But two key words seem to have survived the attrition and withstood the test of time: imperialism and financialism.¹

Talk of imperialism and financialism – and particularly of the nexus between them – remains as catchy as ever. Marxists of different colours – from classical, to neo to post – find the two terms expedient, if not indispensable. Radical anarchists, conservative Stalinists and distinguished academics of various denominations all continue to use and debate them.

The views of course differ greatly, but there is a common thread: for most Marxists, imperialism and financialism are prime causes of our worldly ills. Their nexus is said to explain capitalist development and underdevelopment; it underlies capitalist power and contradictions; and it drives capitalist globalization, its regional realignment and local dynamics. It is a fit-all logo for street demonstrators and a generic battle cry for armchair analysts.

The secret behind this staying power is flexibility. Over the years, the concepts of imperialism and financialism have changed more or less beyond recognition, as a result of which the link between them nowadays connotes something totally different from what it meant a century ago.

The purpose of this article is to outline this chameleon-like transformation, to assess what is left of the nexus and to ask whether this nexus is still worth keeping.

Empire and Finance

The twin notions of imperialism and financialism emerged at the turn of the twentieth century. The backdrop is familiar enough. During the latter part of the nineteenth century, the leading European powers were busy taking over large tracts of non-capitalist territory around the world. At the same time, their own political economies were being fundamentally transformed. Since the two developments unfolded hand in hand, it was only natural for theorists to ask whether they were related – and if so, how and why.

The most influential explanation came from a British left liberal, John Hobson, whose work on the subject was later extended and modified by Marxists such as Rosa Luxemburg, Rudolf Hilferding, Vladimir Lenin and Karl Kautsky, among others.²

Framed in a nutshell, the basic argument rested on the belief that capitalism had changed: originally ‘industrial’ and ‘competitive’, the system had become ‘financial’ and ‘monopolistic’.

This transformation, said the theorists, had two crucial effects. First, the process of monopolization and the centralization of capital in the hands of the large financiers made the distribution of income far more unequal, and that greater inequality restricted the purchasing power of workers relative to the productive potential of the system. As a result of this imbalance, there emerged the spectre of ‘surplus capital’, excess funds that could not be invested profitably in the home market. And since this ‘surplus capital’ could not be disposed of domestically, it forced capitalists to look for foreign outlets, particularly in pristine, pre-capitalist regions.

Second, the centralization of capital altered the political landscape. Instead of the night-watchman government of the laissez-faire epoch, there emerged a strong, active state. The laissez-faire capitalists of the earlier era saw little reason to share their profits with the state and therefore glorified the frugality of a small central administration and minimal taxation. But the new state was no longer run by hands-off liberals. Instead, it was dominated and manipulated by an aggressive oligarchy of ‘finance capital’ – a coalition of large bankers, leading industrialists, war mongers and speculators who needed a strong state that would crack down on domestic opposition and embark on foreign military adventures.

And so emerged the nexus between imperialism and financialism. The concentrated financialized economy, went the argument, requires pre-capitalist colonies where surplus capital can be invested profitably; and the cabal of finance capital, now in the political driver’s seat, is able to push the state into an international imperialist struggle to obtain those colonies.

At the time, this thesis was not only totally new and highly sophisticated; it also fit closely with the unfolding of events. It gave an elegant explanation for the imperial bellicosity of the late nineteenth century, and it neatly accounted for the circumstances leading to the great imperial conflict of the first ‘World War’. There were of course other explanations for that war – from realist/statist, to liberal, to geopolitical, to psychological.³ But for most intellectuals, these alternative explications seemed too partial or instrumental compared to the sweeping inevitability offered by the nexus of empire and finance.

History, though, kept changing, and soon enough both the theory and its basic concepts had to be altered.

Monopoly Capital

The end of the Second World War brought three major transformations. First, the nature of international conflict changed completely. Instead of a violent inter-capitalist struggle, there emerged a Cold War between the former imperial powers on the one hand and the (very imperial) Soviet bloc on the other (with plenty of hot proxy conflicts flaring up in the outlying areas). Second, the relationship between core and periphery was radically altered. Outright conquest and territorial imperialism gave way to decolonization, while tax-collecting navies were replaced by the more sophisticated tools of foreign aid and foreign direct investment (FDI). Third and finally, the political economies of the core countries themselves were reorganized. Instead of the volatile laissez-faire regime, there arose a large welfare-warfare state whose ‘interventionist’ ideologies and counter-cyclical policies managed to reduce instability and boost domestic growth.

On the face of it, this new constellation made talk of finance-driven imperialism seem outdated if not totally irrelevant. But the theorists didn’t give up the nexus. Instead, they gave it a new meaning.

The revised link was articulated most fully by the Monopoly Capital School associated with the New York journal Monthly Review.⁴ Capitalism, argued the writers of this school, remains haunted by a lack of profitable investment outlets. And that problem, along with its solution, can no longer be explained in classical Marxist terms.

The shift from competition to oligopoly that began in the late nineteenth century, these writers claimed, was now complete. And that shift meant that Marx’s ‘labour theory of value’ and his notion of ‘surplus value’ had become more or less irrelevant to capitalist pricing.

In the brave new world of oligopolies, the emphasis on non-price competition speeds up the pace of technical change and efficiency gains, making commodities cheaper and cheaper to produce. But unlike in a competitive system, these rapid cost reductions do not translate into falling prices. The prevalence of oligopolies creates a built-in inflationary bias which, despite falling costs, makes prices move up and sometimes sideways, but rarely if ever down.

This growing divergence between falling costs and rising prices increases the income share of capitalists, and that increase reverses the underlying course of capitalism. Marx believed that the combination of ever-growing mechanization and ruthless competition creates a ‘tendency of the rate of profit to fall’. But the substitution of monopoly capitalism for free competition inverts the trajectory. The new system is ruled by an opposite ‘tendency of the surplus to rise’.

The early theorists of imperialism, although using a different vocabulary, understood the gist of this transformation. And even though they did not provide a full theory to explain it, they realized that the consequence of that transformation was to shift the problem of capitalism from production to circulation (or in later Keynesian parlance, from ‘aggregate supply’ to ‘aggregate demand’). The new capitalism, they pointed out, suffered not from insufficient surplus, but from too much surplus, and its key challenge now was how to ‘offset’ and ‘absorb’ this ever-growing excess so that accumulation could keep going instead of coming to a halt.

That much was already understood at the turn of the twentieth century. But this is where the similarity between the early theorists of imperialism and the new analysts of Monopoly Capital ends.

Black Hole: The Role of Institutionalized Waste

Until the early twentieth century, it seemed that the only way to offset the growing excess was productive and external: the surplus of goods and capital had to be exported to and invested in pre-capitalist colonies. But as it turned out, there was another solution, one that the early theorists hadn’t foreseen and that the analysts of Monopoly Capital now emphasized. The surplus could also be disposed off unproductively and internally: it could be wasted at home.

For the theorists of Monopoly Capital, ‘waste’ denoted expenditures that are necessary neither for producing the surplus nor for reproducing the population, and that are, in that sense, totally unproductive and therefore wasteful. These expenditures absorb existing surplus without ever creating any new surplus, and this double feature enables them to mitigate without ever aggravating the ‘tendency of the surplus to rise’.

The absorptive role of wasteful spending wasn’t entirely new, having already been identified at the turn of the twentieth century by Thorstein Veblen.⁵ But it was only after the Second Word War, with the entrenchment of the Fordist model of mass production and consumption and the parallel rise of the welfare-warfare state, that the process was fully and conscientiously institutionalized as a salient feature of monopoly capitalism.

By the end of the war, the U.S. ruling class grew fearful that demobilization would trigger another severe depression; and having accepted and internalized the stimulating role of large-scale government spending, it supported the creation of a new ‘Keynesian Coalition’ that brought together the interests of big business, the large labour unions and various state agencies. The hallmark of this coalition was immortalized in a secret U.S. National Security Council document (NSC-62), whose writers explicitly called on the government to use high military spending as a way of securing the internal stability of U.S. capitalism.⁶

According to its theorists, monopoly capitalism gave rise to many forms of institutionalized waste – including a bloated sales effort, the creation of new ‘desires’ for useless goods and services and the acceleration of product obsolescence, among other strategies. But the two most significant types of waste were spending on the military and on the financial sector.

The importance of these latter expenditures, went the argument, lies in their seemingly limitless size. The magnitude of military expenditures has no obvious ceiling: it depends solely on the ability of the ruling class to justify the expenditures on grounds of national security. Similarly with the size of the financial sector: its magnitude expands with the potentially limitless inflation of credit. This convenient expandability turns military spending and financial intermediation into a giant ‘black hole’ (our term): they suck in large chunks of the excess surplus without ever generating any excess surplus of their own.⁷

Now, on the face of it, the efficacy of this domestic black hole should have made imperialism less necessary if not wholly redundant. According to the theorists of Monopoly Capital, though, this would be the wrong conclusion to draw. It is certainly true that, unlike the old imperial system, monopoly capitalism no longer needs colonies. But the absence of formal colonies is largely a matter of appearance. Remove this appearance and you’ll see the imperial impulse pretty much intact: the core continues to exploit, dominate and violate the periphery for its own capitalist ends.⁸

Spearheaded by U.S.-based multinationals and no longer hindered by inter-capitalist wars, argued the theorists, the new order of monopoly capitalism has become increasingly global and ever more integrated. And this global integration, they continued, has come to depend on an international division of labour, free access to strategic raw materials and political regimes that are ideologically open for business. However, these conditions do not develop automatically and peacefully. They have to be actively promoted and enforced – often against stiff domestic opposition – and they have to be safeguarded against external threats (the Soviet bloc before its collapse, Islamic fundamentalism and rogue states since then, etc.). And because such promotion and enforcement hinge on the threat and frequent use of violence, there is an obvious justification if not outright need for a large, well-equipped army sustained by large military budgets.

In this context, military spending comes to serve a dual role: together with the financial sector and other forms of waste, it propels the accumulation of capital by black-holing a large chunk of the economic surplus; and it helps secure a more sophisticated and effective neo-imperial order that no longer needs colonial territories but is every bit as expansionary, exploitative and violent as its crude imperial predecessor.

Dependency

The notion of neo-imperialism boosted and gave credence to a subsidiary theory of dependency.⁹ This support was somewhat paradoxical, since the lineage between the two theories was weak if not contradictory. Recall that, by emphasizing the role of domestic waste, the theory of Monopoly Capital served to deemphasize if not totally negate the absorptive importance of the periphery. But the analysts of dependency put their own emphasis elsewhere. The persistence of (neo) imperialism, they claimed, showed that, regardless of its own internal dynamics, the core still needs to keep the periphery chronically subjugated and underdeveloped.

This dependency, went the argument, is the outcome of five hundred years of colonial destruction. During that period, the imperial powers systematically undermined the socio-economic fabric of the periphery, making it totally dependent on the core. In this way, when decolonization finally started, the periphery found itself unable to take off while the capitalist core prospered. There was no longer any need for core states to openly colonize and export capital to the periphery. Using their disproportionate economic and state power, the former imperialist countries were now able to hold the postcolonial periphery in a state of debilitating economic monoculture, political submissiveness and cultural backwardness – and, wherever they could, to impose on it a system of unequal exchange.

Unequal exchange can take different forms. It may involve a wage gap between the ‘less exploited’ labour aristocracy of the core and the ‘more exploited’ simple labour of the periphery. Or the core can compel the periphery to buy its exports at ‘high’ prices (relative to their ‘true’ value), while importing the periphery’s products at ‘low’ prices (relative to their ‘true’ value). As a result of this latter difference, the terms of trade get ‘distorted’, surplus is constantly siphoned into the core (rather than exported from or domestically absorbed by the core), and the eviscerated periphery remains chronically underdeveloped.¹⁰

This logic of dependent underdevelopment was first articulated during the 1950s and 1960s as an antidote to the liberal modernization thesis and its Rostowian promise of an imminent takeoff.¹¹ And at the time, that antidote certainly seemed to be in line with the chronic stagnation of peripheral countries.

But what started as a partial theory soon expanded into a sweeping history of world capitalism. According to this broader narrative, capitalism was and remained imperial from the word go: it didn’t simply start with conquest; it started because of conquest. Its very inception was predicated on geographical exploitation and domination – a process in which the financial-commercial metropolis (say England) used the surplus extracted from a productive periphery (say India) to kick-start its own economic growth. And once started, the only way for this growth to be sustained is for the metropolis to continue to eviscerate the periphery around it. The development of the emperor depends on and necessitates the underdevelopment of its subjects.

The next theoretical step was to fit this template into an even broader concept of a World System – an all-encompassing global approach that seeks to map the hierarchical political relationships, division of labour and flow of commodities and surplus between the peripheral countries at the bottom, the semi-peripheral satellites in the middle and the financial core at the apex. From the viewpoint of this larger retrofit, capitalism is no longer the outcome of a specific class struggle, a conflict that developed in Western Europe during the twilight of feudalism and later spread to and reproduced itself in the rest of the world. Instead, capitalism – to the extent that this term can still be meaningfully used – is merely the outer appearance of Europe’s imperial expedition to rob and loot the rest of the world.

This view reflected a fundamental change in emphasis. Whereas earlier Marxist theorists of imperialism accentuated the centrality of exploitation in production, dependency and World System analysts shifted the focus to trade and unequal exchange. And while previous theories concentrated on the global class struggle, dependency and World System analyses spoke of a conflict between states and geographical regions. The new framework, although nominally ‘Marxist’ on the outside, has little Marxism left on the inside.¹²

And if we are to believe the postists who quickly jumped on the dependency bandwagon, there is nothing particularly surprising about this particular theoretical bent. After all, ‘history’ is no more than an ethno-cultural clash of civilizations, a never-ending cycle of imperial ‘hegemonies’ in which the winners (ego) impose their ‘culture’ on the losers (alter).¹³ To the naked eye, the totalizing capitalization of our contemporary world may seem like a unique historical process. But don’t be deceived. This apparent uniqueness is a flash in the pan. Deconstruct it and what you are left with is yet another imperial imposition – in this case, the imposition of a Euro-American ‘financialized discourse’ on the rest of the world.

Red Giant: An Empire Imploded

The dependency version of the nexus, though, didn’t hold for long, and in the 1970s the cards again got shuffled. The core stumbled into a multifaceted crisis: the United States suffered a humiliating defeat in Vietnam, stagflation decelerated and destabilized the major capitalist countries and political unrest seemed to undermine the legitimacy of the capitalist regime itself. In the meantime, the periphery confounded the theorists: on the one hand, import substitution, the prescribed antidote to dependency, pushed developing countries, primarily in Latin America, into a debt trap; on the other hand, the inverse policy of privatization and export promotion, implemented mostly in East Asia, triggered an apparent ‘economic miracle’. Taken together, these developments didn’t seem to sit well with the notion of Western financial imperialism. And so, once more the nexus had to be revised.

According to the new script, ‘financialization’ is no longer a panacea for the imperial power. In fact, it is prime evidence of imperial decline.

The reasoning here goes back to the basic Marxist distinction between ‘industrial’ activity on the one hand and ‘commercial’ and ‘financial’ activities on the other. The former activity is considered ‘productive’ in that it generates surplus value and leads to the accumulation of ‘actual’ capital. The latter activities, by contrast, are deemed ‘unproductive’; they don’t generate any new surplus value and therefore, in and of themselves, do not create any ‘actual’ capital.

This distinction – which most Marxists accept as sacrosanct – has important implications for the nexus of imperialism and financialism. It is true, say the advocates of the new script, that finance (along with other forms of waste) helps the imperial core absorb its rising surplus – and in so doing prevents stagnation and keeps accumulation going. But there is a price to pay. The addiction to financial waste ends up consuming the very fuel that sustains the core’s imperial position: it hollows out the core’s industrial sector, it undermines its productive vitality, and, eventually, it limits its military capabilities. The financial sector itself continues to expand absolutely and relatively, but this is the expansion of a ‘red giant’ (our term) – the final inflation of a star ready to implode.

The process leading to this implosion is emphasized by theories of hegemonic transition.¹⁴ The analyses here come in different versions, but they all seem to agree on the same basic template. According to this template, the maturation of a hegemonic power – be it Holland in the seventeenth century, Britain in the nineteenth century or the United States presently – coincides with the ‘over-accumulation’ of capital (i.e. the absence of sufficiently profitable investment outlets). This over-accumulation – along with growing international rivalries, challenges and conflicts – triggers a system-wide financial expansion, marked by soaring capital flows, a rise in market speculation and a general inflation of debt and equity values. The financial expansion itself is led by the hegemonic state in an attempt to arrest its own decline, but the reprieve it offers can only be temporary. Relying on finance drains the core of its energy, causes productive investment to flow elsewhere and eventually sets in motion the imminent process of hegemonic transition.

Although the narrative here is universal, its inspiration is clearly drawn from the apparent ‘financialized decline’ of U.S. hegemony. Since the 1970s, many argue, the country has been ‘depleted’: it has grown overburdened by military spending; it has gotten itself entangled in unwinnable armed conflicts, and it has witnessed its industrial-productive base sucked dry by a Wall Street-Washington Complex that prospers on the back of rising debt and bloated financial intermediation.¹⁵

In order to compensate for its growing weakness, these observers continue, the United States has imposed its own model of ‘financialization’ on the rest of the world, hoping to scoop the resulting expansion of liquidity. Some states have been compelled to replicate the model in their own countries, others states have been tempted to finance it by buying U.S. assets, and pretty much all states have been pulled into an unprecedented global whirlpool of capital flow.

The spread of ‘financialization’, though, has only been party successful. For a while, the United States benefited from being able to control, manipulate and leverage this expansion for its own ends. But in the opinion of many, the growing severity of recent financial, economic and military crises suggests that this ability has been greatly reduced and that U.S. hegemony is now coming to an end.

Capital Flow and Transnational Ownership

The highly publicized nature of these imperial misgivings makes this latest version of the nexus seems persuasive. But when we look more closely at the facts, the theoretical surface no longer seems smooth; and as we get even closer to the evidence, cracks begin to appear.

Start with the cross-border flow of capital, the international manifestation of ‘financialization’. This process is often misunderstood, even by high theorists, so a brief clarification is in order. Contrary to popular belief, the flow of capital is financial, and only financial. It consists of legal transactions, whereby investors in one country buy or sell assets in another – and that is it. There is no flow of material or immaterial resources, productive or otherwise. The only things that move are ownership titles.¹⁶

These changes in ownership, of course, are of great importance. If the flow of capital is large enough, the stock of foreign owned assets will grow relative to domestically owned assets. And as the ratio rises, the ownership of capital becomes increasingly transnational.

The history of this process, from 1870 to the present, is sketched in Figure 1, where we plot the total value of all foreign assets as a percent of global GDP (both denominated in dollars). The underling numbers, admittedly, are not very accurate. The raw data on foreign ownership are scarce; often they are of questionable quality; rarely if ever are they available on a consistent basis; and almost always they require painstaking research to collate and heroic assumptions to calibrate. There are also huge problems in estimating global GDP, particularly for earlier periods. But even if we take these severe limitations into consideration, the overall picture seems fairly unambiguous.¹⁷

The figure shows three clear periods: 1870-1900, 1900-1960 and 1960-2003. The late nineteenth century, marked by the imperial expansion of ‘finance capital’, saw the ratio of global foreign assets to global GDP more than double – from 7% in 1870 to 19% in 1900. This upswing was reversed during the first half of the twentieth century. The mayhem created by two world wars and the Great Depression on the one hand and the emergence of domestic ‘institutionalized waste’ on the other undermined the flow of capital and caused the share of foreign ownership to recede. By 1945, with the onset of decolonization under U.S. ‘hegemony’ and the beginning of the Cold War, the ratio of foreign assets to global GDP hit a record low of 5%. This was the nadir. The next half century brought a massive reversal. In the early 1980s, when Ronald Reagan and Margaret Thatcher announced the beginning of neoliberalism, the ratio of foreign assets to GDP was already higher than in 1900; and, by 2003, after a quarter century of exponential growth, it reached an all time high of 122%.

This final number represents a significant level of transnational ownership. According to recent research by the McKinsey Global Institute, between 1990 and 2006 the global proportion of foreign-owned assets has nearly tripled, from 9% to 26% of all world assets (both foreign and domestically-owned). The increase was broadly based: foreign ownership of corporate bonds rose from 7% to 21% of the world total, foreign ownership of government bonds rose from 11% to 31% and foreign ownership of corporate stocks rose from 9% to 27%.¹⁸

The next step is to break the aggregate front and examine the distribution of ownership. This is what we do in Figure 2, which compares the foreign asset shares of British and U.S. owners from 1825 to the present. The chart shows two important differences between the earlier era of ‘classical imperialism’ dominated by Britain and the more recent ‘neo-imperial’ period led by the United States.

First, there is the pattern of decline. British owners saw their share of global assets fall from the mid-nineteenth century onward, but until the end of the century their primacy remained intact. The real challenge came only in the twentieth century, when capital flow decelerated sharply and foreign asset positions were unwound; and it was only in the interwar period, when foreign investment gave way to capital flight, that the share of British owners fell below 50%.

The U.S. experience was very different. U.S. owners achieved their primacy right after the Second World War, when capital flow had already been reduced to a trickle – and that position was undermined the moment capital flow started to pick up. In 1980, when U.S. ‘financialization’ started in earnest, U.S. owners accounted for only 28% of global foreign assets. And by 2003, when record capital flow and the U.S. invasion of Afghanistan and Iraq prompted many Marxists to pronounce the dawn of an ‘American Empire’, the asset share of U.S. owners was reduced to a mere 18%.

Second, there is the identity of the leading owners. In the previous transition, power shifted from owners in one core country (Britain) to those in another (the United States). By contrast, in the current transition (assuming one indeed is underway) the contenders are often from the periphery. In recent years, owners from China, OPEC, Russia, Brazil, Korea and India, among others, have become major foreign investors with significant international positions – including large stakes in America’s ‘imperial’ debt.

Does this shift of foreign ownership represent the rising hegemony of countries such as China – or is what we are witnessing here yet another mutation of imperialism? Perhaps, as some observers seem to imply, we’ve entered a (neo) neo-imperial order in which the ‘Empire’ actually boosts its power by selling off its assets to the periphery?

The Global Distribution of Profit

Surprising as it may sound, such a sell-off is not inconsistent with the basic theory of hegemonic transition. To reiterate, according to this theory, hegemonic transitions are always marked by a financial explosion which is triggered, led and leveraged by the core in a vain attempt to arrest its imminent decline. Supposedly, this explosion enables the hegemonic power to amplify its financial supremacy in order to (temporarily) retain its core status and power. And if retaining that power requires the devolution of foreign assets and the sell-off of domestic ones, so be it.

The question is how to assess this power. How do we know whether the core’s attempt to leverage global ‘financialization’ is actually working? Is there a meaningful benchmark for power, and how should this benchmark be used and understood?

Unfortunately, most theorists of hegemonic transitions tend to avoid the nitty gritty data, so it’s often unclear how they themselves gauge the shifting trajectories of global power. But given the hyper-capitalist nature of our epoch, it seems pretty safe to begin with the bottom line: net profit.

Net profit is the pivotal magnitude in capitalism. It determines the health of corporations, it tells investors how to capitalize assets, it sets limits on what government officials feel they can and cannot do. It is the ultimate yardstick of capitalist power, the category that subjugates the social individual and makes the whole system tick. It is the one magnitude than no researcher of capitalism can afford to ignore.

With this obvious rationale in mind, consider Figure 3, which traces the distribution of global net profit earned by publicly-traded corporations. The chart, covering the period from 1974 to the present, shows three profit series, each denoting the profit share of a distinct corporate aggregate: (1) firms listed in the United States; (2) firms listed in developed markets excluding the United States; and (3) firms listed in the rest of the world – i.e., in ‘emerging markets’.

The data demonstrate a sharp reversal of fortune. Until the mid-1980s, U.S.-listed firms dominated: they scooped roughly 60% of all net profits, leaving firms listed in other developed markets 35% of the total and those listed in ‘emerging market’ less than 5%.

But then the tables turned. During the second half of the 1980s, the net profit share of U.S.-listed firms plummeted, falling to 36% in less than a decade. The 1990s seemed to have stabilized the decline, but in the early 2000s the downward drift resumed. By the end of the decade, U.S. firms saw their net profit fall to 29% of the world total.

The other two aggregates moved in the opposite direction. By 2009, the profits of firms listed in developed countries other than the U.S. reached 53% of the total, while the share of ‘emerging market’ firms quadrupled to 18%.

These numbers, of course, should be interpreted with care. First, note that our profit data here cover only publicly traded firms; they don’t include unlisted, private firms. This fact means that variations in profit shares reflect two very different processes: (1) changes in the amount of profit earned by listed firms, and (2) the pace of listing and delisting of firms. The latter factor became important during the late 1980s and 1990s, when Europe and the ‘emerging markets’ saw their stock market listings swell with many private corporations going public – this at a time when the number of listed firms in the United States remained flat.

Second, the location of a firm’s listing says nothing about its operations and owners. Many firms whose shares are traded in the financial centres of the United States and Europe in fact operate elsewhere. And then there is the issue of ultimate ownership. Recall that currently one third of all global assets are owned by foreigners. This proportion is already large enough to make it difficult to determine the ‘nationality of capital’, and if it were to rise further the whole endeavour would become an exercise in futility.

The theoretical implications of these caveats have received little or no attention from students of hegemonic transitions, and their quantitative implications remain unclear. But even if we take the ‘nationality of capital’ at face value and consider the numbers in Figure 3 as accurate, it remains obvious that ‘financialization’ has not worked for the hegemonic power: despite the alleged omnipotence of its Wall Street-Washington Complex, despite its control over key international organizations, despite having imposed neoliberalism on the rest of the world, and despite its seemingly limitless ability to borrow funds and suck in global liquidity – the bottom line is that the net profit share of U.S. listed corporations has kept falling and falling.

The Engine of ‘Financialization’

Now, in and of itself, the collapse of the U.S. profit share – much like the sell-off of U.S. assets – isn’t at odds with the theory of hegemonic transition. To repeat, this theory suggests that the hegemonic/imperial power, having been weakened by its prior financial excesses (among other ills), will kick-start, promote and sustain a system-wide process of ‘financialization’. According to the theory, the latent purpose is to leverage this process in order to slow down the hegemon’s own decline – but nowhere does the theory say that this ‘strategy’, whether conscious or not, has to succeed.

Presented in this way, the story sounds historically compelling, logically consistent and empirically convincing – but only if we can first establish one basic fact. We need to show that the global process of ‘financialization’ indeed has been led by the United States. This is the starting point. Only if U.S. ‘financialization’ preceded, was bigger than and propelled ‘financialization’ in the rest of the world can we speak of the U.S. leveraging this process for its own ends. And only then can we assess whether that leveraging succeeded or failed.

So let’s look at the evidence.

Concepts and Methods

The initial step in this sequence is to measure ‘financialization’. Conceptually, the task may seem simple. All we need to do is calculate the share of financial activity in overall economic activity and then trace the trajectory of the resulting ratio. When this ratio goes up, we can say that the economy is being ‘financialized’; when it comes down we would conclude that it is being ‘de-financialized’.

But that’s easier said than done.¹⁹

The basic difficulty is that capitalism is mediated through money, and that fact makes every mediated activity both ‘economic’ and ‘financial’ at the same time. As we have already seen, heterodox economists bypass the problem by defining ‘finance’ more narrowly to denote activities that merely shuffle money and credit without producing ‘real’ goods and services (and obviously without generating any surplus value and ‘actual capital’). Unfortunately, though, this yardstick isn’t very practical. In order to use it, the economist needs to know which activity is ‘productive’ and which is not; and yet, strange as it may sound, this is something that economists do not – and indeed cannot – know. Despite hundreds of years of theorizing and endless claims to the contrary, they remain unable to actually measure ‘productivity’. They cannot quantify the productivity of the CEO of a large bank – or of an auto mechanic for that matter. In fact, they don’t even have the units with which to measure such productivity.

The only thing they can do is to assume. Mainstream economists assume that productivity is ‘revealed’ by income, so if the CEO earns 1,000 times more than the mechanic, he must be 1,000 more productive. Marxists reject this arbitrary assumption; instead, they stipulate, also arbitrarily, that financiers are unproductive while mechanics are productive – although this claim still leaves them unsure of how to treat actual corporations, where ‘unproductive’ and ‘productive’ activities are always inextricably intertwined.

The net result is that we don’t have a clear theoretical definition for ‘finance’ and therefore no objective way to assess the extent of ‘financialization’.

But not all is lost.

We certainly can stick with conventions – and the convention, at least among capitalists and investors, is to treat ‘finance’ as synonymous with the FIRE sector; i.e., with firms whose primary activities involve financial intermediation (banking, trust funds, brokerages, etc.), insurance or real estate.

Based on this conventional (albeit theoretically loose) definition of finance, and given our specific concern here with capitalist power, it seems appropriate to proxy the extent and trajectory of ‘financialization’ by looking at the share of total net profit accounted for by FIRE corporations. The magnitude of this share would indicate the extent to which FIRE firms have been able to leverage ‘financialization’ for their own end, and the way this share changes over time would tell us whether their leverage has increased or decreased.

The Inconvenient Facts

This distributional measure of ‘financialization’ is depicted by the two series in Figure 4. The first series shows the net profit of FIRE corporations as a percent of the net profit of all U.S.-listed firms. The second series computes the same ratio for firms listed outside the United States.

And here we run into a little surprise.

According to the theory of hegemonic transition, the engine of ‘financialization’ is the United States. This is the black hole of the World System. It is the site where finance has been used most extensively to absorb the system’s surplus. It is the seat of the all-powerful Wall Street-Washington Complex. It is where neoliberal ideology first took command and from where it was later imposed with force and temptation on the rest of the world. It is the engine that led, pulled and pushed the entire process.

But the facts in Figure 4 seem to tell a different story. According to the chart, the United Sates has not been leading the process. If anything, it seems to have been ‘dragged’ into the process by the rest of the world. …

During the early 1970s, before the onset of systemic ‘financialization’, the U.S. FIRE sector accounted for 6% of the total net profit of U.S.-listed firms. At the time, the comparable figure for the rest of the world was 18% – three times as high! From then on, the United States was merely playing catch-up. Its pace of ‘financialization’ was faster than in the rest of the world; but with the sole exception of a brief period in the late 1990s, its level of ‘financialization’ was always lower. In other words, if we wish to stick with the theory of a finance-fuelled red giant that is slowly imploding as its peripheral liquidly runs out, we should apply that theory not to the United States, but to the rest of the world!

Indeed, even the most recent period of crisis seems at odds with the theory. According to the conventional creed, both left and right, the current crisis is payback for the sins of excessive ‘financialization’ and improper bubble blowing.²⁰ In this Galtonean theory, deviations and distortions always revert to mean, ensuring that the biggest sinners end up suffering the most. And since the U.S. FIRE sector was supposedly the main culprit, it was also the hardest hit.

The only problem is that, according to Figure 4, the U.S. wasn’t the main culprit. On the eve of the crisis, the extent of ‘financialization’ was greater in the rest of the world than in the U.S. And yet, although the world’s financiers committed the greater sin, it was their U.S. counterparts who paid the heftier price. The former saw their profit share decline mildly from 37% to 25% of the total, while the latter watched their own share crash from 32% to 10%.

The gods of finance must have their own sense of justice.

The End of a Nexus?

Of course, this isn’t the first time that a monkey wrench has been thrown into the wheels of the ever-changing nexus of imperialism and financialism. As we have seen, over the past century the nexus had to be repeatedly altered and transformed to match the changing reality. Its first incarnation explained the imperialist scramble for colonies to which finance capital could export its ‘excessive’ surplus. The next version talked of a neo-imperial world of monopoly capitalism where the core’s surplus is absorbed domestically, sucked into a ‘black hole’ of military spending and financial intermediation. The third script postulated a World System where surplus is imported from the dependent periphery into the financial core. And the most recent edition explains the hollowing out of the U.S. core, a ‘red giant’ that had already burned much of its own productive fuel and is now trying to ‘financialize’ the rest of the world in order to use the system’s external liquidity.

Yet, here, too, the facts refuse to cooperate: contrary to the theory, they suggest that U.S. ‘Empire’ has followed rather than led the global process of ‘financialization’ and that U.S. capitalists have been less dependent on finance than their peers elsewhere.

Of course, this inconvenient evidence could be dismissed as cursory – or, better still, neutralized by again adjusting the meaning of imperialism and financialism to fit the new reality. But maybe it’s time to stop the carousel and cease the repeated retrofits. Perhaps we need to admit that, after a century of transmutations, the nexus of imperialism and financialism has run its course, and that we need a new framework altogether.

1. The precise terms are rather loose and their use varies across theorists and over time. Imperialism, empire and colonialism are used interchangeably, as are finance, fictitious capital finance capital, financialization and financialism. Here we use imperialism and financialism simply because they rhyme.
2. John. A. Hobson, Imperialism: A Study (Ann Arbor: University of Michigan Press, 1902 [1965]); Rosa Luxemburg, The Accumulation of Capital, with an introduction by Joan Robinson, translated by A. Schwarzschild (New Haven: Yale University Press, 1913 [1951]); Rudolf Hilferding, Finance Capital: A Study of the Latest Phase of Capitalist Development, edited with an introduction by Tom Bottomore, from a translation by Morris Watnick and Sam Gordon (London: Routledge & Kegan Paul, 1910 [1981]); Vladimir I. Lenin, ‘Imperialism, The Highest State of Capitalism’, in Essential Works of Lenin. ‘What Is to Be Done?’ and Other Writings (New York: Dover Publications, Inc., 1917 [1987]), p. 177-270; Karl Kautsky, ‘Ultra-Imperialism’, New Left Review, 1970, No. 59 (Jan/Feb), p. 41-46 (original German version published in 1914).
3. See, for example, Joseph A. Schumpeter, Imperialism and Social Classes, with an introduction by Bert Hoselitz, translated by Heinz Norden (New York: Meridian Books, 1919; 1927 [1955]); Barbara Wertheim Tuchman, The Guns of August (New York: Macmillan, 1962) and The Proud Tower: A Portrait of the World Before the War, 1890-1914 (New York: Macmillan, 1966); and Paul M. Kennedy, The Rise and Fall of the Great Powers (New York: Random House, 1987), Ch. 5.
4. Some of the important contributions to this literature include Josef Steindl, Maturity and Stagnation in American Capitalism (New York: Monthly Review Press, 1952 [1976]); Shigeto Tsuru, ‘Has Capitalism Changed?’ in Has Capitalism Changed? An International Symposium on the Nature of Contemporary Capitalism, edited by S. Tsuru (Tokyo: Iwanami Shoten, 1956), p. 1-66. Paul A. Baran and Paul M. Sweezy, Monopoly Capital: An Essay on the American Economic and Social Order (New York: Modern Reader Paperbacks, 1966); and Harry Magdoff, The Age of Imperialism: The Economics of U.S. Foreign Policy, 1st Modern Reader ed. (New York: Monthly Review Press, 1969).
5. Veblen’s early analysis is articulated in The Theory of Business Enterprise (Clifton, New Jersey: Augustus M. Kelley, Reprints of Economics Classics, 1904 [1975]).
6. See U.S. National Security Council, NSC 68: United States Objectives and Programs for National Security. A Report to the President Pursuant to the President’s Directive of January 31, 1950. Top Secret (Washington DC, 1950); David A. Gold, ‘The Rise and Fall of the Keynesian Coalition’, Kapitalistate, 1977, Vol. 6, No. 1, p. 129-161; and Jonathan Nitzan and Shimshon Bichler, ‘Cheap Wars’, Tikkun, August 9, 2006.
7. Classical Marxists interpret the role of waste rather differently. In their account, wasteful spending withdraws surplus from the accumulation process; this withdrawal reduces the pace at which constant capital accumulates; and that reduction lessens the tendency of the rate of profit to fall. See for example Michael Kidron, Capitalism and Theory (London: Pluto Press, 1974).
8. Perhaps the clearest advocate of this argument was the late Harry Magdoff, a writer whose empirical and theoretical studies stand as a beacon of scientific research; for a summary, see his Imperialism Without Colonies (New York: Monthly Review Press, 2003). Similar claims (minus the research) are offered by Ellen Meiksins Wood, Empire of Capital (London and New York: Verso, 2003).
9. Some of the important texts here include Raúl Prebisch, The Economic Development of Latin America and its Principal Problems (New York: United Nations, 1950); Paul A. Baran, The Political Economy of Growth (New York and London: Modern Reader Paperbacks, 1957); Andre Gunder Frank, Capitalism and Underdevelopment in Latin America: Historical studies of Chile and Brazil (New York: Monthly Review Press, 1967); Arghiri Emmanuel, Unequal Exchange. A Study of the Imperialism of Trade (New York: Monthly Review Press, 1972); Eduardo H. Galeano, Open Veins of Latin America: Five Centuries of the Pillage of a Continent (New York: Monthly Review Press, 1973). Samir Amin, Accumulation on a World Scale: A Critique of the Theory of Underdevelopment. 2 vols. (New York: Monthly Review Press. 1974); Immanuel Maurice Wallerstein, The Modern World-System. Capitalist Agriculture and the Origins of the European World-Economy in the Sixteenth Century (New York: Academic Press, 1974) and The Modern World-System II: Mercantilism and the Consolidation of the European World-Economy, 1600-1750 (New York: Academic Press, 1980); and Fernando Henrique Cardoso and Enzo Faletto, Dependency and Development in Latin America (Berkeley: University of California Press, 1979).
10. The inverted commas in this paragraph highlight concepts that the theory of unequal exchange can neither define nor measure. Since nobody knows the correct value of labour power, it is impossible to determine the extent of ‘exploitation’ in the two regions. Similarly, since no one knows the ‘true’ value of commodities, there is no way to assess the extent to which export and import prices are ‘high’ or ‘low’. This latter ignorance makes it impossible to gauge the degree to which the terms of trade are ‘distorted’ and, indeed, in whose favour; and given that we don’t know the magnitude or even the direction of the ‘distortion’, it is impossible to tell whether surplus flows from the periphery to the core or vice versa, and how large the flow might be.
11. W.W. Rostow, The Stages of Economic Growth: A Non-Communist Manifesto (Cambridge, England: Cambridge University Press, 1960).
12. The question of what constitutes a ‘proper’ Marxist framework is highlighted in the debates over the transition from feudalism to capitalism. Important contributions to these debates are Maurice Dobb, Studies in the Development of Capitalism. London: Routledge & Kegan Paul Ltd., 1946. [1963]); Paul M. Sweezy ‘A Critique’, in The Transition from Feudalism to Capitalism, Introduction by Rodney Hilton, edited by R. Hilton (London: Verso, 1950 [1978]); Robert Brenner, ‘The Origins of Capitalist Development: A Critique of Neo-Smithian Marxism’, New Left Review, 1977, No. 104 (July-August), p. 25-92; and Robert Brenner, ‘Dobb on the Transition from Feudalism to Capitalism’, Cambridge Journal of Economics, 1978, Vol. 2, No. 2 (June), p. 121-140. For edited volumes on this issue, see Rodney Hilton, ed., The Transition from Feudalism to Capitalism, Introduction by Rodney Hilton (London: Verso, 1978); and T. H. Aston and C. H. E. Philpin, eds., The Brenner Debate: Agrarian Class Structure and Economic Development in Pre-Industrial Europe (Cambridge and New York: Cambridge University Press, 1985).
13. For a typical narrative, see John M. Hobson, The Eastern Origins of Western Civilisation. (Cambridge, UK and New York: Cambridge University Press. 2004).
14. See for example, Fernand Braudel, Civilization & Capitalism, 15th-18th Century, translated from the French and revised by Sian Reynolds, 3 vols. (New York: Harper & Row, Publishers, 1985); Immanuel Maurice Wallerstein, The Politics of the World-Economy: The States, the Movements, and the Civilizations (Cambridge, New York and Paris: Cambridge University Press and Editions de la Maison des sciences de l’homme, 1984); and Giovanni Arrighi, The Long Twentieth Century: Money, Power, and the Origins of Our Times. London: Verso, 1994.
15. For the ‘depletion thesis’, see for example Seymour Melman, Pentagon Capitalism: The Political Economy of War, 1st ed. (New York: McGraw-Hill, 1970) and The Permanent War Economy: American Capitalism in Decline (New York: Simon and Schuster, 1974). A broader historical application is given in Paul M. Kennedy, The Rise and Fall of the Great Powers (New York, NY: Random House: 1987).
16. The generalization here applies to portfolio as well as direct foreign investment. Both are financial transactions, pure and simple. The only difference between them is their relative size: typically, investments that account for less than 10% of the acquired property are considered portfolio, whereas larger investments are classified as direct. The flow of capital, whether portfolio or direct, may or may not be followed by the creation of new productive capacity. But the creation of such capacity, if and when it happens, is conceptually distinct, temporally separate and causally independent from the mere act of foreign investment.
17. The early data on foreign assets are incomplete in that they do not cover all countries (especially smaller ones). As a result, the measured ratio of foreign assets to global GDP in the earlier years of the chart may be somewhat understated (see Maurice Obstfeld and Alan. M. Taylor, Global Capital Markets: Integration, Crisis and Growth [Cambridge: Cambridge University Press, 2004], p. 51-57).
18. See Diana Farrell, Susan Lund, Christian Fölster, Raphael Bick, Moira Pierce, and Charles Atkins, Mapping Global Capital Markets. Fourth Annual Report (San Francisco: McKinsey Global Institute, January 2008), p. 73, Exhibit 3.10.
19. For a detailed analysis of the associated difficulties and impossibilities that we discuss here only in passing, see Jonathan Nitzan and Shimshon Bichler, Capital as Power: A Study of Order and Creorder (New York and London: Routledge, 2009), Chs. 6-8 and 10; and Shimshon Bichler and Jonathan Nitzan, ‘Contours of Crisis II: Fiction and Reality’, Dollars & Sense, April 28, 2009.
20. See Shimshon Bichler and Jonathan Nitzan, ‘Contours of Crisis: Plus ça change, plus c’est pareil?’ Dollars & Sense, December 29, 2008; and ‘Contours of Crisis II: Fiction and Reality’, Dollars & Sense, April 28, 2009.

Since the crisis is still ongoing, such analysis can only be cursory and suggestive. But it is nonetheless useful to put our preliminary research and thoughts in writing. By spelling out what we do know (or think we know) about the crisis, we can better identify what we don’t know and need to ask.

This essay sets the stage for the series. It outlines the conventional wisdom about the cause of crisis; it describes the chronology of events; and it contrasts the pattern and magnitude of the current downturn with those of earlier episodes. The overall picture painted by this analysis is highly stylized: crises appear to come and go with remarkable regularity, their oscillations are fairly similar and they share the same order of magnitude. The whole process seems almost “automatic,” and automaticity is reassuring: it suggests that the current crisis has run much of its course and that doom and gloom will soon give way to a new upswing.

But what if this automaticity is a mirage?

The Mismatch

Most observers like to blame the ongoing turbulence in the global political economy on finance — or more precisely, on a mismatch between finance and reality.

The mismatch begins with the assumption that there are two types of capital: “real” and “financial.” Real capital is a productive entity, made of machines, structures, work in progress and (some say) knowledge. Financial capital is a symbolic entity, consisting of equity and debt claims on real capital. In a perfect world, the two types of capital are exactly equal: the dollar value of GE’s stocks, bonds and other outstanding obligations represents the productive value of the company’s capital stock, so the two magnitudes must be the same. The assets and the entitlements to the assets have to match, by definition.

But the world isn’t perfect. Greed and fear, irrationality and fraud, corruption and manipulation, insufficient competition and too much government, over-regulation and excessive deregulation, imperfect information and short-term memory, all conspire to distort the picture. These distortions cause finance to deviate from its “fair value,” either up or down. And as the deviation grows larger, finance ceases to mirror reality. It becomes a “fiction.”

The current crisis, goes the argument, is the unavoidable consequence of such deviation. Since the 1980s, we are told, finance has inflated into a huge bubble, having risen far above the underlying stocks of real assets. But then, whatever goes up must come down. Since finance, in the final analysis, is merely the image of the real thing, at some point it has to shrink back to its “true” size. And that is exactly what we are now witnessing: a violent financial crisis that dispels the fiction and brings finance down to its “par value.”

The Excess Unwound

According to the mismatch thesis, the current turmoil started in the U.S. housing market. This was the epicenter. From here the tremor spread like a tidal wave: first to the entire U.S. FIRE sector (an acronym for “finance, insurance and real estate”), then to every financial market around the world, and finally to the so-called “real economy.” This domino sequence is listed in Table 1 and illustrated in Figures 1, 2 and 3.

Figure 1 shows the rise and fall of U.S. house prices, along with the expansion and contraction of the FIRE sector. Prices of homes started to soar in 1997/8. According to the pundits, the blaze was fuelled by three key actors. The first was Fed Chairman and Ayn Rand acolyte Alan Greenspan, who lowered interest rates in the belief that “human nature” would limit risk taking. The second were the financial institutions that gladly ignored the risks and went on to offer mortgages to anyone willing to borrow. And the third were the eyes-wide-shut regulators, who seemed unable to see what was going on even if they cared. House prices had nowhere to go but up, and within a decade they tripled.

Everyone was bullish. Home buyers were eager to borrow, convinced that prices would go on rising and that their houses could always be resold at a profit. The bankers bent over backwards to lend them the money — and then melted the individual mortgages into large pools of asset-backed securities. And the so-called investment community — including “high net-worth individuals,” large corporations, money managers and the banks themselves — lined up to buy tranches of the new “structured investment vehicles,” usually without asking too many questions.

And for a while there was little to ask about. Since house prices were rising, default wasn’t an issue. A home owner who couldn’t service his mortgage would have his house repossessed and quickly resold to the next sucker in line, often at a higher price. And if the parties still felt that there was some residual risk left, they could always offset the hazard with higher interest rates, mortgage insurance and a whole slew of derivatives. The process seemed so robust that even “sub-prime” mortgages, lent to borrowers with little or no income, received a triple-A grading from honest-to-god analysts and fail-proof rating agencies.¹

By the early 2000s, the real-estate boom went global. Worldwide, the annual issuance of asset-back securities rose nearly five-fold — from $532 billion in 2000 to $2.5 trillion in 2006 — with much of the expansion accounted for by mortgage-backed instruments, whose new issues rose from $275 billion in 2000 to over $2 trillion in 2006. In the United States, repackaging reached record levels. By the early 2000s, over half of all single home mortgages and roughly one third of multifamily home mortgages were melted and resold as securities — up from 10 and 5%, respectively, in 1980.²

There was simply no way to lose money in this business, and the stock market certainly reflected that belief. The real-estate boom encouraged many other forms of debt financing, ranging from plain vanilla, to the exotic, to the kinky. And with U.S. FIRE companies cutting a profit on every deal, the total equity capitalization of their sector nearly quadrupled — from $1 trillion in 1997 to $3.7 trillion in 2007.

And then the music stopped.

As Figure 1 shows, in July 2006, U.S. house prices started to drop. Initially, investors hung in suspension. Pretending as if nothing had happened, they continued to buy FIRE stocks, pushing the market even higher. But the downward spiral in house prices persisted — and then, suddenly, in May 2007, everyone started rushing for the door. By September 2008, house prices were down nearly 25% relative to their 2006 peak, while U.S. FIRE stocks went into free fall. In October 2008, the total market capitalization of the sector was more than 50% below its May 2007 peak.

The gathering storm didn’t register immediately on the broader stock market. Figure 2 shows the market capitalization of three broad aggregates — U.S. FIRE equities, all U.S. equities, and all world equities. The three series are denominated in current $U.S. and plotted on a logarithmic scale to facilitate comparison.³

The data show that, while the U.S. FIRE sector started to drop in May 2007 (marked by the vertical line in the chart), the overall U.S. and global stock markets took another five months before tanking. However, once the broad reversal started, the downward convergence was swift. From October 2007 to October 2008, U.S. listed corporations lost 38 per cent of their market capitalization, while the global market lost 46 percent.

The last to join the downward spiral was the so-called “real economy.” Figure 3 shows the U.S. Composite Index of Coincident Indicators, a weighted average of four indicators that move more or less together with the business cycle.⁴ Although this Composite Index pertains only to the United States, in the current environment of global integration it provides a good proxy for world trends.

The figure presents two manifestations of the index: one is the actual level; the other is the annual rate of change, calculated by comparing the same month in successive years (so that the reading for October 2008 denotes the rate of change from October 2007, etc.). The growth series, plotted at the bottom of the chart, shows that the “real economy” started to decelerate at the end of 2006. But the actual level of the index, depicted by the top series, peaked at the end of 2007 (marked by the vertical line in the figure) and started its month-to-month declines only in early 2008.

So on the face of it, the world appears to be in the midst of a finance-led crisis, a decline triggered and significantly amplified by the collapse of fictitious capital. “The salient feature of the current financial crisis,” explains George Soros, “is that it was not caused by some external shock. . . . The crisis was generated by the financial system itself.”⁵ According to this view, the biggest distortion was in the U.S. housing sector, whose bubble was the largest and first to deflate. The next victim was the broader financial market, which was also grossly inflated and therefore justly punctured. And the last to capitulate was the “real economy,” whose excesses obviously were more limited yet certainly worthy of a periodic cleanup.

But that is only half the story.

Toward a New Upswing?

The mismatch thesis tells us that fictitious capital, by its very nature, tends to distort the picture in both directions: it grows by too much in the upswing, only to shrink by too much in the downswing. And indeed, many experts are already wondering if finance hasn’t been overly deflated.

Measured against the historical record, the current market collapse certainly is extremely large. The magnitude of this collapse is contextualized in Figure 4 and Figure 5, where we show the history of U.S. stock prices since 1820. Before examining these charts, though, note that they express stock prices not in actual dollars, but in constant dollars. The latter measure is computed by dividing actual stock prices (expressed as an index) by consumer prices (also expressed as an index). This computation serves to “purge” from the stock market index the effect of inflation (and occasionally deflation). And once inflation has been expunged, the result represents stock prices denominated in constant dollars — i.e., in dollars with a “constant purchasing power.”⁶

Why is it so important to distinguish between the two measures? To answer this question, note that stock prices in actual dollars can always be expressed as the product of two separate magnitudes: (1) the average price level of all commodities (in actual dollars), and (2) the ratio between stock prices and the average price level (which yields a pure number). This decomposition is true by definition:

Now, during periods of inflation or deflation, changes in the average price level (the first component on the right-hand side of the equation), can easily overwhelm changes that are unique to the stock market (the second component on the right). To illustrate, between 1900 and 2008, actual stock prices rose 133-fold. In terms of our equation, most of this increase was due to inflation: the average price level rose nearly 30-fold, whereas the ratio of stock prices to the average price level rose less than fivefold.⁷

Clearly, stock owners are focused primarily on the second component. At the very minimum, their concern is not to keep up with inflation but to outperform it, and that is why we gauge the long-term performance of the stock market in constant dollars rather than actual ones.⁸

With this qualification in mind, let us return now to Figure 4. The chart shows the stock market index in constant prices, plotted against a logarithmic scale. The vertical grey bars indicate what we consider to be major bear markets — i.e., periods during which the stock market suffered protracted declines.

As it turns out, there is no general definition for a bear market—let alone a “major” one. So we’ve devised our own. In what follows we define a major bear market as a multiyear period during which stock prices, measured in constant dollars, move on a downtrend, and in which each successive peak is lower than the previous one. According to this definition, over the past two centuries, the United States experienced six major bear markets. These periods are listed in Table 2, along with the cumulative declines in stock prices.

A similar picture emerges from Figure 5, which measures the annual growth rate of the stock market index (again, in constant dollars). The thin line in the chart shows the percent variation from year to year. The thick line smoothes these variations as a 10-year moving average — meaning that every observation in the series measures the average annual growth rate in the previous ten years.⁹

The last data points in Figure 5are for 2008. The year-to-year change shows a drop of 40% — on par with the record declines of 1917, 1931, 1937 and 1974. Furthermore, as the moving-average series indicates and Figure 4 confirms, this decline wasn’t a fluke event, but rather part of a decade-long bear market. According to the smoothed series, the market peaked in 1998, with the 10-year moving average growth rate hovering around 13%. From then on, annual growth rates decelerated, and by 2008 pushed the 10-year moving average down to nearly –4%.

To the eyes of a seasoned financier, these magnitudes mean that the crisis may be approaching a bottom. According to Figure 5, prior crises were similarly bounded. Their highest starting point, measured by the 10-year moving average series, was 13% (in 1929 and in 1959), and their lowest trough, measured by the same series, was –8% (in 1920). The extent of deceleration in growth rates, measured by the peak-to-trough difference of the 10-year moving average, ranged from a low of 6.5% (during in the 1834-1842 crisis), to a high of 15.5% (in 1928-1948).

The present crisis, measured by the 10-year moving average series, has already met or exceeded these extreme values. It started from a record ceiling of 13.3%; its current low is –3.6%; and the extent of its deceleration, computed as the difference between these two values, marks a new record: 16.9%. For long-term investors, these numbers indicate that much of the crisis is probably behind them.

And the news gets even better. According to Figure 4, historically, each major bear market was followed by a long bull run, and each of those bull runs pushed stocks to a new record high. These upswings occurred in 1842–1950, 1857–1905, 1920–1928, 1948–1968 and 1981–1999, and it isn’t far fetched to think that a new one may soon be brewing.

Given that the present bear market is approaching historical lows, and since previously such bottoms were always followed by major upswings, many forward-looking strategists — from permanent bull Barton Biggs, to Wizard of Omaha Warren Buffet, to doom-and-gloom Martin Wolf — are now advising their followers to fasten their seat belts.¹⁰ News from the so-called “real economy” is likely to remain very bad and may possibly get worse — but most of the negatives are already “in the price.” And since fictitious capital is notorious for “overreacting,” particularly during deep downturns, current stock prices offer a once-in-a-life-time buying opportunity for those prescient enough to see into the next takeoff.

But, then, if the market has bottomed and the upswing is so certain, why isn’t every investor buying?

Financial Cycles and the Reordering of Society

It is easy to fall for the aesthetic gyrations of the stock market. Their stylized cycles make them look natural. They “revert to mean,” as Francis Galton would have it. They oscillate within fairly clear boundaries. Their ups and downs seem almost automatic (at least in retrospect). Their regularities are so neat many are tempted to forget David Hume and extrapolate the past into the future.

And here lies the problem. The long-term cycles of the stock market, no matter how stylized and regular they seem, are not self-generating. They don’t just happen on their own. Each cycle has a reason, and that reason is deeply social and historically unique.

Note that, during the twentieth century, every oscillation from a bear to a bull market was accompanied by a systemic societal transformation:

* The crisis of 1905–1920 marked the closing of the American Frontier, the shift from robber-baron capitalism to large-scale business enterprise and the beginning of synchronized finance.

* The crisis of 1928–1948 signaled the end of “unregulated” capitalism and the emergence of large governments and the welfare-warfare state.

* The crisis of 1968–1981 marked the closing of the Keynesian era, the resumption of worldwide capital flow and the onset of neoliberal globalization.

Furthermore, none of these transformations were “in the cards.” Most observers in the 1900s didn’t expect managerial capitalism to take hold; few in the 1920s anticipated the welfare-warfare state; and not too many in the 1960s predicted neoliberal regulation. All three transformations involved a complex set of conflicts, their trajectories were all fuzzy, and their outcomes were all but impossible to anticipate.

In other words, underneath the seemingly repetitive long-term patterns of the market lies an open-ended and inherently unpredictable reordering of the entire political economy. Although past bear markets have always given way to long bull runs, these transitions were never automatic. Each and every one of them reflected a profound transformation of the underlying social structure. And in our view, this correspondence still holds. In order for the current crisis to end and a new upswing to begin, something very big has to happen: the social structure must change.

The precise nature of this transformation — assuming it occurs — is likely to remain opaque until the process is well under way. But one thing seems clear enough. A new upswing means the rekindling of accumulation, and if we are to understand what this upswing might entail, we need to go back to the beginning and start from the entity that matters most: capital.

For more on that issue, stay tuned for the next installment in our series.

1. For a colorful description of the sub-prime lending and investment cycle, see Michael Lewis, “The End,” Portfolio.com, November 11, 2008. For a more detailed account, see Robin Blackburn, “The Subprime Crisis,” New Left Review 50, March-April, 2008, pp. 63-106.
2. See SIFMA, ASF, ESF, AusSF and McKinsey & Company, “Restoring Confidence in the Securitisation Markets,” October 15, 2008, pp. 3-4.
3. A logarithmic scale has two convenient features. First, it amplifies the variations of a series when its values are small and compresses these variations when the values are large. This property enables us to conveniently examine exponential growth (note that the numbers on the scale jump by multiples of 10). It also allows us to compare series with very different orders of magnitudes (note that world market capitalization is 15 times larger than the market capitalization of the U.S. FIRE sector). Second, the slope of a series is indicative of its percent rate of change — the steeper the slope the greater the growth rate, and vice versa.
4. The four coincident indicators that make up the composite index include: (1) the number of employees on non-agricultural payroll (with an index weight of 52.9%), (2) personal income less transfers expressed in constant dollars (20.8%), (3) the level of industrial production (14.7%), and (4) manufacturing and trade sales expressed in constant dollars (11.6%). (The meaning of “constant dollars” is explained later in the article.)
5. George Soros, “The Crisis & What to Do About It,” The New York Review of Books, Vol. 55, No. 19, December.
6. The notion of “constant dollars” is deeply problematic both theoretically and philosophically. But since we are dealing here with the conventional creed, we take this notion at face value.
7. The computations here are based on data charted in Fig 4.
8. Beating inflation is merely the beginning. For the modern investor, the ultimate goal is to beat the performance of other investors — i.e. to achieve differential accumulation. We hope to explore this latter emphasis in future articles in this series.
9. To illustrate, the 10-year moving average for 2008 represents the average growth rate of the stock market index in the period 1999-2008, the 10-year moving average for 2007 represents the average for 1998-2007, and so on.
10. Barton Biggs, “The Mother of Bear Market Rallies is on the Horizon,” Financial Times, November 25, 2008, p. 24; Warren E. Buffett, “Buy American. I Am,” The New York Times, October 17, 2008; Martin Wolf, “Why Fairly Valued Stock Markets are an Opportunity,” Financial Times, November 26, 2008, p. 11.

Back then, our prediction and reasoning were greeted with indifference. The general mood was deflationary, and the experts preferred to analyze the post-invasion dismantling of OPEC and the coming of dirt-cheap energy. But the times, they are a’changin’, and the pundits are quick to adjust. With crude petroleum hovering around $125 per barrel and raw material and food prices having doubled, even the backward-looking IMF now feels it safe to cry inflation.

So far, though, soaring commodity prices have had a relatively minor impact on the overall level of prices, at least by historical standards. Whereas oil is twelve times more expensive now that it was in 1999, consumer prices in industrialized countries are only 20 percent higher.

The question, therefore, is why the sluggish response? What is it that prevents rapid inflation from taking hold? One important reason lies in the nature of profit expectations. As we explained in “Dominant Capital and the New Wars”"

[R]ising inflation is not very different from an investment-led boom. There is little to prevent any individual firm from building new capacity. But for firms to actually go ahead and install new factories, they need to believe that this new capacity will increase profit in the future; and that belief is most likely to trigger action when it is commonly shared. In other words, it is only when many firms begin to view green-field investment favorably that individual companies begin to spend money on new plant and equipment. Once the process is set in motion, increases in production, income and spending make these profit expectations self-fulfilling, but the initial spark usually requires a change in the broad outlook of companies.

A similar process unfolds when inflation begins to accelerate. As more and more firms start raising prices, and as income begins to be redistributed from workers to firms . . . and from smaller to larger ones . . . expectations for differential inflationary profits are ‘validated,’ leading to even more price hikes. But like with investment, here, too, in order for the process to begin, there needs to be a common expectation, a shared view among the dominant groups in society, that inflation will boost their differential profit. (2004: 297)

By early 2003, the imperative of inflation was already clear, at least at the apex of the accumulation structure:

“Greenspan must go for higher inflation,” insist Bill Dudley of Goldman Sacks and Paul McCulley of Pimco in a recent Financial Times article. “Inflation is too low, rather than too high,” they warn, and “the Fed should welcome a modest rise in inflation”. . . . And it is not as if the Fed has not been trying. Over the past two years Alan Greenspan has cut interest rates to levels last seen in the happy 1960s, making money cheaper and cheaper. Fear of deflation is finally creeping into the Fed’s own statements. In a recent announcement, Greenspan warned of “unwelcome substantial fall in inflation”. . . . That is probably the first time since the Great Depression that the U.S. central bank has said that lower inflation is “unwelcome”. And a few days later, Treasury Secretary John Snow extended another invitation for inflation when he suggested that his government would abandon its eight-year “strong-dollar policy.” Clearly, the circumstances have become ripe for a regime change. The only thing missing is a “spark”. (2004: 297-298)

The spark was lit by the US invasion of Iraq. The war pushed the price of oil to historic highs and helped pull up inflation from its historic lows. But these were merely the first steps.

Whereas leading strategists were quick to grasp the need for a pro-inflation outlook, rank-and-file executives fighting in the business trenches were still locked in a different mood. Most corporate officers under the age of 50 have come of age in a world defined by the experience of disinflation. Shaped by this backdrop, their common belief is that profit depends on cutting cost and lowering prices. And it is this widespread outlook that needs to change for inflation to start in earnest.

Inflation started to decline as the globalization of ownership began to gather momentum in the early 1980s. The process was driven by two related transformations: (1) a shift of manufacturing from developed to developing countries, where wage costs are significantly lower; and (2) rapid technical change — particularly in the areas of computing, telecommunications and information technology — which in turn contributed to the progressive cheapening of equipment and consumer goods.

The consequences of this dual transformation are illustrated in the enclosed figure. The chart shows three price series: the US producer price index, the price of crude oil and the US import price index for computers, peripherals, accessories and parts. All three series are expressed in $US and are rebased by setting their January 1995 values equal to 100. For ease of interpretation, the data are plotted against a logarithmic scale, so that the slope of each series is indicative of its rate of change.

As the data show, since January 1995 the price of crude oil rose by a factor of six (and by much more from its 1999 low). The average level of producer prices, however, increased by only 53 percent. The reason for this limited response is suggested by the shape of the bottom series. In contrast to the soaring price of oil, the price of computers and related equipment dropped precipitately — by as much as 70 percent during the period. This ongoing deflation, typical of many imported manufactured commodities, has worked to counteract the soaring cost of energy.

But now the writing is on the wall. Last week, a Financial Times article titled “Laptop Retail Prices Forced Up” (May 8, 2008) reported an ominous development: the negotiation of a new ‘profit sharing’ agreement between the leading Taiwanese laptop producers, like Quanta, Compal and Wistron, and their brand-name buyers, such as Hewlett-Packard, Dell and Acer. The declared purpose of the negotiations is an orchestrated price increase. The costs of raw materials and Chinese labour are rising, and both sides of the negotiations, says the article, recognize that the “entire supply chain is clamouring for price rises.”

The language is certainly new. It suggests that ‘high-tech’ companies, the white knights of the ‘new economy’, are now openly talking about — not to say colluding over — price increases. Furthermore, their deliberations concern commodities whose prices have always fallen. If there is a sign that dominant capital is finally gearing toward inflationary profit, this must be it. And if this shift proves significant enough, the wrath of inflation may still be upon us.

Many observers of the Israeli scene have been perplexed by the country’s apparent resilience to bad political news. The headlines of late seem uniformly dreadful. While the country is still licking its wounds from a botched, if not humiliating, war with Hezbollah, the Palestinian territories again slide into turmoil, and the experts rumour yet another conflict with Syria. The U.S. entanglement in Iraq and Afghanistan is only getting deeper, and many speak of an imminent attack on Iran with untold regional consequences. Israeli politicians and public officials — from the president, through the prime minister, to the chief of staff, to the justice minister — have been embroiled in corruption and other scandals. The courageous capitalist media routinely expose government officials as incompetent crooks and the Israeli Parliament as an irrelevant institution.

And yet none of these headlines seem to impact the economy. It’s roaring.

Local commentators have been trying to make sense of this apparent puzzle for over a year now. Most point to the effect of liberal globalization. The long fight for sound finance, they say, is finally bearing fruit. The government was forced to rein in its spending, and the consequent emergence of budget surpluses now helps free scarce resources for more productive private use. In parallel, free trade and capital decontrols attract global investors, while allowing Israeli capitalists to link up with the rest of the world. Laissez faire has arrived in the Holy Land: the country’s political folly and its security roller coaster no longer matter for its ‘economy.’¹

Foreign analysts offer other explanations. For Thomas Friedman of The New York Times, the secret lies in the Israeli genius.² The imagination, innovation and flexibility of the country’s citizens, bolstered by higher education and government support for entrepreneurship, help Israel adjust and respond to an ever-changing world. Prosperity, according to Friedman, comes from the head.

Social critic Naomi Klein snubs Friedman.³ Israel’s soaring stock market and China-like growth rates, she argues, are fuelled not by the country’s human capital, but by its mutating war economy. Military calamities, terrorism and counterterrorism offer an ideal environment for developing and testing weapons of oppression. Israel has become a big laboratory for such weapons. It develops and tests the hardware and software of violence — against its Arab neighbours and against the Palestinian population — and then sells them to the rest of the world. Economic prosperity thrives on political crisis.

The Historical Context

These explications, whether plausible or not, all fall into the same trap: they believe the capitalist media. They rush to explain why the Israeli economy is roaring without ever stopping to ask whether it is roaring.

Granted, the latter question is not as exiting as the former. But since everyone seems to take the ‘boom’ for granted, we thought it might it be a good idea to check the facts. Just to be on the safe side.

So, is the Israeli economy roaring?

Clearly, the answer cannot be decided on the basis of last year’s performance or the most recent quarter. Israel and the region have been in turmoil for decades, so economic performance, too, must be put in historical context. This is what we do in Figure 1.

The chart focuses on GDP per capita, expressed in constant prices and rebased to purchasing power parity. This measure is constructed in several steps. First, the statisticians estimate, for every year, the country’s gross domestic product, or GDP, expressed in prices prevailing in some base year. This estimate — which economists call ‘real’ GDP — supposedly represents the aggregate ‘quantity’ of newly produced goods and services (in contrast to ‘nominal’ GDP, which represents both the prices and quantities of production).

Next, the statisticians rebase the country’s ‘real’ GDP so it conforms to an international standard of purchasing power parity (PPP). Since different countries produce and consume different ‘baskets’ of goods and services, their ‘real’ GDP levels are not readily comparable. The purpose of the PPP conversion is to enable such comparison. To achieve this conversion, the statisticians make the hypothetical assumption that all countries produce the same international basket. They then impute to each country the level of ‘real’ GDP it could achieve if it were to produce not its own goods and services, but those included in the international basket.

Finally, the statisticians divide the country’s ‘real’ GDP in PPP terms by the size of its population. The result is GDP per capita in constant prices expressed in purchasing power parity. Economists use this latter measure to assess a country’s average productivity and average standard of living — both over time and in comparison with other countries.

Before turning to the data, we should note that these conventional measurements of ‘productivity’ and the ‘standard of living’ are highly problematic, both conceptually and empirically. And the same is true for the common emphasis on ‘aggregates’ and ‘averages’ — emphasis that serves to ignore and conceal distribution and the underlying structure of the political economy. We nonetheless stick here to standard practices so that we can question the conventional creed on its own terms.

Figure 1 compares the per capita performance of Israel with three countries: China, India and the United States. We do so by plotting three series, each of which expresses the ratio between Israel’s per capita GDP and the per capita GDP of one of these three countries.

The overall picture points to the mid 1970s as a clear watershed. During its so-called ‘socialist’ period, Israel outperformed. After the 1977 rise of Likud and the arrival of ‘liberalism’, Israel lagged.

The two lower series, plotted against the left-hand scale, track Israel’s performance relative to China and India. We can see that Israel’s per capita GDP was roughly 6 times China’s in the early 1950s, and that this ratio doubled, to about 12, by the mid 1970s.

From that point onward, though, the process inverted. China’s per capita GDP soared, Israel’s lingered, and the ratio between them dropped precipitately. In 2005, Israel’s per capita GDP was only 3 times bigger than China’s, representing a four-fold relative decline since the mid 1970s.

A similar development, albeit less dramatic, is evident from the comparison with India. Here, too, Israel outperformed till the mid 1970s, after which the process went into reverse.

Seen from this long term perspective, Israel’s recent ‘boom’ — assuming there is one — is a blip on a long term downtrend. Despite its three decades of liberalisation, enterprising genius and military testing, Israel hasn’t been able to deliver anything close to ‘China-like,’ or even ‘India-like,’ growth rates.

Of course, one could reasonably contest this comparison. Obviously, it is misleading to contrast Israel — a mature capitalist society — with ‘emerging markets’ such as China and India.

But, then, Israel hasn’t done that well relative to mature capitalist countries either. The top series in Figure 1 shows the ratio between Israel’s per capita GDP and that of the United States, plotted against the right-hand scale.

Like with China and India, here too Israel outperformed till the mid 1970s and underperformed thereafter. Its per capita GDP fell from a high of 62 per cent of the United States’ in 1975, to 57 per cent in 2005.

Where Have All the Capitalists Gone?

So there is nothing very miraculous about the Israeli economy. But, then, this preoccupation with the ‘Israeli economy’ is itself misleading.

Measures of national growth rates, GDP per capita, unemployment and the like may be of great importance for most Israelis. But they are irrelevant for Israeli capitalists.

There are two main reasons for this assertion. First, and more generally, capitalists are interested not in the growth of ‘material’ output and the so-called ‘real’ capital stock, but in the expansion of their financial assets. And as strange as it may sound, the ‘real’ world of economic performance and the ‘nominal’ world of finance often are unrelated and sometimes even move in opposite directions.⁴

Second, and specifically for our purpose here, is the issue of identity. Economic measures do not matter for Israeli capitalists simply because there are very few ‘Israeli’ capitalists left.

Since the early 1990s, the opening up of Israel, both outward and inward, has created a massive flow of capital going in both directions. Global investors, transnational corporations, Russian oligarchs and money launders have all flocked into Israel. They bought up anything of value — bonds and stocks, entire companies and prime real estate, sport teams and local politicians. In parallel, domestic capitalists have diversified abroad: they took the proceeds of their local divestments and invested them outside Israel.

The net result of this bidirectional process has been the disappearance not only of the ‘Israeli’ capitalist class, but also of ‘Israeli’ companies.

Nowadays, all the large capitalists who happen to live in Israel (at least part of their time) have global investments that often eclipse their holdings in Israel proper. And practically all the leading corporations located in Israel are transnational — in operations, ownership, or both.

In other words, the issue is not that Israeli accumulation has become indifferent to Israeli politics, but rather that Israeli accumulation has become less and less ‘Israeli.’

The consequence of this transnationalization of ownership is illustrated in Figure 2. The chart correlates the annual rates of growth of the Tel Aviv Stock Exchange (TASE) and of the NASDAQ (with underlying monthly data denominated in $US). Each point in the series represents the correlation over the previous five years, with values ranging from a minimum of –1 (indicating that the rates of growth of the two stock markets move exactly in opposite directions), through a mid-point of 0 (denoting that the two markets are unrelated), to a maximum of +1 (when rates of growth move exactly in the same direction).

The trend depicted in the chart is unambiguous. During the 1980s, the two markets were more or less independent. The correlation between them was low and often negative. But over time, and particularly since the early 1990s, the transnationalizaton of ‘Israeli’ capital and capitalists has made the correlation tighter and tighter.

When we first plotted this relationship in 2001, the correlation coefficient approached 0.7. By 2006, it reached 0.92.⁵ In non-technical language, this latter number suggests that, over the 2001-2006 period, 92 per cent of the variations in the TASE could be ‘explained’ by variations in the NASDAQ (it would be difficult to argue the opposite). And, indeed, since the two asset classes share similar owners, have similar sources of earnings, and float in similar pools of liquidity, there is really no reason why they shouldn’t move together.

Thus, if the Israeli stock market is currently booming, it is not because of or despite the ‘political situation.’ It booms for the same reason the NASDAQ does. And if and when the TASE takes a nose dive, again, don’t look for local or regional explanations. Just check the NASDAQ.

Of course, Israeli politics continues to matter in many different ways. It matters to the companies listed in Tel-Aviv insofar as it guarantees that the stock market can open every morning, and that their Israeli operations can function without hindrances. Domestic politics also matters insofar as it affects Middle East developments, and hence global accumulation, the NASDAQ and, therefore… the TASE.

But formal politics matters not because it is public. It matters precisely because it is anti public. As long as the country’s patriotic ‘politicians’ and ‘public officials’ remain obedient to capital in the name of democracy, and as long as the cost of bribing them remains reasonably low, the resulting boom of private accumulation will remain mysteriously ‘delinked’ from the fracturing of public life and the disintegration of autonomy and democracy.

1. Nechemia Strassler, “Buy Me Gaidamak,” Hebrew. Ha’aretz, June 13, 2007.
2. Thomas Friedman, “Israel Discovers Oil,” The New York Times, June 10, 2007.
3. Naomi Klein, “How War was Turned into a Brand,” Guardian, June 16, 2007.
4. See our recent Hebrew monograph, “The Gods Failed, the Priest Lied,” May 2007, and the more general discussion in our “Elementary Particles of the Capitalist Mode of Power,” October 2006.
5. For the early estimates, see Jonathan Nitzan and Shimshon Bichler, The Global Political Economy of Israel, London: Pluto Press, 2002, Figure 6.6, p. 355.