Capitalism - Money Interest and Assets

List of Contents

Abstract

Acknowledgements

Acknowledgements

Background

Introduction

Methodology

Chapter 1
Literature Review with the Macro-facts
Mercantilism
Physiocracy
Classical Economics
Say’s Law
Neoclassic and Marginalist School
Marxist School
Keynesian Economics
The theory of Keynes
The theoretical framework of Keynes theory
Monetarism
Equation of exchange and velocity of money
The quantity theory of money and prices
Towards the end of Chapter 1

Chapter 2
Some evidence for microeconomic inefficiencies
Unemployment, Price (in)stability and Business cycles
Inflation vs. Deflation
The Phillips Curve
The non-accelerating inflation rate of unemployment (NAIRU)

Chapter 3
The ‘Free’ Analysis for the prevalence of inefficiencies
The investment decision
Money and its different definitions
What happens if money fails to deliver one of these functions?
Interest and Compound Interest
Growing Financial Assets

Chapter 4
An evaluation of macroeconomic consequences
Growing societal pressures
The ‘Story of Stuff’
Governments and their debts
Capitalistic, shifting and non-capitalistic economies
The current financial crisis and business cycles ...
The Discussion

Some ideas for the future

Reference List

Bibliography

Appendices
Appendix 1
Appendix 2
Appendix 3
Appendix 4
Appendix 5
Appendix 6
Appendix 7
Appendix 8
Appendix 9
Appendix 10
Appendix 11
Appendix 12
Appendix 13
Appendix 14

Annex 1
Questionnaire

Annex 2

List of Tables

Table 1: Mercantilism and John Locke

Table 2: Physiocracy and Francois Quesnay

Table 3: Classical Economics

Table 4: Marxism, Marx and Engels

Table 5: Keynes theoretical framework

Table 6: Monetarist Transmission-mechanism

Table 7: Matrix summarising schools of macroeconomic thought

Table 8: Inflation and economic growth

Table 9: Functions of Money

Table 10: The Josephs Pfennig

Table 11: Dynamic Analysis

List of Figures

Figure A: The Classical macroeconomic approach

Figure B: The Keynesian macroeconomic view

Figure C: Components of the US money supply

Figure D: Hyperinflation in the Weimar Republic

Figure E: The Phillips/Fisher curve and NAIRU

Figure F: Distribution of GDP

Figure G: long-term (10 years) money-market interest

Figure H: Interest and Compound Interest

Figure I: Simple scheme of wealth transactions

Figure J: The monetary spiral

Figure K: Gap Rich and Poor

Figure L: Growth rates in comparison

Figure M: Environment and Capitalism

Figure N: National Debt

Figure O: National debt development in Germany (billion Euros)

Figure P: Developing countries

Figure Q: Rich versus Poor

Figure R: Financial crisis

Figure S: Financial and monetary aggregates vs. real output

Abstract

The dissertation’s purpose is to prove inconsistencies in the macroeconomic framework to be prevalent and to analyse these failures with the limited information given using secondary research in particular.

It is attempted to result at findings hinting towards inherent problems in the incorporation of capitalism into the macroeconomic framework and the forces acting in a way prone to inconsistencies also drawing upon a conducted primary source.

Concluding the theses made in Chapters 1-4, recommendations will give careful but still practical implication of how to improve the current state of being.

The methodological procedure starts with evaluating mainstream and non-mainstream (emphasis on free-economy approach) economic schools of thought in Chapter 1. After giving some evidence for individual problems concerning the economic schools of thought (Chapter

2) mentioned, Chapter 3 will emphasize the free-economist approach and its contributions and explanations for macroeconomic failure discovered in Chapter 2. Having incorporated the problems laid out in Chapter 3, the emphasis will be on the macroeconomic consequences (Chapter 4) resulting from the argumentative chain in Chapters 1-3. Eventually, the attempt will be to summarise investigated inconsistencies to give careful practical implications of what future steps could be to improve some of the issues discussed around the notion of money, the interest rate and financial assets.

Acknowledgements

I would like to thank Mr. Alan Griffiths for his support and devotion to discuss the subject area extensively. The supervision was very helpful and made me understand how to meet with difficulties regarding this work. I would also like to thank the participants of the questionnaire for their time and effort.

Background

Having finally reached the topic for this dissertation ‘Capitalism - Money Interest and Assets’, a long way preceded. Looking back about two years ago I came to be interested in the ‘Growing Gap between Rich and Poor’, not only between Third World countries but also within industrialised countries analysing e.g. Germany, the UK or the US. To that time, it was clear to me that people living in the Third World do not have the same living standards as in Western democracies. What I did not know was the prevalence of poor people in the West. Building upon these thoughts I began to read more around the subject (which is, straightforwardly, a very wide subject to read around).

At one point I came to know alternative suggestions of why these negative tendencies are felt in the West, and why Third World countries are struggling to keep up with the living standards of industrialised economies, and many other aspects related to it. The ‘free economists’ and there proposal for a ‘free economy’ building upon thoughts of the founder of ‘Freiwirtschaft’ Silvio Gesell, opened a whole new way of approaching the topic. There standpoint of the last decades could be summarised as quite critical, however, leading into directions and giving suggestions of what could be done to improve the situation. I went on reading to try and get some kind of bigger macroeconomic picture of the current, worldwide economic situation in which I included thoughts of the ‘mainstream’ daily press and the more ‘non-mainstream’ thoughts reaching from globalisation-rejecting anarchists to still critical but theoretically-founded free economists. The title of this dissertation is, to the point of writing, the quintessence of macroeconomic inconsistency in which not every individual in the world economy is fully recognised or as De Soto (2000) puts it, within the ‘bell jar’ enjoying capitalism and wealth therein.

Introduction

This piece of work is of extraordinary use for every international management student which will, in the future, act as an economic agent in the world economy. Organisational knowledge is vital, but the arguably well-known PESTLE-factors, the factors influencing an organisation from the outside, are growing in their importance in an unprecedented way. ‘In the period of economic boom, there tends to be little time for deep thinking. Crisis, however, has a way of sharpening the mind’s need for order and explanations into obsession’ (De Soto, 2000, p.214). The focus will lie on E for Economic, more specifically the macroeconomic framework in which the economic agent acts with some of them struggling also due to the ongoing financial crisis in the market.

‘Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?’ (Eliot, n.d. in De Soto, 2000). The complexity of today’s economic activity and financial markets dilute the way in which the current financial crisis stems from in the first place (Humanwirtschaft, 2009).

The main aim in the main body will be to try and analyse the inherent inconsistencies in today’s mix of democracy and capitalism. It will be tried to dig deeper, to analyse the price which is to be paid to reach some kind of stability - if there is stability at all. Chapter 1 will deal with the mainstream macroeconomic schools of thought and the evaluation of their weaknesses or ‘blind spots’¹ in an historical context. Furthermore, some heterodox, non-mainstream approaches, with emphasis on the free-economy approach, will be introduced.

Chapter 2 will deal with prevalent ‘capitalistic appendages’, as I come to call them, of price instability (inflation/deflation), unemployment and business cycles to s]how at least some of the consequences emerging from the afore-mentioned blind spots.

The sole perplexity in solving the problems outlined in Chapter 2 will be dealt with alternatively in Chapter 3 by drawing on heterodox, free-economy thoughts to lead the reader to possible reasons for these instabilities to occur. The primary source being a questionnaire and conducted by the author for the reason of credibility of theories presented, is drawn upon in order to compare theory with practice that is say the thoughts of free-economy members. Having explained the microeconomic problems and drawn upon alternative suggestions for their prevalence, Chapter 4 will deal with the macroeconomic consequences in the world economy.

In the following, the question arises if there is an eclectic approach of macroeconomic schools of thought (Chapter 1) in combination with the free-economist approach (Chapter 3) which could lead to greater economic stability on micro- (Chapter 2) and macroeconomic (Chapter 4) level.

Carefully selected suggestions of what future research on a larger more professional scale could be, is sought in the concluding paragraphs of this work.

The main aim is to make sense of the connections of the four chapters. The objectives set out are thus: analysing macroeconomic schools of thought; describing microeconomic inconsistencies; explaining inconsistencies of capitalism closely related with the notion money, interest rate and financial assets; evaluating macroeconomic consequences; and clarifying the above towards the end.

Methodology

The nature of this work could be summarised as a mix of ‘positivist’ and ‘post-positivist’, (Wisker, 2008) drawing mainly upon an inductive, approach, nevertheless trying to develop theory by using quantitative methods. The interpretation of the subject area is that it is voluntarily wide spread with the attempt to combine ‘macroeconomic factors’ in a way that shows their connection to each other. Knowledge is gathered from a wide range of, mainly secondary, sources and combined to further interpret and evaluate the overall aim of the dissertation to reach a standpoint of high probability that macroeconomic instability is due to certain factors evaluated throughout the thesis.

In order to reach a view on how the members of the heterodox school of ‘free economists’ perceive macroeconomic occurrences closely related with the example of the latest financial crisis, a quantitative research method (questionnaire) was conducted to seek responses from the limited number of participants to combine their views with the current economic state of being. It was not thought to reach a vast number of participants (positivist; Wisker, 2008) but to carefully analyse the questions 5-16 (see Annex 1) which concern the economy and were delivered open-ended in written form (via Internet) to fewer people (number of participants 15) with the attempt to get to real in-depth discovery of people’s attitudes toward the matter. Questions 1-5 were conducted in multiple-choice to undermine the statement made in this work that profound macroeconomic consequences occur and to show similarities of free economists view and the outcome of these consequences. However, in drawing upon thoughts of supporters of the free economist approach the outcome seems to be skewed towards the higher probability of reaching consensus between this work’s outcome and free economist’s view of the matter.

Overall, it is a rather eclectic, manifold approach with emphasis on secondary resources (library work) combined with a quantitative research method, the questionnaire (Wisker, 2008). Furthermore, the author’s view will also slip into the discussion in the end.

Chapter 1 Literature Review with the Macro-facts

The tacit knowledge base regarding the currently capitalistic economic system and its accompanied shortcomings is still open to diverse controversy, different, partly self-contrary views (Bleaney, 1985) and frequently, due to the latest financial crisis, questioned; with some ‘minor adjustments’ (author’s view) being discussed at the recently held G20-summit in London (wiwo.de, 2009).²

Once, George Bernard Shaw said something like if all economists’ views would be lined up, there would not be any solution (Samuelson & Nordhaus³, 2005). The following theories’ brief outline evolves from a predominantly historical background commencing with the earliest and will be finishing with the latest thoughts of economic theory. The approaches will be interpreted as attempts to stabilise advanced Western economies. The unstableness will be explored in Chapter 2, describing prevalent ‘microeconomic inefficiencies’, for which reason, in Chapter 1, an alternative, heterodox approach will be introduced in order to build upon later in the dissertation.

Mercantilism

Mercantilism was the economic philosophy throughout the early modern period in the 16th and 17th century. Important was the positive balance of trade by making sure that a country exported more than it imported. Hereof, the accumulation of wealth was taking place. Bullions like gold and silver were the only way striving for and, accordingly, the leaders of those nations intervened extensively in the market, imposing tariffs on foreign goods to restrict import trade, and granting subsidies to improve export prospects for domestic goods. The protectionist role of these economies, nevertheless leading the way towards capitalistic structures, encouraged many European wars at that time and soon led to anti-mercantilist thoughts of the Classics discussed next (FED, 2009). Before, however, it will be looked at some interesting insights of the arguably most important Mercantilist John Locke.

Table 1: Mercantilism and John Locke

John Locke (1632-1704)

In one of Locke’s many works one can find thoughts about the matter of accumulation. He argues that labour creates property, meaning that value (close to Marx’s surplus value) is created through work. Man’s capacity to produce and man’s capacity to consume, however, marks limits to the accumulation of wealth. Therefore, while also stressing the environmental relief (as later especially Thomas Malthus), the introduction of durable goods is seen as a positive historical incident making it possible to accumulate unlimited property without causing waste through spoilage. Especially important is the introduction of money in form of gold and silver and later paper money as it could be ‘hoarded up without injury to anyone’ (Creutz, 2003), since money could not spoil or decay in the hands of the possessor. Locke was aware of the problems of unlimited accumulation of money but implied that government should intervene to moderate conflicts evolving of e.g. the pursuing unequal distribution of income. Consequently, the main contradictions of the incorporation of ‘money’ in the economic system can be followed back at least as far as to Locke and his thoughts on monetary and money-accumulating matters. The current criticism of globalisation, the unregulated, unlimited free flow of capital and the unequal distribution of income (OECD, 2008) makes it necessary to include Locke’s thoughts having not lost any soundness in current capitalistic structures.

Source: Author

Physiocracy

Physiocracy, literally meaning ‘power of nature’ and the Physiocrats, a group of 18th century French philosophers, believed that nature is the sole source of productivity (Senf, 2008) or agriculture as the sole source of wealth in an economy (FED, 2009). The productive class were farmers and aristocrats, the ones in connection with the productive land. The unproductive class, the bourgeoisie (as later called by Marx) working in manufacturing or commerce was thought not to be participating in any value-added. As a reaction against the Mercantilists’ copious trade regulations the Physiocrats advocated a policy of laissez-faire, which called for minimal government interference in the economy (FED, 2009), but came to an end with the rigidly-appearing feudal structures in the French Revolution in 1789 (Immler, 1985 in Senf, 2009) in which only aristocrats ‘harvested the fruits of nature’ (Senf, 2008) leaving the middle class and farmers with very few. The inherited property of the aristocrats and their hegemony over farmers resulted in peasants’ revolts and proposed a provocation for the growing middle class and especially Adam Smith arguing that not nature but labour is the core source of productivity and value-added.

Table 2: Physiocracy and Francois Quesnay François Quesnay (1694-1774)

Important for economic history is Quesnay’s work ‘Tableau Economique’ in which he created the first economic circle (newschool.edu, 2009). However, within feudal structures desperately tying to legitimise the hegemony of aristocrats during times of growing tensions in the middle class. The surplus value or net product resulting from agriculture and farming was seen as the only way of adding value but, still, Quesnay formulated objections of uncontrolled exploitation of nature and to be cautious not to take more than is actually coming out of it (Senf, 2008). At this point, it is important to notice the early concerns about nature, which is, due to ongoing concerns about the ecological crisis and the scarcity of raw materials, arguably more important than ever before.

Source: Author

Classical Economics

The classical macroeconomic approach marks the historic step into modern economic thought. Adam Smith’s profoundly-changing major work ‘The Wealth of Nations’ by promoting increasing productivity through the division of labour (instead of the Physiocrat’s view of nature as source of productivity and prospering wealth) and the expansion of international trade by reducing trade barriers (instead of the Mercantilists’ protectionist view of the matter) lay the foundations for the liberalisation of markets and the abolishment of feudal structures in the economy (Senf, 2008; Creutz, 1993; FED, 2009). The economists of this time were deeply affected by the Industrial Revolution, a period in the late 18th and early 19th century (however timeframe varies from author to author⁴ ), altering the views of Mercantilists and Physiocrats indispensably.

Table 3: Classical Economics

‘The Classics’ Adam Smith, David Ricardo… and Thomas Malthus

S&N (2005) suggest the monumental work ‘The Wealth of Nations’, written in 1776 by the Scottish pioneer of classical economics Adam Smith (1723-1790), as the primary source in an attempt to convert the notion of macroeconomic supply and demand into more sophisticated contextual understanding. The book revealed Smith’s view that demand depended upon the price of goods whereas, reversely, there was no influence of prices stemming from demand (further explained in Say’s law of markets below). The book identified land, labour, and capital as the three factors of production and the major contributors to a nation's wealth (FED, 2009) and gave the laissez-faire economy its foundation (manager-magazin.de, 2009 leaning on the Physiocrat’s view) by arguing that the ‘ideal economy’ is a self-regulating market system that automatically satisfies the ‘economic needs’ of every individual. There are, however, contradictions in Smith’s work. On the one hand, he argues that labour is the only factor creating value. On the other hand, he argues that wages, profits and the interest rate are ‘rewards’ for the use of the factors influencing production, namely labour, capital and land (manager-magazin.de, 2009; Senf, 2008)??

David Ricardo (1772-1823), building upon the thoughts of Adam Smith that the real value of goods is ‘the toil and trouble of acquiring it’ (emphasizing the production of income, therefore labour), further developed the ‘labour theory of value’ focusing on the distribution of income among landowners, workers, and capitalists (FED 2009, manager-magazin.de 2009). Ricardo saw a conflict between landowners on the one hand and labour and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits (FED, 2009). With the development of a capitalistic ‘mode of production’ (term invented by Marx) sought to maximise productivity increases to benefit ‘the butcher, the brewer, or the baker’ (following Adam Smith) conditions at work worsened (Senf, 2008). Soon the living standards felt to be worsened as well and a labour movement came up calling for improved conditions for work and life and the radical criticism of classical economics headed by Karl Marx.

In stark contrast to the classical views of Adam Smith and opposed to many of the ideas of David Ricardo, Thomas Robert Malthus (1766-1834) had a more grim view of future prosperity. This vision mainly stemmed from his pessimism towards population growth outstripping natural resources (which is also known as the Malthusian catastrophe). Malthus pointed out that human populations tend to grow exponentially⁵, while the capabilities of agricultural resources tend to grow arithmetically. In this respect, Malthus recognised the scarcity of natural resources and the boundaries in which the world economy is moving (further discussed in Chapter 4 under heading Environment) and therefore rejected the Say’s law of markets that, simplistically, supply is creating its own demand mentioning, at least unconsciously, the general saturation of markets. It was a very rare, pioneering view of the matter in times of promoted specialisation (the division of labour) and the ‘logically following’-growing ‘wealth of nations’. Malthus influenced e.g. Keynes in his thoughts (manager-magazin.de, 2009, Keynes, 1936).

Source: Author

Say’s Law

The French economist Jean Baptiste Say (1767-1832) originated the classical analysis with the Say’s law of markets in 1803. The law constituted the impossibility of overproduction which meant that all the products produced by the workforce were also affordable by the workforce at the same time. Hence, according to S&N (1998, 2005), there was no clear-cut difference between a money economy and a barter economy (see box below).

Barter economy vs. Money economy

Even before Mercantilism, when the exchange medium money was not in existence yet, people who wanted to offer their products, had to find a person with the need for the other person’s good. Barter as medium of exchange was a difficult process in which acceptor and supplier both needed to have a superior use of each other’s offers (letting alone that the perceived value of the barter had to correspond in the eyes of both economic agents). In a ‘money economy’ of today, money is legitimated as a ‘universal intermediary’. Therefore, everybody will be able to re-use money for the next encounter with an economic agent to purchase or sell without the fear that the exchange medium money will be unacceptable⁶. This, at first glance, fabulous transition to a universal exchange medium, however, comes with inherent inconsistencies and will be analysed in Chapter 3 more thoroughly.

Many renowned economists were supporters of the classical macroeconomic approach, e.g. additionally including John Stuart Mill (1806-1873), Alfred Marshall (1842-1924) and Arthur Cecil Pigou (1877-1959). The latter constituted the approach in the following passage during the Great Depression: ‘ In absolutely free competition there will always be a strong tendency towards full employment. If there is unemployment to a certain time, it is only because of ‘ frictional resistance ’ , which hinders immediate adjustments of wages and prices ’ (Pigou 1933 in S&N, 2005, p. 963).

In order to understand the above quote and Say’s Law it is important to note the three market mechanisms of classic (and neoclassic) thoughts (Senf, 2008).

S&N (2005) point out that Say’s law is the forming of prices (1st mechanism on the market for goods/products) and wages (2nd mechanism on the labour market) on competitive markets. Both mechanisms are flexible to go up or down, depending on whether an excess of supply over demand or vice versa is occurring. Figure A (only) indicates the self-correcting forces of these two mechanisms in which, simplistically, self-adjustment is taking place (as the red arrows suggest). Therefore, S&N argue, that changes in money supply, fiscal measures and other e.g. governmental expenditures do no influence production and employment in the long term making economic measures to e.g. push aggregate demand worthless attempts to increase (or preventing from decreasing) real economic output and GDP. Prices and wages adjust themselves and provide full employment and only ‘frictional unemployment’ (S&N, 2005) or ‘sectoral disequilibrium’ (Senf, 2008) in the short term as adjustments take place. In the long run, however, the (neo)-classical approach does not support any ‘macroeconomic misuse’ of unexploited resources due to insufficient overall demand.

Figure A: The Classical macroeconomic approach

illustration not visible in this excerpt

Source: Source: Welker’s Wikinomics, 2009

The third mechanism is the interest rate on the capital market, acting as a compensator for the money that is saved and its need for integration into the economic cycle⁷ through credit to equilibrate aggregate demand (Senf, 2008). This is the main task of financial markets and banks: to bring money that is saved (not spend!) back into the economic cycle to make sure that fluctuation in the spending patterns of individuals (the economic agents) is equilibrated. Especially the third mechanism will be under severe criticism later in the discussion.

Due to the (neo)-classical assumption of general equilibrium (S&N, 2005) or ‘the optimal allocation of resources’ (Senf, 2008, p. 54) in the marketplace, unemployment could only stem from continuous frictional disequilibrium. Senf (2008) criticises that the ‘Wealth of Nations’ never really made its way into the wider population and dire poverty was prevalent disregarding the self-regulatory mechanisms as incomplete in their nature.

Neoclassic and Marginalist School

At the beginning of the 1870s the foundations for the Neoclassic were laid independently from each other from the Austrian Carl Menger (catalyst of the Austrian School development), the English-man Stanley Jevons and the French Léon Walras. Many of the ideas, however, were pronounced distinctively earlier from Hermann Heinrich Gossen (1810- 1858) and his rather famous laws closely linked with the Marginalist movement. Details attached later to the theoretical framework⁸ were made by e.g. the Englishman F.Y Edgeworth, Alfred Marshall and the Italian Vilfredo Pareto (Pareto-efficiency when producer and consumer are perfectly satisfied; S&N, 2005). Marxist theory as the counterpart and driving force for the upcoming of the neoclassical school of thought was commonly ignored or distorted with the attempt to oppose the theories brought forward by Marx and Engels (Senf, 2008, p. 117).

Important in this context is the disregard of the Marxian’ theory of the question where value- added or the surplus value comes from in the first place. Furthermore, the classic labour theory of value is not mentioned anymore neither the conflict between labour and capital (as by some Classics). The notions of value, value-added or surplus value are non-existent in the neoclassical framework and solely concentrate on ‘matters on the surface’ as e.g. economic activity and prices on different markets under differing circumstances - a microeconomic approach towards macroeconomic understanding (economictheories.org, 2008). The latter makes the underlying surface of the history of origins of capitalistic structures perfectly invisible and creates (using the afore-mentioned ‘mathematisation-strategy’⁹ ) a picture of capitalism as ‘the only game in town’ with ‘appropriate theoretically-sound backing’. The different theories underlining neoclassical thoughts will not be analysed any further at this point. Only important is the notice that the theory has grown to more and more logical coherence but as Senf (1998) argues is far away from what it should be. Erich Fromm¹⁰ (cited in Senf, 2008) posited: ‘ In order to have a healthy economy, we need emotionally sick people. ’ Modern¹¹ neo-classical thought is build upon the thoughts of Robert Lucas, Thomas Sargent and Robert Barro. Important is the coined term ‘Rational Expectations’ (of the homo oeconomicus) to explain at least part of the deviations of general thought occurring in e.g. the Phillips curve¹². Theoretically, the neo-classical approach leads, under certain circumstances, to a ‘market clearing equilibrium’ of ‘Pareto efficient’ (in perfect competition) due to its ‘mixture’ of rationality and market adjustments (of prices, wages and production essentially¹³ ) creating an ‘aggregate equilibrium’.

The ideas of the self-regulating market forces of the Classics combined with the neoclassical mathematical frameworks to underline the classic assumptions was thought to prevent disequilibrium and unemployment in the marketplace and levelled the way for modern capitalism (Senf, 1998). Marxists, on the other hand, had another - more underlying - view of the capitalistic future which will be briefly outlined below.

Marxist School

The Marxist School challenged the foundations of Classical theory. Karl Marx saw capitalism as an evolutionary phase in economic development. He believed that capitalism would ultimately destroy itself and be succeeded by a world without private property (FED, 2009). Marx insights into capital, as George Soros observed, are often more sophisticated than those of Adam Smith (De Soto, 2000¹⁴ ).

The historical development of capitalism or what Marx called the original or initial accumulation could only happen with the shift of individual labour or work to dependant ‘paid labour’ and the shift from sole capital to ‘productive capital’ (the capitalistic shift from ‘work’ to ‘means of production’ equalling paid labour!). For Marx, these changes were the prerequisites (additionally the upcoming of international trade and the invention of money as store of value or the ‘artificial accumulation of capital’) for the exploitation of workers by means of growing pressures of capital (Senf, 2008).

Another important contributor to the problems of owning property was Pierre-Joseph Proudhon (1809-1865), calling himself an anarchist, talking in his work ‘What is Property’ (1840) about the unjustified power of accumulation possessed by property¹⁵. Both predicted, in their individual ways of expressing the matter, the growing misery for workers, as competition for profit led capitalists to adopt labour-saving machinery, creating a ‘reserve army of the unemployed’ who would eventually rise up and seize the means of production (FED, 2009).

The American economist Lester Thurow points out that as recently as 1941, ‘ the United States and Great Britain were essentially the only major capitalist countries left on the face of the earth … All the rest of the world were fascists, communists or Third World feudal colonies ’. The final crisis of the 1920s and the Great Depression of the 1930s had brought capitalism to the edge of extinction. The capitalism that today seems irresistible could, with just a few missteps, have vanished (De Soto, 2000).

Table 4: Marxism, Marx and Engels

Karl Marx and Friedrich Engels

Karl Marx (1818-1883) and Friedrich Engels (1820 to 1895) and their major economic work ‘Das Kapital’ are the contributors and original strivings for modern day Marxist economics. They predicted the failure of capitalism, that is to say, to a time when Capitalism triumphed in the 19th century and prevailed throughout the industrialized world until the Russian Revolution and the Great Depression (De Soto, 2000). Coming back to two factors influencing production, work and capital, it was classically thought that there were in ‘mutually justifiable exchange’ to each other. Marx, however, evaluated that, despite their main contribution to the finished products, the value-added was not entirely distributed among the workers. The other stake (which Marx called ‘surplus value’) of the value-added flew into the pockets of capital and land owners in form of profits, interest and ground rent (Senf, 2008). The surplus was then, at least partly, re-invested to increase productivity, hence profitability in order to withstand increasing ‘capitalistic pressures’. Essentially,

Marx disregarded Smith’s theory; as if with increasing division of labour wealth would follow for arguably every individual (the invisible hand). On the contrary, Marx suggested that conflicting interests of paid labour and capital would result in growing tensions (Senf, 2008 calls this phenomenon the ‘dialectical unity of the opposite’). The only remedy to this problem Marx and Engels could think of to that time (neglecting to investigate the causes from another standpoint as e.g. of a reform in the monetary system) was the ‘defeat of capitalistic relations of production’ by ‘nationalizing the means of production’.

These are the thoughts on which centrally-planned economies are based on. The Great Depression was for supporters of the Marxist theory evidence for the rightness of Marx’s and Engel’s assumptions, however, proved arguably wrong with the relatively recent collapse of the former Soviet Union and the GDR..

Source: Author

De Soto (2000, p. 208/209) goes on that only twenty-five of the world’s two hundred countries produce capital in sufficient quantity to benefit fully from the division of labour in expanded global markets. ‘The lifeblood of capitalism is capital.’ (De Soto, 2000, p. 209) To illustrate, De Soto explains that capital provides the means to support specialization and the production and exchange of assets in the expanded market. It is capital that is the source of increasing productivity and therefore the wealth of nations. However, following the thoughts of Soros (1998), De Soto did read but probably not understand, at least not expressed properly, that at the end of the day, productive work creates real value(-added) and capital is only the prerequisite as well as the result (thinking about the economic cycle!). George Soros (1998) puts it that way when talking about the role of money and its different functions in the economy: ‘ Money is a means to an end, not an end in itself ’.

As e.g. O’Rourke (1998) and De Soto (2000) argue that the accumulation of wealth is a positive thing, making everyone richer - on average - is commonly accepted nowadays. Marx, however, realised the unequal distribution of income (the pressures of capital and surplus value!) but could not foresee that redistribution is a way of benefiting a growing number of people through the inherent pressures to accumulate in order to compete.¹⁶

Keynesian Economics

‘In the long run, we are all dead!’ (Senf, 2008; Keynes 1936) It was in the early 20th century when the Great Depression¹⁷ curved its way into historic textbooks devaluing the classical approach and justifying the concerns of Marxists. Keynes statement, concerning the above quote, of non-interventionist classical macroeconomic politics questioned the classical approach fundamentally.

Macroeconomic unemployment occurred and even so it was not the first encounter with the same, there was for the first time an alternative analysis to the classical approach within capitalistic structures (in comparison with Marxist view). The Keynesian approach stems from the arguably greatest economist in the 20th century John Maynard Keynes¹⁸ and was immortalized in Keynes most important work ‘The General Theory of Employment Interest and Money’ published in 1936.

The theory of Keynes

Keynesian revolution combined two different elements in which overall supply and overall demand was interpreted differently. Whereas the (neo)-classical approach assumed flexible prices and wages and therefore a vertical supply curve, the Keynesian approach constituted inflexible prices and wages and a flat or slightly upwards proceeding supply curve AS (S&N, 2005). Figure B indicates the Keynesian ideas in times of recession when supply stagnates because of shrinking demand in the marketplace. Real GDP decrease would follow and, according to Keynes, needed to be equilibrated by government intervention to accelerate demand again (also with the multiplier coming into effect¹⁹ ) to eventually overcome the recession. In economic prosperity and boom, he argued, the debts could have been repaid using anti-cyclical fiscal politics to stabilise the booming economy downwards.

Figure B: The Keynesian macroeconomic view

illustration not visible in this excerpt

Source: Welker’s Wikinomics, 2009

The theoretical framework of Keynes theory

Later on, the Keynesian theory became to be called demand-orientated²⁰ and, according to Senf (2008), was hedged in with clauses and mathematical frameworks like the IS-LM- model²¹ diluting the way to the essential thoughts of the English-man. When Keynes wrote his General Theory, he already knew that parts of his theory and ideas explaining the Great Depression would make the neoclassical theory of self-regulation collapse and, therefore (Senf, 2008), gave only hints pointing towards the problems of neoclassical thought. It is fairly easy, however, to explain the matter he was talking about: money. Money, as seen in Figure C (and later on in Chapter 3), and capitalism (in the narrow sense of accumulating capital in form of money) do have great advantages but also some shortcomings. Keynes was able to explain some of the contradictory issues around the subject of modern money and its companions in capitalist economies.

Table 5: Keynes theoretical framework

Keynes theoretical framework in depth

The theoretical frame work of Keynes stands on three pillars, basically:

- The propensity to consume and the inducement to invest
- The investment theory
- The liquidity theory

With the above theories, Keynes gave an explanation of the, back then, recent Great Depression with mass unemployment and gave attempts at a solution with his deriving theory of employment as a basis for future prevention of crises. Keynes, opposed to the neoclassical view, accepted the ‘unstableness’ of capitalism and argued that with developed capitalism, crises will become even more prevalent. He did, however, dispose Marx view for a counter-revolution to overcome capitalism and instead proposed measures for government interference to overcome recessions without much misery.

Keynes first looked at the neoclassical equilibrium between saving and investing on the capital markets. What he found out was, opposing to the neoclassics, that the interest rate is not the dominant factor deciding over whether to consume or invest. More importantly, Keynes argued, is the income level and thereof followed that disequilibrium could occur because of slumping aggregate demand. That was due to his second statement that with growing income the propensity to consume is absolutely increasing but relatively decreasing. Therefore, with growing income the saving ratio is higher. Transferring this on macroeconomic level would mean that mature capitalistic economies would accumulate more and more capital (which will be analysed later). This growing lack of aggregate demand, however, needed to be refilled in order to guarantee a functioning economic cycle. Keynes, otherwise he would not have proposed government interference in monetary form, had his doubts about the contradiction of growing assets and aggregate demand.

The second pillar revealed Keynes argument for which reason aggregate demand would lack behind the growing wealth in capitalist economies. Besides arguing that the ‘principle of self-realising expectations’ could lead to severe downturns as well as incredible upward trends making future investment decisions accordingly either difficult or rather easy respectively (with some importance devoted to the interest rate), Keynes expected an overall decreasing rate of return making investments increasingly unattractive. At this point, the influence from the ‘alternative classic’ Thomas Malthus is definitely given with Keynes talking about the saturation of markets, limitation of aggregate demand, limitation of aggregate supply due to the scarcity of resources etc. He explained in the long-term the decreasing ‘marginal efficiency of capital’ combined with rational expectations of future decreasing rate of return would eventually fall behind the short- term rate of interest rendering investments (due to their risk!) economically not advisable. It would follow a chain reaction eventually leading to an economic crisis. Neoclassical proponents would now see two correcting mechanisms in progress to restore full employment in direction of equilibrium: decreasing interest rate on the capital market (still a common procedure with the central banks’ lowering of the base rate nowadays²² ) and sinking wages on the labour market²³.

The third pillar was closely related with the decreasing rate of the interest rate. The neoclassical view argued for a lowering of the interest rate in recessional times for example to make investments profitable, namely lower than the expected rate of return for future investments. Keynes, however, criticised the neoclassic and the two forms of either consuming or saving (in form of interest-receiving e.g. bonds or treasuries). He presented a third form of utilising money for ‘liquidity preferences’²⁴ to hold money in the most liquid form for e.g. speculative motives. The ‘carrying costs’ of money are low for which reason hoarding was the third way to hold money. The contradiction of the lowering of the interest rate to stimulate demand and the growing tendencies to hoard money are evaluated more closely in Chapter 3. Bleaney (1985) found that many writers much exaggerated the liquidity trap and that the interest rate would effectively be infinitely elastic (this statement will be challenged later).

Source: Author; Senf, 2008

Keynes proposed levelling-out of business cycles to overcome a crisis, however, led to growing national debts and growing inflation pressures in Western economies and paved the way for the counter-revolution of especially Monetarists (wiwo.de, 2009; Senf, 2008). However, before some evidence from his original piece of 1936 that ‘the results of filling in the gaps in the classical theory is not to dispose of the ‘Manchester System’, but to indicate the nature of the environment which the free play of economic forces requires if it is to realise the full potentialities of production’ (Keynes 1936, p. 379). ‘In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far- reaching change in the psychology of investment markets such as there is no reason to expect. [Therefore the] duty of ordering the current volume of investment cannot safely be left in private hands’ (Keynes, 1936, p.320).

Monetarism

Harry G. Johnson (cited in Senf, 2008, p. 242) explained Monetarism to be an ‘effective, theoretical, ideological and economical counterblow’ against Keynesian economics. The foundations were laid by Milton Friedman (1912-2006) as early as in the 1960s but it took until the 1980s and the adoption of a wide array of monetarist policies from then US-president Ronald Reagan²⁵ and UK-prime minister Margaret Thatcher to eventually become accepted as the core macroeconomic policy in Western economies.

Whereas Keynesian supporters argued that there are several forces influencing overall demand, Monetarists supported the view that deviations in the money supply are the main force contributing to production and price shifts (S&N, 2005). Friedman (1973 in Senf, 2008) concluded from the monetary politics of the FED in the US that measures over the past 50 years²⁶ were never appropriate and either too strong or too weak for proper results. Thereof, Senf (2008) follows from the Monetarists that no stabilisation politics²⁷ are the best politics. From this standpoint the monetarist theory of Friedman emerged.

In order to understand the ‘money approach’ (Only money matters!) of monetarists it is helpful to draw upon the equation of exchange, the concept of the velocity of money and the quantity theory (of money and prices).

Equation of exchange and velocity of money

The theory of the velocity of money is based on Alfred Marshall²⁸ and American economist Irving Fisher²⁹ and simply measures how many times an average coin is handed out in exchange for goods and services³⁰. The more often that average coin is exchanged, the higher is the velocity of money. The concept of the velocity of money is formalised in the equation of exchange as outlined in the box below.

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¹ In medical literature a blind spot is the place in the visual field that corresponds to the lack of light-detecting

photoreceptor cells on the optic disc of the retina where the optic nerve passes through it. Since there are no cells to detect light on the optic disc, a part of the field of vision is not perceived. The brain fills in with surrounding detail and with information from the other eye, so the blind spot is not normally perceived (Wikipedia, 2009).

² No responsibility is accepted for the correctness of academic, topic-specific terms used in this work, nor is it the attention, but to show connections without many preconceptions of the subject area

³ From hereon, Samuelson and Nordhaus will be abbreviated as S&N.

⁴ E.J. Hobsbawm in The Age of Revolution 1962, cited in S&N, 2005 (German version) described it thus: ‘The Industrial Revolution was no contemporary phenomenon, which beginning and end we are aware of…It is happening permanently and still today.’

⁵ The word ‘exponentially’ or non-linear will be used in a certainly different context later and stands in stark contrast to the meaning of the word ‘arithmetically’ or linear. Further explanation will be given later.

⁶ Under normal circumstances, exceptions to be evaluated later

⁷ Further information about the economic cycle and the role of money is given in Appendix 1; It is questioned if the term ‘economic cycle’ is appropriate in the English language

⁸ Senf (2008) argues that the later ‘mathematisation’ of the neoclassical theory (but also all the others) at least partially emerged because of the ‘inferiority complex’ of economists to that time which could not present any clear-cut results as scientists or technicians were able to present.

⁹ Marginalists provided modern macroeconomics with the basic analytic tools of demand and supply, consumer utility, and a mathematical framework for using those tools (FED, 2009).

¹⁰ Important social psychologist marked by Marxism and psychoanalysis, lived from 1900 until 1980

¹¹ As the author and e.g. Immler (n.d.) calls the latest adjustments of Neoclassical thought

¹² The Phillips curve will be further analysed in Chapter 2

¹³ Equilibrium of the interest rate is controversial

¹⁴ De Soto talks about the book ‘The Crisis of Global Capitalism’, 1998 of billionaire George Soros

¹⁵ Referenced from a German student in Economics whose dissertation is about Proudhon in a conversation in August, 2008

¹⁶ If Marx would see the current developed world he would probably be surprised. If, however, shown third world countries and starving children, he would have probably been felt confirmation in his opinion on capitalism.

¹⁷ For further information refer to Appendix 2

¹⁸ More information about Joseph A. Schumpeter and the Austrian School is given in Appendix 3; Appendix 4 gives some insights into Keynes life

¹⁹ There is still a lot of debate about the multiplier. The current debate, whether or not the economic policies to inject money into the US-economy are going to be effective, is open to discussion. Paul Krugman says that the multiplier is above 1, meaning the policies would have a positive effect whereas Robert Barro calculated a multiplier smaller than 1, rendering the policies as not as effective. (wiwo.de, 2009)

²⁰ In contrast to supply-orientated Monetarism discussed later.

²¹ The IS-LM model is not from Keynes but was developed by economist John Hicks in 1937 as an interpretation of some of the thoughts from the General Theory and will not be further discussed due to its incoherency of some of the aspects not included in the model.

²² There is, however, no guarantee anymore in mature economies. The best example being Japan and the BoJ

having a base rate of 0 or near to 0% for many years now; later more. ‘Quantitative Easing’ is one of last resorts to finally get the economy going again. The BoJ does it for years, whereas the FED just introduced measures in March 2009 to do the same. Some (e.g. Sicheres Geld, 2009) raise severe concerns for economic stability.

²³ S&N, 2005 argue that the rigidity of wages downwards is clearly evident e.g. in the US. Senf (2008, p. 211) says that trade unions play an important role in the rigidity of wages downwards. Therefore, it renders the neoclassical view a worthless attempt to self-regulate. Creutz, 2003 points out that it would be counterproductive to lower wages due to shrinking aggregate purchasing power in the economy. He also hints towards a new tax system (compare e.g. Humanwirtschaft, 2008) for not only fairer distribution of income but also greater purchasing power in the economy to reduce a drop in aggregate demand considerably.

²⁴ Free-economist supporting Dieter Suhr (Senf, 2008, p. 210) compares money with the Joker in card games due its superior position over goods and services

²⁵ Senf (1998, 2008) relates the shift in macroeconomic policy primarily to the collapse of the Bretton Woods system in the 1970s and the growing inflation pressures for the US-economy due to former Keynesian politics which, by then, could not shifted on to other countries as was possible with stable exchange rates on the foreign exchange market between 1944 and 1971

²⁶ From the Great Depression in the 30s to 1973, of course

²⁷ Neither monetary policies nor fiscal measures

²⁸ Lived from 1842 to 1924 and lectured at Cambridge University. Two important students were Arthur Cecil Pigou and John Maynard Keynes.

²⁹ Further information about Irving Fisher is given in Appendix 5.

³⁰ Compare with the economic cycle in every modern economy outlined in Appendix 1.