )ct $y the A0 "ongress in 9::: gathered its tsunamilike strength from this HGreat oderationI* +Bhe tide of capitalist opinion toward Hprivati(ationI from the O;Ms is wonderfully summari(ed $y the doyen of Italian central $ankers, B Padoa-0chioppa in this, HBhe Genesis of E AI, here http677www*eui*eu7R0")07/P-Be#ts7& :G<NM*html . 4ecause, 3ust as in the 9:=Ms under 2ordism, the sudden reduction in the cost of wage goods for capital made possi$le $y the opening of Hthe "hinese frontierI could allow capital Hto undoI, to demolish and reverse what had $een the unstoppa$le and ominous e#pansion of the role of the 0tate in the A0 economy and worldwide* Bhe industrial analogue of Hfinancial li$erali(ationI was the HreprivatisationI of entire areas of social productive activity that had fallen under the direct management of the 0tate since the %ew !eal* Bhe unprecedented profits and Hglo$al savings glutI +again the title of a 4ernanke speech, here http677www*federalreserve*gov7$oarddocs7speeches7=MMQ7=MMQMN9N7default*htm . coming from "hina and other Hemerging economiesI that were concomitant with the Hglo$ali(ationI of the capitalist economy +see P Famy here http677www*ft*com7cms7s7M7Nd>?>?Nc-=?fd-99eM-;a$cMM9NNfea$N:a*htmlRa#((9"=I5I$G> . J all this had HsilencedI the real HmotorI, the true HengineI of capitalist accumulation, 3ust as 2ordism did in the 9:=Ms J the working class, the antagonism of workers in the workplace and in society, the one and only true HtestI of the real HvalueI and Hprofita$ilityI of capitalist HinvestmentI/ithout its continuous Hconflict and confrontationI with living la$our +with workers. in the workplace and in society, capital is deaf and $lind, it has Hno sensesI $ecause it cannot HgaugeI the actual political command it can e#ercise over workers and over society at large without encountering their HresistanceI in its stage of HvalourisationI +the productive process. and Hreali(ationI +the sale of products.* Bhe real life of capital is precisely this6 - command over living la$our in the process of production J a HprocessI that through workersP antagonism then $ecomes He#tendedI to the whole of HsocietyI and that causes Hthe 0tateI to intervene +and HinterfereI-. in the notionally HprivateI capitalist HmarketI economy* Bo the e#tent that capital fails to engineer HgrowthI, the 0tate needs Hto control growthI, and this leads inevita$ly to the Hgrowth of its controlI over the economy and the society of capital as a whole* Bhe HretreatI from the %ew !eal He#pansionI of 0tate activities is what Hthe Great oderationI allowed* "apital sei(ed the opportunity with $oth hands* Previously, as Kyman insky had perspicaciously shown, the 0tate had $een called upon to play an ever-growing role as Hthe collective capitalistI to rescue the capitalist economy from its fre5uent crises, its $ooms and $usts, $ut each time at a higher level of social antagonism, culminating in the social struggles and high inflation of the 9:GMs and 9:?Ms* %ow, commencing with )rthur 4urns and Paul Solcker at the 2ed in the late O?Ms and through the O;Ms J now was the opportunity Hto re-launchI the capitalist dream of a Hselfregulating market economyI* )nd this is what happened through the Reagan years up until =MM?*

/e were saying J Hthe glo$al savings glutI* Bhe $reathtaking growth of the "hinese economy as the Hassem$lage hallI of consumer goods for e#port to developed economies generated massive amounts of capital +savings. that the "hinese dictatorship could not Hre-investI in domestic consumption for the simple reason that this would hasten the rate of politico-economic HemancipationI of its own workers* )ll dictatorships integrated in the capitalist world HmarketI have this good reason to privilege He#portsI $y +a. suppressing domestic wages and +$. siphoning off capital from domestic consumption, providing in effect He#port su$sidiesI to their leading firms which are owned e#clusively $y mem$ers of the elite +from "hina to India to Hyou name itI, and this includes the German elite which, with its &unker and %a(i past has a $rutal track record of mercantilism Tcf* 0chumpeterPs classic study on OImperialism and 0ocial "lassesPU.* +On "hina, its mercantilist policies and the 2edPs reaction, there is no greater authority than ichael Pettis at www*mpettis*com7=M9M79975e=-and-the-titanic7 . Boo many ar#ist and left-wing critics of the capitalist economy preach the mantra that what causes capitalist crises is the HunderconsumptionI of goods produced due to e#cessive Holigopolistic accumulationI* +,eynes and ,alecki started this neo-Ricardian fa$le, aping Rudolf KilferdingPs OImperialismP thesis, and were then em$raced $y Piero 0raffa and Paul 0wee(y and several strands of Hpost-,eynesiansI* "f this review $y &4 2oster on HBhe 2inancialisation of "apitalismI http677monthlyreview*org7=M9M79M7M97the-financiali(ation-of-accumulation .* It is 5uite ludicrous to argue that workers are una$le to consume what they produce or simply that capital cannot $e invested Hprofita$lyI $ecause there are no HopportunitiesI for investment* Bhis leads to a certain HdefeatismI and, more important, fails to e#plain why indeed, given the more HskewedI distri$ution of income and capital ownership, actual social HtensionsI rise $oth within nation-states and $etween them* In reality, the pro$lem arises for capital when the HsavingsI generated $y HprofitsI cannot $e invested any longer Hprofita$lyI $ecause the growth in employment and consumption or wages ends up HemancipatingI workers* Bhis leads to Hwage-pushI and Hdemand-pullI inflation, with all the attendant pro$lems that that causes in terms of Hprice sta$ilityI and the normal functioning of de$t contracts +which $ecome short-term and impossi$le to fi# predicta$ly.* +Bhe link $etween H"apitalism, "onflict and InflationI is traced admira$ly $y my "am$ridge supervisor 4o$ Rowthorn in his homonymous $ook.* Bhe HcrisisI then $ecomes HrealI and is not 3ust a creature of He#cessI or of Hcasino capitalismI* Bhe HconflictI is real, not engineered artificially +$y 2inan(kapital. or wholly HinternalI to the dynamics of capitalist accumulation* /e will focus on these matters very shortly* 4ut the essential characteristic of Hthe Great oderationI was the a$sence of inflation in developed economies, and the Hglo$al savings glutI represented $y the regurgitation or re-cycling of "hinese dictatorship profits into Hparked savingsI in A0 treasuries and other Hfinancial investmentsI* "om$ined with the Ha$senceI of the working class from wage and industrial disputes, this greater availa$ility of social resources in the form of HcapitalI could only $e HinvestedI $y e#asperating the HfinancialI side of capital J through Hcredit creationI and HleveragingI that resulted in Hasset-price speculationI* )s insky and then ishkin e#plained, low inflation encourages the HlendingI of capital at low rates of interest and the H$orrowingI for longer contract terms in the He#pectationI of higher future income streams from investment in financial assets* )s the market price of assets on $alance sheets of firms rises, the HSalue at RiskI of de$t-financed investment falls inducing capital into what )drian and 0hin have called Hthe risk-taking channelI +http677www*newyorkfed*org7research7staff<reports7srN>:*html - see also & %ocera on HRisk anagementI here http677www*nytimes*com7=MM:7M97MN7maga(ine7MNrisk-t*htmlE pagewantedV9W<rV9 .* 2rom there to the collapse of what $ecomes eventually HPon(i financeI + insky. once the He#pectedI income stream from over-valued assets fails to $e Hreali(edI J in other words, once capital can no longer $e HvalourisedI in the production process -, the road is very short indeed*

Once again, it is the Ha$senceI of the working class, the Ha$senceI of the real Hmotor or engine of capitalist growthI, the real Hacid testI of antagonism and conflict in the production process that allows Hthe rising tide that lifts all $oatsI +asset $u$$les. which, once it recedes, e#poses Hthose who have $een swimming nakedI +/arren 4uffett.* 4ut the pro$lem is precisely this- Bhat $y that stage it $ecomes impossi$le to tell which HinvestmentsI are HrealI and which are HfictitiousI +the infamous Hmark to marketI./orse still, in the financial sphere, the implosion of asset prices and contracts and the conse5uent Hde$t-deflationI +correctly theori(ed $y Irving 2isher here http677fraser*stlouisfed*org7docs7melt(er7fisde$>>*pdf . threaten to destroy not 3ust HvalueI $ut indeed HmarketsI themselves J chief among them the Hinter-$ank loan marketI which allows the vital Hmeta$olismI of capitalist He5uiparationI of loans across disparate $ranches of capitalist investment and social production J necessitating the use of e#ceptional HunconventionalI measures $y monetary authorities that in some cases may lie well $eyond their legal mandate +see 2B article here http677www*ft*com7cms7s7M7Ga:;?NdG-?M=>-99eM-$ea?-MM9NNfea$dcM*htmlRa#((9,P9d!u5s .)s Fahr et alii linked a$ove put it6 H alfunctioning inter$ank and other financial markets called upon central $anks to take on a more active financial Tp*=U intermediation role* Bhey also highlighted the fact that there was no longer a single market rate due to the collapse of normal ar$itrage activities* 0econd, $ecause monetary policy had to $e eased $eyond what is possi$le $y reducing short-term interest rates close to their lower $ound at (ero, a num$er of central $anks had to pursue alternative policies of 5uantitative and credit easing* Bhe notion that the policy-controlled short-term interest rate is the sole tool of monetary policy has therefore $een 5uestioned*I 0o now we come closer to the heart of the rationale of capitalism6 - the efficient allocation of social resources +what they call HcapitalI. under the control of capitalists +now T-U it $ecomes HcapitalI-.* +Bhis point is intended to enlighten all those who wish to have capitalX without Hthe capitalistI4ecause capital is not a HthingI J it is a social relation of su$ordination and e#ploitation of workers $y capitalists*. Bhe 5uestion here is that, given that it is real social antagonism and conflict over the wage relation that occasions the Hasymmetric information pro$lemsI +moral ha(ard, free-rider and principalagent. and not rather these HasymmetriesI themselves +as ishkin on $ehalf of all $ourgeois economists suggests. J given this reality, what has $een and is Hthe present strategyI of capital +$oth HprivateI and Hsocial capitalI acting through the 0tate, or Hthe collective capitalistI.E )s mentioned a$ove, underconsumptionist theses tend to overlook entirely the HconflictI of which financial crises are clear evidence J precisely $ecause they are seen HonlyI as HfinancialI and therefore HfictitiousI in nature given that they seem to arise HoutsideI the sphere of production* &4 2oster, for instance +see link a$ove., dismisses !e 4runoffPs statement in O ar# on oneyP that financial crises are tied to Hreal relations of productionI, wrongly suggesting that she fails to understand the HrealityI of credit crises* %ow, to the degree that financial crises are HrealI and not as HfictitiousI as the capital created, it is only $ecause they arise directly from the HconflictI that capital e#periences in the process of HvalourisationI* Bhe pro$lem with this misapprehension starts perhaps with the very notion of Hsurplus valueI which, whilst it denotes a higher Hrate of e#ploitationI, also seems to suggest that capitalists accumulate a HsurplusI that gives them a Hmargin of manoeuvreI in dealing with living la$our* 4ut this is clearly wrong $ecause, regardless of how large this alleged HsurplusI is supposed to $e, its HvalueI 5uickly HcollapsesI as soon as a HcrisisI occurs J often in 3ust a matter of hours- +Bhe point is made powerfully $y ,aminsky et al* on H2in* "ontagionI here http677docs*google*com7viewerEaVvW5Vcache6w-BR-3guB$k&6wwwpersonal*umich*edu78kathrynd7&EP*"ontagion*pdfYBheYAnholyYBrinityYofY2inancialY"ontagionWhl VenWglVauWpidV$lWsrcidV)!GEE0hF>"3tkR$G(I&FkO=gGSpPw(,AEiQKf2$ho23FFN5Mhg4@Br Pm;A/cD2!13<oh)IsNyaAA;if @pNRPM=FtOgPM#BK0K>yEBdPGBhKs1v3!ol,"IawDl,>m9G ucGcGKiN"/s%cWsigV)KIEt$0F AB%9ia@1:elevAcaIsoll?:sL .* In this regard, whilst it is true that ar# considered capitalPs HvelleityI for a miraculous leap to profit + to P., it must $e stressed

that he regarded this purely as HideologyI, whereas he considered financial crises to $e not only HrealI, $ut indeed HcriticalI to the analysis of capitalism itself- It is the growing opposition or HconflictI $etween the need Hto sociali(e social resourcesI and the need to sociali(e Hthe lossesI that capitalPs attempt Hto eludeI this conflict engenders J it is this HconflictI that is HrealI- 0mall wonder 2oster, and post-,eynesians from ,alecki and 0teindl to 0wee(y and insky, dreamily find many similarities $etween ar# and ,eynes where very few indeed e#istIt is possi$le to gain a strong insight into the nature of the HailmentI +almost a 2reudian HAn$ehangI. of late capitalism $y returning to the conclusions reached from our review of ishkin* /e saw there the contrast that has developed, to the point where it induces chronic HcrisesI, $etween the need of capital to retain its independence from social control J $ecause in that case it would lose its essential characteristic as Hcommand over living la$ourI -, which occurs through deregulation and li$erali(ation of HmarketsIC and then, on the opposing side, the fact that each time such HderegulationI ends up in catastrophic HcrisesI that re5uire the massive Hsystemic interventionI of the 0tate to rescue the capitalist economy, with conse5uent He#pansionI of the role of the 0tate which HderegulationI was supposed to curtail- Bhus, each time that an attempt is made $y the collective capitalist +the 0tate. to allow Hprivate capitalistsI to run the economy, the end-result is the re-assertion and aggravation of the Hcontrol of growthI $y the 0tate* Bhe pro$lem is that Hprivate capitalI is incapa$le of achieving anything like $alanced growth of the economy and that each time the 0tate is forced to intervene the level of intervention re5uired is aggravated and its HeffectivenessI constrained $y the amount of Hpu$lic de$tI accumulated in the preceding Hrescue operationI* Bhe result is a Hfiscal crisis of the 0tateI where$y Hta#payersI end up paying for what, in the period of HderegulationI, were Hprivate profitsI* +!e "ecco descri$es this process Hencomia$lyI well here http677docs*google*com7viewerE aVvW5Vcache6ALdy"1ok1ho&6w>*uniroma9*it7cidei7wpcontent7uploads7working<papers7cideiN:*pdfYmarcelloYdeYceccoWhlVenWglVauWpidV$lWsrcidV)! GEE03N$:M?Bf"wAfSk#=r/hl#K0M;k%t<u,GSo!EKckIK"R(vdvcG;B>I2f3p;wBt=Sp@(Pd&c!p B5PAg3 ea"d,pDIOA0=S?3=,:a25:/)ocE tauIgMO$Po4)n&;>cGBB$>GRv5EWsigV)KIEt$0 /S>Lr:egFyOMGDcSLQQ32sG@/Rg . )t this stage, however, a new Hfault-lineI appears in the system, $ecause now the a$ility of the 0tate to operate a return to HgrowthI within the parameters of a HcapitalistI economy J that is, if it is to respect its legal, proprietary and contractual rules, with a modicum of HprivacyI, or indeed simply to maintain the Hmarket price mechanismI +we already see suggestions, like RE) 2armerPs, of direct intervention in asset markets. J in order for the 0tate to do so, its Hroom for manoeuvreI $ecomes e#ceedingly small and restricted, so that essentially we reach an impasse, an Hinsupera$leI limit where the only way forward isX to a$olish the H$arriersI to social activity J which are ever more Hvisi$lyI the legal categories of capitalist ownership and control over production and society* Bhe first dilemma lies $etween Hregulation7supervisionI and Hderegulation7li$erali(ationI to allow Hmarket allocationI of social resources* Bhis results in Hmoral ha(ardI $ecause the Hpu$lic70tate insuranceI of the Hprivate economyI leads the latter +the capitalists. Hto gameI the rest of society in the knowledge that the Hsocial insuranceI of private investment will secure their Hownership and controlI of social resources* Economic authorities therefore have to engage in a game of Hcat and mouseI with private capitalists in order to induce them to invest Has private ownersI $y utili(ing ever more Hpu$licI means, methods and resources in order to preserve the reproduction of society itselfPrice sta$ility is one target, $ut Hleaning against the windI and all manner of HunconventionalI or Hnon-standardI measures are re5uired +from LE to Hannouncement effectsI to guide He#pectationsI J or ultimately direct investment $y the 0tate to maintain aggregate demand-.* Bhe second dilemma then takes hold, of H0tate supervisionI $eing insufficient or HcollusiveI with Hprivate capitalI and therefore not representing HdemocraticallyI the interests of HsocietyI which are antagonistic to those of HcapitalI* !e "ecco speaks here of Hcredit channelsI that increasingly seem to $e HinformalI and channeled into Htoo $ig to failI institutions* )nd, most important of all, of the fact

that the 0tate itself must fail +$ecause of the fiscal and legal constraints. in its task Hto reviveI the capitalist economy J which is what leads to the paralysis and HfractureI of the H"risis-0tateI +and, perhaps, even of the $ourgeoisie itself-.* In a nutshell, it seems, this is the manifestation of the ar#ian notion of Hcapital $ecomes a $arrier, a limit, to itselfI +Grundrisse.* !e "ecco makes another point, with characteristic acumen, on which we will need to reflect very hard* 2irst, he traces the change of economic paradigm, from the odigliani- iller model of perfect knowledge and rational e#pectations +reconduci$le to KayekPs Oeconomics as co-ordinationP. to the e#istence of Hinformation asymmetriesI which now He#plainI the e#istence of central $anking itself +-. formerly He#oneratedI $y neoclassical theory* Kere is !e "ecco6 http677docs*google*com7viewerE aVvW5Vcache6ALdy"1ok1ho&6w>*uniroma9*it7cidei7wpcontent7uploads7working<papers7cideiN:*pdfYmarcelloYdeYceccoWhlVenWglVauWpidV$lWsrcidV)!GEE0 3N$:M?Bf"wAfSk#=r/hl#K0M;k%t<u,GSo!EKckIK"R(vdvcG;B>I2f3p;wBt=Sp@(Pd&c!pB5PAg3 ea "d,pDIOA0=S?3=,:a25:/)ocE tauIgMO$Po4)n&;>cGBB$>GRv5EWsigV)KIEt$0/S>Lr:egFyOMG DcSLQQ32sG@/Rg
H%eo-classical theory has its natural complement in the odigliani- iller theorem which demonstrates the irrelevance of the financial structure and in so doing e#tends the concept of monetary veil to the whole financial structure* Bhus the systemPs determination depends on e#ogenous varia$les such as consumer choice, factor availa$ility and technology levels and no value can $e assigned to an institution, like the lender of last resort, which can ac5uire legitimacy only if we $elieve that the financial structure is relevant* In particular, we must $elieve that the $anking system, as provider of a pu$lic good as an efficient payments system can $e seen to $e, is relevant to the efficient functioning of the whole economic system* Bhis is why the most consistent among neo-classical economists, 2*Kayek and G*0tigler $eing the $est known among them, have flatly denied any institutional relevance to central $anks especially as lenders of last resort* Bheir faithful disciples have, moreover, striven to demonstrate the free $anking and currency competition are indispensa$le to the well functioning of the economic system* Bhey have reproduced, without of course having any notion of it, the heated de$ated on free $anking and currency competition which raged in Italy in the second half of the @I@th century* > Fess radical neo-classical economists, however, have tried to rationalise the e#istence of institutions like central $anks, which are, $y their very nature, the negation of laisse( faire, within the theoretical conte#t of decentralised decision-making, $y using ad-hoc arguments such as the need to protect the payments system which is a pu$lic good* Bhey did not realise, or realised with some em$arrassment, that, once a limitation is introduced to decentralised decision-making, we get into a dark night of su$-optimal choices where all cows are $lack and uni5ue solutions evaporate or at least $ecome e#tremely unlikely* )s is well known, economists are ill at ease when they think without a precise theoretical framework* Bhis is why they have welcomed the arrival of a new theoretical paradigm, which has $een constructed in the last two decades, the theory of asymmetric information and of decisionmaking under uncertainty* /ithin the new paradigm, the central $ank and the lender of last resort function in particular, can $e found a comforta$le and legitimate u$i consistam* /ith the speed of diffusion which characterises mass societies the new information theories have replaced theories of the real cycle and rational e#pectations as the winning paradigm, as scholars previously wed to it rapidly repudiated their old $eliefs* On the $asis of asymmetric information theory, with its important complements, adverse selection and moral ha(ard, the non-relevance of the odigliani- iller theorem can $e easily esta$lished outside a world of perfect information* Bhe relevance of the financial structure for the dynamics of an economic system can $e then inferred* 2rom that it is only a short step to proving that $anks are uni5ue or at least peculiar credit intermediaries and organisers of the payments system which makes a decentralised decision-making system a working proposition* )t this point, it is not difficult to introduce central $anks, as institutions necessary to safeguard the payments network* If attention is paid to an important feature of a fractional reserve $anking system, namely its capacity to multiply and demultiply credit, it is easy to notice that such a system will $e inherently unsta$le, and that an

economic system $ased on fractional reserve $anks, and therefore unsta$le, will re5uire an institution which will play the role of lender of last resort in the lamenta$le $ut fre5uent cases when the $anking system will demultiply its credit creation powers*I HIt is now appropriate to introduce the concept of moral hazard. In an asymmetric information context, the well known formula known as the Bagehot Rule for the activation of the lender of last resort function will be vitiated by a difficulty: it is practically impossi$le for a central $ank to know whether $anks re5uiring loans of last resort are illi5uid or insolvent. s is known the Bagehot rule mandates that only illi!uid banks be admitted to last resort lending. But if the lender of last resort faces an insolvent bank, if it refuses to bail it out it will by this action most probably determine a serious demultiplication to occur to credit available. "he payments system will be accordingly weakened and since the latter can be considered a public good, it is clear that the Bagehot Rule is not easily applicable and that last resort loans must be provided every time the payments network is in danger and severe demultiplication can occur in the country#s credit system. It follows, of course, that if the 4agehot Rule is modified to include insolvency, all $anks which, $ecause of the state of their $alance sheets, represent a potential threat to the sta$ility of the credit system are perfectly aware of their $eing indispensa$le and therefore virtually immortal as institutions .$rom this awareness they can derive a cavalier attitude toward risk, in the !uest for higher profits. "he banking system can accordingly develop an excessive propensity to expansions followed by e!ually excessive interventions by the monetary authorities. "he latter, aiming to reduce the volume of reserves which they have themselves created to bail out the risk%prone banks, may end up destroying the smaller banks, which are too small to influence the trust of the public in the credit system, while the real culprits, the banks that are too big to fail, manage to escape unscathed and can start, after a short period of !uiet, all over again on too bold a path of expansion*I

%ow, this is a point of inestima$le importance6 - $ecause now, if we admit that central $anks are no longer capa$le of determining who is illi5uid from who is insolventX the entire game is well and truly up- 4ernanke makes the same point when discussing 2isherPs de$t-deflation +in the H acroecons of G!I, where he also reviews Hsticky wagesI.* )nd, like !e "ecco, notes the HswitchI in economic approach to the Hmonetary channelsI leading to insta$ility that ishkin operated, applying the gametheoretic notions of information asymmetry* Kere is 4ernanke6 http677www*mrfaught*org7macroecondepression*pdf +p9?.
2isher's idea was less influential in academic circles, though, $ecause of the counterargument that de$t-deflation represented no more than a redistri$ution from one group +de$tors. to another +creditors.* )$sent implausi$ly large differences in marginal spending propensities among the groups, it was suggested, pure redistri$utions should have no significant macroeconomic effects* Kowever, the de$t-deflation idea has recently e#perienced a revival, which has drawn its inspiration from the $urgeoning literature on imperfect information and agency costs in capital markets*9N )ccording to the agency approach, which has come to dominate modem corporate finance, the structure of $alance sheets provides an important mechanism for aligning the incentives of the $orrower +the agent. and the lender +the principal.* One central feature of the $alance sheet is the borrower&s net worth, defined to $e the $orrower's own +'internal'. funds plus the collateral value of his illi5uid assets* any simple principal-agent models imply that a decline in the $orrower's net worth increases the deadweight agency costs of lending, and thus the net cost of financing the $orrower's proposed investments* Intuitively, if a $orrower can contri$ute relatively little to his or her own pro3ect and hence must rely primarily on e#ternal finance, then the $orrower's incentives to take actions that are not in the lender's interest may $e relatively highC the result is $oth deadweight losses +for e#ample, inefficiently high risk-taking or low effort. and the necessity of costly information provision and monitoring* If the $orrower's net

worth falls $elow a threshold level, he or she may not $e a$le to o$tain funds at all* 9>* ,iyotaki and oore +9::>. provide a formal analysis that captures some of 2isher's intuition* 9N* )n important early paper that applied this approach to consumer spending in the !epression is ishkin +9:?;.* 4emanke and Gertler +9::M. provide a theoretical analysis of de$t-deflation* 0ee "alorniris +9::>. for a recent survey of the role of financial factors in the !epression* 9; : O%E1, "RE!IB, )%! 4)%,I%G 2rom the agency perspective, a de$t-deflation that une#pectedly redistri$utes wealth away from $orrowers is not a macroeconomically neutral event6 Bo the e#tent that potential $orrowers have uni5ue or lower-cost access to particular investment pro3ects or spending opportunities, the loss of $orrower net worth effectively cuts off these opportunities from the economy* Bhus, for e#ample, a financially distressed firm may not $e a$le to o$tain working capital necessary to e#pand production, or to fund a pro3ect that would $e via$le under $etter financial conditions* 0imilarly, a household whose current nominal income has fallen relative to its de$ts may $e $arred from purchasing a new home, even though purchase is 3ustified in a permanent-income sense* 4y inducing financial distress in $orrower firms and households, de$t-deflation can have real effects on the economy* If the e#tent of de$t-deflation is sufficiently severe, it can also threaten the health of $anks and other financial intermediaries +the second channel.* 4anks typically have $oth nominal assets and nominal lia$ilities and so over a certain range are hedged against deflation* Kowever, as the distress of $anks' $orrowers increases, the $anks' nominal claims are replaced $y claims on real assets +for e#ample, collateral.C from that point, deflation s5uee(es the $anks as well*'' )ctual and potential loan losses arising from de$t-deflation impair $ank capital and hurt $anks' economic efficiency in several ways6 2irst, particularly in a system without deposit insurance, depositor runs and withdrawals deprive $anks of funds for lendingC to the e#tent that $ank lending is speciali(ed or information-intensive, these loans are not easily replaced $y non$ank forms of credit* 0econd, the threat of runs also induces $anks to increase the li5uidity and safety of their assets, further reducing normal lending activity* +Bhe most severely decapitali(ed $anks, however, may have incentives to make very risky loans, in a gam$ling strategy*. 2inally, $ank and $ranch closures may destroy local information capital and reduce the provision of financial services*

/hat 4ernanke and ishkin forget is that Hthe capitalist economyI has little to do with Huse valuesI in terms of what is socially useful allocation of resources, and even less to do with +Kayekian. HcoordinationI in the sense of He#change and pricing of OinformationPI on anything resem$ling HdemocraticI principles- Bhis last is a crucial point, and it is our central point of attack- J 4ecause what ishkin would have us $elieve is that Hde$t-deflationI occurs when there are simple HasymmetriesI in the e#change of HinformationI* 4ut we know all too wellX* that these HasymmetriesI +free-rider, principal-agent, moral ha(ard. arise $ecause ofX*the very real HantagonismI of capitalist social relations of production, with the wage relation at the centre- Indeed, it this antagonism that e#plains the Hultimate sourceI of financial insta$ility that ishkin relegates to the never-never or to HshocksI or H$lack swansI or Hune#pected disinflationI or HuncertaintyI or Hsudden rise in interest ratesI or other He#ogenous factorsI-Perhaps $efore we leave '4ernanke' +save to return to him - so 'central' is his contri$ution, if read critically, to the theorisation of the present 'crisis'., could I rapidly 'situate' the discussion in a 'theoretical' conte#t - an essential task if we are to rise a$ove the 'noise' of the 5uotidian 'random walk'* Indeed, it will $e recalled that in neoclassical theory, it is the very assumption of 'perfect information' + odigliani- iller., of 'common knowledge' +game theory., and /alrasian 'tatonnement' +in e5uili$rium analysis. that make the e#change of information 'symmetrical' and that reduce the entire field of 'economic science' to 'the pro$lem of co-ordination' +see Kayek's 'Individualism and Economic Order', discussed in Foas$y's 'E5uili$rium and Evolution' for an attempt to 'historicise' the pro$lem.*

It is evident that there can $e no space in all of these 'theories' for central $anks, nor indeed for 'financial intermediation' +hence Kayek's virulent opposition to central $anks and fractional reserves as a 'negation' of the market pricing mechanism.* Bhe 'separation' of $orrower's risk and lender's risk first raised $y ,alecki and ,eynes - and the conse5uent recognition that 'money is not neutral' remains 'internal' to the function of capital6 it is, as it were, a 'division of la$our'* 4ut an understanding of why, how and where 'information asymmetries' arise in the 'channel' that links investment decisions with financial structure is a$solutely essential* Bo leave the entire matter to 'asymmetric information' arising 'after' some 'e#ogenous shock' +see any of ishkin's papers on the su$3ect. is 5uite simply inade5uate* +0imilarly, the '%ew Institutional Economics' of "oase, /illiamson and !emset(, e#plain away the 'internalisation' of these 'asymmetries' as the need to minimise 'transaction costs' - which then raises the conundrum of why the capitalist economy is not constituted $y one 'mega-firm'-. In this paper on H2inancial 2ragility and Economic PerformanceI + http677docs*google***RDDRNPoOa&1,a,2M?L . , 4ernanke and Gertler identify the 'ultimate source' of asymmetries in the '$orrowers' net worth position' - the lower the net worth, the higher the risk of implosion* )gain, this fails to isolate 'the virus' responsi$le for the disease, $ut it offers some hints* Bhe first hint is that 'high net worth firms' will $e 'ensconced' from de$t-deflation initially $y their 'oligopolistic' and hence 'systemic' importance +too $ig to fail.* )nd the second is that each successive 'crisis' $rings a$out a series of 'mergers and ac5uisitions' whether voluntary or 'shot-gun marriages' that increases further the degree of 'oligopoly' of capitalist enterprise and therefore its future 'fragility' - the 'systemic riskiness' of the system* +0ee this 2B story on W) activity following G2" http677www*ft*com7intl7cms7s7M7>f;QfQGc-;N:a-99eM-afc$MM9NNfea$dcM*htmlRa#((9FOQg24dI . )nd finally, the growing 'systemic riskiness' of the structure of capitalist enterprise, together with the parallel 'centrality' of 0tate authorities in 'crisis management', mean that central $anks $ecome 'lenders of first +not last. resort'* Indeed, 4ernanke and Gertler (oom into this specific HchasmI or HlacunaI +,eynesPs Hslip Otwi#t the cup and the lipI. seeking to determine what HfactorI would trigger a de$t-deflation implosion of the credit pyramid +remem$er6 a pyramid of term contracts ena$led $y low inflation for prolonged periods.* Bhis is what they come up with at p;;6
HIn this paper we take a step toward an operational definition of financial sta$ility* /e argue that financial sta$ility is $est understood as depending on the net worth positions of potential $orrowers* Our $asic reasoning is as follows6 generally, the less of his own wealth a $orrower can contri$ute to the funding of his investment 'pro3ect,' the more his interests will diverge from those of the people who have lent to him* /hen the $orrower has superior information a$out his pro3ect, or the a$ility to take uno$served actions that affect the distri$ution of pro3ect returns, a greater incompati$ility of interests increases the agency costs associated with the investment process* /e define a financially fragile situation to $e one in which potential $orrowers +those with the greatest access to productive investment projects, or with the greatest entrepreneurial skills. have low wealth relative to the si(es of their pro3ects* 0uch a situation +which might occur, e*g*, in the early stages of economic development, in a prolonged recession, or su$se5uent to a 'de$t-deflation''. leads to high agency costs and thus to poor performance in the investment sector and the economy overall* /e illustrate this general point in the conte#t of a specific model of the process of investment finance* In this model individual

entrepreneurs perform costly evaluations of potential investment pro3ects and then undertake those pro3ects that seem sufficiently worthwhile* Bhe evaluation process gives the entrepreneurs +who must $orrow in order to finance pro3ects. $etter information a$out the 5uality of their pro3ects than is availa$le to potential lenders* )s in yers and a3luf TI:;N9 and others, this informational asymmetry creates an agency pro$lem $etween lenders and the entrepreneurs-$orrowers* Bhis agency pro$lem +which is more severe, the lower is $orrower net worth. raises the prospective costs of investment finance and thus affects the willingness of entrepreneurs to evaluate pro3ects in the first place* /e show that,, in general e5uili$rium, $oth the 5uantity of investment spending and its 9* Bhe term is due to Irving 2isher T9:>>U* 0ee 4ernanke and Gertler TI:;:9 for an analysis* 2I%)%"I)F 2R)GIFIB1 )%! E"O%O I" PER2OR )%"E e#pected return will $e sensitive to the 'creditworthiness' of $orrowers +as reflected in their net worth positions.* Indeed, if $orrower net worth is low enough, there can $e a complete collapse of investment*

%ow, the thing to $e noticed instantly is that, unlike ishkin who leaves the 5uestion of the precise HoperationI of Hasymmetric informationI in the actual structure and function of capitalist enterprise might give rise to these HasymmetriesI, preferring to attri$ute them to He#ogenous factorsI +listed a$ove., 4WG concentrate here on the structural HendogenousI factors that might Hpre-disposeI the system to de$t-deflation and find +or hypothesi(e. that it is Hthe net worth positionI of the $orrower that is determinant* Bhis would seem to support our initial hypothesis that the HfunctionalI predisposition of the HlendingI aspect of capitalist investment is to reduce risk, even at the cost of sacrificing profit ma#imi(ation* Bhis stands to reason $ecause ma#imi(ing profit is never the real goal of capital J it is merely the pursuit of safe profit a$ove what is called Hthe risk-free rate of interestI which merely represents the interests of Hsocial capitalI* %ote +-. that 4WG look at HfragilityI from an He# postI position, that is, HafterI a de$t-deflationI has occurred and therefore what they mean $y HfragilityI is the ina$ility of the investment cycle Hto restartI owing to the low net worth of entrepreneur-$orrowers* 4ut in fact it can $e argued that this situation can arise even He# anteI, that is, that insta$ility increases H$eforeI de$t-deflation* ) surfeit of capital in the sense of either e#cessive li5uidity vis-a-vis actual Hproductive activityI +note that 4WG themselves refer to Hproductive T-U investment pro3ectsI and fail to specify what they m e a n $y this-. and therefore the a$ility to find Hproductive investment pro3ectsI e#cept those of entrepreneurs lacking the re5uisite skillsX - either of these possi$ilities reduce the Hnet worthI, the Hskin in the gameI of the entrepreneurs selected $y lenders for loans* J Kence the HfragilityI $ e f o r e de$tdeflation occurs once the volume of investments reaches a HcriticalI stage* )gain, 2isherPs Hde$tdeflationI, or inskyPs HhypothesisI, only tackle the HimplosionI of Pon(i finance J $ut not its HgenerationIBhey do this desultorily in the "onclusion6 HPutting aside the reasons for the increase in leverage, it still may $e asked whether the higher level of de$t implies greater financial fragility* Our answer is, 'It depends*' /e $elieve that the focus on de$t versus e5uity ignores the primary determinant of Tp999U financial sta$ility-the net worth of $orrowers, or, as we may call it for the purposes of this discussion, the 'insiders' stake*'(> If the

insiders' stake is high, de$t need not $e harmful* 2or e#ample, as has $een fre5uently pointed out, &apanese corporations have traditionally relied much more on de$t than have A* 0* firms* Bhis has not posed a pro$lem for the &apanese, however, $ecause managerial decisions are tightly monitored $y financial $ackers-$anks or parent corporations* Effectively, insider stakes in &apan are highC among other things, this means that firms' finances can efficiently $e restructured when circumstances change* Bhus, whether the A* 0* economy is in a financially fragile condition depends fundamentally more on the magnitude of insiders' stakes in the Anited 0tates than on the composition of firms' e#ternal lia$ilities* Bhere have $een factors pushing insiders' stakes in $oth directions in the Anited 0tates during this decade* 2or e#ample, to the e#tent that the wave of takeovers and $uyouts has represented the sei(ure of corporate control $y well-financed management teams, there may have $een an effective increase in insiders' stakesC likewise, increased monitoring of management $y takeover specialists and investment $anks may have had a salutary effect* 'orking in the other direction, increasing securitization (for example, the greater reliance on )unk bond financing a t the expense of commer% cial bank loans*+has typically reduced the overlap between the providers of financial capital and the insiders in the corporation, greater use of -arm&s length- financing trends to increase financial fragility* easurement of the effects of these countervailing forces on the sta$ility of the A* 0* financial system is a difficult, $ut not impossi$le, empirical challenge*I

0o here we have an evident HdivideI $etween Hsocial capitalI +capital as a whole represented $y finance capital. and individual capitals* )nd when 4WG remind us that the HcreditworthinessI of $orrowers is a function of their Hnet worth positionI, then we know we are on to something e#tremely important* J 4ecause this Hnet worthI will depend in large part not merely on the individual position of the $orrower, $ut a$ove all on the specific weight +weight-. that this individual capitalist plays in the capitalist economy, in terms of how HpivotalI it is to social reproduction overall and its specific role in a certain HsectorI +or HmarketI, if you like. J in other words, on the degree of HoligopolyI +recall 0ylos-Fa$iniPs point on how Hlollies differ from steelI-.* 4WG touch $riefly on this at Part S on Hde$tor $ail-outsI* Indeed, the ultimate significance of 0tate intervention in a HcrisisI to restore the HflowI of capitalist activity threatened $y the HdisintermediationI of financial institutions and the emergence of the central $ank as Hlender of first resortI have to do with the impossi$ility at a certain level of de$t-deflation of the monetary authorities to distinguish $etween li5uidity and solvency and $etween HidiosyncraticI and Hsystemic shocksI or crises +p9M;., that is , to tell apart the HrealI and the HfictitiousI parts of capitalist activity or investment in terms of Huse valueI and of arms-length allocation of social resources $etween individual capitalists* In the end, it is the Hsystemically importantI capitalist firms that simply must survive J they $ecome Htoo $ig to failI once a relevant degree of HoligopolyI is achieved* ishkin, to $e fair, had already insisted on the a$ility of large firms +oligopolies. to issue securities to finance themselves . an evident adoption of the 4WG thesis on the importance of net worth for surviving de$t-deflation* /orse still, each HcrisisI simply tolls the death-knell for smaller capitalist firms +financial and industrial. that are then ac5uired and merge with $igger ones in a growing spiral of capitalist HconcentrationI* J Antil, that is, the collective capitalist has to intervene Hin first personI, through financial disintermediation, tighter regulation and supervision, and +in e#tremis. outright Hnationali(ationI +anathema $ut nearly a reality in the latest A0 crisis-.*

/e find here a curious $ut undenia$le and significant inversion or contra-diction of 0chumpeterPs Hentrepreneurial spiritI, in that the HtrustificationI of capital either saps and suppresses or at least Hinternali(esI the HInnovationspro(essI that he had singled out as the differentia specifica of capitalism* It is in this perspective or dimension that one must read 0chumpeterPs late dou$ts a$out the very survival of capitalism as a form of social organi(ation* Bhus, here not only the process of innovation $ut also that of concentration J that is to say, the Hinternali(ationI of HinformationI within individual firms or Hunits of commandI which the %IE had attri$uted +foolishly. to the reduction of Htransaction costsI - $ecome critically Hsu$ordinateI to that of wage-relation antagonism* It is the capitalist imperative to preserve the HprivateI character of the allocation of resources, the artificial HseparationI of the social division of la$our J the need of capital to avoid at all costs the Hdemocrati(ationI of the process of production in the face of its Hre-compositionI $y workers +$y HsocietyI- even $y Hsocial capitalI-. that leads inevita$ly to the HcrisisI* )nd, in an apparent parado#, it is the higher level of social interdependence or integration of production J the very process of capitalist concentration J that provokes crises and necessitates ever-higher levels of 0tate intervention to restore the $roken Hco-ordinationI, to a$olish the HasymmetriesI that had emerged as a result of the peculiar HprivateI character +or Brennung. operated $y capitalist private ownership of the means of production and their HseparationI of workers from them and from one another* 4ernanke and Gertler have not ceased to surprise us with their insights, however* Bhis one is at p;:6
H"his paper also contains some novel policy results, not dis% cussed in our earlier work. "he most striking of these is that, if "legitimate" entrepreneurs are to some degree identifiable, then a policy of transfers to these entrepreneurs will increase welfare. 'e show that a number of standard policies for fighting financial fragility can be interpreted along these lines*I

/e will look closer at what HlegitimacyI means here* Bhe central pro$lem is that from $eing purely HfrictionI and relegated to He#ternalitiesI such as Htransaction costsI, which together were $undled up in the HunificationI of micro- and macroeconomic theory J 3ust the em$arrassing HfactI that money is central to a capitalist economy +PatinkinPs Hyou canPt $uy goods with goodsIC see also /icksell on /alras in OIandPP, p==. -, now these HfrictionsI +impossi$ly Hgenerali(edI $y /illiamsonPs H%IEI to the point of destroying any and all Heconomic theoryI. come to the fore of the entire $ourgeois HscienceI to the point that they HreplaceI the ma#imi(ation of HwelfareI as the sine 5ua non of economic activity and regulation* In other words, truly with Kayek we have shifted from an Heconomics of priceI to an Heconomics of informationI* +On all this, see the wonderful review $y ,laes here http677docs*google*com7viewerE aVvW5Vcache6lG 03F"s"4;&6www*eshet*net7pu$lic7:;9MG;NMM<klaes*pdfYKellwig,Y artinY+9::>.6 Y'BheY"hallengeYofY onetaryYBheory',WhlVenWglVauWpidV$lWsrcidV)!GEE0gL;Nn:%omILw9NAg; Rk#uMs!0u2w:0Ai1,o3M"gi10ER ;#KFnF"DtDPAg1/c)04=M5)M35whMLo/eh3c;k:p%NK >ld)Pm$0&irs=(o3%$r<M#gyBF@p9&@4K3%i3fv,- )WsigV)KIEt$L;3Got&aQa@4gn 42w?905 D=QDg In his sweepingly devastating conclusion,
H/hile the folk history of transaction costs is often told as a story of remarka$le success, the historical sketch presented here, which focuses on the transaction cost notion itself, suggests a rather different picture* Bhe study of the use of transaction costs in the literature of modern economics turns out to $e the history of the 5ui#otic struggle of the discipline to endogeni(e one of the most pervasive residual categories of the neoclassical heritageZthe category of institutional friction*I .

%ow two pro$lems arise in this respect* Bhe first lies with the HmeaningI of HinformationI* )nd the second is with esta$lishing why this HinformationI is su$3ect to HasymmetriesI- 4ourgeois economists steadfastly refuse to face these two 5uestions that go to the heart of Heconomic scienceI, preferring instead +5uite wisely. to hide HwithinI the $ounds of their meanings and simply seeking Hto s5uee(eI the status 5uo +capitalist relations of production. safely within these categories J what they call HendogenisingI all these HfrictionsI or what I call Hinternali(ingI the He#ternalitiesI- )s long as this gre# venalium +this venal herd. steers very clear of the HultimateI 5uestions J those 5uestions that undermine its very HrationaleI, its very H$asis and foundationI J they can play on very safe ground* 4ut the pro$lem is that Hthe realityI of capitalist HantagonismI never ceases to intrude- )nd it intrudes most J lo and $ehold- J in the monetary sphere, the root of all evil, not 3ust in popular lore, $ut in $ourgeois economic theory as well- Go figureKere is Gertler in his review of the )I literature right in the first paragraph +http677docs*google*com7viewerEaVvW5Vcache6rL3Nf=aRvo&6www*nviegi*net7teaching7master7gertler*pdfYGertler,Y ark*Y9:;;a* Y2inancialY0tructureYandY)ggregateYEconomicY)ctivity6Y)nYOverview* Y&ournalYofWhlVenWglVauWpidV$lWsrcidV)!GEE03eP0m,GnvNt4G:iehF yOK4(&(Dd(BQcLoRR,& ;-O"i;A3tcNo So=r,3P9a><GDc>PGRKy12OGcFcgB>04FKEL$@It<LlQ=Gt?NgB<9,IeIsy!sl E:t$/GDkstE"QmP p3y$WsigV)KIEt$Ly(ovE>I0eum,,ud3lB!MGolto@w .
HRecently, interest has grown in e#ploring the possi$le links $etween the financial system and aggregate economic $ehavior* Bhis interest partly reflects the ongoing $eliefs of applied economists and policymakers that financial markets and institutions deserve serious attention - that they play important roles in the growth and fluctuation of output*I

Bhe reluctance to tie the two 5uestions together J financial structure and growth of output J is too evident* Bhe cancer at the core of economic theory was and remains HmoneyI, $ecause money is the one HinstitutionI that $ourgeois theory cannot digest, cannot assimilate* 4ut that such He#ternali(ationI of money is an a$3ect admission of defeat J a further proof of the insolent scorn that $ourgeois economists have not 3ust for truth $ut even for intellectual coherence J is shown not only $y the frantic and desperate attempt Hto endogeniseI money, $ut a$ove all $y the prepotent emergence of the reality of capitalist practice J the utter inveterate yelp for help of the $ourgeoisie for the 0tate to rescue it form its theoretical-ideological $lindness- Bhe crushingly inconfuta$le reality of late capitalism is that, in 2isherPs words +5uoted $y Gertler at pQG9. 'they +de$ts. TareU great enough to not only 'rock the $oat' $ut to start it capsi(ing*' Bhus, not only is Hthe monetary 5uestionI central for $ourgeois economic theoryC it is also increasingly HcriticalI for the survival of capitalism itself+Interestingly, Gertler relates how later conventional ,eynesian theories, including the monetarist perversion, tended to divorce monetary from HrealI factors and then again credit from monetary factors6 H"onsidera$le de$ate arose over the empirical significance of the mechanism linking money to real activity* Indeed the early ,eynesians emphasi(ed the importance of 'real factors' such as the multiplier7accelerator mechanism and fiscal policy* Bhe monetarists, with an intellectual foundation tied closest to classical theory $ut nonetheless influenced $y ,eynesian thinking, provided the main support for the importance of the monetary mechanism,I +pQG=.*. /e should stress here that whilst $orrowersP and lendersP risk are only internal functions of capitalist command, this is not to say that therefore the Hvalourisation and realisation hiatusI ceases to $ind or that money and finance are secondary to HrealI considerations in the production process* On the contrary, the hiatus $inds even more $ecause now the distinction $etween HrealI and HmonetaryI $ecomes superfluous in the sense that the two are aspects of a single unitary process in the circulation

of capital* Bhat $ourgeois HscienceI seeks to conceal the reality of social relations that gives rise to Hfictitious capitalI with e5ually fictitious HasymmetriesI, Htransaction costsI and other He#ternalitiesI or HfrictionsI is yet another sign of its perennial attempt to mystify those relations* Parado#ically, money is precisely what living la$our imposes on capitalistsC for, not only does the capitalist wish to pay as little as possi$le, $ut also he seeks to pay Hin kindI- oney is the HuncertaintyI that gnaws at the $ourgeoisie, that mortal loss of H0ekuritatI +the refuge of Individualitat., the Hslip Otwi#t the cup and the lipI* oney is what stands $etween HinvestmentI and HprofitI J that P in the formula -"XPX"P- P that stands for Hprocess of productionI that sym$oli(es the chasm, the hiatus, the insupera$le antagonism of the wage relation* H oney dissolvesI the feudal link at the dawn of the capitalist era* 4ut it also dissolves every H$ondI, every H$ridgeI that capital may wish to pro3ect to tie living la$our to its own fate and destiny, to its goals* Kere is Gertler on )I6 H)nother current limitation is that these frameworks have very am$iguous policy implications* In analogy to the intermediation literature, the $asic issue involves whether the government can improve on the types of contractual arrangements that would arise in an unfettered private economy* Bhe results are highly sensitive to the postulated information structureX 2inally, the analyses are not well integrated with monetary theory* Bhe ma3or o$stacle is pro$a$ly the general difficulty of incorporating money into general e5uili$rium frameworks* )s a result, it is difficult to sharply evaluate the effects of monetary policy,I +pQ;=.* )s ,laes +at p999. 5uotes Kellwig,
HIn the words of artin 2* KellwigPs 9::= Presidential )ddress to the European Economic )ssociation6 TBUhe pro$lem is to find appropriate conceptual foundations for monetary economics* I $elieve that we do not, as yet, have a suita$le theoretical framework for studying the functioning of a monetary system* Bhe main o$stacle to the development of such a framework is our ha$it of thinking in terms of frictionless, organi(ed, i*e* /alrasian markets +Kellwig 9::>, p* =9Q.*I