Monday, March 30, 2009

Inflation Monster (2009)

Book Review from the March 2009 issue of the Socialist Standard

The Origin of Financial Crises. George Cooper. (2008. Harriman House)

Even though this book isn’t written by a Marxist but by someone taking much of his inspiration from Keynes, it is for the most part well worth reading as an explanation of asset price bubbles. It is also, at root, a good attack on ‘efficient markets hypothesis’ – the view that prices accurately reflect all known information at any one point in time and that markets are efficient allocators of resources.

Few conventional writers on economics come to the same conclusions as Marx without mentioning him or otherwise being aware of him, though Cooper seemingly manages it on two counts: his analysis of the causes of asset price bubbles, and his analysis of the cause of inflation and the role it plays within capitalism.

While he uses language more loosely sometimes than he might, talking freely about ‘credit creation’ when it is clear that what he means by this is the constant recycling of deposits into loans by the banking system rather than the creation of credit out of thin air, his explanation of asset price bubbles is sound. Essentially he takes the view that the process of the circulation of capital in the market economy is aided by the extension of credit and that this inherently gives rise to the possibility of financial dislocation and crisis (as did Marx, even if Marx argued that this possibility only became a reality when a crisis of overproduction for particular markets took place in the real economy).

Though it is something of a generalisation, Cooper contends that the tendency of markets for commodities to respond to rising prices through falling demand is not matched by the behaviour of markets for financial assets, which have a tendency to generate increased demand when prices rise (being typically intended for investment not consumption). This process can act in reverse, because when prices for commodities fall demand then generally increases, but when asset prices fall, demand for them falls too, as in the current financial crisis.

This is partly because much of the credit extended to purchase the assets has been granted by the banks against underlying collateral that is losing its nominal value. In this sense, there is no supposedly efficient pricing mechanism to reallocate resources – merely self-feeding panic as falling asset prices lead to enforced asset sales, and then further price declines caused by this lead to yet more asset sales as a consequence: ‘the process of collateralised lending generates one of the key destabilising forces in financial markets. Borrowers whose assets have already fallen in value may not have additional collateral to hand, and the bank’s decision to sell their collateral, into what is by definition a falling market, may simply exacerbate the borrowers’ and the bank’s losses.’ (p.100). This is essentially what has been happening during the credit crunch.

His analysis of what he calls the ‘inflation monster’ also largely hits the mark. While he does not overtly use a labour theory of value, he traces the origins of money through the establishment of gold as a recognised standard and store of value, and then considers the development of gold depository certificates and paper money as a consequence of this. He argues that with the expansion and contraction of money and credit during trade cycles, prices rise in booms and then fall in slumps but there can be no permanent tendency towards inflation while money is convertible into gold.

When convertibility into gold is suspended then the inflation monster can (and has been) unleashed by governments and central bankers: ‘The new currency regime, without a gold exchange rate, is known as fiat money. The movement from a currency backed by gold to one with no fixed gold price represented a momentous shift in our financial architecture . . . Governments had now awarded themselves the right to create their own money without any corresponding liability; since there was no longer a promise to convert the printed money into gold, there was no longer a liability associated with printing that money’ (p.69). In other words, governments could inject excess purchasing power into the system, in the form of an over-issue of inconvertible paper currency, that would only serve to push up prices.

Cooper identifies the collapse of the Bretton Woods international trading system in 1971 when the dollar was no longer pegged to gold as the definitive moment here, though in truth full convertibility had been suspended long before this in the US and all other advanced economies (in Britain it was as early as 1931 and by the time of the collapse of Bretton Woods in 1971 only around 1 per cent of the currency issue in the UK had even a nominal gold backing).

He argues that an excess issue of inconvertible paper currency can be directly used to finance government expenditure, as he thinks is about to happen now. He also makes the point – as have we – that there is a sense that governments prefer rising prices to falling prices partly on the grounds that it can increase their net tax-take, and perhaps because industrial unrest is more likely when workers have to resist falling wages than when they have what are generally rising nominal (if not real) wages under inflationary conditions. This partly presupposes that governments recognise a causal link between an excess note issue and rising prices, which is a moot point – though he also includes an interesting quote from Ben Bernanke, before he became chairman of the US Federal Reserve, which illustrates that there is certainly recognition of a linkage of sorts (even if they might view it as just one cause of inflation alongside others).

The tentative recommendations that Cooper makes later in the book for dealing with capitalism’s financial crises need not detain us too long, though it is interesting to note that the inability of mainstream economics to adequately account for the current crisis is again leading others towards the type of analysis that has all too rarely been seen, in recent decades, outside the pages of the Socialist Standard.

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