Emperors of Finance subdued Captains of Industry

Extract from The Creditary/Monetarist Debate in Historical Perspective
by Dr. Michael Hudson

The promise of French and German industrial banking prompted Marx to believe that finance capital would become subordinate to industrial capital. In Part III of his Theories of Surplus Value (Moscow 1971:468) he analyzed the tendency of finance capital to grow at compound rates of interest without limit, but then dropped his analysis of this phenomenon on the ground that finance capital, like land rent, was becoming thoroughly subordinated to the dynamics of industrial capital.

“In the course of its evolution, industrial capital must therefore subjugate these forms and transform them into derived or special functions of itself,” he wrote optimistically. Although not originally established “as forms of [industrial capitalism’s] own life-process,” monetary and banking fortunes would be mobilized to fund economic expansion, just as the land itself was being industrialized into what today is called agribusiness. “Where capitalist production has developed all its manifold forms and has become the dominant mode of production,” Marx concluded, “interest-bearing capital is dominated by industrial capital, and commercial capital becomes merely a form of industrial capital, derived from the circulation process.” There is no anticipation here of debt dragging down the industrial system.

Nearly all historically minded economists shared this optimistic view of finance capital’s subordinate role. The German Historical School and others pointed to the fact that interest rates tended to fall steadily with the progress of civilization; at least, rates had been falling since medieval times. Credit laws were becoming more humanitarian, and the debtors prisons described so graphically by Charles Dickens were being phased out throughout Europe, while more lenient bankruptcy laws were freeing individuals to start afresh with clean slates. Public debts in Europe and North America were on their way to being paid off during the remarkable war-free century 1815-1914. Savers and investors were seeking out heavy transport, industry, mining and real estate to fund, mainly through the bond market. The consensus among economists was that the debt burden would be self-amortizing. Debt problems were curing themselves, by being co-opted into a socially productive credit system.

As matters have turned out, emperors of finance subdued captains of industry. What is striking is how unlikely the prospect of a corrosive and unproductive debt overhead appeared a century ago. When war broke out in 1914, Germany’s rapid victories over France and Belgium seemed to reflect the superior efficiency of its financial system. To some observers the Great War appeared as a struggle between rival forms of financial organization to decide not only who would rule Europe, but also whether the continent would have laissez faire or a more state socialist economic system. In 1915, shortly after fighting broke out, the German Christian Socialist priest-politician Friedrich Naumann summarized the continental banking philosophy in Mitteleuropa. In England, Prof. H. S. Foxwell drew on Naumann’s arguments in two essays published in the Economic Journal in September and December 1917 (Vol. 27, pp. 323‑27 and 502‑15): “The Nature of the Industrial Struggle,” and “The Financing of Industry and Trade.”

Foxwell quoted with approval Naumann’s contention that “the old individualistic capitalism, of what he calls the English type, is giving way to the new, more impersonal, group form; to the discipline, scientific capitalism he claims as German.” This conclusion followed from Naumann’s claim that “Into everything today there enters less of the lucky spirit of discovery than of patient, educated industry. To put it otherwise, we believe in combined work.” Germany recognized more than any other nation that industrial technology needed long‑term financing and government support. In the emerging tripartite integration of industry, banking and government, Foxwell concluded (p. 514), financing was “undoubtedly the main cause of the success of modern German enterprise.” The nation’s bank staffs already included industrial experts who were forging industrial policy into a science. Bankers and government planners were becoming engineers under the new industrial philosophy of how governments should shape credit markets. (In America, Thorstein Veblen voiced much the same theory in The Engineers and the Price System.)

The political connections of Germany’s bankers gave them a voice in formulating international diplomacy, making “mixed banking . . . the principal instrument in the extension of her foreign trade and political power.” But rather than recognizing the natural confluence of high finance, heavy industry and interventionist government policy, English common law opposed monopolies and other forms of combination as constituting restraints on trade, while Britain’s medieval guilds had evolved into labor unions that had embarked on a class war against industrial employers. Germany’s historical form of organization was the professional guild developed at the hands of masters, leading to industrial cartels.

Foxwell’s articles implied a strategy of capital working with governments to undertake military and diplomatic initiatives promoting commercial expansion. The economic struggle for existence favored growing industrial and financial scale, increasingly associated with government support. The proper task of national banking systems was to finance this symbiosis, for the laws of economic history were leading toward political centralization, national planning and the large‑scale financing of heavy industry.

The short-term outlook of English merchant bankers ill suited them for this task. They based their loan decisions on what they could liquidate in the event of loan default, not on the new production and income their lending might create over the longer run. Instead of taking risks, they extended credit mainly against collateral available for seizure: inventories of unsold goods, money due on bills for goods sold to customers but not yet paid for, and real estate.

British bankers paid out most of their earnings as dividends rather than investing in the shares of the companies that their loans supposedly were building up. This short time horizon forced borrowers to remain liquid rather than giving them the leeway to pursue long‑term strategies. Foxwell warned that British manufacturers of steel, automotives, capital equipment and other heavy industry were becoming obsolescent largely because the nation’s bankers failed to perceive the need to extend long‑term credit and promote equity investment to expand industrial production. By contrast, German banks paid out dividends (and expected such dividends from their clients) at only half the rate of British banks, choosing to retain earnings as capital reserves and invest them largely in the stocks of their industrial clients. Viewing these companies as allies rather than merely as customers from whom to make as large a profit as quickly as possible, German bank officials sat on their boards and extended loans to foreign governments on condition that these clients be named the chief suppliers in major public investments.

Although Britain was the home of the Industrial Revolution, little of its manufacturing had been financed by bank credit in its early stages. Most industrial innovators were obliged to raise money privately. England had taken an early lead in stock market promotion by forming Crown corporations such as the East India Company, the Bank of England and the South Sea Company. Despite the collapse of the South Sea Bubble in 1720, the run-up of share prices in these monopolies from 1715 to 1720 established London’s stock market as a popular investment vehicle for the Dutch and other foreigners as well as for British investors. But industrial firms were not major stock issuers. The stock market was dominated by railroads, canals and large public utilities. In fact, Britain’s stockbrokers were no more up to the task of financing industrial innovation than were its banks, having an equally short‑term frame of reference.

After earning their commissions on one issue, they moved on to the next without much concern for what happened to the investors who had bought the earlier securities. “As soon as he has contrived to get his issue quoted at a premium and his underwriters have unloaded at a profit,” complained Foxwell, “his enterprise ceases. ‘To him,’ as the Times says, ‘a successful flotation is of more importance than a sound venture.’”

Much the same was true in the United States. Rejecting the methodical German approach, the Anglo-American spirit found its epitome in Thomas Edison, whose method of invention was hit-and-miss, coupled with a high degree of litigousness to obtain patent and monopoly rights. America’s merchant heroes were individualistic traders and political insiders who often operated on the edge of society’s laws to gain their fortunes by stock-market manipulation, railroad politicking for land giveaways, and insurance companies, mining and natural resource extraction.

Neither British nor American banks were technological planners for the future. Their job was to maximize their own short-run advantage, not to create a better and more productive society. Most banks favored large real estate borrowers, along with railroads and public utilities whose income streams easily could be forecast. Manufacturing only obtained significant bank and stock market credit once companies had grown fairly large.

The monetarist attack on public planning

Industrial banking principles imply a distinction between “real wealth” and “paper wealth” in the form of loans and securities that represent claims on tangible assets. To prevent financial systems from loading economies down with debt without helping create the means to pay, it is necessary to distinguish credit to finance direct investment in new means of production from speculative banking and stock market promotion that merely inflates asset prices. This distinction might well form the basis for a more industrially oriented financial regulation. But like other investors, most banks and stock market investors want to be left alone to make money as quickly as possible. Their opposition to regulation is responsible for some of the most serious blind spots in monetarist economic philosophy.

Prior to the early 1960s most observers viewed the trend of history as leading society to take control of its evolution. Economic thought aimed at refining the ways in which governments might plan their fate. Most countries adopted Keynesian macroeconomic planning to “fine-tune” their economies. France pursued planification, while England nationalized many industries. But what was being “fine tuned” was GNP. This broad measure drew no distinction between wealth and overhead. During the Vietnam War decade the inflation that ensued as America pursued an economic policy of both “guns and butter” led to a reaction that sought to limit the authority of government planning generally. So well funded was this anti-state ideology – and so silent the response by social democrats – that it soon achieved censorial power in the world’s universities, finance ministries and central banks.

Monetarism achieved its first international victory in Chile in its 1973 military coup. Free-market economists did not endorse the idea of a free market in ideas, to be sure. All economic and social science departments were closed down except for those at the Catholic University, which had established close ties to the University of Chicago. Having blocked dissent, the monetarists let supporters of the military form financial conglomerates that ran deep into debt to buy the nation’s public companies, stripping them bare and leaving the economy to be swept by a wave of bankruptcies in 1981-82.

A more politically respectable neo-liberal regime gained office in England behind Margaret Thatcher in 1979, and in 1981 Ronald Reagan brought in his backers to dismantle public oversight in the United States. Deregulation of America’s S&L industry led to a real estate bubble and collapse of the Federal Savings and Loan Insurance Corp. (FSLIC), increasing the federal debt by half a trillion dollars on its way to quadrupling. Reagan’s advisors rewrote the nation’s racketeering laws to permit takeovers by corporate raiders who repaid their backers by emptying out the bank accounts and pension fund reserves of targeted companies, selling off their divisions, cutting back on R&D and other long-term investment, and downsizing the labor force. The fact that the leading practitioners were sent to prison did not prevent a growing portion of revenue hitherto declared as profits and wages from being earmarked to pay interest on the economy’s debt load. The stock market soared as a result of raiders borrowing the money to “take companies private” and then carving them up to repay their backers.


While environmental deregulation opened the floodgates to abuses that lay the groundwork for future cleanup costs, a parallel phenomenon was occurring in the form of debt pollution as business, personal and mortgage debt levels soared. The issue of high-interest “junk” bonds to fund corporate takeovers did not fund much new tangible investment. The allocation of savings was deregulated, and savers then were bailed out of the problems suffered by the economy by their having been badly channeled. Government intervention and heavy new public borrowing were coming not through regulation, but via the need to clean up the financial bubble spurred by deregulation.

But monetarists only criticized public debt levels. Government spending was to be cut back for programs other than to reimburse savers for the bad loans their banks and S&Ls had made. This “value-free” financial philosophy meant that social values of the sort supported by Keynesian macroeconomics were to be replaced by government support for financial and real estate speculation. In Britain, monetarist concerns led to constraints being placed on the Public Sector Borrowing Requirement (PSBR) in order to limit the degree to which the public sector could issue bonds or other securities. The intention was to restrict the government’s ability to promote full employment by running into debt and thus increasing the tax burden caused by interest payments to bondholders and other creditors.

A political conflict erupted over what most people thought had long been settled: whether economies should be planned by elected representatives in the public interest, or by financial institutions seeking their own gains. One of the factors that re-opened this issue in Britain was the degree to which public enterprise had become dysfunctional. Strong union control of the British Labour Party after World War II helped make that nation one of the world’s most socialist (and highly taxed) economies. The Labour Party platform called for managing the economy in the interests of long-term development guided not by pecuniary gain-seeking but by industrial engineering principles as steered by public officials. But instead of financing new direct investment, Britain maintained employment by bureaucratic regulation and by the government itself serving as the employer of last resort.

The financial conditions for industrial modernization were neglected as Labour party planners left financial concerns to the bankers. The Treasury agreed to self-imposed guidelines that limited the public sector’s ability to run deficits. Borrowing by government enterprises was counted as part of the deficit rather than as a separate category of “productive debt” to finance tangible investment (as distinct from consumption or welfare spending). Public enterprise was left without a means to raise new investment funds, especially after the Labour government submitted to IMF austerity planning in 1976. The upshot was that the Treasury denied the nationalized steel industry and other leading public enterprises access to the credit they needed to enable them to modernize and remain competitive in the world economy.

This straitjacket left only one option to enable companies to raise the required funds. They were sold to private buyers, who were free of the Treasury’s public borrowing constraints. In this way British privatization reflected not only monetarist narrow-mindedness, but also a loss on the part of socialist planners of the classical distinction between productive and unproductive credit. No politician advocated making an exception to the Public Sector Borrowing Constraint in the case of funding direct investment for public enterprises. And in New Zealand and Australia, local Labour Party policies were even more restrictively monetarist and neo-liberal, leading to stock market and real estate bubbles that seriously disrupted their economies.

What is remarkable is that despite the fact that economic ideology at both ends of the political spectrum had come to ignore the financial logic of industrial development, Britain had developed an alternative. In 1930 the Macmillan Committee, which included Keynes as well as the trade union leader Ernest Bevin, recognized the need for long-term industrial financing. Although Bevin himself did nothing to put the report’s recommendations into effect when he became a leading member of the postwar Labour government, an institutional structure was put in place by the Borrowing (Control and Guarantees) Act of 1946. Echoing the Defense Legislation of 1939, the Act’s loan guarantees might have promoted industrial credit by enabling banks to lend to small companies for capital purposes. But this “small print” of the financial law seems never was used, and Mrs. Thatcher’s Conservatives repealed the Act in 1985.

By this time the Chicago School’s anti-government economics had won a public relations coup by capturing the hearts and minds of the Royal Swedish Academy of Sciences. To popularize monetarist views under the seemingly objective banner of science, the Academy awards its annual Economics Prize to academics seeking to strip economics of its historical and institutional dimension. A caricature of economic science is promoted that opposes public taxation and regulation of wealth on technocratic grounds of economic efficiency, whose scope is narrowly construed in a rather asocial manner.

[11]
The 1999 Nobel Prize was given to Robert Mundell, largely as an endorsement for his politically narrow version of the euro. His proposal for a limited currency union reflects the monetarist view of money as being created by private traders for their own convenience, without any need of intercession (to say nothing of management) by public institutions. A single currency simply would save “menu costs,” that is, the inconvenience of prices having to reflect currency shifts and the transaction fees entailed in making payments from one country to another within the European Community.[12]

As his colleague Arthur Laffer points out, “Mundell’s impact on the practical world of real politics can be seen in Reagan’s America, in Thatcher’s Britain, in the renaissance of Chile and Argentina, and in Jacob Frankel’s monetary policy in Israel.”[13] Exactly! Awarding him the Economics Prize endorses monetarist austerity of the sort that has loaded economies down with debt as an alternative to taxing finance and real estate, while shifting the fiscal burden onto labor. Mr. Laffer adds: “Many in the profession called him a kook. Today they call him a Nobel laureate.”

One may ask what the difference is, in view of the fact that the Nobel awards have helped redefine “economic science” in such a way as to strip away the social and institutional dimensions needed to guide governments in regulating economies.

Monetarist policy works through central banks and finance ministries to restrict regulation of the euro to so narrow a range as to shift economic planning to the financial sector. By making the Economics Prize a vehicle to counter social democratic regulation, the Swedish Academy evidently hopes to see Europe integrated on the basis of finance capital dominating governments, not the other way around. The preferred model seems to be the looser European Free Trade Association (EFTA) created by the Nordic countries and England in the late 1950s as an alternative to the European Community. Little recognition is given to the virtues possessed by the industrial banking and strong government activism of continental Europe and postwar Japan. Today’s fin-de-siecle cynicism has given up belief in society’s ability to steer itself better than can be done by its wealthiest members at the top of the pyramid increasing the degree of economic polarization via their control of finance, insurance and real estate.

Dressed up as positivist economics, monetarism is an anti-government ideology, yet it implies its own form of national planning. Russian government bureaucrats recently (1999) complained that IMF conditionalities were as intrusive as was the pre-1990 Communist planning. The difference is that the IMF program is not an industrial strategy, but favors financial interests at the expense of labor, industry and the government’s fiscal position.

The past half-century has seen an ideological war fought over whether planning should be done by governments or by financial engineers in the banking, insurance and stock-brokerage industries, and their representatives in the central banks and finance ministries. If government agencies do not take the lead, these financial institutions will fill the decision-making vacuum. It is no exaggeration to say that today’s monetarist evangelism represents the most radical proposal to restructure society since antiquity. Never before has there been a call to dismantle government as such. Every social philosophy and religion in history, as well as most political and economic theory has been developed to help guide public regulation to raise living standards and increase human happiness.

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