Early in 2011, we received a surprising invitation from the Financial Times Lexicon. A reader had suggested that an entry on differential accumulation be added to the Lexicon, and the online content developer asked us if we would be willing to write it.

Our first thought was that this must have been a mistake. The FT speaks for capital. Like all mainstream financial media, its theoretical-ideological baseline is staunchly neoclassical (plus ‘distortions’ to account for the disobedient facts). Occasionally, it allows the odd piece by a soft-Keynesian, but that tends to be the far-left marker. Rarely if ever would you read in this newspaper a real critique of capitalism, let alone one that goes to the root (unless you include in this category Op-Ed pieces by Wall-Street-warriors-turned-social-activists and other converts specializing in the ‘social justice’ niche). All things considered, it wasn’t the natural outlet for our analysis of dominant capital, modes of power and strategic sabotage. Not by a long shot.

So how did we get invited?

Simple. The content editor received a request for an entry on ‘differential accumulation’. Naturally, he didn’t know what the term meant, so he searched it on Google and found The Bichler & Nitzan Archives. At that point, he should have taken the time to read a bit. Had he done so, he would have realized that this was the wrong subject to pursue. But slaving for the FT, he had already seen it all. He knew all the tricks of self-promotion, all the ways of making banality look like novelty, all the paths to a reinvented wheel. There was nothing Bichler & Nitzan, whoever they were, could possibly teach him. So instead of reading, he passed the buck and asked us to write the entry. It wasn’t too much of a risk. If the piece ended up being a misfit, he could always flip-flop and refuse it.

We knew all about such flip-flops. Over the years, we have received enough invitations-turned-rejections to work out the template. The cycle typically comprises three stages. It begins with our receiving an enthusiastic, flattering letter asking us to make an original contribution. It continues with a steady stream of encouragements and inquiries about delivery time. And it ends with a prolonged silence, after the editor realizes he got more than he had bargained for: a piece too creative for its own good and clearly unfit for print.

Still, the invitation was tempting. This was not some obscure academic journal, or a marginal newspaper. It was the Financial Times Lexicon. Posting a permanent entry there could help us present radical ideas to a very large conservative audience. And the time seemed right. As one FT writer put it, the ongoing crisis has robbed capitalists of their ‘intellectual compass’, and intellectual confusion often opens the door for radical alternatives. Maybe this was our chance?

We decided to test the water. We asked the content developer how long the article could be: ‘as long as you wish’, he replied (virtual bytes cost nothing). We inquired whether we could incorporate figures and charts: ‘yes’, he said (visuals always sell well). We emphasized that our entry would offer a new approach: he had no objection whatsoever (tomorrow it will be flushed down with the rest of yesterday’s news). He did warn us, though, that the FT does not pay for contributions: we never thought of asking for money (suckers). The whole exchange seemed amicable, and the content developer was encouraging, even enthusiastic. And besides, we had nothing to lose but our chains.

We worked on the piece, and the content editor, fulfilling his role in the script, kept sending us encouraging queries. By the end of March, the piece was completed, and we delivered it safely to the FT. The editor replied promptly, promising to examine it ‘as soon as he can’. And then he fell silent. Ten days later, having heard nothing, we wrote to inquire. The editor apologized for not writing. He was ‘busy’ and would reply ‘as soon as he can’. Another two weeks passed, and we sent another email. It was a ‘busy time again’, we learnt, but the editor promised to look at the definition in the ‘next couple of weeks’. Those two weeks came and went, and when the silence persisted, we sent another friendly query. This time, the reply was automatic: the editor was out of the office. We waited patiently for the standard two-week period and wrote again. The editor, forever polite, apologized. He needed more time – but not to worry, he would definitely get back to us ‘within the next two weeks’.

We were getting ready for yet another two-week period, but then we noticed that there was a footnote to the email. The content editor must have realized we weren’t getting the message, so he decided to be a bit blunter: ‘Please note that some of our FT readers do not speak English as a first language, so definitions must be clear’.

And then it dawned on us.

The problem wasn’t our ideas. It was our words: they were simply too complicated. Power, sabotage, dominant capital, and differential accumulation – these are difficult words. They challenge one’s worldview. They rattle the mind. They can even make you think. And that, the content developer insinuated, is not what we need in our Lexicon.

What we need are clear words. Conventional words. Words like ‘free competition’, ‘productive investment’, ‘profit maximization’, ‘deregulation’, ‘efficient markets’ and ‘sound finance’. Words that can help us standardize the FT readership. That is what we need.

And so, we lost our chains and set our article free. You can read it below, with no FT strings attached.

The concept of differential accumulation is part of a new approach to the study of capitalism. This approach, first developed by Shimshon Bichler and Jonathan Nitzan, emphasizes the primacy of power rather than of consumption and production. The emphasis on power accentuates the centrality of relative rather than absolute measures and of disaggregate rather than aggregate methods. It focuses attention not on the quest for profit maximization by capital in general, but on the drive for differential accumulation by dominant capital in particular.

The Conventional Dual View

In the conventional view, epitomized by the neoclassical doctrine, capital belongs to the productive-material sphere of the ‘economy’. When free from outside ‘distortions’, the economy is an autonomous sphere, clearly demarcated from other spheres of society. It has its own laws, logic and purpose. Driven by the mechanical forces of supply and demand, energised by the quest for equilibrium, disciplined by competition and pushed forward by individualism, the ultimate achievement of the economy is utilitarian: it maximizes pleasure and minimizes pain.

The principles of the economy negate hierarchy: they defuse all power relations through voluntary market clearing. Power certainly exists, but it exists mostly ‘outside’ the economy proper, primarily in the realm of politics and state. Governments never tire of imposing their power on the economy. They ‘intervene’ by using taxes and subsidies, regulation and discrimination, public spending, tariffs and levies, among other strategies. But since the interventions are always ‘exogenous’, coming from outside the economy, their outcomes are always sub-optimal, by definition.

The Great Depression softened this fundamentalist division. After the 1930s, the strict separation between economics and politics gave way to a synthetic compromise: government was given a positive ‘macroeconomic’ role, adjacent to the ‘microeconomic’ role of individual consumers and firms. But the new synthesis didn’t change the meaning, position and logic of capital: it remained a productive-material entity, located in the economy and subject to its strict laws.

The neoclassical doctrine sees capital as a dual entity. Capital is both productive capacity and market value, a ‘real’ thing whose material quantity is reflected in its ‘nominal’ price. On the face of it, modern capitalist decisions are driven by finance; but according to the dual view, in the final analysis finance is a derivative of production. From this perspective, the dollar market value of General Electric’s stocks and bonds mirrors the company’s overall productive capacity. When GE’s productive capacity increases – when it adds more factories, when it improves its plant and equipment, when it increases its knowhow – the real quantity of its capital grows, and that real growth causes a corresponding increase in the company’s dollar market value. And conversely – when the company neglects to boost its productive capacity, its real accumulation falters; and as real accumulation decelerates, the company’s dollar market value follows suit.

This real-nominal correspondence is merely a first approximation: it holds only in the ideal world of perfectly competitive equilibrium. The actual world, though, even according to neoclassicists, is rarely if ever in a perfectly competitive equilibrium. Unlike the models, reality is besieged by disequilibrium, irrationality and distortions, and these imperfections cause the nominal magnitude to mismatch and deviate from the real one.

This account, argue Bichler and Nitzan, is deeply problematic for at least two reasons. The first reason is theoretical. Capital, they say, is simply not a dual entity. Contrary to the conventional view, it has only one quantity: its nominal dollar value on the stock and bond markets. And that’s it. There is no underlying ‘real’ quantity to be examined, let alone measured. And without a real quantity, there is nothing for the dollar value of capital to match or mismatch.

Economists might find this later claim nonsensical: after all, most countries provide detailed quantitative estimates of their ‘real capital stock’, so how could one say that these quantities do not exist? According to Bichler and Nitzan, though, these estimates, popular as they may be, do not – and indeed cannot – measure the real capital stock. In order to know the quantity of real capital, the statisticians have to sum up the quantities of individual ‘capital goods’ – plant, equipment, and infrastructure, as well as patented knowledge and goodwill, among other things. And this aggregate, say Bichler and Nitzan, is impossible to compute. According to neoclassical theory, the aggregate of capital goods, like every basket of commodities, is measured in terms of the utils it supposedly generates. But ‘utils’ are fictitious quanta that cannot be observed, let alone measured.

So in practice, argue Bichler and Nitzan, the statisticians go in reverse: they use the dollar price of capital goods to ‘reveal’ their so-called productive quantity (i.e., their ability to generate utils). The first step in this process is to pick a point in time and claim it represents perfectly competitive equilibrium. The second step is to assume that, in a perfectly competitive equilibrium, the nominal dollar value reveals the real quantity of capital (so if the dollar price of a patent X is ten times bigger than that of machine Y, X must have ten times as much real capital as Y). The third step is to use these nominal values as weights with which to aggregate the different capital goods into real capital (multiplying the number of capital goods in each category by their dollar value and summing the results). And the fourth and final step is to announce that the nominal magnitude that emerges from this procedure is the quantity of real capital (read its util-generating capacity). But since perfectly competitive equilibrium and the utils this equilibrium is said to ‘reveal’ are all fictitious entities, the resulting measure of real capital is devoid of any real meaning.

The second problem of the real-nominal view is empirical. In practice, the oscillations of finance seem to have little to do with those of productive capacity – even when capacity is measured in nominal dollars (rather than in so-called real terms). To see the problem, note that, according to the conventional creed, the deviations of finance from real capital, however large, tend to be pro-cyclical. In general, the market value of capital is expected to overshoot real accumulation during a boom and undershoot it in a bust. In the first case, euphoria inflates a speculative bubble; in the latter case, panic deflates it.

But the evidence, at least in the United States, doesn’t sit well with this pro-cyclical convention. Figure 1 contrasts two growth series (based on nominal dollar data, since the ‘real’ measures are fictitious). The thick line shows the rate of growth of the productive capacity of U.S. corporations as measured by the current replacement cost of their fixed assets. The thin line shows the rate of growth of the dollar market value of U.S. corporate stocks and bonds. And here lies a puzzle: the growth of corporate market value, instead of moving in tandem with – and possibly amplifying – the growth of ‘real’ assets, appears to move in exactly the opposite direction. The figure shows a systematic, long-term counter-cyclical pattern in which the market value of corporations accelerates exactly when the dollar value of their ‘real’ capital decelerates, and vice versa.

Now, since capitalist decisions are driven by finance, this inversion, say Bichler and Nitzan, means that theorists of accumulation have to make a hard choice: they can stick to the conventional dual view and end up being unable to explain what drives capitalists, or they can go back to square one and develop a new framework altogether.

Capitalization Reconsidered

Bichler and Nitzan take the second route. Their starting point is the meaning of capitalism. In their framework, capitalism is not a mode of consumption and production, but a mode of power: a totalizing regime that defines, shapes and regulates the general trajectory of society.

The centre of this regime is the institution of capital. Earlier modes of power were organized through the complex codes of religion, kingship, feudal servitude and castes, among others. The capitalist mode of power replaces these complex codes with a universal logic: the power logic of capital. Now, in conventional theory, capital is a narrow economic entity that produces goods and services for its individual owners. But according to Bichler and Nitzan, this portrayal is deeply deceiving. Capital, they say, is not a productive entity but the key power institution that regulates capitalist society. Its language is not utilitarian, but financial. The ever-changing quantities of finance – expressed as capitalization – reflect not the capacity of capital goods to produce well-being, but the power of capitalist owners to constantly reshape the course of their society in their own interest. The logic of finance and capitalization is the anonymous, undifferentiated mechanism through which they control society.

Capitalization represents the discounting to present value of risk-adjusted expected future earnings, and each of its symbolic components – the expected future earnings, the risk that capitalists associate with these earnings, and the normal rate of return that they use to bring them to present value – is a manifestation of organized power.

The primacy of power, say Bichler and Nitzan, is built into the concept of private ownership. The very concept implies exclusion and deprivation. In this sense, private ownership is a negative, not a positive, entity. It is based not on the ability to produce, but on the capacity to incapacitate. It is wholly and only an institution of exclusion, and institutional exclusion is a matter of organized power. Of course, exclusion does not have to be exercised. What matter here, argue Bichler and Nitzan, are the right to exclude and the ability to exact pecuniary terms for not exercising that right. This right and ability are the foundations of accumulation. They enable capitalists to profit greatly from mismanaging the world’s ecosystem, from making society more unequal and from blocking the development of humane alternatives – and to do all that under the guise of ‘scientific management’ and the ‘efficient allocation’ of resources.

Capital, Bichler and Nitzan claim, is nothing but organized power. This power, they say, has two sides: one qualitative, the other quantitative. The qualitative side comprises the many institutions, developments and conflicts through which capitalists constantly creorder – or create the order of – their society; that is, the processes through which they shape and restrict the social trajectory in order to extract their tributary income. The quantitative side is the universal algorithm that integrates, reduces and distils these numerous qualitative processes down to the monetary magnitude of capitalization.

In principle, every stream of expected income is a candidate for capitalization. And since income streams are generated by social entities, social processes, social organizations and social institutions, we end up with capitalization discounting not the so-called sphere of economics, but potentially every aspect of society. Human life, including its social habits and its genetic code, is routinely capitalized. Institutions – from education and entertainment to religion and the law – are habitually capitalized. Voluntary social networks, urban violence, civil war and international conflict are regularly capitalized. Even the environmental future of humanity is capitalized. Nothing escapes the eyes of the discounters. If it generates expected future income, it can be capitalized, and whatever can be capitalized sooner or later is capitalized.

Business and Industry

What is the object of capitalist power? How does it creorder society? According to Bichler and Nitzan, the answer begins with a conceptual distinction between two spheres: the first is the creative/productive potential of society – or what American political economist Thorstein Veblen called ‘industry’; the second is the realm of power, which, in the capitalist epoch, takes the form of ‘business’. Veblen conceived of industry as the collective knowledge and effort of humanity, a sphere that is inherently cooperative, integrated and synchronized. Business, in contrast, isn’t collective; it is private. Its goals are achieved through the threat and exercise of systemic prevention and restriction – that is, through strategic sabotage. The key target of this sabotage is the resonating pulse of industry – a resonance that business constantly upsets through built-in dissonance.

Bichler and Nitzan illustrate this interaction of business and industry conceptually and empirically. Conventional economics, they say, postulates a positive relationship between production and profit. Capitalists, the theory argues, benefit from industrial activity; and, therefore, the more fully employed their equipment and workers, the greater their profit. But if one thinks of capital as power, exercised through the strategic sabotage of industry by business, the relationship becomes nonlinear – positive under certain circumstances, negative under others.

This latter relationship is exemplified, hypothetically, in Figure 2. The chart depicts the utilization of industrial capacity on the horizontal axis against the capitalist share of income on the vertical axis. Now, up to a point, the two move together. After that point, the relationship becomes negative. The reason for this inversion can be explained by looking at extremes. If industry came to a complete standstill at the bottom left corner of the chart, capitalist earnings would be nil. But capitalist earnings would also be zero if industry always and everywhere operated at full socio-technological capacity – depicted by the bottom right corner of the chart. Under this latter scenario, industrial considerations rather than business decisions would be paramount, production would no longer need the consent of owners, and these owners would then be unable to extract their tributary earnings. For owners of capital, then, the ideal Goldilocks condition, indicated by the top arc segment, lies somewhere in between: with high capitalist earnings being received in return for letting industry operate – though only at less than full potential.

Figure 3 operationalizes this thought experiment for the United States since the 1930s. The horizontal axis approximates the degree of sabotage by using the official rate of unemployment, inverted (note that unemployment begins with zero on the right, indicating no sabotage, and that, as it increases to the left, so does sabotage). The vertical axis, as before, shows the share of national income received by capitalists.

And the empirical picture seems very close to the theoretical one. Like in Figure 2, the best position for capitalists is not when industry is fully employed, but when there is considerable unemployment – in this case, around 7 per cent. In other words, the so-called ‘natural rate of unemployment’ and ‘business as usual’ are two sides of the same power process: a process in which business accumulates by strategically sabotaging industry.

Differential Accumulation and Dominant Capital

Now, power, argue Bichler and Nitzan, is never absolute; it’s always relative. For this reason, both the quantitative and qualitative aspects of capital accumulation have to be assessed differentially, relative to other capitals. Contrary to the claims of conventional economics, say Bichler and Nitzan, capitalists are driven not to maximize profit, but to ‘beat the average’ and ‘exceed the normal rate of return’. Their entire existence is conditioned by the need to outperform, by the imperative to achieve not absolute accumulation, but differential accumulation. And this differential drive is crucial: to beat the average means to accumulate faster than others; and since the relative magnitude of capital represents power, capitalists who accumulate differentially increase their power (to emphasize, for Bichler and Nitzan capitalist power relates not to the narrow neoclassical notion of ‘market power’, but to the broad strategic capacity to inflict sabotage).

The centrality of differential accumulation, claim Bichler and Nitzan, means that the analysis of accumulation should focus not only on capital in general, but also and perhaps more so on dominant capital in particular – that is, on the leading corporate-state alliances whose differential accumulation has gradually placed them at the centre of the political economy.

Figure 4 plots the differential accumulation of dominant capital in the United States since 1950. Dominant capital is approximated here using two slightly different measures: one is the largest 100 firms in the Compustat universe (comprising firms listed in the United States); the other is the largest 100 U.S. firms in the Compustate universe (comprising firms that are both incorporated and listed in the United Sates). The constituents of each group are determined annually on the basis of market capitalization (the reason for using two different measures is that aggregate data for market capitalization cover all listed firms regardless of their country of incorporation, whereas the aggregate profit data of the national accounts pertain only to U.S.-incorporated firms). The chart shows two differential series – one for capitalization, based on the first definition of dominant capital, and another for net profit based on the second definition of dominant capital.

Differential capitalization denotes the ratio between the average market value of dominant capital (U.S.-listed firms) and the average market value of all U.S.-listed firms. The series shows that, during the 1950s, a typical dominant capital corporation had 7.4 times the capitalization (read power) of the average listed company. By the 2000s, this ratio had risen to 35.5 – nearly a fivefold increase.

This measure, though, significantly underestimates the power of dominant capital. Note that the vast majority of firms are not listed. Since the shares of unlisted firms are not publicly traded, they have no ‘market value’; the fact that they have no market value keeps them out of the statistical picture; and since most of the excluded firms are relatively small, differential measures based only on large listed firms end up understating the relative size of dominant capital.

In order to get around this limitation, Bichler and Nitzan plot another differential measure – one that is based not on capitalization but on net profit – and that measure includes all U.S.-incorporated firms, listed and unlisted. The computational steps are similar. They calculate the average net profit of a dominant-capital corporation (the total net profit of the top 100 Compustat companies incorporated and listed in the United Sates divided by 100); they then compute the average net profit of a U.S. corporation (total corporate profit after taxes divided by the number of tax returns of active corporations); finally, they divide the first result by the second.

As expected, the two series have very different orders of magnitude (notice the two log scales). But they are also highly correlated (which isn’t surprising, given that profit is the key driver of capitalization). This correlation, say Bichler and Nitzan, means that we can use the broadly based differential profit indicator as a proxy for the power of dominant capital relative to all corporations. And the result is remarkable. The data show that during the 1950s, a typical dominant capital corporation was 2,586 times larger/more powerful than the average U.S. firm. By the 2000s, this ratio had risen to 22,097 – nearly a ninefold increase.

Capital as Power in Middle-East Energy Conflicts

Bichler and Nitzan’s research offers various historical studies of differential accumulation in which they examine the quantities and qualities of capital as power. One of these is their work on the Middle East. Figure 5 shows the differential performance of the world’s six leading privately owned oil companies relative to the Fortune 500 benchmark. Each bar in the chart shows the extent to which the oil companies’ rate of return on equity exceeded or fell short of the Fortune 500 average. The gray bars show positive differential accumulation – i.e. the per cent by which the oil companies exceeded the Fortune 500 average. The black bars show negative differential accumulation; that is, the per cent by which the oil companies trailed the average. Finally, the little explosion signs in the chart show the occurrences of ‘Energy Conflicts’ – that is, regional energy-related wars.

Now, conventional economics, say Bichler and Nitzan, has no interest in the differential profits of the oil companies, and it certainly has nothing to say about the relationship between these differential profits and regional wars. Differential profit is perhaps of some interest to financial analysts, and Middle-East wars are the business of experts in international relations and security analysts. But since each of these phenomena belongs to a completely separate realm of society, no one has ever thought of relating them in the first place. And yet, these phenomena, argue Bichler and Nitzan, are not simply related. In fact, they could be thought of as two sides of the very same process – namely, the global accumulation of capital as power. They point to three remarkable relationships depicted in the chart.

• First, every energy conflict was preceded by the large oil companies trailing the average. In other words, for an energy conflict to erupt, the oil companies first had to differentially decumulate – a most unusual prerequisite from the viewpoint of any social science.

• Second, every energy conflict was followed by the oil companies beating the average. In other words, war and conflict in the region, which social scientists customarily blame for ‘distorting’ the aggregate economy, have served the differential interest of certain key firms at the expense of other key firms.

• Third and finally, with one exception, in 1996-7, the oil companies never managed to beat the average without there first being an energy conflict in the region. In other words, the differential performance of the oil companies depended not on production, but on the most extreme form of sabotage: war.

According to Bichler and Nitzan, these relationships, and the conclusions they give rise to, are nothing short of remarkable. First, the likelihood that all three patterns are the consequence of statistical fluke is negligible. In other words, there must be something very substantive behind the connection of Middle-East wars and global differential profits.

Second, these relationships seamlessly fuse quality and quantity. In their research on the subject, Bichler and Nitzan show how the qualitative power aspects of international relations, superpower confrontation, regional conflicts and the activity of the armament and oil companies, on the one hand, can both explain and be explained by the quantitative global process of capital accumulation, on the other.

Third, all three relationships have remained stable for half a century, allowing Bichler and Nitzan to predict, in writing and before the events, both the first and second Gulf Wars. This stability suggests that the patterns of capital as power – although subject to historical change from within society – are anything but haphazard.

Links

• The Bichler & Nitzan Archives.
• Bichler Shimshon and Jonathan Nitzan (2004) ‘Dominant Capital and the New Wars’ Journal of World-Systems Research (10:2).
• Nitzan, Jonathan and Shimson Bichler (2002) The Global Political Economy of Israel (London and Sterling VA. Pluto Press).
• Nitzan, Jonathan and Shimson Bichler (2006) ‘New Imperialism, or New Capitalism?’ Review (XXIX: 1).
• Nitzan, Jonathan and Shimshon Bichler (2009) Capital as Power: A Study of Order and Creorder (London and New York: Routledge).
• Thorstein Veblen (1904; 1975) The Theory of Business Enterprise (Clifton, New Jersey: Augustus M. Kelley, Reprints of Economics Classics).

The universality of this reduction makes capitalization the most supple power instrument ever known to humanity. Previously, distributive power was associated with clear socio-ecological distinctions – differences between king and subject, owner and slave, tiller and landlord, field and citadel, village and town. Capitalization flattens these qualitative features to the point of irrelevance. In principle, anyone can be a capitalist, and what distinguishes one capitalist from another is the quantity of their capitalization: the most powerful are those with the greatest capitalization (dominant capital), and those that hold that power achieve and augment it by increasing their capitalization faster than others (differential accumulation). In this way, capitalization crystallizes the power of capitalists to shape their world, as well as the resistance of those that oppose this power. It gauges the capitalists’ success in directing production and consumption, in shaping ideology and culture, in affecting the law, public policy, conflict, war and even the environment. It is the all-encompassing algorithm that creorders – or creates the order – of the capitalist mode of power.

The purpose of our paper is to examine the breakdown of this algorithm. To be sure, this type of inquiry is hardly novel. Marxists have long searched for objective signs of capitalist collapse, preliminary omens that would foretell the system’s imminent disintegration. However, because of their dual conception of capital, they’ve tended to look for such signs in the so-called real sphere of production and consumption, while paying far less attention to finance, which, in their view, is merely a distorted mirror of that reality. But finance isn’t a mirror of real capital; it is real capital – and indeed the only real capital. So if we want to look for signs of systemic crisis and possible disintegration, our search should begin here, in the very ritual of capitalization.

The specific focus of the article is two historical ruptures of modern finance – the periods of 1929-1939 and 2000-2010. During both periods, capitalists abandoned the conventional forward-looking ritual of capitalization, resorting instead to the backward-looking posture of pre-modern finance. In our view, these rare episodes are of great importance for understanding the nature of capitalist confidence and the capitalists’ ability to rule – as well as the possibility that this system of rule will collapse. Our inquiry seeks, first, to characterize key features of these episodes; second, to speculate on their causes; and third, to assess, however speculatively, what they might imply for the future of capitalism.

Propositions

We set the stage with a number of related propositions. These propositions aim to establish a “nested relationship” between a series of entities – beginning from the broad concept of a mode of power, and continuing with confidence in obedience, dominant ideology, the ritual of capitalization and the forward-looking disposition of modern finance. Most of time, the components of this nested relationship are mutually reinforcing. But on rare occasions the relationship implodes. The trigger for such implosion is systemic fear: fearing for the collapse of their system, capitalists lose sight of the future; with the future having become opaque, the ritual of capitalization falls into disarray; with capitalization having been punctured, dominant ideology is deeply shaken; with dominant ideology having cracked, the capitalists’ confidence in obedience tumbles; and with no confidence in obedience, the very continuation of the capitalist mode of power is put into question. Let’s examine the relationship between these concepts more closely, beginning with power.

● Modes of power and confidence in obedience. Hierarchical societies, we argue, are characterized by their modes of power. Every mode of power – whether slave-based, feudal or capitalist ­– rests on confidence in obedience: the confidence of rulers in the obedience of their subjects. This confidence is never perfect: the ruled often resist, rise up and revolt; occasionally they demand and periodically achieve moderate change; sometimes they even manage to effect significant reform; and in very rare instances they take over power, though only for a brief historical moment. But as long as the bottom-up disobedience of the underlying population does not significantly undermine the top-down confidence of those who rule them – a breach that seldom happens on a large enough scale – the mode of power itself remains intact.

● Confidence in obedience and dominant ideology. The framework that shapes and fixates this confidence in obedience is the dominant dogma, or ideology: the broad belief system that propels and restricts the social imagination. The dogma or ideology that dominates a given mode of power conditions action and inaction, justifies the prevailing social structure and provides its organizing principles. It molds rulers and ruled alike – and in so doing locks them both into the same mode of power.

● Dominant ideology and capitalization. The dominant ideology of modern capitalism revolves around the ritual of capitalization: the financial algorithm that discounts expected future earnings to their present value. This ritual is all pervasive. The capitalist system is denominated in prices, and for the past century or so, the habitual price-setting mechanism has been capitalization. Discounting seems to pervade every thing and every process: it determines the prices of human life and its genomic code; it sets the prices of consumer goods and services, it generates the prices of corporate assets and government debt; it calculates the prices of military operations and humanitarian aid; it is even used to compute the price of our ecological future. The imperatives of capitalization are accepted, internalized and obeyed, usually without question, by the rulers as well as the ruled – and that acceptance makes capitalization central to the dominant ideology of our society.

● Capitalization and the forward-looking outlook. The ritual of capitalization is feverishly forward looking: it is concerned not with the past or the present, but with the future. The elementary particles of capitalization – earnings, investors’ hype, risk perceptions and the normal rate of return – represent not what is known to have happened, but what is expected to happen. The expectations themselves are inherently uncertain and always in flux. But underneath their shifts and turns, one thing remains constant: the conviction that the capitalization process itself will continue to rule and organize humanity, forever.

This latter conviction is necessary for the existence of modern capitalism, at least in its present form, and the easiest way to demonstrate that necessity is to assume it away. Suppose for argument’s sake that capitalists, instead of expecting capitalization to continue indefinitely, believed that the process would cease to exist at some future point. At that point, with capitalization gone, their assets would have a nil value, by definition; and with future prices being zero, current prices would have nowhere to trend but down. Now, the fact that capitalists invest shows that they expect the very opposite – i.e., that the value of their assets will grow, not contract – and that expectation means that, consciously or not, they also think that the ritual that valuates their assets will never end.¹

These propositions lead to two related conclusions. First, they suggest that the very existence of capitalization attests to the capitalist confidence in obedience. The fact that this ritual is so pervasive implies that most people believe it will remain so; and the only way for this ritual to remain pervasive is if capitalists are convinced that they can continue to impose it on a society that is unwilling or unable to oppose it. The second conclusion is that a protracted breach of capitalization – a period during which the ritual breaks down – signifies the loss of confidence in obedience, the potential disintegration of the dominant ideology and, ultimately, a threat to the very existence of the capitalist mode of power. If correct, these conclusions can offer a quantitative insight into the long-term outlook of the ruling capitalist class – and, by extension, into the prospect of systemic change to the capitalist mode of power.

The first question, then, is how do we know that capitalization has “broken down”? What are the features of such a breakdown? How do these features differ from investment as usual? Can these features be quantified – and if so, how?

Takeoff

To begin answering these questions, let us backtrack a bit and consider the situation in early 2010. The capitalist class is finally seeing light at the end of the tunnel. For many months now, its analysts, statisticians and public officials have been spotting “green shoots” everywhere they look. The snowballing global recession, they say, seems to have slowed down and perhaps even ended. Managers the world over are purchasing more inputs after a period of buying much less; the factories of Asian exporters are running at full steam; raw material prices have rebounded strongly; bank lending is reviving and home owners are starting to refinance their mortgages at lower rates; and in the United States, the world’s biggest producer-consumer, initial unemployment claims seem to have peaked, while consumers are beginning to loosen their purse strings. But the most important sign that the worst of the crisis is over comes from the equity market: stock prices are the ultimate barometer of capitalist health, and they have been soaring.

The market takeoff is evident in Figure 1. The chart traces the U.S. dollar price of three key indices – all world equities, U.S. equities, and the equities of the U.S. FIRE sector (finance, insurance and real estate). All three indices show a sharp, synchronized rise. In slightly more than a year, from February 2009 to April 2010, the world index gained 67%, the U.S. index 62%, and the U.S. FIRE index – previously the most battered of the three – a whopping 93%.

Suddenly, the bulls are everywhere. The greatest returns are usually earned during the initial part of a rally, and no respectable fund manager likes being beaten by a rising average. With the economy apparently bottoming out and with the stock market having been in a major bear phase for nearly a decade, investors are no longer afraid of losing money; their fear now is not making enough of it.² And so arises the specter of “panic buying,” a frenzied attempt to jump on the bandwagon before the really large gains are gone.³

Of course, not everyone buys this rosy scenario. Many observers continue to feel that the recent stock market rally is no more than a dead-cat bounce. In the eyes of the pessimists, investors are knee-jerking to a false start. The economic recovery, they say, will be W-shaped, and the market will re-collapse before any real boom can begin. This recession, they warn, is nasty and likely to linger for years.⁴

Looking Forward

Regardless of who is right, though, there is something fundamentally wrong with the debate itself. The current news may be good or bad, revealing or misleading – but, then, investors aren’t supposed to take their cue from the current news in the first place.

To trade assets on the basis of today’s statistics is to be backward looking. It is to be retrospective rather than predictive, to react rather than initiate, to trail rather than lead. It puts investors at the tail end of social dynamics.

Needless to say, such behavior is entirely improper. According to the sacred annals of modern finance, formalized a century ago by Irving Fisher (1907) and popularized during the Great Depression by Benjamin Graham and David Dodd (1934), asset prices are forward looking: “The value of a common stock,” dictate Graham and Dodd in their immortal doorstopper, “depends entirely upon what it will earn in the future” (p. 309).

These lines were written against the backdrop of the 1920s. The roaring stock market and the accompanying optimism ushered in by the end of the First World War offered a fertile breeding ground for what Graham and Dodd called the “New-Era Theory,” especially in the land of limitless possibilities. The principles of discounting the future gained adherents, and soon enough past profits became passé. They no longer mattered for the stock market. From now on, declared the gurus of finance, one should view the markets “from the standpoint of eternity, rather than day-to-day” (Benjamin Graham quoted in Zweig 2009). Looking forward, the only thing that counted was the future trend of earnings.⁵

It should be noted, though, that initially this approach didn’t win too many supporters. In fact, it faced a rather stiff opposition, and not for naught. The late nineteenth century gave birth to a new entity: the modern, publicly traded corporation. It was an entirely novel way of organizing business, both inside and outside the firm, and it spread very quickly, carried on a tidal wave of public offerings. Forward-looking securities of every color, size and denomination were being floated in ever larger numbers, all promising a future of riches to the daringly prescient, and the sheer magnitude and exponential growth of it all left economists baffled and public officials gasping for air.

At the time, there were very few theoretical tools and scarcely any data to make sense of this new development. There was no corporate transparency to speak of, no models to predict future earnings, let alone their trend, and no formal methods to assess risk. To make matters worse, the newspapers were only too happy to amplify the forward-looking exploits of corporate promoters. The key owners and their bankers were blamed, not without cause, for “overcapitalizing” their assets and “watering” their stocks relative to their “actual” (read greenfield) investments – all in order to rip off the innocent public.⁶

The whole thing smelled of a racket: “the principle that capitalization should be based on earning capacity rather than on actual cost,” declared one disgruntled rejectionist, “is not only unsound in theory but is also vicious in its practical application” (Bonbright 1921: 482). Under these conditions, officials and theorists were unsure of how to reconcile the new practice of discounted future earnings with the familiar “par value.” It seemed much easier to stick to the conservative principles of “historical cost” accounting.

In retrospect, though, these were futile acts of resistance. Forward-looking finance was not a mere technical gismo. It was the basis for a totally new architecture of power: capitalization. As noted, capitalization is a symbolic financial entity, a ritual that the capitalists use to discount to present value risk-adjusted expected future earnings. This ritual has a very long history. It was first invented in the capitalist bourgs of Europe, probably sometime during the fourteenth century. It overcame religious opposition to usury in the seventeenth century, to become, for the first time, a conventional practice among bankers. And its mathematical formulae, previously relying on habit and rules of thumb, were first rigorously developed and synthesized in the mid-nineteenth century by a group of German foresters. But it was only in the late nineteenth century, with the birth of the publicly-traded modern corporation, that these principles were poised to become the broad norm of what we now call modern finance.⁷

Capitalization: Marx’s Fiction

Karl Marx, one of the first to dissect the social underpinnings of capitalization, sided with the rejectionists. The capitalist system, he said, fancies two different entities: “actual” capital and “illusionary” or “fictitious” capital. The driving force of the system is actual capital, which exists as commodities. For Marx, actual capital comprises means of production, work in progress and commodity money, whose prices are governed by the reality of labor time, whether historical or current. By contrast, fictitious capital is an ownership claim on future earnings, an illusionary entity whose price is the present value of those earnings.⁸

According to Marx, the latter entity is fictitious for three separate reasons. First, the ownership claim on earnings often has no “actual” principal to call on, as is the case with state debt, for instance. Second, the claim extends into the uncertain future: it capitalizes expected earnings, and these could easily fail to materialize. Third and finally, discounting depends on the rate of interest, which means that the same flow of earnings can give rise to many different levels of capitalization (Marx 1909, Vol. 3: 546-47 and 550-51).

For Marx, then, actual and fictitious capitals are totally different creatures. They consist of different entities, and they are quantified through different processes – the former via past and current productive labor time, the latter through future earnings expectations and the rate of interest. So, when considered separately, their respective magnitudes and movements need have nothing in common. The problem, though, is that they cannot be considered separately. The capitalist system is denominated in prices, and as Marx himself conceded, prices are affected by both fictitious and actual accumulation. As a result, any divergence of the former from the latter is bound to “distort” the value system:

All connection with the actual process of self expansion of capital is thus lost to the last vestige, and the conception of capital as something which expands itself automatically is thereby strengthened…. The accumulation of the wealth of this class [the large moneyed capitalists] may proceed in a direction very different from actual accumulation…. Moreover, everything appears turned upside down here, since no real prices and their real basis appear in this paper world, but only bullion, metal coin, notes, bills of exchange, securities. Particularly in the centers, in which the whole money business of the country is crowded together, like London, this reversion becomes apparent; the entire process becomes unintelligible” (Marx 1909, Vol. 3: 549, 561 and 576, emphases added).

These considerations led Marx – and many Marxists since – to view the “illusion” of capitalization as antithetical to the “real” essence of value and accumulation, and therefore as offering only secondary insight into the larger analysis of capitalism.⁹ The seemingly independent gyrations of fictitious capital of course could be hugely important, and in recent years Marxists have put increasing effort into their analysis. But this importance is mostly negative and temporally limited. In the short run, capitalization wreaks havoc: it contaminates the underlying system of labor values, it sends false signals, and it amplifies the underlying economic cycle with an even more violent financial cycle that oscillates between euphoric bubbles and deflationary crashes. In the long run, though, it is the “real” economy of production, not the nominal “fiction” of finance, that counts. Production is the Galtonian anchor, the historical trend from which finance deviates and to which it must eventually revert. And since the key to capitalist development remains a proper understanding of the labor process, the extraction of surplus value and the accumulation of actual capital, Marxists never felt they needed to develop their own unique theory of capitalization, let alone to place such a theory at the heart of their analysis.

Capitalization: The Neoclassical Reconstruction

This later task was taken on by the liberals. Contrary to the Marxists, who begin from two different entities, the neoclassicists start from equivalence: capitalization both derives from and reflects the actual capital goods. One of the first stylized expressions of this symmetry is due to Irving Fisher. In an article aptly titled “What is Capital?” (1896), Fisher opens by devising a consistent set of definitions. His starting point is a distinction between “stock” (quantity at a point in time) and “flow” (quantity per unit of time). Capital is a stock; income is a flow. Capital gives rise to income, whereas income gives capital its value. The precise correspondence between these concepts is articulated in his book The Rate of Interest (1907):

The statement that “capital produces income” is true only in the physical sense; it is not true in the value sense. That is to say, capital-value does not produce income-value. On the contrary, income-value produces capital-value…. [W]hen capital and income are measured in value, their causal connection is the reverse of that which holds true when they are measured in quantity. The orchard produces the apples; but the value of the apples produces the value of the orchard…. We see, then, that present capital-wealth produces future income-services, but future income-value produces present capital-value. (13–14, original emphases)

The feedback loop is illustrated in the Table 1, adopted from Fisher (14):

Explanation: In the material world, depicted by step 1 of the sequence, capital wealth (measured by the physical quantity of capital goods) produces future income services (similarly measured by their physical quantity). In the nominal world, depicted by step 3, the income value of the future services (measured in dollars) is discounted by the prevailing rate of interest to generate the present value of capital (also measured in dollars). The two worlds are connected through step 2, whereby the physical quantity of future income services determines their dollar price.

Hypothetical numerical illustration: Intel has 10 million units of capital wealth, which, during its future life, will produce 1 billion units of income services in the form of microchip-generated utils (step 1). These 1 billion utils’ worth of services, spread over the life of the capital wealth, will fetch 100 billion dollars’ worth of future profits and interest (step 2), which in turn are discounted to 50 billion dollars’ worth of capital value (step 3).

From a theoretical standpoint, this articulation is deeply problematic – primarily because neoclassical “capital goods,” much like Marx’s “actual capital,” cannot be measured in universal units, whether we call them utils or abstract labor hours.¹⁰ But this difficulty hardly deterred the neoclassicists. At stake here was the wholesale conversion of capitalism to a new, financial footing, and the articulations offered by Fisher and other liberal economists provided the detailed rituals on which this new capitalized structure were to stand from then to eternity.

Dominant Ideology

And, indeed, liberals soon began to believe, first, that any expected income flow can be discounted to present value; second, that, in addition to earnings, discounting reflects both the normal rate of return and the risks specific to the income in question; and finally, that capitalization applies universally across time and space. Now, since in capitalism every process has a potential impact on the flow of income, it follows that accumulation, seen through the spectacles of capitalization, incorporates, at least potentially, every aspect of social life. From this viewpoint, capital is no longer a narrow matter of economics – or, alternatively, everything is now a matter of finance. Whatever affects the future trend of earnings, risk and the normal rate of return can be capitalized; and once capitalized it becomes part of capital.

And so a new comprehensive ethic was born. What Marx dismissed as a fiction, and what early twentieth-century liberals considered a rip-off, became the new template for creordering capitalist power. By the middle of the twentieth century, the forward-looking notion that asset prices discount the deep future had replaced “actual cost” as the new creed. In the 1950s, capitalization started to appear in finance textbooks; in the 1960s and 1970s, it helped propagate portfolio theory and took over corporate budgeting; in the 1980s and 1990s, it was underwriting the worldwide spread of neoliberalism and the tenfold increase in global stock prices; and by the 2000s, it was safely established as a sacrosanct gospel, an organized belief system with more followers than all of the world’s religions combined.

The rituals of this forward-looking gospel are now articulated, published and republished in millions of learned papers and monographs, and reproduced endlessly in finance textbooks. They are deeply embedded in computer models and are hardwired into pocket calculators. Every accountant, analyst and capitalist accepts them as an article of faith; most politicians and government officials are conditioned to follow their dictates; and the remainder of humanity – from employees and small business owners, through pensioners and the unemployed, to criminals and illegal aliens – unknowingly obeys their decree. Encompassing, imposing and largely beyond dispute, forward-looking capitalization has become the heart and center of today’s dominant ideology.

The Puzzle

Now, turning from this broad discussion back to the current historical moment, a puzzle arises: if asset prices look forward to the long-term future trend of earnings, why worry about the ongoing economic cycle, however volatile?

Every investor is conditioned to know that crises come and go with remarkable regularity and that recession always gives way to expansion, so what’s the point of following the latest news on green shoots, commodity prices, or the actions and inactions of purchasing managers and policy makers? Although these immediate news items may be important for journalists, politicians and even economists, their impact on the long-term trajectory of profit is negligible – so why should they be of any concern to dominant capitalists and their prescient strategists?

The short answer is that, normally, the latter indeed don’t seem to care. But there are crucial exceptions to this rule. And in order to understand both the exceptions and the rule from which they deviate, we need first to step back and examine the historical record.

The Great Divide

Consider Figure 2, which shows the relationship between the dollar price and dollar earnings per share of the S&P 500, a group representing the largest listed corporations in the United States.¹¹

The chart contains two sets of monthly series. The top set, starting in January 1871, displays the actual levels of the series. The price series is calculated as the monthly average of daily closings. The earnings-per-share series is computed in two steps: first by interpolating monthly earnings from annual data (before 1926) and from quarterly data (after 1926); and then by expressing the result as a 12-month moving average. In the chart, both series are normalized, with September 1929=100, and are plotted against the left logarithmic scale to facilitate visual inspection.¹²

The bottom set, beginning in December 1874, shows the respective rates of change of the top series. The series are calculated, first, by computing for each month the percent growth rate relative to the same month a year earlier, and then by smoothing the resulting data as a three-year moving average (so that each observation shows the average annual growth rate of the last 36 months). The resulting series are plotted against the right-hand arithmetic scale.

Table 2 shows the Pearson correlation coefficient between the two growth rate series (smoothed as three-year moving averages). The coefficient, which quantifies the co-movement of the series, is measured separately for the periods before and after 1917, as well as for four sub-periods that make up the post-1917 era.¹³ The rationale for delineating between the different periods is explained in what follows.

If we take a bird’s-eye view of the entire period from 1871 to 2010, equity prices seem to have moved more or less together with earnings per share. But from a shorter perspective, there is a great divide between the periods before and after the First World War.

During the period ending in 1917, which the figure shades for easier visualization, the correlation between the two series is very high. The fit is evident in the tight co-movement of the levels of price and earnings per share (top series) and even more so in their almost identical rates of change (bottom set). Between 1873 and 1917, the Pearson correlation between the latter series was +0.72, and this tight fit shouldn’t surprise us.¹⁴

Recall that during that period, forward-looking finance was still in its infancy, and that investors were conditioned to believe that “what you see is what you get.” According to Graham and Dodd, the investment outlook was largely conservative, and most stock owners tended to view common equities as little more than glorified bonds. The main reason for holding equity was dividends – which, at the time, were free of any taxes and accounted, on average, for 70% of corporate profits (compared with less than 50% in the second half of the twentieth century and about 45% since the mid 1970s).¹⁵ There were of course those who bought stocks with an eye to future capital gains, but these were considered “speculators,” not “investors.” For the latter, the main criteria for choosing stocks were: (1) stable dividends; (2) a somewhat higher level of earnings to support such dividends and maintain the company; and (3) a stock price that was solidly backed by so-called tangible assets.¹⁶

Like the interest on bonds, corporate earnings and dividends were not expected to trend upwards; although investors would have welcomed such an increase, the common premise was that both streams would remain solidly stable. And since the ownership of equities, like the ownership of bonds, was supposed to generate a fairly constant yield, equity prices tended to fluctuate closely with current corporate earnings and dividends – which is more or less what we see in Figure 2.

The second period, though, from 1917 onward, is completely different. For the most part, the fit between price and earnings per share is very loose and often negative: the variations of the series are usually out of sync, the magnitudes of the variations are often very different, and there are extended periods during which the numbers move in opposite directions. The Pearson correlation coefficient for the growth-rate series over the entire post-1917 period (including the anomalous 1930s and 2000s) is a mere +0.35 – less than half of its pre-1917 level.

Of course, theorists of finance don’t consider this decoupling problematic. On the contrary, they see it as a vindication of their forward-looking model, clear evidence that capitalist finance has finally come into its own.

Decoupling Price from Earnings

According to the modern forward-looking habitus, investors price an asset by discounting the future profit trend that the asset is expected to generate. In this ritual, the participants set the price of the asset – say a share of Microsoft – as equal to the ratio between what they expect Microsoft’s future profits to be on the one hand and the rate of return they wish those profits to represent on the other. For instance, if investors expect ownership of a Microsoft share to generate a fixed annual profit stream of $100 in perpetuity, and if they want this stream to represent a 20% rate of return, then they would be willing to pay for the share (or demand to be paid) a price of $500. We can represent this computation symbolically, so that:

where Kt is the price of Microsoft’s share in year t, E is the level of annual earnings investors expect Microsoft to generate in perpetuity, and r is the decimal rate of return appropriate for Microsoft.

Now, given the common belief that capitalism is a perpetual growth system, it seems only reasonable to expect Microsoft’s annual earnings to flow not at a fixed rate E, but at a rate that grows over time. This expectation could easily be fit into the framework by substituting a higher fixed level of earnings for the exponentially growing one. Alternatively, if we assume, as investors habitually do, that the expected growth of earnings will be maintained indefinitely at a rate g, say 10%, and provided that this growth rate is lower than the discount rate r, Microsoft’s share price can be computed as follows¹⁷ :

In general, the practical pricing process can be far more intricate, but the basic ritual of contrasting expected profits with a discount rate of return is always present.¹⁸ Now, regardless of the merits of this ritual, one thing seems obvious: prices set in this manner should bear little or no relationship to the current level of profit.

There are three reasons for the dissociation. First, since the price reflects the future trend of earnings, and since this trend is affected only marginally, if at all, by present or past earnings, there is no inherent reason why month-to-month fluctuations in current profits should affect stock prices. And that is just for starters. Note that the future earnings trend, by its very nature, cannot be known with certainty and is forever conjectural. For this reason, investors discount not the profits they will earn, but the profits they expect to earn. In the case of Equation 1 above, for example, investors can easily misjudge the perpetual future flow of Microsoft’s earnings per share to be $50 or $400 instead of the eventual $100; this error will in turn cause them to price the company’s stock at $250 or $2000, respectively (=50/0.2 or 400/0.2). Similarly, if investors erroneously predict that Microsoft’s earnings will grow annually by 1% or 19% instead of the eventual 10%, they will misprice its stock at $526 or $10,000, respectively. And since profit expectations are rather open ended and commonly hyped either positively or negatively, the effect is to widen further the disparity between the movement of price on the one hand and of current earnings on the other.

Second, a given level of expected earnings can generate any number of asset prices, depending on the discount rate of return. For instance, if the discount rate in Equation 1 were 10% (rather than 20%), the stock price would double to $1,000 (=$100/0.1). Now, the discount rate changes constantly – partly because of variations in the overall rate of interest and partly in response to changing perceptions of risk specific to the particular equity in question. However, since in and of themselves these changes are unrelated to current earnings, the effect is to reduce the correlation further.

Finally, investors are not always able to follow the rituals of finance with sufficient precision. Regardless of how hard they try, their computations are constantly thrown off, or so we are told, by various market “imperfections,” government “intervention” and other such diseases; and sometimes, particularly when investors get overly excited, the calculations can even become “irrational.” Now, since neither the miscalculations nor the irrationality are correlated with current profits, the result is to loosen the fit even more.

So if we adhere to the scriptures of modern finance, we should expect to see no systematic association between equity prices and current profits. And given that most if not all present-day investors obey the scriptures – including the allowed imperfections and irrationalities – their actions tend to validate the “theory.”

But not always.

Looking Backward

Figure 2 and Table 2 show two clear exceptions to the rule: the first occurred during the 1930s, the second during the 2000s. In both periods, which Figure 2 shades for easier visualization, equity prices moved together – and tightly so – with current earnings. Between 1929 and 1939, the correlation between the respective growth rates of the two series (smoothed as 3-year moving averages) was +0.89, while in the period between 2000 and 2010 it was +0.64. The difference with the rest of the post-1917 period is stark: in the period from 1917 to 1929 the correlation was a much lower +0.29; and in the period from 1939 to 2000 the correlation was –0.15 – which means that the series had very limited co-movement, and that the limited relationship that did exist was actually negative.

Needless to say, the tight positive correlation of the 1930s and the 2000s, reminiscent of a bygone era, is a gross violation of modern forward-looking finance. In fact, the violation is worse than it seems. Note that, despite their name, monthly earnings per share represent profits that were earned not during the current month, but during the previous twelve months. This measurement convention means that, during the 1930s, and again during the 2000s, investors committed a cardinal sin. They priced assets based not on future earnings, and not even on current earnings, but on past earnings!

What caused this sharp departure from conventional practice? Why would investors regress to a backward-looking posture that the scientists of finance tell them is patently “false”? Why would they suddenly abandon their convenient forward-looking ceremony and instead take their cue from the dead past? Why give up the predictive powers of precise positivism in favor of poor historicism?

A naïve observer, unschooled in the rituals of modern finance, may be tempted to blame such regression on the heightened turbulence of the two periods. According to this view, investors are always forward looking. But when rattled by crisis, they become more cautious about the future, and that greater caution causes them to use the movement of current earnings as an indication of heightened future risk. As a result, increases in current earnings mitigate risk perceptions; lower risk perceptions reduce the discount rate; and a lower discount rate raises stock prices (and vice versa).

This type of behavior, although possible, would be entirely inconsistent with the basic ritual of forward-looking asset pricing. First, according to this ritual, the level of caution – or the “risk premium” embedded in the discount rate (r) of Equations 1 and 2 – is a slowly-changing magnitude. It reflects the overall price volatility of the assets – historically as well as with an eye to the future – and as such, it changes very little from year to year. Second, in the manuals of modern finance the “risk premium” pertains to the volatility not of earnings (E), but of prices (Kt). This association means that even if the risk premium were to exhibit large temporal variations, still there would be no reason for such variations to track the ups and downs of current earnings.

So what is behind the two reversals?

Systemic Fear

In our view, the reason is systemic fear.

Systemic fear is a class of its own. It has little to do with the periodic downswings that make capitalists cautious, and it has no connection to the dread and apprehension that regularly puncture their habitual greed. “Business as usual” is always uncertain, and with capitalism constantly in flux, investors are forever fearful about profit and wary about risk: they are concerned that earnings may not rise as quickly as they hope, or that they might fall; that volatility will increase; that interest rates will rise; and so on.

But these fears, no matter how intense, are self-contained. They pertain to the level and pattern of profit, not to its existence. They do not impinge on the normality of profit – i.e., on the belief that assets have a “natural” tendency to grow and that capitalists have the power and right to enforce and appropriate such expansion. And most crucially, they reflect the belief that expected profits, whether high or low, could always be priced to their present value. Regardless of the market’s ups and downs, the underlying assumption is that the capitalization process itself – the ritual that creorders modern capitalism and anchors its dominant ideology – will remain intact.

Occasionally, though, there arises a very different and far deeper type of fear: the terrifying thought that the entity of profit – and, worse still, the very institution of capitalization on which the entire capitalist megamachine stands – might cease to exist.¹⁹ This latter fear is associated with systemic crisis – that is, with periods during which the very future of capitalism is put into question. It is what Hegel meant when he spoke of the bondsman’s “fear of death”:

For this consciousness [of the capitalist bound to the steering wheel of a megamachine gone wild] was not in peril and fear for this element or that [such as falling profit or rising volatility], nor for this or that moment of time [like a sharp market correction or a declaration of war], it was afraid for its entire being; it felt the fear of death, the sovereign master [the ultimate wrath of the ruled]. It has been in that experience melted to its inmost soul, has trembled throughout its every fibre, and all that was fixed and steadfast has quaked within it [will capitalism survive?]. (Hegel 1807: 237)

The first time capitalists were gripped by such systemic terror was during the Great Depression of the 1930s. The second time is during the present crisis, a protracted turbulence that started in the early 2000s and is still ongoing.

The 1930s

Let’s examine each of these periods more closely, beginning with the 1930s.

Figure 3 “magnifies” the data from Figure 2. It focuses specifically on the period from the late 1910s to the early 1950s, with the shaded area denoting the period of systemic crisis. For ease of comparison, the two top series are rebased with October 1929=100 and plotted against an arithmetic left scale. The rate-of-growth series, as before, are plotted against the arithmetic right scale.

The data show that, after the First World War and during the happy 1920s, stock prices moved rather independently of earnings, exactly as the “New-Era Theory” decreed. But once the stock market crashed in 1929 and the Great Depression began, the “New-Era Theory” broke down: the two series, instead of moving independently of each other, suddenly converged and remained tightly locked for nearly a decade.

Both series fell in tandem from 1930 to 1932, and then rose in tandem from 1933 to 1936 – charting what initially looked like a V-shaped recovery. But the hopeful V soon became a disheartening W. In 1937, a new downturn began, and the two series, which briefly decoupled, again converged in a free fall. It was only in 1939, after a decade of frustration, that the two series again diverged and that the “New-Era” theorists could breathe a sigh of relief.

The political-economic background of the period requires little elaboration. During much of the 1930s, the United States, along with the rest of the world, was mired in a systemic crisis. The very existence of the capitalist mode of power was at stake, with liberalism fighting for its life against both communism and fascism. The dominant ideology suffered a major blow. The “free market” didn’t seem to be working, and with laissez faire theories in deep disarray, the rulers were no longer confident in the obedience of the ruled. Few felt certain that capitalism would survive, and many – including some of the system’s leading advocates – feared its imminent demise.

In this context, the “future trend of earnings” was no longer a very meaningful concept, and there was little point in extrapolating, let alone quantifying, its growth rate. Furthermore, the very institution of capitalization was put into question, so even if future earnings could somehow be predicted, it didn’t seem certain that future ownership claims on these earnings could be priced and transacted.

There was no anchor ahead. All that was solid melted into air, all that was holy was profaned. And so, in despair, forward-looking investors found themselves latching onto the only “real” thing they could see: the past. Like the Aymara Indians of South America, they suddenly realized that the future was behind them.²⁰ Nominally, their assets still represented a claim over the future; but the only way to price that future was to look backward, to what the assets had already earned.

The pricing anomaly ended in 1939. Suddenly, the disorder dissipated, optimism re-emerged and history could again be forgotten. The onset of the Second World War and the boom that ensued sent profits soaring (they doubled in less than two years). And the capitalists, cajoled by the apparent efficacy of the new welfare-warfare state, regained their systemic confidence. They abandoned the stale past, returned to their forward-looking rituals and resumed the discounting of expected future earnings. Within two years, the stock market was down 25%, but this decline was no longer symptomatic of systemic fear. On the contrary, it was evidence that capitalism had survived and that capitalists could fearlessly practice their capitalization rituals.

The 2000s

This situation lasted for sixty years. During that period, capitalism went through many ups and downs, and there was the occasional scare that sent markets reeling. But none of the jolts was serious enough to evoke the Hegelian fear of death. At no point was the existence of the system itself in doubt. It was business as usual, with greed and fear easily incorporated into future earnings projections and risk calculations. The financial model seemed to work like clockwork.

But in 2000, the machine stopped. The threat of a new systemic crisis suddenly loomed large, and the specter of backward-looking pricing, having been dormant for decades, returned to haunt the markets.

Figure 4 displays price and earnings per share data from 1970 to the present, with the shaded area denoting a period of systemic crisis. The two top series, denoting levels, are rebased with December 2007=100 and graphed against the left arithmetic scale. The bottom series express the annual rates of change (smoothed as 3-year moving averages) and are plotted against the right arithmetic scale.

As the data in Figure 2 and Figure 4 show, from 1939 to the early 2000s, both price and earnings per share trended upwards. But in line with the “New-Era Theory” – which by now had become mainstream finance – the short-term correlation between them remained loose and indeed negative (see Table 2). During that long stretch, earnings went through several sharp declines. For instance, during the end-of-communism crisis of 1989-1991 they dropped 37%, and following the emerging markets scare of 1997-1998 they fell 6% – yet in both cases stock prices continued to soar. And conversely, in 1972-1974 earnings increased by 42% while prices dropped by 43%; similarly, at the end of 1987 earnings increased by 14% while prices dropped by 27%. All in all, then, investors seemed perfectly happy to obey the theory. Throughout the period, they ignored the ephemeral present in favor of the eternal future.

But in 2000, they suddenly lost their forward-looking vision, and they haven’t regained it since. Over the past decade, earnings have experienced two very violent swings; yet stock prices, instead of remaining impartial to the immediate gyrations of the earnings cycle, have traced it, and rather tightly: the correlation coefficient between the rates of growth series, smoothed as 3-years moving averages, jumped to +0.64, up from to –0.15 in the preceding six decades.

A fairly similar picture arises at the global level. Figure 5 shows price and earnings per share for the Datastream world equity index, covering the period between January 1973 and April 2010 (there are no prior data). The top series, plotted against the left logarithmic scale, show levels and are rebased with January 1986=100. The bottom series show the annual rates of change, smoothed as a three-year moving averages, and are plotted against the right arithmetic scale. As before, the shaded area denotes a period of systemic crisis.

Because the world aggregate is far broader than the U.S. one, reflecting many different markets that often move through different phases and that are subject to different conditions, one would expect the correlation between the two series to be looser throughout. But it is not. For the period from January 1974 to August 2000, the Pearson correlation coefficient between the two rate-of-growth series, smoothed as 3-year moving average, is –0.16, which is similar to that of the U.S. And the coefficient for the subsequent period is +0.48 – lower than U.S.’s +0.64, but still far too high for the forward-looking ritual.

Is Capitalization Approaching a Glass Ceiling?

Let’s examine the experience of the past decade more closely, beginning with the first market cycle, which started to decline in 2000, troughed in 2003 and peaked in 2008 (given the similar statistical patterns in Figure 4 and Figure 5, our discussion refers to the former figure only). The 2000 “dotcom” crash and the demise of the “new economy,” together with the 2001 collapse of the Twin Towers and the onset of the “infinite war on terror,” signaled the beginning of a new era of uncertainty. Analysts started to debate the end of the “Washington Consensus,” strategists deliberated over the decline of the “American Empire,” and culturalists lamented the death of the “global village.”

It is true that, initially, nobody was seriously contemplating the “end of capitalism.” But capitalists nonetheless started to grow wary. This didn’t feel like yet another “crisis as usual,” and the long-term trajectory of future profits – which in previous decades had appeared neatly bounded and relatively easy to project – suddenly looked murky. And so, once again, capitalists found themselves with their backs to the future. As we can see in Figure 4, instead of projecting the earning trend looking forward, they began to watch earnings as they unfolded and to discount their past declines.

By the middle of 2002, the earnings crisis finally appeared to have ended, and in early 2003 the stock market bottomed. Profits staged a massive, V‑shaped recovery and, over the next five years, rose by nearly 350%. And yet, despite the surge, capitalists still found the future hard to envisage. The earnings boom certainly was real enough – but so were its limits.

These limits become visible when we take a bird’s eye view of the postwar period. During that period, U.S. market capitalization was fueled by a highly favorable combination of several power processes.²¹ First, after the Great Depression, capitalists managed to force a systematic redistribution in their favor, seeing the combined share of their pretax profit and interest in national income rise from about 12% in the 1930s and 1940s to roughly 17% in the 2000s. Second, they also succeeded in pushing down the effective corporate tax rate – from 55% in the 1940s to less than 30% in the 2000s – a decline that caused their after-tax corporate earnings to increase even further. Third, the broader consolidation of power relations and the establishment of capital-friendly regulations and macro stabilization policies helped them reduce earning volatility – and, by extension, their own perceptions of risk. This decline in perceived risk, along with the general fall in interest rates since the late 1970s, lowered the rate at which they discount their expected earnings, thereby boosting their present value even more.

These power processes all had the same impact on the stock market: they pushed it up. The effect of income redistribution and falling corporate taxes convinced capitalists that net profits would continue to rise much faster than national income, while falling risk perception along with the drop in interest rates over the past thirty years allowed them to re-price this steep earning trend at ever lower discount rates. The net consequence was that the overall stock market capitalization rose more than four times faster than the gross national income: it soared from $167 billion in 1952 to $20.3 trillion in 2007 – a 127-fold increase – compared with a mere 39-fold increase in dollar value of gross national income, which grew from $312 billion to $12.4 trillion.²² ,²³

The trouble was that, by the early 2000s, after half a century in overdrive, these power processes have already run much of their course, making future increases in stock prices more difficult to achieve. Capitalism is inherently conflictual, so power is always imposed against opposition. This built-in conflict means that from a certain point onward, there tends to be a positive relationship between the existing level of capitalist power on the one hand, and the force that needs to be exerted in order to further increase that power on the other. Thus, the higher the income inequality, the harder it is to make it more unequal; the lower the corporate tax rate, the harder it is to cut it further; the smaller the volatility of earnings, the harder it is to stabilize them further; and the lower the rate of interest, the harder it is to see it fall further.

The exhaustion of these redistributional/conflictual fuels left the stock market at the mercy of aggregate growth – and yet the “real economy” too seemed to be running into the sand.²⁴ Expressed in purchasing power parity, annual GDP growth in the United States has drifted downwards, from 3.6% in the period from 1950 to 1975 to 3.1% since then, while world GDP growth dropped from 4.7% to 3.5%.²⁵ Since the late 1990s, official growth measures seemed to have recovered, leading capitalists to hype the unlimited potential of “high technology” and the “knowledge economy,” along with the fabulous riches promised by rapid urbanization in the so-called “emerging markets.” But by the early 2000s, these hopes were increasingly spoiled by new doomsday scenarios, ranging from “peak oil” and “climate tipping” to “runaway pandemics” and “environmental devastation” (scenarios that we consider later in the paper).

The fact that redistributional difficulties tend to arise together with overall stagnation is no accident. In order to redistribute income and assets in their favor, rulers need to exert their power on the rest of society; to exert such power, they have to strategically limit and partly sabotage the well-being of the underlying population; and this strategic sabotage tends to appear at the aggregate level in the form of stagnation.²⁶ The rulers themselves, because of their social position, cannot comprehend, let alone accept, this necessity, and their dominant dogmas and ideologies hide and deny it. But the historical evidence, particularly during acute crises, proves it time and again: unable to see the contradiction, the rulers attempt to alleviate the general malaise as well as to keep their redistributional power intact; but because their power depends on the sabotage they cause, this attempt invariably fails.

In light of this discussion, and given the current convergence of redistributional and aggregate limits, can we say that the capitalist mode of power is approaching a glass ceiling? During the early 2000s, few capitalists were expressing the question in such stark terms; but the menacing possibility was certainly lurking in the background, and with the future looking disheartening at best, most preferred to keep their eyes on the immediate past. Share prices started to rise only in October 2002, a full six months after the earnings upswing began, and for the next five years they increased in tandem with profits (albeit at a much lower rate).

And then came the “subprime crisis,” and all hell broke loose.

Is the Dominant Ideology Broken?

As Figure 4 shows, between their June 2007 peak and their May 2009 bottom, earnings fell by 91% – a decline greater than the 75% collapse experienced during the first three years of the Great Depression. If capitalism were here to stay, this must have been the mother of all investment opportunities: with profits bound to rebound back to their long-term trend, their rise was sure to be spectacular – as were the gains to investors loyal to the forward-looking ritual. But few seemed convinced. And, so, instead of anticipating the Galtonian reversion to trend, share prices continued to slide, closely following the footsteps of current earnings.

Given that the bear market, measured in rates of change, was approaching historical lows, and since such bottoms had previously always been 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 – were advising their followers to fasten their seat belts in preparation for an imminent takeoff.²⁷ And in early 2009 they were finally vindicated.

But the rebound had to do neither with the advice of analysts nor with the prescience of capitalists. The real trigger was earnings. Recall that, by now, investors had lost their belief in the inevitable, at least for the time being, and that instead of looking forward to eternity they kept staring at the past. Everyone was glued to the earning cycle, anxiously waiting for it to find a bottom. And, sure enough, it was only after profits finally started to increase that stock prices began to rise.²⁸ By April 2010, the market was up 60%; but as with the decline, the increase, too, merely traced the path of earnings. Given the thrust of the profit up-cycle, though, with earnings having risen more than nine-fold from their near-zero level at the 2008 bottom, the question arises again: why are investors still behaving as if they doubt that the upswing is real, not to say sustainable?

In our view, the answer is that the crisis of the late 2000s reintroduced an additional and far deeper form of fear. During the early 2000s, the concern was largely practical: the stock market appeared to be running out of fuel, and the main fear, however fuzzy, was that the level of capitalization may have been approaching a glass ceiling. But since the late 2000s, the very ideology of capitalization has been put into question: the capitalist class seems to have lost confidence in its own theories and rituals – and, therefore, in its ability to rule.

“Uncertainty is the only certain thing in this crisis,” bemoan the editors of the Financial Times. As of today, nobody knows what is going to happen:

[A] dense fog of confusion has … descended, obscuring where we are – falling fast, slowly, bumping along the bottom, or finally turning the corner…. Economies are behaving unpredictably and will continue to do so. The instability is both cause and consequence of the great uncertainty that has been spreading out from the financial markets. Fearful and confused, people react erratically to changing news, reinforcing confused market behavour. It doesn’t help that our economic theories were constructed for a different world. Most models depict economies close to equilibrium…. And unlike what most models assume, prices are not properly clearing all markets…. [etc. etc.] (Editors 2009)

This sentiment is echoed in numerous publications and speeches, academic and popular. “The whole intellectual edifice . . . collapsed in the summer of last year,” concedes former Fed Chairman Alan Greenspan (Andrews 2008). “Our world is broken – and I honestly don’t know what is going to replace it,” grieves Bernie Sucher of Merrill Lynch. “[T]he pillars of faith on which this new financial capitalism were built have all but collapsed,” observes Gillian Tett in a special Financial Times series on the future of capitalism, and that collapse, she concludes, “has left everyone from finance minister or central banker to small investor or pension holder bereft of an intellectual compass, dazed and confused (Tett 2009). And with no intellectual compass to rely on, confesses Bank of England Governor Mervyn King, “judging the balance of influences on the economy” becomes “extraordinary difficult” (Editors 2009).

Financial crisis, argues György Lukács, threatens the foundations of the capitalist regime. The ruling class loses its self-confidence and begins to substitute ad-hoc excuses for natural-state-of-things theories. And as the ideological glue that holds the regime together weakens, class conflict becomes visible through the cracks of universal rhetoric, while the threat of naked force suddenly looms large behind the front window of tolerance.

The present stage of the crisis fits this pattern, and so do the justifications. Some, like Alan Greenspan, blame it all on humans failing to live up to their true nature:

All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firm’s capital and risk position. (Greenspan 2009).

[T]hose of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined. (U.S. Congress 2008)

Other observers, like Oxford economist John Kay, see the fault not at the level of the individual, but of the system as a whole. When the Queen of England wondered why “the credit crisis and its evolution were not predicted” by the experts, her “loyal subject” (as Kay names himself), quickly jumped to his colleagues’ defense. National economies, financial markets and businesses, he explained, are simply too complex, dynamic and non-linear, and these systemic intricacies turn prediction into a “wild goose chase” (Kay 2008).

And then there are those, like financial commentator Gideon Rachman, for whom the problem is largely temporary. The economists, Rachman suggests, have actually made great strides in understanding how the economy works. But from time to time the delicate machine gets infected by a “new type of economic virus,” and we need to be a bit patient until the economists discover the cure (Rachman 2009).

By 2010, though, it seems that the virus continues to elude the pundits. The threat of default has spread from business enterprise to sovereign governments, with countries like Iceland, Dubai, Greece and who-knows-who-is-next flirting with bankruptcy. Participants at a special conference hosted by Soros’ Institute for New Economic Thinking at Kings College, including five Nobel-winning economists, expressed grave concern that “many investors now find it hard to judge the ‘real’ riskiness of sovereign debt.” Gillian Tett conveys the atmosphere of theoretical bewilderment and ideological anxiety:

Three years ago, it seemed inconceivable that a country such as Greece would be allowed to default, or exit the eurozone. But back then it seemed equally hard to imagine that Lehman Brothers might fail. Now that Lehman has gone, who knows what the worst-case scenario might be? Could the eurozone break up? Could Greece default? What might happen to other debt-laden nations, such as the US, if the worst case scenario occurred? The one thing that is clear is that the answers to those questions now depend as much on culture and politics as on macro-economics…. In this new world of sovereign risk, what really matters is a set of issues that cannot be plugged into a spreadsheet. The old compass no longer works. (Tett 2010)

The predicament is so serious that even the know-all “market” – the collective brain of the capitalist class – has become disoriented. According to Martin Wolf, chief economics commentator at the Financial Times, the markets “don’t know what to fear: will it end up in deflation, default, inflation, financial shocks, or all of these?” “Markets are unpredictable,” he informs his son, “like children….” And when the youngster asks “So what’s going to happen next?” the elder, who is usually able to answer questions that most people cannot even ask, replies: “If I knew that, I wouldn’t be a mere economic journalist…” (Wolf 2010)

Mene, Mene, Tekel, and Parsin: Is Capitalism Heading for Systemic Collapse?

The decade-long breakdown of capitalization is no fluke. The fact that for ten years now capitalists have been pricing equities based on past profit betrays deep distress. Their fear now is not only that the level of capitalization may be bumping into a glass ceiling; it is also that the very ritual of capitalization – the universal crystal ball through which they have been “seeing” the future for nearly a century – may be giving them awfully wrong signals. And when the future looks bleak, and the dominant ideology appears opaque if not misleading, there arises the specter of systemic fear.

Given the foregoing, the obvious question to ask is: does systemic fear signal the imminent collapse of capitalism?

This is by no means an easy question to answer. The difficulty is threefold. First, systemic fear – in capitalism as in other modes of power – is rare and therefore difficult to generalize about. Second, although much has been written about previous episodes of social collapse, it is unclear how much of it applies to the capitalist mode of power. Third and finally, systemic fear and systemic collapse are deeply intertwined in ways that may not be easy to disentangle. Nonetheless, given that we are dealing with the very existence of capitalism, discussing these questions – even speculatively, as we do in the remainder of the paper – seems appropriate.

To start with, we need to distinguish between gradual decline and final collapse. The slow weakening of a mode of power – for instance, the prolonged descent of European feudalism, or the progressive decay of Soviet Union – can happen for many different reasons, stretched over a long period of time. But, in our view, for a mode of power to finally implode, these reasons must be complemented by the loss of confidence in obedience. When the ruling class is no longer certain of its ability to govern, it becomes indecisive; indecision inhibits ruthlessness; lack of ruthlessness fuels opposition; and effective opposition is the other side of disintegrating rule. It is only at that point, when it becomes obvious that the ruling class, benumbed by systemic fear, has lost control, that final collapse becomes possible.

Systemic fear often appears when it is least expected. On the surface, the mode of power seems unassailable, the rulers hubristic and the underlying population submissive. But under the surface, redistribution requires greater sabotage and larger doses of force, and as social stress builds up, the stage is set for the crucial inversion. One such drama is narrated in the biblical story of Babylon. The last Babylonian emperor, Belshazzar, celebrates the height of his power at a sacred royal feast when, suddenly, a mysterious hand comes out to put an indecipherable writing on his wall and sudden terror in his heart: “the king’s color changed, and his thoughts alarmed him; his limbs gave way, and his knees knocked together” (Book of Daniel, Ch. 5: Verse 6). None of his enchanters, Chaldeans or astrologers can read the strange writing. Only one pundit – a foreign analyst named Daniel – knows what it means. “Mene, Mene, Tekel, and Parsin,” he reads the menacing omen: “MENE, God has numbered the days of your kingdom and brought it to an end; TEKEL, you have been weighed in the balances and found wanting; PERES, your kingdom is divided and given to the Medes and Persians” (Ch. 5, Verses 24-28). That very night, the king is slain, and his empire collapses.

The socio-ecological collapse of Easter Island, whose final implosion occurred sometime during the seventeenth century, was also triggered by hubris-cum-fear. In a last-ditch effort to stave off their decline, the island’s rulers engaged in a competitive orgy of statue building. The likely purpose was to bolster their status and self confidence; but since statue building did nothing to alter the social structure, the only consequence was a hastening of the destruction of their environment and the demise of their mode of power. Soon after, the rulers and priests fled, the island sank into civil war, a new religion came into being, and the giant moai statues – the chief symbol of the rulers’ power – were systemically toppled and broken (Diamond 2005: Ch. 2).

A similar story can be told of the Soviet Union. Shortly before its collapse, General Secretary Mikhail Gorbachev asserted that Perestroika was a “revolution from above,” and that, “Naturally, we [read the country’s rulers] have no intention to change Soviet power; we will not depart from its basic principles” (Gorbachev 1987: 30-31). But signs of deep fear were there for everyone to see – from the Party’s admission that administered prices distorted the law of value (whatever that “law” means) to its apprehension that central planning could no longer deliver growth to keep the mode of power together. “We only thought we were in the saddle,” confessed Gorbachev, “while the actual situation that was arising was one that Lenin warned against: the automobile was not going where the one at the steering wheel thought it was going” (p. 18). Two years later, the Soviet Union was no more.

The collapse of a mode of power is always underwritten by its own historical circumstances. But as these and numerous other examples suggest, it is the rulers’ systemic fear and loss of confidence that makes those circumstances – whatever they are – culminate in an abrupt crash. In and of themselves, fear and loss of confidence are rarely if ever sufficient to set off the implosion; but they are always necessary, and that necessity makes them important to analyze.

Complex Systems and Time Transformers

As noted, systemic fear is not unique to capitalism. But in our opinion, the likelihood of systemic fear turning gradual decline into rapid collapse is much greater in capitalism than in any prior mode of power. There are two related reasons for this claim. First, modern capitalism is much more “complex” than earlier modes of power, and that complexity makes it susceptible to implosion.²⁹ Second, unlike other modes of power, the ritual of capitalization acts as a “time transformer”: it condenses the long future into the singular present, and that reduction can turn capitalist expectations – particularly during times of systemic fear – into an immediate reality. Let’s consider these reasons more closely.

Most of the time, the high complexity of capitalism allows it to quell and encompass limited challenges to power and local breakdowns of rule. But the agility and flexibility of capitalism have limits, and when these limits are crossed, complexity can turn “against the system.” At that point, internal challenge, external attack and ecological calamity, instead of being counteracted and absorbed, get amplified. And as the reverberations spread, the system doesn’t simply weaken; it implodes.

This type of scenario, in which complexity facilitates collapse, is spelled out in David Korowicz’s Tipping Point (2010). His argument, like others in this genre, builds mainly on standard “real-growth” economics, of which we are critical, and it offers very little discussion of the power relations that we emphasize. But his analysis of complexity could easily be extended to a broader power perspective and therefore is worth exploring in some detail.

Korowicz claims that the imminent peaking of oil production is a “tipping point” – a threshold beyond which capitalist civilization will not simply decline, but rapidly disintegrate. His initial premises are similar to those of most peak-oil analysts: (1) capitalism requires continuous economic growth; (2) ongoing economic growth necessitates ever-increasing energy inputs; (3) the key energy input – oil and its derivatives – has no immediate substitutes; and (4) once the production of oil – and of fossil fuels more generally – peaks and starts to decline, economic growth and the capitalism that is based on it must follow suit. The disagreement is over what follows. According to most analysts, the systemic consequences of peak oil are likely to be gradual: the optimists envisage an unstable period during which the piecemeal development of renewable energy sources and energy-saving techniques substitutes for the decline of fossil fuels, while the pessimists see a drawn-out process of deindustrialization and social decline. For Korowicz, though, these gradual scripts all suffer from a crucial omission: they ignore the operational fabric of capitalism, and that oversight leads them to the wrong conclusion.

Global production, he says, is mediated through highly complex and deeply intertwined critical infrastructures – including money, trade, transportation, communications, water, and electricity, among others. The operation of these integrated infrastructures rests on and presupposes the ongoing expansion of credit and debt. And that expansion is possible only because investors believe that the additional credit and debt will be serviced and ultimately repaid. According to Korowicz, though, this latter belief – and therefore the entire operational fabric that rests on it – can only hold in a growing economy. And here lies the trap.

Once humanity passes the threshold of peak oil, economic growth must turn negative – and, at that point, the assumption of ever-growing credit and debt breaks down. Investors suddenly realize that, looking forward, their assets have an inherently negative yield. And since this realization inverts the basis on which the whole society operates, the result is not a gradual decline but sudden collapse. The first to tank are the equity and debt markets; these are followed by mutually reinforcing reverberations and the eventual rupture of money, trade, investment, communications and other critical infrastructures; and the process is then sealed by conflict, war and die-off (as argued for example by Jay Hanson).³⁰

Note that the collapse here begins with a seemingly inconspicuous change. Roughly half of the oil is still under ground, and its extraction rate is still positive. But that rate, instead of accelerating, is now decelerating, and this deceleration is enough to set the social avalanche in motion. Because the operational fabric of capitalism is highly complex and mediated by forward-looking debt and credit, the mere realization that this is the beginning of a long, secular decline in oil output causes a contiguous implosion of the entire society.

Korowicz’s collapse scenario focuses on peak oil, but its dynamics can be readily generalized. Regardless of whether the capitalist of mode of power is expanding, declining or collapsing, the forces that drive it – social as well as ecological – are always mediated through the ritual of capitalization. This ritual is unlike any the world has ever known. It endows every member of society with a miraculous power previously reserved to wizards, oracles and prophets: the ability to “transform” the future into the present. By discounting expected future earnings and risk, capitalization encapsulates their complex social and ecological causes into a single value – and then sends it back to the present.

Under normal circumstances, this all-encompassing “time transformer” enables capitalists to mange their fears and exert their power in ways that previous rulers could only have dreamed of. But the ritual also has a dark side, a lightning-like menace that prior rulers could not even fathom. As long as capitalists take their mode of power for granted, capitalization makes their power appear unassailable. But when they begin to doubt their own ability to rule, any serious future threat – from peak oil and climate change to the inability to further redistribute income and reduce earning volatility – can be time-transformed into an immediate collapse.

Warning Signs?

This threat perhaps explains, at least in part, the growing literature on systemic collapse: Why do complex systems implode? Is the disintegration patterned? And if so, is there a clear “writing on the wall”? Can we find warning signs to help us anticipate and perhaps prevent the calamity?³¹ Analytical and empirical modeling of natural phenomena suggests that “collapse” – formally defined as a rapid or quantum-like shift of the system from a high to a low level of complexity – tends to have fairly clear patterns. Moreover, very often collapse is preceded by quantitative warning signs: the key variables of the system may begin to flicker between alternate states; they may become slow to recover from small perturbations; they may exhibit a surge of path dependency in the form of rising auto-correlation; and they may display rising cross-correlations between different components of the system. Most remarkably, through, these warnings signs seem to be generic – i.e., they tend to occur independently of the concrete features of the system in question.³²

However, identifying similar warnings signs in complex social system is far more difficult. There are two reasons for this difficulty. First, until capitalism, most modes of power generated very little quantitative information, so it is hard to see how universal warnings signs can be constructed in the first place. Second, unlike natural systems, society contains an inescapable entanglement: its actual trajectory is inextricably bound up with its dominant dogmas, ideologies and theories.³³ Under normal circumstances, the latter seems useful in describing and even “predicting” the former. But as the system approaches collapse, so do its leading dogmas, ideologies and theories – and at that point, prediction and even description based on these dogmas, ideologies and theories becomes difficult if not impossible. Let’s unzip these reasons, staring with quantities.

Quantification

As the dismal record of apocalyptic prophecies warns us, predicting collapse before it happens is much harder than explaining it afterwards. One stumbling block is that, until recently, historical societies simply didn’t provide the kind of quantitative information with which physicists, biologist and environmentalists make their predictions. It is true that nowadays we may know quite a lot about these historical societies. But the data we posses commonly come from ex-post excavation, research and estimates. Most were unavailable and in many cases inconceivable when these societies existed, leaving the art of social prediction to astrologers and oracles.

The arrival of capitalism abolished this scarcity. For the first time in history, social quantities became abundant to the point of being virtually free. The price system quantifies everything that can be owned – from tangible and intangible objects, to human beings, to social structures – and the application of probability and statistics shapes these quantities into an infinitely complex numerical structure. This is the quantitative context from which political economy, the first mechanical science of society, came into being; it is the bedrock on which social sciences could subsequently flourish, and it is the raw material that gives contemporary students of society the confidence that they can scientifically articulate its future.

Entanglement

The most successful, at least in their own opinion, are the economists. Their quantitative models, large and small, track the regularities of production, consumption, prices and finance, and they provide certain boundaries within which future economic events – such as growth, inflation and government deficits – are likely to unfold.

However, this quantitative scheme, which mimics the natural sciences, has an important weakness: it takes it for granted that there exists an underlying “model” that regulates the economy/society, and it further assumes that this model is unchanging. This dual assumption may seem adequate for complex natural systems, whose various states – whether stable, gradually changing or leaping into collapse – are believed to be governed by the same heteronomous rules. But unlike in nature, the rules of society are autonomous. They are created not by an external logic, but by society itself.³⁴ And that autonomy implies that the collapse of society and the disintegration of its rules, by definition, are one and the same.

The flip side of this implication is that, until the collapse actually begins and the dominant ritual of capitalization crumbles, capitalists are more or less compelled to deny what is in front of their nose:

[W]e are all capable of believing things which we know to be untrue…. [T]he frightening facts can exist some where or other in [...] consciousness, simultaneously known and not known…. Intellectually, it is possible to carry on this process for an indefinite time: the only check on it is that sooner or later a false belief bumps up against solid reality… (Orwell 1946)

However, because capitalism is deeply entangled with its dominant ideology, as long as that ideology prevents capitalists from accepting the demise of their society, the “solid reality” remains fluid and the collapse indeterminate.

Indeterminacy

This indeterminacy is evident in accounts such as Korowicz’s Tipping Point. Reduced to its bare essentials, the critical assumption underlying his collapse scenario is a temporal mismatch between the hard facts and mass psychology: the development and implementation of alternative energy sources, he says, is simply too slow to prevent investors from plunging into terminal pessimism. Korowicz does not deny that there are existing alternatives to oil, and that other options might be discovered or invented. The problem is that, barring a scientific-technological miracle, there isn’t enough time to develop and implement these alternatives on a sufficiently large scale.³⁵ Most energy observers believe that oil production has already peaked or that it will peak within the next twenty years.³⁶ In other words, whatever the alternatives to oil, they are too little, too late. And since the increase of alternative energy sources will lag the drop of oil, he says, it is virtually certain that overall energy production will peak sometime within the next few decades. Moreover, if peak energy ends up triggering social collapse, there is little chance of the alternative energy infrastructure ever growing beyond its pre-collapse levels.

This sequence, though, isn’t as tight as it may seem. Note that, according to Korowicz, the collapse is triggered not by peak oil per se, but by a decisive psychological change in investors’ expectations regarding that reality. Now, for the latter to follow from the former, investors must come to believe all of the following: (1) that peak oil has already happened or is imminent; (2) that peak oil will be followed by an irreversible decline in overall energy production; and (3) that the drop in capitalization caused by the decline of energy will not be offset by opposite forces that Korowicz does not discuss – for instance, by further pecuniary redistribution in favor of capitalists, by greater concentration of ownership in favor of leading capitalists, etc.

Although possible, none of these changes in expectations is imminent, or even necessary. After all, theories of resource scarcity date back to Malthus if not earlier, and the inevitability of peak oil was spelled out already in the 1950s – and, yet, rationally or not, so far investors have chosen to ignore or deny these forward-looking pronouncements. Moreover, even if peak oil were imminent (which it may well be), and even if at some point investors do come to accept it (which isn’t far fetched), they might still shy from immediately concluding that the overall production of energy is about to decline. And if the latter conclusion is postponed for long enough, alternative energy sources might have sufficient time to replace falling oil production, thus removing the specter of immediate capitalist collapse, and perhaps even of a drawn out decline. Finally, even if these aggregate processes cannot be stopped, capitalists may still bank their hopes on forceful redistribution to offset the aggregate loss of social energy.

Systemic Fear and the Future of Capitalism

In sum, capitalism is the first mode of power to be truly quantified, and it is definitely the most complex. These intertwined features suggest that, when faced with adverse social and ecological circumstances, its structure is susceptible, perhaps more than earlier modes of power, to sudden systemic collapse. And judging by the scholarly and popular attention, there seems to be a growing feeling that such a collapse may be in the offing. But despite the heightened interest and sophisticated analysis, nobody has been able to say how likely the collapse is and when it may happen.

The reason for the difficulty is that the science of complex natural systems may not be readily applicable to complex social systems. The amount of comparative quantitative data on most historical systems remains too limited to draw meaningful generalizations; and even in the capitalist mode of power, where the data seem limitless, the entanglement of society-as-an-object with society-as-a-subject, particularly during periods of deep crisis, creates an infinite regress that cannot be disentangled.

However, while the likelihood and timing of capitalist collapse is impossible to foretell, some of the preconditions for such collapse may be readily observable. In this paper, we have argued that in order for a mode of power to collapse, the ruling class must lose its confidence in obedience. This confidence, articulated and enforced by the dominant ideology, is the glue that holds the mode of power together; and it is only when the ruling class is struck by systemic fear and the glue disintegrates that collapse becomes possible.

Historical analyses of social collapse tend to ignore this factor, and perhaps for a good reason. History tells us very little about confidence in obedience, and the little that we do know is rarely if ever quantitative and therefore difficult to analyze systematically. But capitalism is very different. Unlike earlier modes of power, it is quantified to the teeth, and that quantification includes the mindset of the ruling class.

The chief form of quantification is the universal ritual that all capitalists are conditioned to perform: capitalization. Under normal circumstances, the performance of this ritual quantifies the way capitalists expect their power to unfold: the earnings they hope to redistribute, the risk they try to minimize and the normal rate of return that secures their rule as natural and their command as eternal. But during times of systemic fear, when the very future of their power is put into question, discounting cannot be properly performed, and the capitalization ritual, which otherwise embodies their confidence in obedience, breaks down.

This breakdown is readily visible, but only indirectly. Looking at the stock market alone doesn’t help. Equity prices may fall sharply or even collapse; but if the observed decline properly discounts the change in investors’ expatiations, it actually serves to confirm that the ritual of capitalization is fully operational and that the capitalist class, however uneasy in the short term, retains its long-term confidence in obedience.

In order to see that something is systemically wrong, we need to think not positively, but negatively. Specifically, we need to look for market patterns that are inherently inconsistent with forward-looking capitalization. The manifestation of such patterns would then prove, by negation, that the ritual is broken. The specific pattern emphasized in this paper is one in which stock prices, instead of looking into the deep future, nervously trace the ups and downs of current and past earnings. This backward-looking pattern goes against the very gist of forward-looking finance. And when it emerges – as it did during the crisis of the 1930s and again in 2000 – we can be fairly certain that capitalization has broken down and that the ruling class has lost its confidence in obedience.

A shrewd academic might have leveraged this apparent anomaly into a full-blown mechanized model, complete with a universal taxonomy of “fear-of-death” eras, a sliding scale of price-profit correlations alerting investors when to switch and reswitch between forward- and backward-looking postures, and an easy-to-follow list of “how to profit” from both. And judging by what is on sale in the analysis market, this model could end up having plenty of paying followers.

We prefer to forego this investment opportunity and instead keep our speculations tentative and free. Capitalism may survive this systemic crisis, as it survived that of the 1930s. As before, this survival may require a significant transformation – one that restructures the entire architecture of power, including its material technology and dominant ideology – and such transformation is certainly possible. But there is also a very real possibility that the current crisis will prove too much for the capitalist class to handle. “The history of all hitherto existing society,” write Marx and Engels in the opening paragraphs of the Communist Manifesto, “is the history of class struggles.” And that struggle can end “either in a revolutionary reconstitution of society at large, or in the common ruin of the contending classes (Marx and Engels 1884: 57-58).

So far, the capitalists’ loss of confidence in obedience hasn’t elicited significance opposition – but that can change quickly. However, if the opposition fails to establish an effective and hopefully progressive alternative – an alternative that so far seems absent – it is not impossible for the reverberations of the clash, amplified by the high complexity of capitalism, to culminate in systemic collapse and collective ruin.

A shorter version of this paper first appeared in Dollars & Sense (Nitzan and Bichler 2009b). The basic concepts in this article, along with their significance for the modern capitalist epoch, are articulated and explored more fully in Nitzan and Bichler (2009a).

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1. Note that this conviction is a necessary but not a sufficient condition. For modern accumulation to exist, many other conditions have to hold as well.
2. Given the extent of the crash, some strategists had already started to speak of an imminent bull run in late 2008. But the bulk of the pack remained in watchful waiting, and it was only in mid 2009, after the market had finally turned, that run-of-the-mill analysts started to claim they had anticipated it all along. For a historical examination of major bear markets and subsequent bull runs, see Bichler and Nitzan (2008).
3. “A long-unheard phrase was on the lips of many equity traders during this week’s market rally – panic buying. Even after two months of steady gains for stocks, there were few signs of investor fatigue – indeed, the overriding sense was the fear of being left behind. . . . ‘You could say there was an element of panic about it – there were a lot of underweight players driving the market higher out there,’ said Tony Betts, senior sales trader at CMC Markets in London. ‘We clearly reached a situation where the bears felt they had suffered enough punishment’” (Shellock 2009).
4. In the second half of 2009, while the market was still booming, prophet-of-doom Nouriel Roubini, whose claim to fame comes from accurately predicting the recent crisis, listed no less than seven reasons why the ongoing recovery was likely to be U-shaped rather than V-shaped, and two additional reasons why it might end up being W-shaped, accompanied by either deflation or stagflation (Roubini 2009). With the 2010 onset of the Euro crisis, his pessimism has been reproduced and amplified by numerous other experts.
5. Graham and Dodd were very critical of the early “New-Era Theory.” They thought it was dangerously optimistic and logically incomplete, and that it had to be supplemented by proper valuation, cool-headed research and sufficient diversification. But they wholly endorsed the theory’s most important feature: the need to look forward.
6. This early financial history is told with great insight and much fanfare in Matthew Josephson’s classic tale of The Robber Barons: The Great American Capitalists, 1861-1901 (1934).
7. For a critical historical and theoretical analysis of capitalization, along with an outline of its role as the capitalist architecture of power, see Nitzan and Bichler (2009a: Part III).
8. “The forming of a fictitious capital,” writes Marx, “is called capitalising. Every periodically repeated income is capitalised by calculating it on the average rate of interest, as an income which would be realised by a capital at this rate of interest” (1909, Vol. 3: 548).
9. For a careful reconstruction and extension of Marx’s analysis of capitalization, see Perelman (1990). Subsequent Marxist approaches to finance include Rudolf Hilferding’s notion of finance capital, which focuses on the institutional and political takeover of industry by financial interests and on the accompanied authoritarian transformation of domestic and foreign policy (Hilferding 1910); Baran and Sweezy’s notion of finance as a form of absorbing the rising surplus of industry (Baran and Sweezy 1966; Foster 2007); and the view of Arrighi and others who speak about the transition from industry to finance and on the so-called process of financialization that eviscerates the productive base of society (Arrighi 1994; Williams et al. 2000; Froud et al. 2002; Epstein 2005; Krippner 2005). These interpretations, although different in their details, share one key assumption: they all presume the existence of “true” productive capital – an entity from which the monetary appearance of finance deviates and which it distorts.
10. The notion of abstract labor was first articulated by Marx (1859). The term util was coined by Fisher (1892). For a review and critique of both concepts, see Nitzan and Bichler (2009a: Ch. 8).
11. The S&P 500 index splices the following three series: the Cowles/Standard and Poor’s Composite (1871–1925); the 90-stock Composite (1926–1957); and the S&P 500 (1957–present).
12. A logarithmic scale amplifies the variations of a series when its values are small and compresses these variations when the values are large (note that the numbers on the scale jump by multiples of 10). It also has the convenient feature that the slope of a series is proportionate to its temporal rate of change. These two properties make a logarithmic scale particularly suitable to visualizing exponential growth.
13. The Pearson correlation coefficient ranges between +1 and –1. A value of +1 denotes perfect positive correlation, 0 denotes no correlation and –1 denotes perfect negative correlation.
14. Note that until 1926, monthly earning data are interpolated from annual rather than quarterly reports, which probably serves to force down the measured correlation.
15. Computed from data in Robert Shiller’s website, retrieved on May 20, 2010.
16. For more on the beliefs, rituals and behavior of equity investors before the First World War, see the summary in Graham and Dodd (1934: Ch. XXVII).
17. For the mathematical derivation of Equation 2, see Nitzan and Bichler (2009a: 153-155) or consult any text on infinite series. As noted, Equation 2 holds only if the rate of growth of earnings g is lower than the rate of interest r. Otherwise, we get the Bernoullian Petersburg Paradox: the price becomes infinite (if g = r) or negative (if g > r), the ritual breaks down, and the equation has to be patched with auxiliary assumptions (for the first systematic account of this annoying glitch, see Durand 1957).
18. For a detailed political economy of discounting, see Nitzan and Bichler (2009a: Ch. 11).
19. The concept of the megamachine was invented and articulated by Lewis Mumford (1967; 1970). Its relevance to capitalism is developed in Nitzan (1998) and Nitzan and Bichler (2009a: Ch. 12).
20. The Aymara language, spoken by Indians in Southern Peru and Northern Chile, reverses the directional-temporal order of most languages. It treats the known past as being “in front of us” and the unknown future as lying “behind us.” To test this inverted perception, just look up at the stars: ahead of you you’ll see nothing but the past (see Núñez and Sweetser 2006).
21. The argument in the remainder of this section highlights long-term themes that we are currently developing for a forthcoming publication.
22. Note that market capitalization can also increase due to the public listing of new or previously private firms, and that this increase is independent of the overall income of capitalists. The overall effect on capitalization of new listings was positive till the late 1970s, but with massive buybacks since then, the impact has become negative (Nitzan 1996).
23. The data for equity market capitalization are net of foreign holdings by U.S. citizens and are taken from the U.S. Federal Reserve Board (FL893064105 for market capitalization; FL263164003 for foreign equities held by U.S. citizens). Pretax corporate profits, interest, and the effective corporate tax rate are from the U.S. Bureau of Economic Analysis.
24. We use inverted commas to highlight our objection to the theoretical notion and empirical measurements of the so-called “real economy.” However, since capitalists take the concepts and measurements of the real economy for granted, we refer to them here “as is.” For a critical assessment of these issues, see Nitzan and Bichler (2009a: Ch. 8).
25. The growth data are from Angus Maddison’s vertical file, retrieved on June 1, 2010.
26. The first to elaborate the concept of strategic sabotage and its importance for the power of rulers in general and for capitalists in particular was Thorstein Veblen (1904; 1923). For further theoretical and empirical development of this association, see Nitzan and Bichler (2009a: Ch. 12).
27. See Biggs (2008), Buffett (2008) and Wolf (2008).
28. When we prepared the earlier version of this paper (Nitzan and Bichler 2009b), stock prices had already begun to rise, but the aggregate earnings numbers, which are calculated from firm-level data with a few months’ delay, were still unavailable. Doubtful that the coming rally marked the end of systemic fear, we wrote that “the early 2009 increase in prices could end up being correlated with a yet-to-be reported rise in current earnings” – a projection that subsequent data proved correct.
29. Although there is no single definition of “complexity,” there can be little doubt that capitalist society is more temporally and spatially integrated than any prior mode of power; that it comprises many more “relationships”; that these relationships have many more nonlinearities; that differential information plays a more crucial role; etc.
30. Jay Hanson was one of first to emphasize and bring to public attention the social consequences of peak oil. For an abstract of his views, along with an annotated bibliography, see Dieoff. Similar expressions of concern can be found in the many discussions on The Oil Drum.
31. See for example, Tainter (1988; 2000), Diamond (2005), Kambhu, Weidman and Krishnan (2007), May, Levin and Sugihara (2008), Orlov (2008) and Scheffer (2009).
32. For a succinct summary of these findings, see Scheffer et al. (2009).
33. This entanglement has been long recognized, with its most recent application being George Soros’ “reflexivity” (1998).
34. The notions of heteronomy and autonomy, traceable to the ancient Greeks, are developed in the social and philosophical writings of Cornelius Castoriadis (see, for instance, 1991).
35. On the limits of renewable energy, see for example Ted Trainer (2010).
36. Korokwicz shows that, cumulatively, 30% of the experts think that the decline has already begun, 50% feel it will happen before 2015, and 95% believe it will occur before 2030 (pp. 51-52).

This breakdown is no accident. Every mode of power evolves together with its dominant theories and ideologies. In capitalism, these theories and ideologies originally belonged to the study of political economy – the first mechanical science of society. But the capitalist mode of power kept changing, and as the power underpinnings of capital became increasingly visible, the science of political economy disintegrated. By the late nineteenth century, with dominant capital having taken command, political economy was bifurcated into two distinct spheres: economics and politics. And in the twentieth century, when the power logic of capital had already penetrated every corner of society, the remnants of political economy were further fractured into mutually distinct social sciences. Nowadays, capital reigns supreme – yet social scientists have been left with no coherent framework to account for it.

The theory of Capital as Power offers a unified alternative to this fracture. It argues that capital is not a narrow economic entity, but a symbolic quantification of power. Capital has little to do with utility or abstract labor, and it extends far beyond machines and production lines. Most broadly, it represents the organized power of dominant capital groups to reshape – or creorder – their society.

This view leads to a different cosmology of capitalism. It offers a new theoretical framework for capital based on the twin notions of dominant capital and differential accumulation, a new conception of the state of capital and a new history of the capitalist mode of power. It also introduces new empirical research methods – including new categories; new ways of thinking about, relating and presenting data; new estimates and measurements; and, finally, the beginning of a new, disaggregate accounting that reveals the conflictual dynamics of society.

The Capitalist Cosmology

As Marx and Engels tell us at the beginning of The German Ideology (1970), the capitalist regime is inextricably bound up with its theories and ideologies. These theories and ideologies, first articulated by classical political economy, are much more than a passive attempt to explain, justify and critique the so-called economic system. Instead, they constitute an entire cosmology – a system of thinking that is both active and totalizing.

In ancient Greek, Kosmeo has an active connotation: it means “to order” and “to organize,” and political economy does precisely that. It explains, justifies and critiques the world ­– but it also actively makes this world in the first place. Moreover, political economy pertains not to the narrow economy as such, but to the entire social order as well as to the natural universe in which this social order is embedded.

The purpose of this paper is to outline an alternative cosmology, one that offers the beginning of a totally different framework for understanding capitalism.

Of course, to suggest an alternative, we first need to know the thing that we contest and seek to replace. To lay out the groundwork, we begin by spelling out what we think are the hallmarks of the present capitalist cosmology. Following this initial step, we enumerate the reasons why, over the past century, this cosmology has gradually disintegrated – to the point of being unable to make sense of and recreate its world. And then, in closing, we articulate some of the key themes of our own theory – the theory of capital as power.

Foundation I: Separating Economics from Politics

Political economy, liberal as well as Marxist, stands on three key foundations: (I) a separation between economics and politics; (II) a Galilean/Cartesian/Newtonian mechanical understanding of the economy; and (III) a value theory that breaks the economy into two spheres – real and nominal – and that uses the quantities of the real sphere to explain the appearances of the nominal one. This and the following two sections examine these foundations, beginning with the separation between politics and economics.

During the thirteenth and fourteenth centuries, there emerged in the city states of Italy and the Low Countries an alternative to the rural feudal state. This alternative was the urban order of the capitalist Bourg. The rulers of the Bourg were the capitalists. They were the owners of money, trading houses and ships; they were the managers of industry; they were the enterprising pursuers of new social technologies, the seekers of innovative methods of production.

These early capitalists offered an entirely new way of organizing society. Instead of the vertical feudal order in which privilege and income were obtained by force and sanctified by religion, they brought a flat civil order where privilege and income came from rational productivity. Instead of the closed loop of agricultural redistribution by confiscation, they promised open-ended industrial growth. Instead of ignorance, they brought progress and knowledge. Instead of subservience, they offered opportunity.¹

Theirs was the future regime of capital, an explicitly “economic” order based on an endless cycle of production and consumption and the ever-growing accumulation of money.

Initially, the Bourg was subservient to the feudal order in which it emerged, but that status gradually changed. The Bourgs began to demand and obtain libertates – that is, differential exceptions from feudal penalties, taxes and levies. The bourgeoisie recognized the legitimacy of feudal politics, particularly in matters of religion and war. But it demanded that this politics not impinge on its urban economy. This early class struggle, the power conflict between the declining nobility and the rising bourgeoisie, is the origin of what we now consider as the separation of economics and politics.

The features of this separation are worth summarizing, beginning with the liberal view. Over the past half millennium, liberals have grown accustomed to classifying production, technology, trade, income and profit as aspects of the economy. By contrast, entities like state, law, army and violence are classified as belonging to politics.

The economy is taken to be the productive source. It is the realm of individual freedom, rationality, frugality and dynamism. It creates output, raises consumption and moves society forward. By contrast, politics is conceived as coercive-collective. It is corrupt, wasteful and conservative. It is a parasitical sphere that latches onto the economy, taxing it and intervening in its operations.

Ideally, the economy should be left on its own. Laissez faire politics would produce the optimal economic outcome. But in practice, we are told, this is never the case: political intervention, constantly distorts economics, undermines its efficient operation and hampers the production of individual well-being. The liberal equation, then, is simple: the best society is one with the most economics and the least politics.

The Marxist view of this separation is different, but not entirely. For Marx, the liberal project of severing civil society from state is a misleading ideal, if not outright self-deception. The legal act of setting the private economy apart from public politics alienates property; and that very alienation, he says, serves to defend the private interests of capitalists against the collective pursuit of a just society. From this perspective, a seemingly independent political-legal structure is not antithetical but essential to the material economy: it allows the organs and bureaucracy of the state to legitimize capital, give accumulation a universal form and help maintain the capitalist system as a whole.

In other words, Marx readily accepts the liberal duality – but with a big twist. Where liberals see an inconsistency between economic well-being and political power, Marx sees two complementary forms of power: a material-economic base of exploitation and a supporting legal-state structure of oppression.

Historically, the coercive institutions and organs of the state evolve as necessary complements to the economic mechanism of surplus extraction: together, they constitute the totality that Marxists refer to as a “mode of production.” But the relationship between these two aspects isn’t symmetric: in any particular historical epoch, the nature and extent of state intervention are predicated on the concrete requirements of surplus extraction. To illustrate, during the nineteenth century, these requirements dictated the hands-off methods of laissez faire; toward the middle of the twentieth century, they called for the macro-management of Keynesianism; and at the beginning of the twenty-first century, they mandate the multifaceted regulations of financialized neoliberalism.

In other words, unlike in the liberal cosmology, where society consists of utility-seeking individuals for whom the state is a specialized service provider at best and a distortion at worst, in the Marxist cosmology the state is necessary to the very possibility of capitalism. But that necessity is conditioned on the state being distinct from – and ultimately subjugated to – the economy.

Following the footsteps of his classical predecessors, particularly Smith and Ricardo, Marx, too, prioritized economics over politics. Enthralled by the methods and triumphs of bourgeois science, he looked for latent reasons, for the ultimate mechanical forces that lie behind and move the social appearances. And just like his bourgeois counterparts, he, too, found the locus of these forces in the “economy.”

The productive sphere, and especially the labor process, he argued, is the engine of social development. This is where use value is created, where surplus value is generated, where capital is accumulated. Production is the fountainhead. It is the ultimate “source” from which the other spheres of society draw their energy – energy that they in turn use to help shape and sustain the sphere of production on which they so depend. And so, although for Marx capitalist economics and politics are deeply intertwined, their interaction is that of two conceptually distinct and asymmetric entities.²

Foundation II: The Galilean/Cartesian/Newtonian Model of the Economy

The new capitalist order emerged hand in hand with a political-scientific revolution – a revolution that was marked by the mechanical worldview of Machiavelli, Kepler, Galileo, Descartes, Hobbes, Locke, Hume, Leibnitz and, most importantly, Newton.³

It is common to argue that political economists have borrowed their metaphors and methods from the natural sciences. But we should note that the opposite is equally true, if not more so: in other words, the worldview of the scientists reflected their society.

Consider the following examples.

Galileo and Newton were deeply inspired by Machiavelli’s Prince. The Prince relentlessly pursues secular power for the sake of secular power. His concern is not the general good, but order and stability. And he achieves his goals not with divine help, but through the systematic application of calculated rationality.

Hobbes’ “mechanical human being” was modeled after Galileo’s pendulum, swinging between the quest for power on the one hand and the fear of death on the other – but, then, Galileo’s own mechanical cosmos was itself a reflection of a society increasingly pervaded by machines.

Newton could make up a world of independent bodies because he lived in a society that began to critique hierarchical power and praise and glorify individualism. He envisaged a liberal word in which every body was a lonely soul in the cosmos, inter-acting with but never dictating its will to other bodies. There is no ultimate cause in Newton, only inter-dependence.

Descartes could emphasize the immediacy of cause and effect – the leaves move only if the wind touches them – because he lived in a world that increasingly contested religious, church-invoked miracles that operated at a distance.

Lavoisier invented his law of conservation of matter while he was building a wall around Paris, turning the city into a sealed container in order to capture the mass of its taxable income.

Darwin’s “survival of the fittest” was based on Malthus’ population theory. And so on.

These relatively recent examples shouldn’t surprise us. Human beings tend to impose on the cosmos the power structure that governs their own society. In other words, they tend to politicize nature.

In archaic societies the gods are usually numerous, relatively equal and hardly omnipotent. Hierarchical, statist societies tend to impose a pantheon of gods. And absolute rule tends to insist on a single god and a monotheistic religion. In each case, the forces that make up nature reflect, and in turn are reflected in, the forces that shape society.⁴

Capitalism is no exception to this historical rule. Consider the mechanical worldview. The liberal God is nothing but absolute rationality, or natural law. The language of God is mathematical, and therefore the structure of the universe is numerical. The universe that God created is flat, filled with numerous bodies that are not subservient and dependent, but free and interdependent. These bodies are propelled not by differential obligations, but by the universal force of gravity. They are attracted and repelled to one another not by the will of the Almighty, but through the interaction of force and counterforce. And, finally, they are ordered not by decree, but by the invisible power of equilibrating inertia.

This flat universe mirrors the flat ideals of liberal society. A liberal society consists of equally small actors, or particles, none of which is large enough to significantly affect the other particles/actors. These particles/actors are energized not by patriarchal responsibilities, but by scarcity – the gravitational force of the social universe. They are attracted to and repelled from one another not by feudal obligations, but through the universal-utilitarian functions of demand and supply. And they obey not a hierarchical rule, but the equilibrating force of the invisible hand of perfect competition.

Foundation III: Value Theory and the Duality of Real and Nominal

Capitalism is a system of commodities and therefore denominated in the universal units of price. To understand the nature and dynamics of this architecture, we need to understand prices, and that is why both liberal and Marxian political economies are founded on theories of value – the utility theory of value and the labor theory of value, respectively.

Value theories begin by splitting the economy itself into two parallel, quantitative spheres: real and nominal. The key is the real sphere. This is where production and consumption take place, where supply and demand interact, where utility and productivity are determined, where power and equilibrium compete, where well-being and exploitation take place, where surplus value and profit are generated.

Now, on the face of it, it seems difficult if not impossible to quantify the real sphere: the entities of this sphere are qualitatively different, and that qualitative difference makes them quantitatively incommensurate.

For the economists, though, this problem is more apparent the real. Physicists and chemists express all measurements in terms of five fundamental quantities: distance, time, mass, electrical charge and heat. In this way, velocity can be defined as distance divided by time; acceleration is the time derivative of velocity; force is mass times acceleration, etc. And economists, according to themselves, are able to do the very same thing.

Economics, they say, has its own fundamental quantities: the fundamental quantity of the liberal universe is the util, and the fundamental quantity of the Marxist universe is socially necessary abstract labor.⁵ With these fundamental quantities, every real entity – from concrete labor, to commodities, to the capital stock – can be reduced to and expressed in the very same unit.

Parallel to the real sphere stands the nominal world of money and prices. This sphere constitutes the immediate appearance of the commodity system. But that is merely a derived appearance. In fact, the nominal sphere is nothing but a giant, symbolic mirror. It is a parallel domain whose universal dollar magnitudes merely reflect – sometimes accurately, sometimes not – the underlying real util and abstract labor quantities of production and consumption.

So we have a quantitative correspondence. The nominal sphere of prices reflects the real sphere of production and consumption. And the purpose of value theory is to explain this reflection/correspondence.

How does value theory sort out this correspondence? In the liberal version, the double-sided economy is assumed to be contained in a Newtonian-like space – a container that comes complete with its own invisible laws, or functions, whose role is to equilibrate quantities and prices. The Marxist version is very different, in that it emphasizes not equilibrium and harmony, but the conflictual/dialectical engine of the economy. However, here, too, there is a clear bifurcation between the real and the nominal. And here, too, there is an assumed set of rules – the historical laws of motion – that governs the long-term interaction of the two spheres.

Now, since these principles, or laws, are immutable, the role of the political economist, just like the role of the natural scientist, is simply to “discover” them.⁶ The method of discovery builds on the research paradigm of Galileo, Descartes and Newton on the one hand, and on the application of analytical probability and empirical statistics on the other. In this method, discovery takes place through the fusion of experimentation and generalization – a method that liberals apply through testing and prediction (albeit mostly of past events), and that Marxists apply through the dialectics of theory and praxis.

Finally, unlike economics, politics doesn’t have its own intrinsic rules. This difference has two important consequences. In the liberal case, the notion of a self-optimizing economy means that, with the exception of “externalities,” political intervention can only lead to sub-optimal outcomes. In the Marxist case, politics and state are inextricably bound up with production and the economy. However, since politics and state have no intrinsic rules of their own, they have to derive their logic from the economy – either strictly, as stipulated by structuralists, or loosely, as argued by instrumentalists.

To sum up, then, the cosmology of capitalism is built on three key foundations. The first foundation is the separation between economics and politics. The economy is governed by its own laws, whereas politics either is derived from these economic laws or distorts them. The second foundation is a mechanical view of the economy itself – a view that is based on action and reaction, flat functions and the self-regulating forces of motion and equilibrium, and in which the role of the political economist is merely to discover these mechanical laws. The third foundation is the bifurcation of the economy itself into two quantitative spheres – real and nominal. The real sphere is enumerated in material units of consumption and production (utils or socially necessary abstract labor), while the nominal sphere is counted in money prices. But the two spheres are parallel: nominal prices merely mirror real quantities, and the mission of value theory is to explain their correspondence.

The Rise of Power and the Demise of Political Economy

These foundations of the capitalist cosmology started to disintegrate in the second half of the nineteenth century, with the key reason being the very victory of capitalism. Note that political economy differed from all earlier cosmologies in that it was the first to substitute secular for religious force. But, like the gods, this secular force was still assumed to be heteronomous; i.e., it was an objective entity, external to society.

The victory of capitalism changed this perception. With the feudal order finally giving way to a full-fledged capitalist regime, it became increasingly apparent that force is imposed not from without, but from within. Instead of heteronomous force, there emerged autonomous power, and that shift changed everything.⁷ With autonomous power, the dualities of economics/politics, the separation of real/nominal and the mechanical worldview of political economy were all seriously undermined. With these categories undermined, the presumed automaticity of political economy no longer held true. And with automaticity gone, political economy ceased being an objective science.

The recognition of power was affected by four important developments. The first development was the emergence of totally new units. By the late nineteenth and early twentieth centuries, the notion of atomistic interdependent actors had been replaced by large hierarchical organizations – from big business and large unions to big government and large NGOs – organizations that were big enough to alter their own circumstances as well as to affect one another.

The second development was the emergence of new phenomena, unknown to the classical political economists. By the beginning of the twentieth century, total war and a seemingly permanent war economy had been established as salient features of modern capitalism, features that appeared no less important than production and consumption. Governments started to actively engage in massive industrial and macro stabilization policies, policies that completely upset the presumed automaticity of the so-called economic sphere. Capitalists incorporated their businesses, and in the process they bureaucratized and socialized the very process of private accumulation. The singular act of labor grew not simpler and more homogenous, but ever more complex, and workers no longer lived at subsistence. There emerged a labor aristocracy, the workers’ standard of living in the main capitalist countries soared, and, with rising disposable income, issues of culture grew in importance relative to work. Finally, the nominal processes of inflation and finance assumed a life of their own, a life whose trajectory no longer seemed to reflect the so-called real sector.

The third development was the emergence of totally new concepts. With the rise of fascism and Nazism, the primacy of class and production was challenged by a new emphasis on masses, power, state, bureaucracy, elites and systems.

Fourth and finally, the objective/mechanical cosmology of the first political-scientific revolution was undermined by uncertainty, relativity and the entanglement of subject and object. Science was increasingly challenged by anti-scientific vitalism and postism.

The combined result of these developments was a growing divergence between universality and fracture. On the one hand, the regime of capital has become the most universal system ever to organize society: its rule has spread to every corner of the world and incorporated more and more aspects of human life. On the other hand, political economy – the cosmology of that order – has been fatally fractured: instead of what once was an integrated science of society, there emerged a collection of partial and exclusionary social disciplines.

The mainstream liberal study of society was split into numerous social sciences. These social sciences – economics, political science, sociology, anthropology, psychology, and now also culture, communication, gender and other such offshoots – are each treated as a “discipline,” a closed system guarded by proprietary jargon, unique principles and a bureaucratic-academic hierarchy.

But this progressive fracturing didn’t save economics. Although most economists refuse to know it and few would ever admit it, the rise of autonomous power destroyed their fundamental quantities. With autonomous power, it became patently clear that both utils and abstract labor were logically impossible and empirically unknowable. And, sure enough, no liberal economist has ever been able to measure the util contents of commodities, and no Marxist has ever been able to calculate their abstract labor contents – because neither can be done. This inability is existential: with no fundamental quantities, value theory becomes impossible, and with no value theory, economics disintegrates.

The Neoclassical Golem

The neoclassicists responded by trying to shield their utils from the destructive touch of power. The process was two-pronged. First, they created a heavily subsidized fantasy world, titled General Equilibrium, where, buttressed by a slew of highly restrictive assumptions, everything still works (almost) as it should.⁸ To achieve this end, though, they had to turn their economy into a null domain. They excluded from it almost every meaningful power phenomenon – and they did it so thoroughly that their perfectly competitive model now perfectly explains next to nothing.

The second step was to brand the excluded power phenomena “deviant,” and then hand them over to the practitioners of two newly-created sub-disciplines: micro “distortions” and “imperfections” were given to Game Theorists, while government “interventions” and “shocks” were passed on to the macroeconomists. The problem is that, over the past half century, Game Theory and macroeconomics have grown into a theoretical Golem. They’ve expanded tremendously, both bureaucratically and academically – and that expansion, instead of bolstering liberal cosmology, has seriously undermined it.

Although Game Theorists and macroeconomists rarely advertize it and many conveniently ignore it, their models, whether good or bad, are all affected by – and in many cases are exclusively concerned with – power. This is a crucial fact, because, once power is brought into the picture, all prices, income flows and asset stocks become “contaminated.” And when prices and distribution are infected with power, the utility theory of value becomes irrelevant.

Now, until the 1950s and 1960s, neoclassicists could still pretend that the extra-economic “distortions” and “shocks” were local, or at least temporary, and therefore redundant for the grander purpose of value analysis. But nowadays, with Game Theory increasingly taking over the micro analysis of distribution, and with governments directly determining 20 to 40 percent of economic activity and price setting and indirectly involved in much of the rest, power seems everywhere. And if power is now the rule rather than the exception, what then is left of the utility-productivity foundations of liberal value theory?

The Neo-Marxist Fracture

Unlike the neoclassicists, Marxists chose not to evade and hide power but to tackle it head on – although the end result was pretty much the same. To recognize power meant to abandon the labor theory of value. And since Marxists have never come up with another theory of value, their worldview has lost its main unifying force. Instead of the original Marxist totality, there emerged a neo-Marxist fracture.

Marxism today consists of three sub-disciplines, each with its own categories, logic and bureaucratic demarcations. The first sub-discipline is neo-Marxist economics, based on a mixture of monopoly capital and permanent government intervention. The second sub-discipline comprises neo-Marxist critiques of capitalist cultural. And the third sub-discipline consists of neo-Marxist theories of the state.

Now, it’s worth stressing here that both Marx and the neo-Marxists have had very meaningful things to say about the world. These include, among other things, a comprehensive vista of human history – an approach that negates and supersedes the particular histories dictated by elites; the notion that ideas are dialectically embedded in their concrete material history; the link between theory and praxis; the view of capitalism as a totalizing political-power regime; the universalizing-globalizing tendencies of this regime; the dialectics of the class struggle; the fight against exploitation, oppression and imperial rule; and the emphasis on autonomy and freedom as the motivating force of human development.

These ideas are all indispensable. More importantly, the development of these ideas is deeply enfolded, to use David Bohm’s term, in the very history of the capitalist regime, and in that sense they can never be discarded as erroneous.⁹

But all of that still leaves a key issue unresolved. In the absence of a unifying value theory, there is no logically coherent and empirically meaningful way to explain the so-called economic accumulation of capital – let alone to account for how culture and the state presumably affect such accumulation. In other words, we have no explanation for the most important process of all – the accumulation of capital.

Capitalism, though, remains a universalizing system – and a universalizing system calls for a universal theory. So maybe it’s time to stop the fracturing. We don’t need finer and finer nuisances. We don’t need new sub-disciplines to be connected through inter- and trans-disciplinary links. And we don’t need imperfections and distortions to tell us why our theories don’t work.

What we do need is a radical Ctrl-Alt-Del. As Descartes tells us, to be radical means to go to the root, and the root of capitalism is the accumulation of capital. This, then, should be our new starting point.

The Capitalist Mode of Power

In the remainder of the paper we briefly outline some of the key elements of our own approach to capital. We begin with power. We argue that capital is not means of production, it is not the ability to produce hedonic pleasure, and it is not a quantum of dead productive labor. Rather, capital is power, and only power.

Further, and more broadly, we suggest that capitalism is best viewed not as a mode of production or consumption, but as a mode of power. Machines, production and consumption of course are part of capitalism, and they certainly feature heavily in accumulation. But the role of these entities in the process of accumulation, whatever it may be, is significant primarily through the way they bear on power.

To explicate our argument, we start with two related entities: prices and capitalization. Capitalism – as we already noted, and as both liberals and Marxists correctly recognize – is organized as a commodity system denominated in prices. Capitalism is particularly conducive to numerical organization because it is based on private ownership, and anything that can be privately owned can be priced. This situation means that, as private ownership spreads spatially and socially, price becomes the universal numerical unit with which the capitalist order is organized.

Now, the actual pattern of this order is created through capitalization. Capitalization, to paraphrase physicist David Bohm, is the generative order of capitalism. It is the flexible and all-inclusive algorithm that creorders – or continuously creates the order of – capitalism.

Capitalizing Power

What exactly is capitalization? Capitalization is a symbolic financial entity, a ritual that the capitalists use to discount to present value risk-adjusted expected future earnings. This ritual has a very long history. It was first invented in the capitalist Bourgs of Europe, probably sometime during the fourteenth century. It overcame religious opposition to usury in the seventeenth century to become a conventional practice among bankers. Its mathematical formulae were first articulated by German foresters in the mid-nineteenth century. Its ideological and theoretical foundations were laid out at the turn of the twentieth century. It started to appear in textbooks around the 1950s, giving rise to a process that contemporary experts refer to as “financialization.” And by the early twenty-first century, it has grown into the most powerful faith of all, with more followers than of all the world’s religions combined.

Now, as Ulf Martin argues in a forthcoming paper, capitalization is an operational-computational symbol. Unlike ontological symbols, capitalization isn’t a passive representation of the world. Instead, it is an active, synthetic calculation. It is a symbol that human beings create and impose on the world – and in so doing, they shape the world in the image of their symbol.

Capitalists – as well as everyone else – are conditioned to think of capital as capitalization, and nothing but capitalization. The ultimate question here is not the particular entity that the capitalist owns, but the universal worth of this entity defined as a capitalized asset.

Neoclassicists and Marxists recognize this symbolic creature – but given their view that capital is a (so-called) real economic entity, they don’t quite know what to do with its symbolic appearance. The neoclassicists bypass the impasse by saying that, in principle, capitalization is merely the image of real capital – although, in practice, this image gets distorted by unfortunate market imperfections. The Marxists approach the problem from the opposite direction. They begin by assuming that capitalization is entirely fictitious – and therefore unrelated to the actual, or real capital. But, then, in order to sustain their labor theory of value, they also insist that, occasionally, this fiction must crash into equality with real capital.

In our view, these attempts to make capitalization fit the box of real capital are an exercise in futility. As we already saw, not only does real capital lack an objective quantity, but the very separation of economics from politics – a separation that makes such objectivity possible in the first place – has become defunct. And, indeed, capitalization is hardly limited to the so-called economic sphere.

In principle, every stream of expected income is a candidate for capitalization. And since income streams are generated by social entities, processes, organizations and institutions, we end up with capitalization discounting not the so-called sphere of economics, but potentially every aspect of society. Human life, including its social habits and its genetic code, is routinely capitalized. Institutions – from education and entertainment to religion and the law – are habitually capitalized. Voluntary social networks, urban violence, civil war and international conflict are regularly capitalized. Even the environmental future of humanity is capitalized. Nothing escapes the eyes of the discounters. If it generates expected future income, it can be capitalized, and whatever can be capitalized sooner or later is capitalized.

The encompassing nature of capitalization calls for an encompassing theory, and the unifying basis for such a theory, we argue, is power. The primacy of power is built right into the definition of private ownership. Note that the English word “private” comes from the Latin privatus, which means “restricted.” In this sense, private ownership is wholly and only an institution of exclusion, and institutional exclusion is a matter of organized power.

Of course, exclusion does not have to be exercised. What matter here are the right to exclude and the ability to exact pecuniary terms for not exercising that right. This right and ability are the foundations of accumulation.

Capital, then, is nothing but organized power. This power has two sides: one qualitative, the other quantitative. The qualitative side comprises the institutions, processes and conflicts through which capitalists constantly creorder society, shaping and restricting its trajectory in order to extract their tributary income. The quantitative side is the process that integrates, reduces and distils these numerous qualitative processes down to the universal magnitude of capitalization.

Industry and Business

What is the object of capitalist power? How does it creorder society? The answer begins with a conceptual distinction between the creative/productive potential of society – the sphere that Thorstein Veblen called industry – and the realm of power that, in the capitalist epoch, takes the form of business.¹⁰

Using as a metaphor the concept of physicist Denis Gabor, we can think of the social process as a giant hologram, a space crisscrossed with incidental waves. Each social action – whether an act of industry or of business – is an event, an occurrence that generates vibrations throughout the social space. But there is a fundamental difference between the vibrations of industry and the vibrations of business. Industry, understood as the collective knowledge and effort of humanity, is inherently cooperative, integrated and synchronized. It operates best when its various events resonate with each other. Business, in contrast, isn’t collective; it is private. Its goals are achieved through the threat and exercise of systemic prevention and restriction – that is, through strategic sabotage. The key object of this sabotage is the resonating pulses of industry – a resonance that business constantly upsets through built-in dissonance.

Let’s illustrate this interaction of business and industry with a simple example. Political economists, both mainstream and Marxist, postulate a positive relationship between production and profit. Capitalists, they argue, benefit from industrial activity – and, therefore, the more fully employed their equipment and workers, the greater their profit. But if we think of capital as power, exercised through the strategic sabotage of industry by business, the relationship becomes nonlinear – positive under certain circumstances, negative under others.¹¹

This latter relationship is illustrated, hypothetically, in Figure 1. The chart depicts the utilization of industrial capacity on the horizontal axis against the capitalist share of income on the vertical axis. Now, up to a point, the two move together. After that point, the relationship becomes negative. The reason for this inversion is easy to explain by looking at extremes. If industry came to a complete standstill at the bottom left corner of the chart, capitalist earnings would be nil. But capitalist earnings would also be zero if industry always and everywhere operated at full socio-technological capacity – depicted by the bottom right corner of the chart. Under this latter scenario, industrial considerations rather than business decisions would be paramount, production would no longer need the consent of owners, and these owners would then be unable to extract their tributary earnings. For owners of capital, then, the ideal, Goldilocks condition, indicated by the top arc segment, lies somewhere in between: with high capitalist earnings being received in return for letting industry operate – though only at less than full potential.

Now, having laid out the theory, let’s look at the facts. Figure 2 shows this relationship for the United States since the 1930s. The horizontal axis approximates the degree of sabotage by using the official rate of unemployment, inverted (notice that unemployment begins with zero on the right, indicating no sabotage, and that, as it increases to the left, so does sabotage). The vertical axis, as before, shows the share of national income received by capitalists.

And lo and behold, what we see is very close to the theoretical claims made in Figure 1. The best position for capitalists is not when industry is fully employed, but when the unemployment rate is around 7 percent. In other words, the so-called “natural rate of unemployment” and “business as usual” are two sides of the same power process: a process in which business accumulates by strategically sabotaging industry.

Differential Accumulation

Now, power is never absolute; it’s always relative. For this reason, both the quantitative and qualitative aspects of capital accumulation have to be assessed differentially – that is, relative to other capitals. Contrary to standard political economy, liberal as well as Marxist, capitalists are driven not to maximize profit, but to “beat the average” and “exceed the normal rate of return.” Their entire existence is conditioned by the need to outperform, by the imperative to achieve not absolute accumulation, but differential accumulation. And that makes perfect sense. To beat the average means to accumulate faster than others; and since capital is power, capitalists who accumulate differentially increase their power.

Let’s illustrate this process with another example, taken from our work on the Middle East.¹² Figure 3 shows the differential performance of the world’s six leading privately owned oil companies relative to the Fortune 500 benchmark. Each bar in the chart shows the extent to which the oil companies’ rate of return on equity exceeded or fell short of the Fortune 500 average. The gray bars show positive differential accumulation – i.e. the percent by which the oil companies exceeded the Fortune 500 average. The black bars show negative differential accumulation; that is, the percent by which the oil companies trailed the average. Finally, the little explosion signs in the chart shows the occurrences of “Energy Conflicts” – that is, regional energy-related wars.

Now, conventional economics has no interest in the differential profits of the oil companies, and it certainly has nothing to say about relationship between these differential profits and regional wars. Differential profit is perhaps of some interest to financial analysts. Middle-East wars are the business of experts in international relations and security analysts. And since each of these phenomena belongs to a completely separate realm of society, no one has ever thought of relating them in the first place.

And yet, as it turns out, these phenomena are not simply related. In fact, they could be thought of as two sides of the very same process – namely, the global accumulation of capital as power.

We started to study this subject when we were still graduate students, back in the late 1980s, and we’ve published quite a bit about it since then. This research opened our eyes, first, to the encompassing nature of capital; and, second, to the insight that one can gain from analyzing its accumulation as a power process.

Notice the three remarkable relationships depicted in the chart. First, every energy conflict was preceded by the large oil companies trailing the average. In other words, for an energy conflict to erupt, the oil companies first had to differentially decumulate – a most unusual prerequisite from the viewpoint of any social science.

Second, every energy conflict was followed by the oil companies beating the average. In other words, war and conflict in the region, which social scientists customarily blame for “distorting” the aggregate economy, have served the differential interest of certain key firms at the expense of other key firms.

Third and finally, with one exception, in 1996-7, the oil companies never managed to beat the average without there first being an energy conflict in the region. In other words, the differential performance of the oil companies depended not on production, but on the most extreme form of sabotage: war.

Needless to say, these relationships, and the conclusions they give rise to, are nothing short of remarkable. First, the likelihood that all three patterns are the consequence of statistical fluke is negligible. In other words, there must be something very substantive behind the connection of Middle East wars and global differential profits.

Second, these relationships seamlessly fuse quality and quantity. In our research on the subject, we show how the qualitative aspects of international relations, superpower confrontation, regional conflicts and the activity of the oil companies on the one hand, can both explain and be explained by the quantitative global process of capital accumulation on the other.

Third, all three relationships have remained stable for half a century, allowing us to predict, in writing and before the events, both the first and second Gulf Wars. This stability suggests that the patterns of capital as power – although subject to historical change from within society – are anything but haphazard.

Toward a New Cosmology of Capitalism

This type of research has gradually led us to the conclusion that political economy requires a fresh start.

At about the same time, in 1991, Paul Sweezy, one of the greatest American Marxists, wrote a piece that assessed Monopoly Capital (1966), a deservingly famous book that he wrote together with Paul Baran twenty-five years earlier. In that piece, Sweezy admitted that there is something very big missing from the Marxist and neoclassical frameworks: a coherent theory of capital accumulation. His observations are worth quoting at some length because they show both the problem and why economics cannot solve it:

Why did Monopoly Capital fail to anticipate the changes in the structure and functioning of the system that have taken place in the last twenty-five years? Basically, I think the answer is that its conceptualization of the capital accumulation process is one-sided and incomplete. In the established tradition of both mainstream and Marxian economics, we treated capital accumulation as being essentially a matter of adding to the stock of existing capital goods. But in reality this is only one aspect of the process. Accumulation is also a matter of adding to the stock of financial assets. The two aspects are of course interrelated, but the nature of this interrelation is problematic to say the least. The traditional way of handling the problem has been in effect to assume it away: for example, buying stocks and bonds (two of the simpler forms of financial assets) is assumed to be merely an indirect way of buying real capital goods. This is hardly ever true, and it can be totally misleading. This is not the place to try to point the way to a more satisfactory conceptualization of the capital accumulation process. It is at best an extremely complicated and difficult problem, and I am frank to say that I have no clues to its solution. But I can say with some confidence that achieving a better understanding of the monopoly capitalist society of today will be possible only on the basis of a more adequate theory of capital accumulation, with special emphasis on the interaction of its real and financial aspects, than we now possess. (Sweezy 1991, emphases added)

The stumbling block lies right at the end of the paragraph: “the interaction between the real and financial aspects.” Sweezy recognized that the problem concerns the very concept of capital – yet he could not solve it precisely because he continued to bifurcate it into “real” and “financial” aspects. And that shouldn’t surprise us. “Whatever happens,” writes Hegel (1821: 11), “every individual is a child of his time; so philosophy too is its own time apprehended in thoughts. It is just as absurd to fancy that a philosophy can transcend its contemporary world as it is to fancy that an individual can overleap his own age, jump over Rhodes.” Sweezy and his Monthly Review group had pushed the frontier of Marxist research for much of the post-war period, but by the 1990s their ammunition had run out. They recognized the all-imposing reality of finance, but their bifurcated world could not properly accommodate it.

As younger researchers socialized in a different world, we didn’t carry the same theoretical baggage. Uninhibited, we applied the Cartesian Ctrl-Alt-Del and started by assuming that there is no bifurcation to begin with and therefore no real-financial interaction to explain. All capital is finance and only finance, and it exists as finance because accumulation represents not the material amalgamation of utility or labor, but the creordering of power.

To challenge capitalism is to alter and eventually abolish the way it creorders power. But in order to do so effectively, we need to comprehend exactly what is it that we challenge. Power, we argue, isn’t an external factor that distorts or supports a material process of accumulation; instead, it is the inner driving force, the means and ends of capitalist development at large. From this viewpoint, capitalism is best understood and contested not as a mode of consumption and production, but as a mode of power. Perhaps this understanding of what our society is could help us make it what it should be.

1. The historical tension between the civil urban space of economy and capital and the coercive violent space of politics and state is explored from different perspectives in Robert Lopez’s The Birth of Europe (1967), Charles Tilly’s Coercion, Capital, and European States, AD 990-1992 (1992) and Henri Lefebvre’s The Urban Revolution (2003).
2. This separation haunts even the most innovative Marxists. Henry Lefebvre, for example, introduced the notion of urban society as a way of transcending the base-superstructure of Marx’s industrial society – only to find himself describing this new society in terms of … economics and politics.
3. The fascinating evolution and path-breaking heroes of the mechanical worldview are described in Arthur Koestler’s unparallel history of cosmology, The Sleepwalkers (1959). The philosophical underpinnings of the scientific revolution, particularly in physics, are examined in Zev Bechler’s Newton’s Physics and the Conceptual Structure of the Scientific Revolution (1991).
4. The history of the notion of force, from ancient thought to modern physics, is told in Max Jammer’s Concepts of Force (1957). The social myths of the gods are narrated in Robert Graves’ The Golden Fleece (1944) and analyzed in his study of The Greek Myths (1957).
5. The notion of abstract labor was first articulated by Karl Marx in his Contribution to the Critique of Political Economy (1859). The term util was coined by Irving Fisher in his Mathematical Investigations in the Theory of Value and Price (1892).
6. The notion that there exists an external rationality – and that human beings can do no more than discover this external rationality – was expressed, somewhat tongue in cheek, by the number theorist Paul Erdös. A Hungarian Jew, Erdös did not like God, whom he nicknamed SF (the supreme fascist). But God, whether likable or not, predetermined everything. In mathematics, God set not only the rules, but also the ultimate proofs of those rules. These proofs are written, so to speak, in “The Book,” and the mathematician’s role is simply to decipher its pages (Hoffman 1998). Most of the great philosopher-scientists – from Kepler and Descartes to Newton and Einstein – shared this view. They all assumed that the principles they looked for – be they the “laws of nature” or the “language of God” – were primordial and that their task was simply to “find” them (Agassi 1990).
7. The difference between heteronomy and autonomy is developed in the social and philosophical writings of Cornelius Castoriadis – see, for example, his Philosophy, Politics, Autonomy (1991).
8. We say “almost” since the issue isn’t really settled. The highest academic authorities on the subject still debate, first, whether, even under the most stringent (read socially impossible) conditions, a unique general equilibrium can be shown to exist (at least on paper); and, second, if such equilibrium does exist, whether or not it is likely to persist.
9. The notion of enfoldment, or the nesting of different levels of theory, consciousness and order, is developed in David Bohm’s Wholeness and the Implicate Order (1980) and David Bohm and David Peat’s Science, Order, and Creativity (1987).
10. Cf. The Theory of Business Enterprise (Veblen 1904) and Absentee Ownership and Business Enterprise in Recent Times (Veblen 1923).
11. Note that these considerations pertain only to the quantitative aspect of industrial activity; they do not deal with the qualitative nature of its output, or the conditions under which the output is produced. Obviously, these latter aspects are equally important, and here, too, business sabotage often operates to restrict the human potential by forcing social activity into trajectories that are as harmful as they are profitable.
12. See, for example, Jonathan Nitzan and Shimson Bichler, The Global Political Economy of Israel (2002: Ch. 5), Shimshon Bichler and Jonathan Nitzan, “Dominant Capital and the New Wars” (2004) and Jonathan Nitzan and Shimson Bichler, “New Imperialism, or New Capitalism?” (2006).

Abstract of Sean Starrs’ paper ‘State and Capital: False Dichotomy But Still Inter-Related’.

Nitzan and Bichler’s latest book, Capital as Power, marks a major advancement in the study of political economy. Their power theory of value, differential accumulation, and conceptualization of capitalism as a mode of power are all fundamental contributions. Where I think their theoretical framework goes astray, however, is in their conceptualization of ‘the state of capital’. While I accept their assertion that economics cannot be separated from politics, in this paper I argue that this should not imply that politics cannot be separated from the logic of capital. That is, while capital (and capitalism) cannot exist without the state, the state can certainly exist without capital. Thus, I suggest that one can still conceptualize a ‘state mode of power’, and that this conceptualization does not necessarily have to reproduce the false dichotomy between state and capital. Also, I believe that one should conceptualize the state as representing the balance of social forces within a particular social formation. Today, this balance is certainly in favour of capital, but that does not preclude the existence of other logics, some of which are non- or even anti-capitalist, and the relationship between capital and these other logics is open, dialectical, and dependent on struggle.

Sean Starrs claims that we need to discard our notion of the ‘state of capital’. The gist of his argument is simple enough. Capitalist societies, he says, involve a myriad of power relations, many of them very important. These relationships, although often linked to the logic of capital, are distinct from that logic and therefore cannot be reduced to it. And since we are talking about separate social processes, we cannot encompass them all under the same rubric. His conclusion: the notion of a totalizing mode of power – which we call the state of capital — must be dispensed with.

The following notes attempt to clarify. They seek to explain, first, what we mean by a ‘mode of power’, and, second, why we use this concept in the first place. The sequence of our presentation is as follows. We begin by contrasting two spatial conceptions of the state. We then explain the notion of capitalization, which in our view represents the logic of the state of capital. And, finally, we flesh out the argument with a series of historical examples.

Space

In our 2009 book, Capital as Power, we define ‘modes of power’ in relation to the notion of space. Newton thought of space as a container. Space for him is an independent ‘place’, an entity that exists regardless of the items it contains.

What does this independence mean? According to Newton, space acts on the entities it contains – for example, through the law of inertia. But the opposite doesn’t hold: the entities have no bearing on the space within which they are contained. The space and its laws exist whether the space is empty or populated.

This Newtonian notion of an independent space is common in social analysis. The liberal ‘market space’, for example, determines the laws of supply and demand. The entities of ‘market space’ – namely consumers and producers – obey these laws, but they have no effect on them. In this sense, ‘market space’ exists independently of its contained entities. Over time, non-market distortions cause some individual particles to collate into larger bodies – corporate coalitions, labour unions, NGOs, etc. – but these bodies, however large, continue to obey without ever altering the logic of the space in which they exist. Other social spaces, such as gender, ethnicity, race, culture and communication, may have their own distinct logics, whether structural or postist, and these logics continuously impinge on, intervene in and affect what happens in ‘market space’. But the intrusion, coming from the outside, affects merely the entities of ‘market space’, not its inner logic.

Now, the conventional liberal creed – which some Marxists seem to have adopted – is that the government, or the state, is a synthetic entity. According to this view, at any point in time the state reflects the ‘balance of forces’ between the various entities that populate the different spaces of society.

For example, in the United States, where the balance of forces tilts in favour of capitalism, the state is overly representative of the interests of dominant capitalists. By contrast, in China, where the balance of forces is very different, the state is dominated by the oligarchy of the Communist Party.

But then, note the terminology here: the state as a balance of forces. The notion of a ‘balance of forces’ is Newtonian par excellence. It was born with the political­-scientific revolution of the seventeenth century to reflect the new flat cosmology of interdependent mechanized bodies that act and react on but never dominate one another; it was politicized by Voltaire and others in the eighteenth century to justify the liberal-capitalist revolution; and it was reproduced in the nineteenth and twentieth centuries in numerous concepts, including ‘economic forces’, ‘checks and balances’, ‘countervailing powers’, ‘social equilibrium’ and so on.

So we have a serious problem right from the word ‘go’. We think of the state as a general, universal entity, capable of taking many different forms. Yet we describe this entity as a ‘balance of forces’ – i.e., in terms that are decidedly liberal and capitalistic.

This is where the alternative notion of Leibnitzian space comes into the picture. Unlike Newton, Leibnitz, and later Einstein, described space not as an independent container, but as the positional property of things. The space and its bodies are co-defined and co-determined. This view is both totalizing and dynamic: it is totalizing because the space ‘constitutes’ the bodies and vice versa; and it is dynamic because both space and the bodies it comprises are constantly changing.

Marx’s concept of a ‘mode of production’ is definitely Liebnitzian, at least in principle: the social entities and the societies that these entities make are co-characterized and co-determined by the changing nature of production. But there is an important discontinuity. For Marx, the engine of historical society – namely the production, appropriation and use of the surplus – is an ‘economic’ process, and that classification ends up fracturing his Leibnitzian totality. The state, being a ‘political’ entity, is distinct from the ‘economy’, by definition, and that distinction necessitates two different forms of power: ‘economic exploitation’ and ‘political oppression’.

Our own notion of a ‘mode of power’ is also Leibnitzian: the entities that make up the society and the society they make up are jointly characterized and determined by the nature of power. However, unlike in Marx, here there is no distinction between ‘economic’ and ‘political’ power, so the fracture does not arise to begin with.

The Capitalist Mode of Power

In our view, every hierarchical social order is characterized by a unique mode of power: we call this mode of power the ‘state’ of that society.

The capitalist mode of power – like the feudal and the slave-based modes of power that preceded it – is marked by its particular pattern of power relations: in this case, by relations that are specifically capitalistic.

Note that we do not mean to suggest that in the capitalist mode of power ‘all power = capitalist power’, and not even that all power can be ‘reduced’ or ‘translated’ to capitalist power.

Instead, we argue first that as capitalism develops, the logic of capitalist power increasingly permeates the social space; and second that, consequently, every social relationship is gradually imprinted with and to some extent transformed by this logic of power.

Capitalization

Symbolically, the logic of capitalist power is represented by capitalization. Capitalization is the central ritual of capitalism. It is the process through which capitalists – along with everyone else – discount risk-adjusted expected future earnings to their present value.

This ritual has a very long history. It was first invented in the capitalist Bourgs of Europe, probably sometime during the fourteenth century. It overcame religious opposition to usury in the seventeenth century to become a conventional practice among bankers. Its mathematical formulae were first articulated by German foresters in the mid-nineteenth century. Its ideological and theoretical foundations were laid out at the turn of the twentieth century. It started to appear in textbooks around the 1950s, giving rise to a process that contemporary experts call ‘financialization’. And by the early twenty-first century, it has grown into the most powerful faith, with more followers than all of the world’s religions combined.

Contrary to the impression given by finance books, capitalization isn’t a mere technical formula. And contrary to Marx’s pronunciation, it is anything but ‘fictitious’. First and foremost, capitalization is the power algorithm of capitalism, a distilled representation of organized social power. Every component of capitalization – be it earnings, hype, risk or the normal rate of return – is driven and shaped by power relations, and only by power relations. And since power is relative, the focus of our analysis isn’t absolute capitalization, but differential capitalization.

Second, capitalization is a universalizing process. It tends to spread into and penetrate various facets of social life, engulfing more and more power relations into its fold. Any power process that is touched by capitalization gets discounted, and what gets discounted is encompassed into the capitalist mode of power.

Third and finally, capitalization is self-transformative. Over time, it alters the processes that it enfolds, but it also gets transformed by those very processes.

The Embrace of Public Debt

Let’s illustrate these dynamic features with some examples, beginning with the public debt. As noted, most liberals ­as well as some Marxists think of the state as reflecting the balance of forces of society. From this viewpoint, contemporary states can be characterized as hyper capitalist, social democratic, socialist, communist, theocratic or fascist – all depending on the particular mix of their power relations. And of course there is nothing inherently wrong in such a differentiation.

For us, though, the key issue is not the differences between contemporary states, but their commonalities.

One such commonality is that, nowadays, all states are indebted. According to The Economist, the 2010 global sum of all state debt is $37 trillion. This is a universal feature. There is probably no single government – whether hyper capitalist, social democratic, socialist, communist, theocratic or fascist – that isn’t indebted.

Remarkably, this universal indebtedness is a totally new phenomenon. During much of human history, the situation was exactly the opposite: commonly, the debt was held by the ruler, not owed by the ruler.

This historical pattern started to become inverted a few hundred years ago in Europe. Kings and princes, being strapped for liquid cash, began to finance their war expeditions by selling bonds to the financiers of the Bourgs. For the rising bourgeoisie, the bonds constituted an undifferentiated financial claim – with an important twist. The collateral for the claim was not the productive capacity of the ruler, but his power. The price of the bond quantified that power: it denoted the present value of the ruler’s future power to tax, confiscate and loot. In this way, the government got bonded to the capitalists, who in turn became de facto ‘shareholders’: holders of standardized shares in the organized force of society.

Conventional analysis tends to discount this bondage on the grounds that the state is ‘sovereign’, and a sovereign can always renege on its debt. This claim – an anachronistic remnant of the princely order – is perhaps correct, but only in a formal sense. In practice, default is fairly rare, and it is rare because of its harsh differential repercussions. Governments that default, or even consider such option, find it much harder to borrow, and those that cannot borrow quickly find themselves left behind those that can. For this reason, today’s governments, although calling themselves sovereign, have internalized – indeed, have become bounded to – this logic of capital.

China: Communist or Capitalist?

Does this logic apply equally to capitalist and non-capitalist states?

Take China. According to Starrs, in China capital isn’t in the driver’s seat. Whereas in countries such as the U.S. and the U.K. the government is hostage to capitalist principles, in China, he argues, the situation is reversed: the Communist Party oligarchy uses capitalist principles to advance its own power. And again, on the face of it, this statement may seem plausible, and many Communist Party officials – just like the feudal lords before them – probably love to believe it.

But does it hold water?

Let’s examine this case a bit more closely. The Chinese government has public debt obligations of $1.1 trillion. It also holds nearly $2.4 trillion in foreign assets. The sum of these debits and credits – a total of $3.5 trillion – is managed according to the universal principles of capitalization. The $1.1 trillion in debt discounts the ability of the Chinese government to levy taxes and the risk that it may be unable to do so; the $2.4 trillion in assets discount the earnings and risk of the many foreign investments that the Chinese government owns.

In this sense, the oligarchy of the Chinese Communist Party obeys the very same rules as the capitalists. And that obedience makes the Chinese government – regardless of how ‘sovereign’ or ‘non-capitalist’ it may otherwise look – part and parcel of the capitalist mode of power.

Of course, the situation wasn’t always like that. Recall that a ‘mode of power’ is like a Leibnitzian space: it changes along with the entities that comprise it. Thirty years ago, China had only $2.5 billion worth of reserves. Since then, this sum has increased a thousand fold – an increase that came together with massive social reorganization along capitalist lines. Thirty years ago we could perhaps still speak of a communist mode of power, but can we do so now?

New Heroes

During the Cultural Revolution, the heroes of Chinese communism were peasants and workers. But with the principles of capitalization having taken over, the heroes changed.

In 2009, the Communist Party introduced a new champion: the banking executive. One banker was honoured, to quote the Financial Times, for ‘helping clients manage their finances and save money’, while another was hailed for her ‘selfless devotion to financial services during the Olympics’. The official advertisement was careful to reiterate the primacy of the Communist Party: ‘Amidst the deepening and spreading financial crisis … these financial sector cadres overcame difficulties, strived to maintain growth, protect people’s livelihoods, maintain stability and wholly promote socialist political and cultural construction as well as the grand project of constructing the party’.

According to this advertisement, in China capitalism and financialism are merely ‘tricks’ that the Communist Party uses to promote socialism, although it’s doubtful that even the advertisers believe this doublespeak.

Workers and Farmers as Investors

The Communist Party oligarchy likes to see itself as the workers’ vanguard, but in matters of capitalization it seems to follow rather than lead the global worker.

In the West, workers have been tempted and forced into the logic of capitalization for more than a century now; they have become bounded to mortgages, car loans, credit cards, pensions, mutual funds and other assorted ‘instruments’. The life of a contemporary Western worker is more or less fully discounted – a process that is nicely matched by the fact that finance courses now are taught not only in universities and high schools, but in elementary schools as well.

The Chinese worker still has a lot of catching up to do, but, to its credit, one must say that the Communist Party is trying to help. In the late 1990s, the party started to privatize the country’s stock of houses. This privatization opened the door to a massive explosion of capitalization and credit on the one hand, and to the transformation of workers into ‘investors’ on the other. And, then, in the late 2000s, the party took a second leap forward by starting to monetize the country’s agricultural land, a move that has the potential of turning the other part of the population – roughly 700 million peasants – into equally smart ‘farmers-investors’.

The lesson from these examples is rather simple. China’s historical development is certainly different from that of the United States, England, or India. But having been absorbed into the world of public bonds, foreign investment, mortgaged housing and monetized agriculture – in other words, into the world of capitalization – this historical development, although seemingly under the control of the Communist Party oligarchy, is part and parcel of the evolving capitalist mode of power.

Of course, since we are dealing with a Leibnitzian space, the integration works both ways. China gets embedded in the capitalist mode of power, while simultaneously changing this very mode of power. In this sense, the evolution of China today is part of the ongoing creordering of the capitalist mode of power.

Capitalized Wars

Another key institution that is associated with the state, and that Starrs points to, is war.

War is much older than capitalism, having existed in all class societies, past and present. But in every mode of power, war tends to assume features that are unique to that mode of power. This uniqueness is certainly true of capitalism, as evidenced by the voluminous research on capitalist wars and imperialism. However, so far little attention has been paid to the fact that modern wars are increasingly conceived, executed and measured specifically in terms of capitalization.

Begin with the national statisticians. Whether American, Swedish or Chinese, they all define and measure weapons as ‘assets’ and ‘wealth’, and they associate with such weapons capitalised quantities, depreciation rates and implicit rates of return.

In line with this definition and measurement, army strategists and commanders now speak of military campaigns as ‘investments’, calculating their current ‘costs’ and future ‘benefits’ with standard discounting practices.

Finally and most strikingly, government and military officials now use the rituals of capitalization to assess the very success of their campaigns. During the Bush surge in Iraq, for example, it was common to compare spreads between Iraqi and global sovereign bonds. These spreads are taken as the market assessment of risk; and since the market knows best, when the spreads fall the surge must be working, and when they rise the surge must be failing. …

The Ecological Future of Humanity

Our final example concerns the social implications of climate change.

Obviously, the climate, just like war, isn’t unique to capitalism. Yet, we almost treat it as if it were.

Most scientists agree that human activity contributes to global warming/dimming, but that agreement per se doesn’t tell us what’s to be done. The problem is that the damage of global warming will be inflicted in the future, while the cost of preventing that damage must be incurred now. So we need to compare present and future values, and the way that governments go about doing it, is by using – yes, you guessed it – capitalization.

Now, although the computational ritual itself is universal, its precise application can conjure up very different policy omens, depending on the particular rate of interest being used.

Lord Nicholas Stern, for example, used in his Economics of Climate Change a discount rate of 1.4 per cent. According to his computation, a $1,000 worth of environmental damage a 100 years from now has a huge present value of $250. By contrast, Professor William Nordhaus, in his rebuttal of Stern’s work, used a discount rate of 6 per cent. This higher rate reduces the present value of the damage to a miniscule $3.

So we end up with two very different recipes for how to save humanity from itself. The first recipe calls for massive and urgent action, the second for no action at all, and both are derived from the same power algorithm of the capitalist mode of power: the ritual of capitalization.

In Sum

The definition of the ‘state’ as the mode of power of society is a broad framework, not a particular theory. Taken on its own, the notion of the capitalist mode of power, just like Marx’s mode of production, is not meant to account for any specific entity, occurrence and process: it cannot explain a particular war, a particular set of gender relationships, a particular ethnic context, or a particular cultural trait. But in our epoch, these social processes are all embedded in the capitalist mode of power, and the argument we’re making here is that they need to be analyzed within that framework.

Contemporary governments are part and parcel of this capitalist mode of power. They can differ greatly in their composition; they can reflect and represent different social groups; and they can employ different policies. But the power space within which these governments are enfolded is increasingly capitalistic, and that enfoldment makes them elements of the state of capital.

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.