No More Learning

Apparently the scheme was a bit too politically incorrect for US voters to digest and was quickly shot down. But there was really nothing exceptional about it. Violent events do affect profits, so investors continuously try to discount the prospects of such events into asset prices. This ongoing capital- ization means that even without an official bourse for violence the military can still tease out information from the capital market: all it has to do is look at the interest-rate spread between the bonds of the affected country and comparable international instruments. Victory is in the eye of the bond- holder. 19
The future of humanity
The all-encompassing role of discounting is most vividly illustrated by recent discussion of environmental change. One key issue is the process of global warming/dimming and what humanity should do about it. Supporters of immediate drastic action, such as Nicholas Stern, argue that there is no time to waste. According to The Economics of Climate Change (2007), the report produced by a review panel that he headed for the British Government, the world should invest heavily in trying to limit climate change: the cost of inac- tion could amount to a permanent 5-20 per cent reduction in global GDP (p. xv). But this conclusion is by no means obvious. Critics such as William Nordhaus (2007) argue against drastic actions. In their view, the overall cost of climate change may end up being negligible and the investment to avert it a colossal blunder.
19 Chaney (2007) looks at variation in the yield spread on Iraqi sovereign debt to evaluate the US 'pacification policy' in Iraq, while Greenstone (2007) uses a similar method to judge the success of the US troop 'surge' in Iraq. The latter author explains in his article's abstract that 'After the Surge, there was a sharp decline in the price of those bonds, relative to alternative bonds'. In his opinion, 'This decline signals a 40% increase in the market's expectation that Iraq will default. This finding suggests that, to date, the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it'. Go argue otherwise.
? A brief anthropology 165
The interesting thing about this debate - apart from the fact that it may affect the future of humanity - is that both sides base their argument on the very same model: capitalization. Climate change is likely to have multiple effects - some positive, most negative - and the question is how to discount them to their net present value. Part of the disagreement concerns the even- tual consequences and how they should be priced relative to each other and in relation to other social outcomes. But the most heated debate rages over the discount rate. At what rate of return should the damage be capitalized?
One thousand dollars' worth of environmental damage a hundred years from now, when discounted at 1. 4 per cent, has a present value of -$249 (negative since we measure cost). This is the discount rate that led Stern to conclude that climate change would be enormously harmful, and that urgent action was needed. But the same one thousand dollars' worth of damage, discounted at 6 per cent, has a present value of only -$3. This is the long-term discount rate that Nordhaus likes to use in his computations. It implies that the impact of climate change may end up being minimal, and so should the response be, at least for now. 20
Although most investors are probably unaware of this climate-splitting debate, they too view the process through the lens of capitalization. By 2007, there were nearly 50 'climate change' funds listed on the Bloomberg news service. The HSBC Global Climate Change Benchmark Index, an investment vehicle that tracks 300 companies that 'make money from fighting climate change', has outperformed the MSCI World Index by 70 per cent since 2004 (Oakley 2007). In parallel, there has been a boom in the market of 'catastrophe bonds'. The emergence of these bonds in the 2000s has enabled investors to buy from insurance companies the 'tail risk' of large-scale cata- strophes such as earthquakes, pandemics and perfect storms, and by so doing has given capitalists the illusion they can somehow 'externalize' the more cataclysmic impacts of nature on society (Lewis 2007).
It seems that, just like the Salamander traders who underwrite the slow- motion holocaust in Karel Capek's War with the Newts (1937), capitalists today cannot resist the temptation of dancing at both weddings: on the one hand they contribute to climate change, while on the other they cheerfully discount the boom in the doom. As long as their capitalization keeps rising, they themselves will happily go under with their thumbs up. 21
20 The controversy over the 'proper' discount rate has been staged with much fanfare by the panellists of the Copenhagen Consensus conference (Lomborg 2004).
21 'The history of the newts is thus characterised from the very outset by its perfect and rational organization; the principal but not exclusive credit for this must go to the Salamander Syndicate; it should, however, be acknowledged that science, philanthropic endeavour, enlightenment, the press and other factors also played a considerable part in the spectacular spread and progress of the Newts. That said, it was the Salamander Syndicate which, so to speak, daily conquered new continents and new shores for the Newts, even though it had to overcome many an obstacle to that expansion. . . . In short, unlike human
? 166 Capitalization
Capitalization and the qualitative-quantitative nomos of capitalism
Extrapolating the foregoing illustrations, we can say that in capitalism most social processes are capitalized, directly or indirectly. Every process - whether focused on the individual, societal or ecological levels - impacts the level and pattern of capitalist earnings. And when earnings get capitalized, the processes that underlie them get integrated into the numerical architecture of capital. Moreover, no matter how varied the underlying processes, their inte- gration is always uniform: capitalization, by its very nature, converts and reduces qualitatively different aspects of social life into universal quantities of money prices. In this way, individual 'preferences' and the human genome, the structure of persuasion and the use of force, the legal structure and the social impact of the environment - are qualitatively incomparable yet quanti- tatively comparable. The capitalist nomos gives every one of them a present value denominated in dollars and cents, and prices are always commensurate.
? colonisation of the globe, the spread of the Newts proceeded in accordance with a plan and on a generous scale; had it been left to nature it would have dragged on over hundreds and thousands of years. Say what you will, but nature is not, and never has been, as enterprising and purposeful as human production and commerce. . . . ' (Capek 1937: 122-23).
10 Capitalization
Fiction, mirror or distortion?
He had the same trouble as all intellectuals - he was ineffectual. He knew too many things, and they confused him.
--Louis-Ferdinand Ce? line, Journey to the End of the Night
How are we to theorize the all-embracing architecture of capital? The exam- ples in the previous chapter suggest that capitalization is an encompassing social process of valuation in need of a comprehensive theory of value. The conventional neoclassical and Marxist approaches, though, lack such a theory and therefore fall back on narrow 'economic' explanations. In both cases, capitalization is explained in relation to the so-called material-productive processes of capitalism.
As usual, the starting points of the two approaches are diametrically opposed. Marx considers capital goods the real thing and nominal capital- ization a mere fiction, whereas the neoclassicists view nominal capitalization as a mirror of capital goods (and vice versa). Yet in the end, because of their wrong starting point, the two schools meet in the middle of nowhere, with capitalization seen as an inescapable 'distortion'. We have mentioned these biases several times in the book, and it is now time to look at them more closely.
From fiction to distortion: Marx's view
Marx wrote before the corporation emerged as the dominant form of busi- ness organization, and therefore before capitalization came into its own. Nonetheless, he was familiar with the technique of discounting and offered one of the first attempts to understand the role of credit and financial markets in capitalist dynamics.
He started by juxtaposing two different entities: 'actual' capital versus 'illusionary' or 'fictitious' capital. Actual capital exists as commodities - means of production, work in progress and commodity money whose prices are governed by labour time, whether historical or current. By contrast,
168 Capitalization
fictitious capital consists of ownership claims on earnings whose price is the present value of those earnings. 1
Why is the latter capital 'fictitious'? Marx lists three basic reasons. First, a claim on earnings often has no actual capital, or 'principal', to call on. This is the case of state debt, for instance. Here the capitalist lends money to the government, yet this money does not create - nor is it intended to create - means of production. Instead, it is spent on current operations. And since the government repays the money plus interest out of its revenues, the capitalist ends up having a claim not over actual capital, but merely over state taxes (or the printing press, as the case may be). Second, a claim on earnings, even on those generated by actual capital, extends into the future. It covers expected as well as current payments, and the two cannot be treated equally. Unlike present income, future income expectations may not materialize; and since their level cannot be known beforehand, their present value could end up being partly or wholly illusionary. Finally, a given flow of income, whether generated by actual capital or not, would create different levels of capital- ization depending on the rate of interest (Marx 1909, Vol. 3: 546-47 and 550-51).
Clearly, actual and fictitious capitals are totally different creatures. They consist of different entities and are quantified through different processes - the former via past and current productive labour time, the latter through future earnings expectations and the rate of interest. So, when considered separately, their respective magnitudes and movements need have nothing in common. The problem, though, is that they cannot be considered separately. The capitalist system is denominated in prices, and as Marx himself conceded, prices are affected by both fictitious and actual accumulation. As a result, any divergence of the former from the latter is bound to 'distort' the value system.
How big is this distortion? Marx's own view was ambivalent. On the one hand, he made it sound as if fictitious capital contaminates the price system to the point of making it incomprehensible:
All connection with the actual process of self expansion of capital is thus lost to the last vestige, and the conception of capital as something which expands itself automatically is thereby strengthened. . . . The accumula- tion of the wealth of this class [the large moneyed capitalists] may proceed in a direction very different from actual accumulation. . . . Moreover, everything appears turned upside down here, since no real prices and their real basis appear in this paper world, but only bullion, metal coin, notes, bills of exchange, securities. Particularly in the centers, in which the whole money business of the country is crowded together, like
1 'The forming of a fictitious capital is called capitalising. Every periodically repeated income is capitalised by calculating it on the average rate of interest, as an income which would be realised by a capital at this rate of interest' (Marx 1909, Vol. 3: 548).
? Fiction, mirror or distortion? 169 London, this reversion becomes apparent; the entire process becomes
unintelligible.
(Marx 1909, Vol. 3: 549, 561 and 576, emphasis added)
On the other hand, Marx seemed to believe that the relationship between the two types of capital can be mapped. Focusing on the accumulation of 'money capital', he asks:
To what extent is it, and is it not, an indication of an actual accumulation of capital, that is, of reproduction on an enlarged scale? The so-called plethora of capital, an expression used only with reference to the interest- bearing capital, is it only a peculiar way of expressing industrial over- production, or does it constitute a separate phenomenon alongside of it?
(Vol. 3: 559)
Marx himself never provided a systematic answer to this question. As noted, he was writing early in the processes and perhaps believed that capi- talism would collapse well before fictitious capital could become entrenched. The Marxists after him, however, could no longer ignore the process. Consequently, they have tried to piece together his scattered insights and, weaving in their own interpretation, yield a Marxist theory of capitalization.
According to the careful reconstruction of Michael Perelman (1990), Marx saw fictitious capital as having a contradictory effect. As a form of credit it helps make the organization of production much more flexible. Yet as a source of information it sends the 'wrong' price signals, and in so doing undermines the coordination of production.
During the boom, the two processes diverge. Ballooning fictitious capital facilitates investment, while growing price distortions amplify the misalloca- tion of resources. These are conflicting trajectories, however, and therefore cannot continue forever. Sooner or later a crisis strikes, and the 'excessive imbalance' between prices and values is rectified:
In order for the price system to work, financial forces should cause ficti- tious capitals to move in directions that parallel changes in reproduction values. . . . By losing any relationship to the underlying system of values, strains eventually build up in the sphere of production until a crisis is required to bring the system back into a balance, whereby prices reflect the real cost of production. The fiction of fictitious value cannot be main- tained indefinitely. At some unknown time in the future, prices will have to return to a rough conformity with values. . . .
(Perelman 1990: 83)
And so we come full circle. Recall that Marx began by suggesting that actual and fictitious capitals are two different entities. But, then, since ficti- tious capital distorts the relationship between prices and labour time, it serves
170 Capitalization
to undermine Marx's labour theory of value. To uphold the labour theory of value, this distortion must be neutralized. And the only way to neutralize it is to assume that the system periodically 'equilibrates' fictitious and actual capital. In the end, the two entities, although different in essence, have to assume the same appearance.
There is of course another possibility altogether, and that is that prices do not obey the labour theory of value. In this latter case, capitalization has no material/productive benchmark to converge on, so we need another theory to explain its trajectory and oscillation.
Unfortunately, there is no way to choose between these two opposing views for the simple reason that labour values cannot be known even if they exist. This impossibility means that we cannot tell whether prices deviate from values, and therefore whether fictitious capital is larger or smaller than the underlying 'actual' capital.
The net result is to leave Marxists with no scientific theory of capitaliza- tion, and therefore with neither a unique explanation for nor an alternative to the actual capitalism of the present. As noted in Chapter 7, this void has been filled by culturalists and state theorists of various denominations who usually have no clue as to what they are missing. And the few who still try to study fictitious capital seriously are fighting a losing battle. Being unable to use labour time as their anchor, most have gravitated toward the hedonic measures of neoclassical economics. Their empirical studies - including those that have adopted Minsky's financial instability hypothesis (1975; 1982) - see credit and fictitious capital as oscillating around the util-denominated 'capital stock' publicized by the national accounts. And with orthodox measurements come orthodox explanations, leading one observer to conclude that 'there is no qualitatively distinct radical monetary perspective' and that no monetary approach within radical political economy can be 'prevalidated as Marxian' (Dymski 1990: 58-59). 2
From mirror to distortion: the neoclassical view
Contrary to the Marxists, who begin from two different entities, the neoclas- sicists start from equivalence: capitalization both derives from and reflects on capital goods. The stylized expression of this symmetry is due to Irving Fisher. In an article aptly titled 'What is Capital? ' (1896), Fisher opens by devising a consistent set of definitions. His starting point is a distinction between 'stock' (quantity at a point in time) and 'flow' (quantity per unit of time). Capital is a stock, income is a flow. Capital gives rise to income, whereas income gives capital its value. The precise correspondence between these concepts is articulated in his book The Rate of Interest (1907):
2 Wall Street (1997) by Doug Henwood is one of the more comprehensive radical dissections of modern finance. But even a razor-sharp and highly versatile author like Henwood is unable to inject much Marxism into the subject.
? Fiction, mirror or distortion? 171
The statement that 'capital produces income' is true only in the physical sense; it is not true in the value sense. That is to say, capital-value does not produce income-value. On the contrary, income-value produces capital- value. . . . [W]hen capital and income are measured in value, their causal connection is the reverse of that which holds true when they are measured in quantity. The orchard produces the apples; but the value of the apples produces the value of the orchard. . . . We see, then, that present capital- wealth produces future income-services, but future income-value produces present capital-value.
(pp. 13-14, original emphases) The feedback loop is illustrated in the following table (p. 14):
Table 10. 1
Quantities Values
Fisher's house of mirrors
Present capital
Capital wealth Capital value
? ? ? ?
Future income
Income services
? ?
Income value
? ? ? Explanation: In the material world, depicted by step 1 of the sequence, capital wealth (measured by the physical quantity of capital goods) produces future income services (similarly measured by their physical quantity). In the nominal world, depicted by stage 3, the income value of the future services (measured in dollars) is discounted by the prevailing rate of interest to generate the present value of capital (also measured in dollars). The two worlds are connected through stage 2, whereby the physical quantity of future income services determines their dollar price.
Hypothetical numerical illustration: Intel has 10 million units of capital wealth, which, during its future life, will produce 1 billion units of income services in the form of microchip-generated utils (step 1). These 1 billion utils' worth of services, spread over the life of the capital wealth, will fetch 100 billion dollars' worth of future profits and interest (step 2), which in turn are discounted to 50 billion dollars' worth of capital value (step 3).
Unfortunately, this neat sequence cannot work. As we saw in previous chapters, a collection of capital goods cannot have a definite physical quan- tity, so it is impossible to say how much services these capital goods 'produce' (thus annulling step 1). And since we don't know the physical productivity of capital goods, obviously we cannot deduce from this productivity either their nominal value (cancelling step 2), or their dollar capitalization (invalidating step 3). So we are still in a bind. While money income is routinely discounted to its present value, there is no way to connect the resulting dollar capitaliza- tion with the 'physical quantity' of the so-called underlying capital goods.
172 Capitalization
At this point, then, the neoclassical search should have been called off. Needless to say, that didn't happen. On the contrary, the quest for the Holy Grail continues unabated. Neoclassical analysts and theorists remain convinced, today perhaps more than ever, that there exists an invisible bridge between the under world of machines and technology and the over world of discounted capitalization. And they certainly have put their mouth where the money is.
Over the past century, they have built numerous models, estimated countless regressions and written billions of words - all with the purpose of keeping the bridge standing and the faith unbending.
So in order not to nip their investment in the bud, let's put aside our concern for logical consistency and in what follows assume, along with the believers, that the material quantity of capital goods (whether that quantity 'exists' or not) can be measured by their prices. This assumption puts Fisher's 'capital value' and 'capital wealth' on the same monetary footing, denominated in dollars and cents. And since the two entities are now perfectly comparable, the test becomes pragmatic: for the doctrine to stand there must be empirical correspondence between capitalization and the money price of capital goods.
Sadly, though, even this watered-down correspondence doesn't exist. It turns out not only that the two magnitudes are very unequal, but that their rates of growth oscillate in opposite directions. Let's see why.
Microsoft vs General Motors
Begin with a simple example. Figure 10. 1 provides basic information on two leading corporations in the United States - Microsoft and General Motors (GM). There are four sets of bars in the chart, each presenting a different set of facts about the two companies. The grey bars are for GM, the black ones for Microsoft. On top of each of the Microsoft bars, we denote the per cent ratio of Microsoft relative to GM.
The two sets of bars on the left present data on the 'material' operations of the two firms. In terms of relative employment, depicted by the first set, GM is a giant and Microsoft is a dwarf. In 2005, GM had 335,000 workers, 5. 5 times more than Microsoft's 61,000. The second set of bars denotes the respective dollar value of the companies' plant and equipment, measured in historical cost. In line with our concession, we assume that these dollar values are proportionate to the 'productive capacity' of the two companies. According to these statistics, in 2005, GM's 'productive capacity', standing at $78 billion, was 33 times larger than Microsoft's, whose capital goods were worth a mere $2. 3 billion.
The two sets of bars on the right show the companies' respective capital- ization. Here the picture is exactly the opposite, with Microsoft being the giant and GM the dwarf. In 2005, Microsoft's equity had a market value of $283 billion, nearly 26 times GM's $11 billion. And even if we take the sum of debt and market value (which supposedly stands as the total claim on a
500
400
300
200
100
0
Fiction, mirror or distortion? 173
? ? ? ? ? ? ? GM
Microsoft
? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? 18%
2,583%
64%
? ? ? ? ? ? 3%
www. bnarchives. net
? ? ? ? ? ? ? ? ? ? ? Employees (000)
Plant and Equipment ($bn)
Market Value ($bn)
Market Value and Debt ($bn)
Figure 10. 1 General Motors versus Microsoft, 2005
Note: The per cent figures indicate, for any given measure, the size of Microsoft relative to GM.
Source: Compustat through WRDS (series codes: data29 for employees; data8 for net plant and equipment; data24 for price; data54 for common shares outstanding; data181 for total liabilities).
company's productive assets), the GM total of $475 billion was only 55 per cent greater than Microsoft's $306 billion - a far cry from its relatively huge work force and massive plant and equipment.
The usual response to such a discrepancy, from Alfred Marshall onward, points to 'technology' and 'human capital'. This is the 'knowledge economy', tells us Peter Drucker (1969: Ch. 12). Obviously, Microsoft's dispropor- tionate market value must be due to its superior know-how, packed as 'intan- gibles'. And since intangibles are not included in the plant and equipment category of corporate balance sheets on the one hand yet bear on capitaliza- tion on the other, we end up with a market value that deviates, often consid- erably, from the tangible capital stock.
This is a popular academic claim, and for a good reason: it is entirely reversible and totally irrefutable. To illustrate, simply consider the reverse assertion - namely that GM has more know-how than Microsoft. Since nobody knows how to quantify technology, how can we decide which of the two claims is correct?
174 Capitalization
Tobin's Q: adding intangibles
The discrepancy between capitalization and real assets is by no means limited to individual firms or particular time periods. In fact, it appears to be the rule rather than the exception. Consider Figure 10. 2, which plots the so-called Tobin's Q ratio for US corporate sector from 1932 to 2006. 3 In this figure, Tobin's Q measures the ratio between corporate capitalization and capital goods: for each year, the series takes the market value of all outstanding corporate stocks and bonds and divides it by the current replacement cost of corporate fixed assets (plant and equipment). Since both magnitudes are denominated in current prices, the ratio between them is a pure number.
3. 5
3. 0
2. 5
2. 0
1. 5
1. 0
0. 5
0. 0
1930 1940 1950
1960 1970 1980 1990
2000 2010 2020
? ? ? ? ? ? ? Tobin's Q
(ratio of the market value of corporate equities & bonds to the current cost of corporate fixed assets)
2. 8
? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? mean = 1. 24
? ? ? ? ? ? ? ? ? ? ? ? 0. 6
? ? ? www. bnarchives. net
? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? Figure 10. 2 Tobin's Q in the United States
Note: The market value of corporate equities and bonds is net of foreign holdings by US residents.
Source: U. S. Bureau of Economic Analysis through Global Insight (series codes: FAPNREZ for current cost of corporate fixed assets). The market value of corporate equities and bonds splices series from the following two sources. 1932-1951: Global Financial Data (market value of corpo- rate stocks and market value of bonds on the NYSE). 1952-2007: Federal Reserve Board through Global Insight (series codes: FL893064105 for market value of corporate equities; FL263164003 for market value of foreign equities held by US residents; FL893163005 for market value of corporate and foreign bonds; FL263163003 for market value of foreign bonds held by US residents).
3 The Q-ratio was proposed by James Tobin and William Brainard (1968; 1977) as part of their analysis of government stabilization and growth policies.
? Fiction, mirror or distortion? 175
Here too we uphold our theoretical concession. We assume that Fisher's symmetry between real assets and capitalization, although failing the materi- alistic test, can still hold in nominal space. Now, if this assumption were true to the letter, Tobin's Q should have been 1. One dollar's worth of 'real assets' would create a definite future flow of money income, and that flow, once discounted, would in turn generate one dollar's worth of market capitaliza- tion. The facts, though, seem to suggest otherwise.
There are two evident anomalies. First, the historical mean value of the series is not 1, but 1. 24. Second, the actual value of Tobin's Q fluctuates heavily - over the past 75 years it has oscillated between a low of 0. 6 and a high of 2. 8. Moreover, the fluctuations do not look random in the least; on the contrary, they seem fairly stylized, moving in a wave-like fashion. Let's inspect these anomalies in turn.
Why is the long-term average of Tobin's Q higher than 1? The conventional answer points to mismeasurment. To reiterate, fixed assets consist of plant and equipment; yet, as we have already seen in the case of Microsoft vs GM, capitalization accounts for more than just plant and equipment. And since Tobin's Q measures the ratio between the whole and one of its parts, plain arithmetic tells us the result must be bigger than 1. But, then, how much bigger?