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Principles of Political Economy, Part Two

By James H. Nolt

Last week, I outlined the first four of eight key principles of political economy the way I do it in the weekly blog column, now amounting to over 100 articles. This week I complete this overview of the principles underlying the method I use every week to analyze public affairs and political economic issues.

Credit determines the value of money

Economists treat money like everything else, as something that is scarce and whose value is determined by supply and demand. This is a muddled view. Money is not a physical thing like gold that must be manufactured. It is merely one species of a credit relationship, whether in the form of a bank account (effectively, when you deposit money you lend it to the bank), currency (a circulating note that is a credit instrument issued by a private or public bank), bills, or some other form.

The economists’ idea of the “supply” of money nowadays tends to focus on central banks. Many textbook models show the government central bank absolutely and exactly controlling the money supply. This is absurd, since most money is created privately to facilitate private transactions. The government may influence but never controls the money supply. Furthermore, people do not “buy” money the way they buy ordinary commodities. Various things may function as money or not, according to the whim of their owner. For example, economists may arbitrarily consider the balance in my checking accounts as money, whereas the balance in my brokerage account is not considered money. Yet, one is easily transferred into the other and either may function for a variety of purposes according to my strategic intent. These bank balances may function as a means of payment for goods, a means of payment for assets, or as a reserve store of value for future use. There is no one substance that always and reliably plays the role of money as a source of demand for output. Indeed, output bought on credit is purchased without immediate concern about one’s own stock of money, whatever that is.

Furthermore, money balances are easily and flexibly expanded or contracted according to the private whims of creditors who chose to advance or deny credit according to their own strategic intent as bulls or bears. The expansion and contraction of credit is largely a private power, although governmental policies may influence the private credit strategies, they never control them.

Generally, when credit expands (consider this analogous to an increasing “supply” of money, but the process is much broader), the value of money will eventually fall. It may not fall immediately if the economy has significant excess capacity because the credit expansion helps activate idle productive resources resulting in more real output. When the value of money falls, the price of goods rises. We call this “inflation.” Conversely, when credit contracts, the value of money rises, meaning prices fall, which is called “deflation.” Since most debts are priced in money units, inflation benefits debtors and deflation benefits creditors. The changing value of money also changes the value of debts, which is the most potent impact of revaluing money, yet it is so often ignored in textbooks.

Endogenous business cycle 

Textbook economics claims that the ordinary state of a market economy is general equilibrium of supply and demand. If that were true, there would be no boom and bust business cycle. Yet in fact for centuries credit-driven capitalist economies have been punctuated by a very active boom and bust cycle. Economies are dynamic and unstable. Individual markets are frequently not in equilibrium, sometimes far from it. The business cycle is not something extraneous or exogenous to capitalist economies, but rather is a necessary result of the rivalry between opposing bears and bulls, each struggling to realize their own strategic bet. Bulls win when economies expand and asset values increase. Bears win when economies contract and asset values plunge. Because capitalism is a two-party system, it is inherently unstable. Governmental efforts to stabilize economies may have some influence at the margins, occasionally dampening cycles, but never in eliminating them. The reason is that as long as credit expansion and contraction remain key private powers, there are always interests pushing in opposite directions. Even if governments try to mediate and regulate, one or the other opposing force may come to power and unbalance the regulatory regime toward one party or the other. Government is within society, not above it. So the forces that drive the business cycle in opposite directions also act on governments too.

Duality of capital 

Textbooks treat capital as a single type of productive stuff. This conflates two very different states of capital. Money capital is in some sense capital in its pure form, as self-expanding value. Money capital typically increases when it is lent out at the current interest rate. Alternatively, money capital may be invested in productive machinery and materials, becoming physical capital. Only physical capital can create actual output. Textbooks typically ignore this duality, treating capital as something like money capital when they argue that it has myriad alternative uses (which money capital certainly does), but then treating it as physical capital when they refer to capital as a “factor of production,” along with labor and land. These are, however, quite distinct. Money capital is fungible, by contrast physical capital produces particular output and typically involves specific machinery that is not useful for producing just anything, but only the specific products it was engineered to manufacture. Many problems follow from obscuring this fundamental difference in form.

Interplay of public and private power 

When I was an undergraduate student, I had a dual major in political science and economics. In my political science classes I often got the feeling that if the professor would just introduce the economic interests at stake in whatever issue we were studying things would become so much clearer. Likewise, in my economics classes I often found myself rolling my eyes at the political naïveté of economists. They kept imagining all sorts of supposedly ideal policies without ever considering whether they had any relationship to real distributions of power. An ideal means little if it is not possible. At that time, I did not yet grasp the complete solution, but at least I felt I had identified a real problem in the way the social sciences fragmented the issues of policy and power so that no comprehensive understanding was even possible. I resolved that my life’s work should be to fill the gap between the discordant and fragmented ways we view our political and economic lives.

Part of the problem is the language we use. For example, I object to the widely popular paring of “the state” versus “the market” as two supposedly divergent social institutions. Modern “conservatism” (which is more akin to anarchism, rests on the conviction that problems are almost always solved more efficiently in the supposedly autonomous realm of “the market.” On the other hand, liberals more typically put their faith in legalistic powers of “the state” to regulate social life in a way that is fairer than pure markets. Both Platonic ideal types of “state” and “market” are too pristine and abstract to be of any use. 

According to my Machiavellian viewpoint, abstracting these conceptual opposites tends to obscure the fact that all governments are deeply penetrated by influences of private power. Likewise, “the market” itself is a myth since there is no such realm of pure economic freedom unsullied by the exercise of both private and public power. Laws and rules do matter, but so do cartels and bribery, to select a couple examples. Therefore, it is ridiculous to train “political scientists” who are almost entirely innocent of private power and economists who are even more naïve about it. Out of the mud and muddle of real political economy emerges real strategic action by private interests, parties, cliques, and social movements. Real political economy is not pretty; it can be disheartening. However, it is also the arena of exciting social dynamics and occasionally brilliant reform or revolution.

*****

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James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.

[Photo courtesy of Private Collection]

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