Contribution to the International Communist Seminar
‘Economic Crises and Possibility of a Major World Crisis’
Brussels, 2-4 May 2002

www.icsbrussels.org , ics[at]icsbrussels.org

Denmark
Karen Sunds, Danish Communist Party / Marxist-Leninist (DKP/ML)

The growing contradiction between real economy and speculation economy

One of the most conspicuous results of the last 20 or 30 years of capital liberalisation is the increasingly parasitic character of Capitalism which, among other things, shows itself in the fact that while «only» 20 pct. of the financial transactions were speculative in 1975, today 97 pct. of these transactions are purely speculative without any connection to real economy. Real transactions, i.e. transactions related to trade etc., represent only 3 pct. of all transactions that amount to the astronomic sum of about one and a half billion dollars a day.

How should these phenomena be understood and interpreted from the point of view of Marxist economic theory? Why have we witnessed such a huge disproportional expansion of the financial sector? In order to answer these questions, this paper will focus on some central points in Marx’ «Capital» and Hilferding’s «Financial Capital» and relate them to the present development.

The division of profit on the industrial and rentiers’ capitalists

The contradiction between the two different groups of capitalist, the active capitalists in the productive sector and the rentiers or loan capitalists was discussed many times in the works of Marx, Hilferding and Lenin. Hilferding, for example, explains how the original role of the banks was payments transfer in order to convert passive Money Capital into active Profitable Capital, i.e. «servicing the industrial capitalist». The payment for this service was a share in the profit cake. A kind of symbiosis so to say…

With the development of Capitalism, this relation is transformed into its opposite in the sense that Bank Capital is becoming still more domination in spite of the fact that surplus value is created by the industrial capitalist. It could be called a «cuckoo-in-the-nest» effect.

Both in Marx’ and Hilferdings’ works it is stressed that only production is generating profit on the basis of surplus value, while no surplus value is generated in the trade and financial sectors. Hilferding writes:

«A certain part of the total Capital is now separated and gets an independent form as Money Capital whose capitalist function exclusively is to carry out these operations for the whole class of industrial and commercial capitalists… Thus, the movements of this Money Capital are only movements performed by a layer of the Industrial Capital during its reproduction process… It is also evident that their profit only is a deduction of the surplus value as they only operate with already existing values.» (Hilferding: Financial Capital, p. 264)

Hilferding describes how the average profit is divided into two parts: a) entrepreneur’s profit for the industrial capitalist and b) interests for the loan capitalist.

The interest rate is determined by the money market, by supply and demand of Loan Capital, while the entrepreneur’s profit then is determined residually. There is no stable, fixed relation between these two types of profit. Besides the situation on the loan market, also the relative strengths between the two groups of capitalists influence on the division. (see Marx: Capital, volume 3, p. 488)

Marx argues that the interest rate tends to go down in longrun, putting forward two arguments:

a) There will be an increasing supply of Capital because the class of rentiers is growing.

b) All available savings in society will little by little be transferred into credits because of the growing development/perfection of the credit system. (see Marx: Capital, volume 3, p. 470)

Hilferding thinks that this is wrong, both in theory and practice. He argues that the interest rate doesn’t have to go down when the profit rate does, as the interest rate is not a fixed and determined part of the profit. His argument is that because of the tendency for the profit rate to fall, interest will become a relatively greater part of profit in comparison with entrepreneur’s profit, i.e. the inactive capitalists will earn still more to the detriment of the active ones. Hilferding believes that this is an important lever for the transformation of Capital into Financial Capital. (Hilferding: Financial Capital, p. 190)

It is evident that this is a very crucial question, both in theory and in practice, and that it ought to be analysed in further details. Here it is enough to state that the interest rate cannot be totally independent from the profit rate. It will up to a certain extension be bound to the profit rate because of the equalisation of the profit rate between the different sectors. When the profit rate goes down and the interest doesn’t do it in the same relation, a flow of Capital from the industrial to the banking sector will be provoked until the supply of Loan Capital is so big that the interest rate once more has fallen to a level of equilibrium. (see Marx: Capital, volume 3, p. 490)

Dumenil and Levy’s empirical analyses

In the light of these theses of Marx and Hilferding, it is important to study how the division of the profit between the interest and entrepreneur’s profit has behaved. It could be a key to understand why the financial sector swells.

The two French economists, Dumenil and Levy, have recently made some conspicuous empirical analyses where they for the first time have tried systematically to divide the economy in a real sector and a financial sector in order to compare their estimated profit rates. These are important analyses that bring us a big step forward in the efforts to update Marxist economic theory.

Dumenil and Levy’s most important conclusion are:

In 1982, the profit rate started to recover after two decades of constant fall.

But because of the quickly growing real interest rate, most of the increased profits goes to the banking sector.

This means less entrepreneur’s profit to the active capitalist producers, some thing that leads to an indebtedness of the real sector.

The high profit in the banking sector causes a big flow of Capital towards the banking sector, some thing that can explain the swelling of the financial sector.

Accordingly, we see that the interest from about 1980 has constituted a significantly bigger part of the gross profit. If we turn back to the discussion between Marx and Hilferding about the longrun of interests in order to judge which of the two theses can be supported by the empirical data, it seems that in spite of the dramatic growth of interests since 1980 to the detriment of the entrepreneur’s profit, there is no real support for Hilferding’s thesis to be found in these empirical data. According to Hilferding, the profit rate should fall while the interest rate were more or less stable. But the empirical data show the following:

In the period where the profit rate is falling, the real interest rate is also slightly falling.

In the period where the interest rate is strongly growing, the profit rate is also growing.

This doesn’t support Hilferding’s predictions. Hence, there might be other dynamics and relations.

An important reason why the real interest rate was so high from about 1980 was the falling inflation rate which is also a result of the strong priority given to low inflation policies. It is a main point for Dumenil and Levy that this reflects the fact that the financial sector has taken the control over the political instruments. This, however, will not be discussed here.

The crucial thing must be to analyse whether the fact that the interest rate has made up a much bigger part of gross profit during the last two decades, represents a structural and thus persistent change? This question still expects an answer and needs more investigation.

The mobilisation of capital

Another central aspect of the analyses of Marx and Hilferding is the mobilisation of Capital, i.e. the separation between ownership and use of Capital. It is a fundamental aspect of Financial Capital. I his book «Financial Capital», Hilferding engages in a detailed description of the development of Share Capital which creates the basis of the so-called «Fictitious Capital»:

«With the transformation of the private enterprise into a private limited company, the Capital seems to have doubled. But the original Capital supplied by the shareholders has definitively changed into Industrial Capital and lives, in reality, on as such… Thus, the money paid in the later share trading is not at all the original money that originally was supplied by the shareholders and that has been consumed; it is not a part of the Capital of the private limited company, of the Capital of the enterprise. It is extra money that is necessary for the circulation of the capitalised profit certificates. Likewise, the price of the share is in no way determined as a part of the Enterprise Capital; quite opposite, it is the capitalised profit share.» (Hilferding: Financial Capital, pp. 196-197)

This means that on the basis of a small amount of Real Capital, a much larger amount of Fictitious Capital is established through share issue. In this way, Capital obtains a double existence: both as Real Capital in the form of machines etc. and as Fictitious Capital in the form of securities, shares etc., that are only an reflection of the real existing Capital of the company: They can be bought, sold, used as security for bank loans etc. Shares don’t represent Money Capital, but they are claims against future surplus value produced on the basis of the invested Capital.

When the Fictitious Capital expands through share issue, a lot of money is created and divided into foundation profit and Productive Capital. Now, the shares have been sold and, thus, separated from the Industrial Capital as such. The foundation profit constitutes the difference between Real Capital and Fictitious Capital and is distributed between three agents (bank, industrial capitalist and shareholder) according to their relative strength. It is this separation between Real Capital and Fictitious Capital that creates the starting point for speculation. Hilferding says:

«Speculation doesn’t concern the capitalist enterprise… Buying and selling of interest certificates is a pure displacement in the distribution of private property, without any effect on the production and realisation of profit. Gains or losses through speculation are only generated as difference in the actual estimates of the interest certificates. Gains are not profit, they are not a part of surplus value, but spring from fluctuations in the estimates of the parts of surplus value designated at the shareholders – fluctuations that don’t need to have any relation to the actually realised profit. They are pure difference gains… The speculators only earn from each other. The loss of one speculator is the gain of another speculator.» (Hilferding: Financial Capital, p. 224)

Hilferding also point out that «speculation, understood as share trading with the one purpose of gaining from the trading, is irrelevant to the real sector».

It is evident that this thesis is no longer correct. Today, speculation causes a lot of harm to real economy. In the following, we will look upon the qualitative changes in the function of Capital that can explain this phenomenon.

Why does speculation have real economic effects today?

There is a number of reasons why speculation has huge real economic effects today. In the following, we will look upon some of the channels that are directly connected to the analyses of Marx and Hilferding.

A. The market value of the enterprise

Today, the market value of a quoted company (defined as the «share price multiplied with the number of shares«) is the variable used to estimate the economic situation and value of the company. It is, thus, the basis of the estimate of a company’s solidity, how big credits and loans the company can achieve etc. This means that today the share prices have a very direct influence on the company’s daily freedom of action. The company is therefore very interested in a high quotation of its shares at the Stock Exchange.

But due to speculation, among other things, the company is not the master deciding the development of share prices. As we have seen, great fluctuations in share prices may occur due to other, external reasons. During financial crises, healthy companies have, in fact, become insolvent overnight due to a decline in share prices.

B. The daily competition to gain the investors’ favour

The companies are, thus, very interested in having a good place in the share index at the Stock Exchange. But the capitalists of today are more treacherous than ever. The mobilisation of Capital on the present financial markets has been brought to grotesque perfection. The technological development has made it possible for an investor to withdraw his Capital and invest it in something more profitable from one minute to another. This means that the company’s profitability should be estimated on a daily basis and compared with all other quoted companies’ expected profitability. It thus becomes relative. The institutional investors, e.g., only maintains their shares during an average of two years before selling them. Ten years ago, it was four years. (see Eatwell 1996). This means rapid buying and selling in function of the highest return.

This, of course, means a sharpening of the competition between the companies in order to attract investors through high return on shares, i.e. dividends. As a consequence of this development, the companies raise the dividend payments. Dumenil and Levy show that a significantly bigger part of the profit is distributed to the shareholder in the period of neoliberalism: today, more than 60 pct. is paid in form of dividend compared to 30 pct. in the 1970’s.

In this way, we can identify another channel through which a growing part of the gross profit flows from the active capitalists to the owners of Capital, i.e. through a violent raise in the dividend payments. This part of the profit also flows to Financial Capital. It is important to remember that to the owner of Capital, «investment in shares» and «lending capital» are two way of investment that are substitutes. Financial Capital operates both places according to the perspectives for profit.

This is, indeed, a possible explanation of the strong expansion of the financial sector.

C. Huge volatility of the share prices

Finally, we will look upon the possible reasons why share prices have experimented much bigger fluctuations during the 1980’s and 1990’s and, generally, have been quoted very high during this period. We must distinguish between two different reasons for share trading:

A normal investment in order to get a share of the profit (dividend).

A purely speculative act, i.e. only with the purpose of exploiting price differences.

Regarding the normal trading in shares, it is logical that high expectations to profit mean higher share prices. But due to the mentioned growth in the dividend payments, the return to the shareholders will grow relatively more than the company’s profitability in fact justifies. This means that even in relation to the normal component, we will se how the share prices drift away from the real «value».

As regards the speculative component, this speculation is highly determined by cyclical movements. It starts when there is a surplus of available Capital, and it continues and develops long time after the signs of crisis have shown up in the real sector. The speculative bubble develops, but sooner or later an adjustment has to come. The longer the bubble has been developing, the more dramatic will be the adjustment. Speculation strongly enhances the cyclical movements. (see Minsky)

During the last decade, the skyrocketing of share prices has by large exceeded what can be explained by expected profitability, i.e. the speculative component has been important. This picture is not new. It has been described in detail by economists, even before Marx. The new thing is that the share prices now seem to have significantly longer periods of building up and, accordingly, significantly deeper falls when the adjustment occurs. (see Friedman/Laibson 1989 and BSI Economic Papers 1994)

What is the reason of this phenomenon? It seems that it is due to the development on the financial markets. We can mentioned the development of a derivative market, the appearance of institutional investors etc. With the financial liberalisation, there is a enormous growth in the possibilities for speculations: now you can speculate in the possible break-down of the exchange rate, in interest spreads (different interest rate among the countries) etc. At the same time, this has become a self-increasing circle: the more speculation, the bigger the volatility of the asset prices, the greater the need to protect oneself against the risk for a time (the original motive for the hedging market), the bigger the growth in the derivative market, the more possibilities for speculation.

Hence, it can be said that the big institutional investors and the big commercial banks themselves are creating the insecurity from which they earn so much money. They are market-makers of the hedging market. They live from instability.

Conclusions

To sum up, there are two channels through which a part of the gross profit flows from the real sector to the capital owners in the financial sector: a) through payment of interest on the Loan Capital and b) through the payment of dividends to the shareholders.

We have seen that these two flows have grown considerably during the last decade. This is the explanation of the important expansion of the financial sector. The growing flow of profit to the Capital owners through dividend payments seem to be a permanent phenomenon. But it is not sure that the same counts for the strongly growing interest payments. Further investigations have to be carried through in order to determine whether this is the case.

At the same time, we have to conclude that the expansion of the financial sector takes place to the detriment of the real sector: the bigger the part of the profit that is paid to the owners of Capital instead of using it to consolidate and invest in production, the weaker the liquidity and solidity of the company. For many companies, this vulnerability expresses itself in a marked growth in the company’s indebtedness.

Hence, the expansion of the financial and speculative sectors are directly harmful to the accumulation of Capital. This must be a basic contradiction in the development of capitalism as the real sector is the only part of the capitalist activities that produces surplus value. The parasitic plant is figuratively speaking sucking out all the force of the mother plant. It is evident that this development will sharpen the inner contradictions of capitalism and cause even greater instability and fragility.

Literature

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Chossudovsky, Michael: Global Financial Crisis.

Dumenil/Levy: Costs and Benefits of Neoliberalism. A Class Analysis. (2001)

Dumenil/Levy: The Real and Financial Components of Profitability.(2001)

Eatwell, John: International Financial Liberalization: The Impact on World Development. (UNDP 1996)

Friedman/Laibson: Economic Implications of Extraordinary Movements in Stock-Prices. (1989)

Hilferding, R.: Financial Capital. (Danish edition)

Kregel, J: Derivatives and Global Capital Flows: Applications to Asia. (1998)

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