Chapter 3: Finance of enterprises

The macroeconomic pre-validation and validation of production

in The unity of the capitalist economy and state

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Contents

Introduction

Division 1. Finance of enterprises and finance capital

3§1 Finance of enterprises, passive finance capital and the distribution of surplus-value to financiers

Division 2. Pre-validating finance by banks

3§2 The monetary circuit of pre-validating finance by banks (PVF): the pure case

3§3 Saving by by capital owners and labour: the triadic debt-credit relationship

3§4 The payment of interest by enterprises to banks

Division 3. Ex-post substitution for the pre-validating finance by banks

3§5 Capital owners as financiers: dividend bearing and interest bearing finance capital

3§6 Pre-validating finance by banks as ex-post substituted for by non-banking finance capital (the RPVF)

Division 4. The foundation of banks and enterprises

3§7 The foundation of banks and enterprises

Division 5. Validation of macroeconomic surplus-value by macroeconomic expenditure

3§8 Investment versus finance

3§9 Investment and saving: the macroeconomic inequality of investment and saving (I≠S)

3§10 Validation of macroeconomic surplus-value by macroeconomic expenditure

Summary and conclusions

Appendix 3A. Two contingencies of the finance-capital market: intertemporal trade and re-substitution trade

3A-1 The finance-capital market

3A-2 Pension funds: inter temporal trade – premiums, pension and degree of recollected surplus-value for labour

3A-3 Re-substitution trade in financial paper

Appendix 3B. Contingent lending by banks to labour and to capital owners

3B-1 The lending power of banks: money dealing and interest paid by banks

3B-2 Generalisation of the form of money lending

3B-3 Lending to labour

3B-4 Lending to capital owners: finance doubling

Appendix 3C. Rent as a contingent share in the production enterprises’ surplus-value

3C-1 Rent as a contingent share in the production enterprises’ surplus-value

List of figures chapter 3

Introduction

This chapter grounds the production and accumulation of capital in the financing of enterprises by banks. It was shown that money creation by banks is a necessary condition of existence for the accumulation of capital (2D4). In the way this grounding moment of money creation was presented – that is, starting from the concept of money – it has been implicit that banks in fact finance enterprises. In making this explicit in the current chapter (Division 2) we will see not only that the finance by banks is a continuous necessity for the accumulation of capital, but also that it is unlike any other type of finance. In the course of Division 3 it will be shown how other types of finance, once bank finance has done its work, may substitute for the finance provided by banks.

At that stage of the exposition, a grounding of the starting point’s pre-position (1§1) of ‘capital accumulated’ can be provided (Division 4).

It will be seen in this chapter that a systematic exposition of finance is inevitably connected to key macroeconomic questions and theorems. Next to the concept of finance, the key concepts are investment and saving. Based on a ‘monetary circuit approach’ – as opposed to the traditional quantity of money (or money fund) approach – it will be shown: (1) that saving is no precondition for investment;1 (2) that – given the existence of saving – there is no macroeconomic investment ‘out of saving’; (3) that there may be merely an ‘ex post’ portfolio investment out of savings; (4) that the latter is always preceded by banks’ financing of the enterprises’ investment; a finance on the basis of an ex nihilo creation of money (Divisions 2 and 5).

Even if saving is no precondition for investment and the accumulation of capital, saving is nevertheless ubiquitous. Its negative effect on the realisation of surplus-value – and hence on the accumulation of capital – is presented in Division 5 in terms of macroeconomic effective demand; here I build on insights from Kalecki.

Beside the chapter’s main focus of the finance of enterprises, Appendix B outlines lending by banks to labour and to capital owners. Appendix A outlines two contingencies of the finance-capital market regarding the scope of pension funds and the secondary trade in financial paper. Appendix C briefly expands on the treatment of rent in this book.

Scheme 3.1 outlines the systematic of the chapter.

d1534211e8214Scheme 3.1

Systematic of the finance of enterprises (outline Chapter 3)

Legend

grounded in (conditioned by)

bottom moment derives from top moment

*

The moment 3D4 derives from 3D2. Along with it, it is a major ground of the starting point (1D1).

Division 1. Finance of enterprises and finance capital

3§1 Finance of enterprises, passive finance capital and the distribution of surplus-value to financiers

1 Finance and the distribution of surplus-value

In the last division of Chapter 2 (2D7), I started distinguishing between ‘active capital’ (the capital assets of the enterprise) and ‘passive capital’. From now on, the latter will more specifically be called ‘passive finance capital’ – the main subject of the current chapter. Active capital is always financed by some form of ‘passive finance capital’.

Within the latter category a distinction is made between the external form of finance capital (provided by external financiers), and the remaining internal form of finance capital, which is the ‘own capital’ (firm) or the ‘equity’ (corporation) of the enterprises’ owners.

Within the form of external finance capital, a distinction is made between external finance by banks and other external finance (finance by capital owners) – see Figure 3.2a. At the top of this figure (column four) we have banks – we will see in 3D2 that any finance (including internal finance) necessarily starts with bank finance.

Figure 3.2b shows where, and in what form, surplus-value (stemming from the enterprises’ production, associated with active capital) is distributed. In the form of interest it is distributed to banks and to capital owners (amplified in 3§4–3§5). The remaining part is internal profit (in common parlance, ‘profit’).2 One part of the latter is distributed to capital owners in the form of a ‘dividend’, whilst the remaining part of ‘retained profit’ is added to the enterprise’s ‘own capital’ (for firms) or ‘equity’ (corporations).

2 Banks and ‘banking entities’

In order to keep the exposition in this chapter as simple as possible, banks are conceptualised purely as creators of money and as financiers. Any labour that this might require is outsourced to a separate ‘production branch’ of the banking entity, which I subsume under the enterprises sector. This means that the (pure) banks are not producers. Empirically ‘banking entities’ are engaged in gigantic bookkeeping services (account management), credit evaluations and various advisory services. These are equally allotted to the banking entity’s ‘production branch’.

d1534211e8298Figure 3.2a

Active capital and forms of passive finance capital

d1534211e8305Figure 3.2b

The distribution of surplus-value to passive finance capital

Prior to introduction of the state.

*

More precisely the result of production and its validation (explained in 3§10).

Includes rent (see Appendix 3C).

Banks receive (net) interest from enterprises. Part of this interest is added to the bank’s own capital (own capital or equity). The remaining part of the interest is distributed to the banking entity’s ‘production branch’, which may itself also have commission income for its various activities.

As indicated, this chapter (its main text) deals with the finance of enterprises. Banks are also engaged in money creation and the finance of other actors. This is briefly dealt with in Appendix 3B (and regarding the state in Chapter 8).

3§1-a Explication. The balance sheet of enterprises

Sheet 3.3 shows the equivalent of Figure 3.2a in the form of the balance sheet of enterprises.

Sheet 3.3

Balance sheet of enterprises

Assets [active capital]

Liabilities [passive finance capital]

plant and equipment

External finance capital

a

raw materials etc.

Loans from banks

work in progress

Loans from non-bank financiers (bonds)

commodities produced

Internal finance capital

b

current account with banks

value equivalent of a + b

K

K=FC

This sheet relates to enterprises that produce commodities, rather than enterprises engaged in their distribution (mainly transport and retail) or various services, for which the assets side would have a modified form. Commercial claims and commercial debts have been omitted (and are neglected in this chapter).

Division 2. Pre-validating finance by banks

3§2 The monetary circuit of pre-validating finance by banks (PVF): the pure case of non-saving

In a capitalist economy, the creation of money coincides with the act of lending by banks (2§8). Put more strongly, net lending by banks is money creation. It was shown that the expanded creation of money by banks is necessary for the accumulation of capital (2§10).

1 Accumulation of capital necessarily initiated by banks’ pre-validating finance

Expanded money creation is now further concretised as the banks’ finance of enterprises (the current division). In a capitalist economy, any macroeconomic accumulation of capital, and hence any economic growth, must be not only accommodated but also necessarily initiated with money creation by banks. More precisely, with the provision of money-creating loans to enterprises, banks provide a flow of pre-validating finance of production (cf. 2§10 on pre-validation). Banks thus provide enterprises with passive finance capital.

The pre-validating money creation by banks is required for the finance of investment in means of production. On top of that, there is a systemic continuous necessity for the creation of money to finance the payment of wages.3 (Cf. the ‘monetary circuit approach’ – Addendum 3§2-e).

The required pre-validating money creation by banks is the common theme throughout this chapter. The current section presents this for the analytical case – the ‘pure case’ – in which economic actors do not save. As we will see, this pure case sheds an important light on the functioning of a capitalist economy. We will see this especially in the next section (3§3) when we consider the actually common situation in which many actors do save.

Banks are not usually interested in the enterprises’ intended destination of a ‘pre-validating finance’ of production (PVF) as long as enterprises can provide sufficient securities to the bank. However, for analytical reasons the exposition in the current and the following division specifies the intended destination of the bank credit (PVF), thus revealing analytical circuits of credit flows.

The current section presents the pre-validation in three stages (subsections 2–4). Subsection 5 draws some conclusions.

2 PVF for wages payment and for purchase of means of production: three macroeconomic categories (capital owners yet implicit)

For the credit flows presented in Circuit 3.4 three macroeconomic categories are distinguished: banks; the integrated set of enterprises; and labour. In pre-validating production (2§10), banks create account money for the set of enterprises.

Regarding the pre-validating finance (PVF) that enterprises destine for wages payments, the money created is transferred to the accounts of the labourers hired. Were all of this money transferred to labour or be spent with enterprises – that is, if there were no saving – then the money returns to the enterprises’ accounts, so that the loan for the PVF with the bank can be fully redeemed (see the left stream in Circuit 3.4). The influx of money (start stream 1) is so compensated by a full efflux.

d1534211e8615Circuit 3.4

Macroeconomic pre-validating finance (PVF) by banks for wages payment and for purchase of means of production (MP) and their full redemption in case of full expenditure of the wage (capital owners being implicit)

Note: Circuit 3.4 is a picture of the money ‘circulation’ within bank accounts (the banks’ bookkeeping), that is, first, the money creation (1a) followed by the transfers (1b–1d), and second, the money creation (2) followed by (internal) transfers (2b–2c) between enterprises.

Regarding the PVF that enterprises destine for the purchase of means of production (the right stream in Circuit 3.4), purchases and sales occur as equivalents within the macroeconomic set of enterprises, whence macroeconomically the PVF gets fully redeemed. (That is, provided the pre-validation of production indeed gets validated, or, in other words, when the planned validation of production would get realised – see Division 4).4

d1534211e8644Circuit 3.5

Pre-validating finance (PVF) by banks for the purchase of means of production (MP), and its full redemption in case of full expenditure of the wage; two macroeconomic enterprises’ sectors (capital owners being implicit)

Note: For simplicity the PVF is reduced to one ‘shot’ (to Enterprises 2). Depending on the rate of depreciation of MP, the initial PVF may be redeemed within one period (rate 1 – this is what the picture shows) – or within several periods (rate <1); in the latter case the initial PVF may be equivalent to redemptions by other enterprises within the period. (For example, Enterprises 1 may immediately redeem a previous loan, in which case a stream 3 would go up to the banks, so postponing the streams 4–8).

3 PVF for purchase of means of production along with wages payment: four macroeconomic categories (capital owners yet implicit)

Circuit 3.5 presents the matter distinguishing two macroeconomic enterprises’ sectors (those producing means of production and those producing consumer goods). Here the PVF combines purchases of means of production and wages payments. (All these are analytically reduced to ‘one shot’ of PVF – in practice there are numerous shots).

Note that both circuits 3.4. and 3.5 merely show how the production is financed by banks (and so far only by banks). These circuits do not show any surplus-value result along the production processes (1D5, specifically 1§14). (Explication 3§2-b shows the connection).

4 PVF for wages payment, purchase of means of production and payment of dividends

Circuit 3.6 reintegrates the macroeconomic enterprises sector (as in Circuit 3.4). Now, however, capital owners and their consumption are made explicit. Part of the surplus-value is distributed to capital owners in the form of dividends. Henceforth the term ‘dividends’ will include the ‘quasi dividends’ that flow from non-incorporated enterprises to their owners. At this point of the exposition it is analytically assumed that capital owners collect dividends of no more than their consumption (as is actually most often the case for non-incorporated enterprises).5 In the next section (3§3) this assumption will be dropped.

Enterprises tend to maximally accumulate surplus-value as active capital, and to minimise on bank-credits, including for any transfers to capital owners (at some agreed point in time). To the extent that capital owners spend dividends for their consumption, this consumption validates production (amplified in 3D5). The payment of dividends therefore tends to be financed via a pre-validating bank finance, one that macroeconomically is redeemed to the extent that capital owners spend (in this section fully).6 This is shown in the outer right flow of Circuit 3.6. I repeat that the PVFs shown analytically pertain to their destination, and that banks are not usually interested in the destination so long as enterprises provide sufficient securities to the bank.

Alternatively the payment of dividends might be settled out of monetary inflows to enterprises from sales. That would merely mean that the redemption of PVFs for wages and/or means of production would be postponed. In whatever way enterprises actually settle the payment of dividends, it is analytically insightful to separate these flows. (The same holds for interest payments to capital owners, which will be systematically introduced only in 3§5).

d1534211e8722Circuit 3.6

Pre-validating finance for wages, means of production and dividends; no saving by labour and by capital owners

*

The same applies for interest to capital owners (implicit until 3§5).

5 PVF: saving not a precondition for investment

So far this section has shown that savings are no condition for investment because in the ‘pure case’ presented above none of the actors saves. This is economically of utmost importance (expanded in 3§2-c).

In the three PVF circuits presented above, the influx of money is compensated by a full efflux. Upon economic growth, this is followed by an increas-ing PVF and along with it an increased re-influx and re-efflux of money (thus in non-recession periods, the macroeconomic PVF increases over time).

Savings are not necessary for the existence of the capitalist economy, but rather contingent (introduced in 3§3). The interest that banks charge is presented in 3§4.

3§2-a Explication. Macroeconomic varieties

Generally a macroeconomic approach provides particular insights that cannot be derived from a microeconomic approach, and vice versa. This explication briefly expands on some main macroeconomic varieties. (1) A one-enterprise-sector macroeconomic approach implies that all intermediate sales between enterprises are treated as being cancelled out (Circuits 3.4 and 3.6). In effect it implies a constellation ‘as if’ all enterprises are integrated into one enterprise. (2) The monetary circuit theory that I build on in this chapter insists that banks as creators of money should be treated as a separate macroeconomic category (cf. Addendum 3§2-e). (3) A two-enterprise-sector macroeconomic approach (Circuit 3.5) distinguishes between enterprises producing investment goods and those producing consumer goods. In effect this implies a constellation ‘as if’ all enterprises were treated as being integrated into two such distinguished enterprises.

These distinctions apply before and after the state and foreign relations are taken into account.

3§2-b Explication. Pre-validating finance and realisation of surplus-value – an illustration by way of a two-enterprises-sector model

This Explication is for those readers who might wonder how the constellation of pre-validating finance, as set out in 3§2, could accommodate the realisation of surplus-value for enterprises. This can be illustrated by way of a simple two-enterprises-sector model.7 We have two sectors of production: Sector 1 produces means of production (MP); Sector 2 produces consumer goods (CG). Assume that: (1) all surplus-value (integral profit) is accumulated as capital (in the form of MP) – thus capital owners do not consume (or they also have a job as a worker); (2) there are no savings out of wages; and (3) all means of production are fully used up within the production period. The simple numerical example below (Figure 3.7) is in e.g. billions of some monetary standard ¤ and depicts an equilibrium case: the output of Sector 2 (CG) of ¤200 just equals the wages sum of the two sectors together (¤200); the output of Sector 1 (MP) just equals the replacement of the means of production of the two sectors together (¤160) plus their surplus-value (¤40) as accumulated into additional means of production.

d1534211e8812Figure 3.7

Numerical example of a simple two-enterprises-sector model (in monetary standard ¤)

(1) Sales: (80replacement-1 + 20investment-1) + (80replacement-2 + 20investment-2) = 200

(2) Sales: 100consumption-Labourers-1 + 100consumption-Labourers-2 = 200

Then the question is how this constellation is accommodated in terms of pre-validating finance by banks. Normally this would go in several ‘shots’ of finance to each of the sectors. In order to keep this illustration as simple as possible, I assume just one PVF shot of ¤100 from the banks to the CG-producing enterprises. This caricatures the extent of the money-creating PVF, which is normally a fraction thereof. The earlier Circuit 3.5 can now be reinterpreted in these terms (thus each stream in this circuit, 1, 2, etc., represents a value ¤100).

  • Each sector started production (stylised) with a current flow stock in MP of ¤80. We are at the (stylised) end of the production period; the MP input has been used up. Each sector has ended up with an output of ¤200. Wages have not been paid yet. No one has money means to buy.

  • The bank pre-validates Sector 2’s ¤100 purchase of MP for the next period (streams 1 and 2 in Circuit 3.5). Sector 2 has now ¤100 MP on stock for the next period of production.

  • With the ¤100 received, Sector 1 enterprises internally spend for ¤100 on MP whence they equally have ¤100 MP on stock for the next period (stream 3). This ¤100 is also a sales revenue for Sector 1, upon which they pay wages (stream 4), etc.

  • Finally (stream 8) Sector 2 cancels the PVF with the bank.8

Generally, if workers spend all their wages, then: (1) the total surplus-value (integral profits) of enterprises would be just equal to the total investment of enterprises (investment → realisation of surplus-value);9 (2) enterprises would merely require shots of credit from banks (in the example simply reduced to one shot), credit that would be cancelled by the spending on investment and consumption.

For completeness I must here briefly anticipate 3D5 (readers who find this anticipation too difficult may return to it later). The surplus-value (SV in the third column) is not a saving; rather this surplus-value only exists as such when it has been expended in the form of additional means of production (i.e. as investment expenditure). The banks provide the financial means for this expenditure, and these same means and expenditure realise the surplus-value. Thus there is (so to speak) no ‘intermediating act’ of saving by enterprises. Rather, I repeat, there is merely an investment expenditure by enterprises as accommodated by the banks. (To further complicate the matter, we will see in 3D5 that orthodox mainstream economics defines this investment expenditure as a saving (!), which is analytically not very helpful – thus it defines an expenditure as a saving).

3§2-c Explication. The redundancy of saving as a precondition for investment

Section 3§2 has been called ‘the pure case’ of finance by banks. It is also a transparent case and so one that we will regularly return to in this chapter. In terms of the necessary requirements for the reproduction of the capitalist economy, the stage of exposition that we now reach is pretty near to complete for those requirements. It is just that we still lack the concept of saving (and saving, as we will see in the sections to follow, introduces a vast set of complications). However, in principle, the capitalist economy could do without saving. This is in effect what 3§2 shows. For some readers educated in neoclassical economics, this must come as a surprise, because that strand strongly holds that savings are a blessing and that these are a precondition for investment.10 The theoretical details of this can only be set out in 3D3 (after savings have been introduced in 3§3).

Keynes (1936) largely ignored production and rather challenged the ‘received’ (classical and neoclassical) view as one in which money plays no determining role (if there were any use of money at all, this would be a ‘veil’ over the real economy, one that must be revealed). He showed that the erroneous idea that saving enables investment is based on the false thesis that a capitalist economy can be modelled along the lines of a barter economy instead of a monetary economy. Although my line of argument in the sections to follow will be somewhat different from that of Keynes, I most often agree with him on this matter.

3§2-d Amplification. Point in time of wages payment and the implicit credit provided by labour

The point of time at which wages are paid (end of the day, week, month, etc.) is contingent. The longer the time span, the more it is labour that provides (implicitly) a credit to the enterprises. This is in the enterprises’ interest because as such they require less capital. However, given that benefit, enterprises are faced with the question as to whether to finance wages payments out of a capital fund or rather on the basis of a credit line with banks. The longer the time span between wages payments, the more the opening credit lines will scale down the capital requirements. This implies that, next to any other requirement for pre-validating finance by banks, the pre-validation for wages payments will tend to be permanent. See Figure 3.8, which shows, schematically, the development of credit lines for end of the month wage payments.

Just to get a feel for the numbers involved, consider that around 2010 the average labour income share in the EU and the USA was just under 60% of GDP. Hence, neglecting holidays and end of year allowances, about 5% of GDP must be paid each month from the accounts of enterprises to those of labour.

In the ‘pure case’ of 3§2 the influx of money to pay wages is compensated by a full efflux of money upon the full expenditure of the wages. More precisely ‘full expenditure’ is time dependent. Even if the wages are paid at the end of the day, they are not fully spent at the end of the day but within some lapse of time.

d1534211e8931Figure 3.8

Bank-provided PVF for wages payment: full redemption

3§2-e Addendum. The Monetary Circuit Theory

Much of the current division has commonalities with the theory of the Monetary Circuit that evolved from about 1980 in France and Italy, though it has important forerunners before 1950 (including Schumpeter – see Bellofiore 1992). For overviews and further references see Graziani (1989, 2003) and the introductions and contributions in Deleplace and Nell (eds) (1996), Rochon and Rossi (eds) (2003), Fontana and Realfonzo (eds) (2005), Arestis and Sayer (eds) (2006), and Argitis, Evans, Michell and Toporowski (2014, sections 8 and 10).

Among the contributors to this literature that have sought to integrate Monetary Circuit theory into the marxian paradigm as a ‘monetary theory of production’, I mention (non-exhaustively) Bellofiore (1989, 2004, 2005a, 2005b), Bellofiore, Forges Davanzati and Realfonzo (2000), Bellofiore and Realfonzo (1997, 2003), and Forges Davanzati (2011).

Both the post-Keynesian and the Monetary Circuit approaches agree that money is essentially created ex nihilo and that normally it is endogenously created by commercial banks (as opposed to the view that an ‘exogenous’ supply of money by the central bank determines the money in circulation, as neoclassicals and also ‘new Keynesians’ would have it).11 They also agree that banks should not be seen as financial intermediaries that channel savings to investment (again, contrary to the neoclassical and ‘new Keynesian’ views that do see banks as intermediaries in this respect); instead, and as Keynes emphasised, investment gives rise to saving. (See Rochon and Rossi 2003 for a comparison).

However, and in reference to Circuits 3.4–3.5 above, post-Keynesians tend to start off with money-creating lending for investment (or also consumption); Circuitists, on the other hand, insist that, for reasons of transparent theory, one should start with money-creating lending for wage payments.12 For the latter this would also fit a pure macroeconomic approach. I agree with these Circuitist considerations. However, the two approaches are not inconsistent; rather it is a question of whether one starts with a macroeconomic one-enterprises-sector or with a macroeconomic two-enterprises-sector model. In each case the key point is rather that the theorisation of the capitalist monetary economy, and a macroeconomic account of it, inevitably requires the distinction between enterprises and banks as creators of money (cf. Graziani 1989; cf. 2D5 on the separation-in-unity of enterprises and banks), and that the accumulation of capital inevitably requires the money-creating pre-validation by banks (2§10).

3§3 Saving by capital owners and labour: triadic debt-credit relationships

Bank loans to enterprises pre-validate the latter’s production. With the bank account money created, enterprises settle money transfers between them and transfer money to labour and capital owners. It was shown in 3§2 that if all of the money transferred to labour and capital owners were spent with enterprises – that is, in the event that there would be no savings – then the money returns to the enterprises’ accounts, so that the PVF loan with the bank can be fully redeemed. Thus, in principle, capitalist production and its validation could proceed and grow without any saving.

Saving is contingent. However, it is rather that ‘saving’ or ‘non-saving’ is contingent: one of the two must necessarily be the case. Thus the two being methodologically on a par, saving and the degree of saving is nevertheless contingent.13

When there are these savings, this has important necessary consequences. The money transferred to labour and capital owners that is saved does not return to enterprises’ accounts, and thus cannot be used to cancel their bank credit, and so ends up as a saving of account money. This results in triadic debt-credit relationships: banks are in debt to these actors for this saving of accountmoney, the latter sum being just equivalent to the remaining debt of enterprises to banks. (See Circuit 3.9: in comparison with Circuit 3.6 only the items in blue have been added).

d1534211e8997Circuit 3.9

Pre-validating finance for wages, means of production and dividends; saving by labour and by capital owners

* The same applies for interest to capital owners (implicit until 3§5).

Note 1. The ‘only’ difference between this circuit and Circuit 3.6 consists in the savings by labour and capital owners (the dotted lines with ends 1B and 3B), and as a result the mere partial redemptions of the PVF (ends 1A and 3A).

Note 2. The dotted lines are in fact not transfers: after the payment of wages and dividends, the relevant savings remain on the accounts of labourers and capital owners. (Only in the historically relevant case of banknote circulation might these be transfers: a deposit at the bank).

From the perspective of enterprises then, savings are in fact a nuisance. The upshot is that the banks are (continue to be) the enterprises’ financiers for the amounts saved. Given these savings, enterprises as a whole are inevitably in debt.

For enterprises the PVF from banks is an ex ante finance, the finance precedes (the expansion of) investment and production. This is a finance created ex nihilo. For banks, however, the expansion of their own finance (their liabilities) is an ex post finance through the savings.

3§3-a Explication. The non-necessity of saving for the investment by enterprises

It was emphasised in 3§3 that saving is a nuisance for enterprises. Even if saving is ubiquitous in a capitalist economy (and even if for individual actors it can be rational for precautionary reasons), savings are not necessary for enterprises, and enterprises would be better off without savings because their loans with banks could be non-problematically redeemed.

For banks, however, savings are no nuisance at all, as lending is their main business.

Sheet 3.10a

Integrated balance sheet of enterprises

Assets [active capital]

Liabilities [passive finance capital]

plant and equipment

External finance capital

raw materials etc.

loans from banks

a

work in progress

loans from non-bank financiers (bonds)

commodities produced

Internal finance capital

b

current account with banks

value equivalent of a + b

K

K=FC

Introduced in 3§6

3§3-b Explication. Ex ante finance of enterprises by banks, and enforced ex post finance of banks by labour and capital owners – the balance sheets of enterprises and banks

I expand on 3§1-a. Recall that the ‘assets side’ of the balance sheet of enterprises measures the active capital (K). The ‘liabilities side’ indicates how the enterprise is financed through ‘finance capital’ (FC). See Sheet 3.10a.

For the aggregate of enterprises, the expansion of the liabilities side is an ex ante finance of the expansion of the assets side: the finance precedes new investment in the assets. The expansion of the liabilities originates exclusively from a PVF – finance created by the banks ex nihilo. (It will be shown in 3§6 that this also applies, or has applied, for the internal finance capital of the enterprise; all of the latter stem from PVFs).

Sheet 3.10b

Integrated balance sheet of banks

Assets [financial]*

Liabilities [finance]*

Assets bank: non-financial (leased)**

Own capital banks

e

Assets bank: financial

d

Borrowed from non-bank financiers

(bank bonds, time accounts)

Current accounts [CA]: borrowings

g

Loans to enterprises

(d)

Current accounts: enterprises (borrowed)

Loans to non-enterprises

Current accounts: labour (borrowed)

Current accounts: capital owners (borrowed)

Current accounts: other (borrowed)

Loans to other banks

Borrowed from other banks

Balance Sheet Total[a =] d = e + g

Balance Sheet Total e + g = d

*

Only in this balance sheet (with these items crossed out) do all of the banks’ activities serve as Finance Capital for enterprises.

**

Leased from the banking entities’ production branch (3§1, heading 2).

Presented in Appendix 3B.

Because the balance sheets of banks have been integrated, these items cancel out.

Regarding the banks’ balance sheet, however (see Sheet 3.10b), the expansion of their own finance (liabilities) is an ex post finance through the savings, which are generated only after the PVF has been provided. Hence banks do not finance enterprises (or other actors) out of a pre-existing ‘loanable fund of savings’. The neglect of this distinction between ex ante and ex post finance in the conventional macroeconomics that neglects banks is a source of enormous confusion (amplified in 3§6-d).

Savings, if any, are no precondition for any of the finances (enterprises, banks). We sufficiently saw this for the ‘pure’ constellation of 3§2. Again – for the case of saving – the finance of enterprises being an ex ante one, this finance does not originate with savings: it originates with the bank’s PVF, which itself is financed ex post.

Moreover, in the aggregate the latter is an enforced finance. Capital owners or labourers that save might switch from one bank to another, but they cannot escape from financing the lot. The only freedom within this enforcement is that of the degree of liquidity: current accounts, time accounts, etc. (In the day of the fading away of the notes of the Clearing/Central Bank, people may still take illusionary comfort in the possibility of hoarding heaps of CB-notes, through which – in fact – they finance the CB).14

In this perspective, consider Sheet 3.11, which casts the money streams of Circuit 3.9 regarding labour in terms of alterations of the banks’ balance sheet (a similar sheet might be made for capital owners).

Sheet 3.11

Alteration of banks’ balance sheet: case of saving by labour

1. money-creating loans to Enterprises for wages payment:

loans to Enterprises (PVF)

$ x

current accounts Enterprises

$ x

2. payment of wages:

loans to Enterprises (PVF)

$ x

current accounts Enterprises

0

current accounts Labour

$ x

3. spending of $(x-s) (hence a saving of $ s):

loans to Enterprises (PVF)

$ x

current accounts Enterprises

$ (x-s)

current accounts Labour

$ s

4. Enterprises cancel part of their loans:

loans to Enterprises (RPVF*) [x-(x-s)]

$ s

current accounts Enterprises

0

current accounts Labour

$ s

*

RPVF: Remaining PFV

In the last row of Sheet 3.11 we have the equivalent of labour’s enforced ex post finance of banks.

Because of the saving out of wages ($s), the initial loans to enterprises cannot be fully cancelled, whence the bank keeps on financing them for the amount $s, which is the equivalent of the bank’s debt to labour. Note that ex post it seems as if enterprises are indirectly financed out of savings (as if we had bank intermediation of ‘loanable funds’). However, this is a false appearance. From the start the enterprises’ investment was financed by ex nihilo created money, and the non-redeemed part is still being financed by ex nihilo created money. Saving does not give rise to investment; rather the investment – as accommodated by ex nihilo created money – gave rise to income out of which saving took place (cf. Keynes 1936).

Considering the banks’ balance sheet, the enterprises at first financed the bank(!) through their current account: see Sheet 3.11 entry 1 (liabilities side). In the end (entry 4), labour substitutes for the enterprises. The enterprises’ finance of the banks (entry 1) had nothing to do with any saving.

3§4 The payment of interest by enterprises to banks

Recall the distinction between on the one hand ‘banks’ as purely creators of money and as financiers, and on the other hand the banking entities’ ‘production branch’ that is subsumed under the enterprises sector (3§1, heading 2).

In the form of the interest that enterprises have to pay to banks, the banks receive a share in the surplus-value produced in enterprises. Because pure banks only engage in money-creating finance, it does not matter how individual enterprises settle the way of payment of the interest (as long as they pay the interest on the date due). They might pay the interest out of their monetary inflow from sales, or alternatively they might use their credit line with banks, which means that they take an additional loan – as always this just requires that they can offer the bank sufficient securities. When the latter is satisfied, banks do not care about the destination of a loan, and on the other hand they do not care from what fund the enterprise pays the interest.

Considering this macroeconomically, two points are at issue.

First, especially from Circuit 3.5 (and from that circuit in combination with Figure 3.7) it can be seen that one or several ‘shots’ of pre-validating finance can generate a numerically much larger income stream (in terms of e.g. net production) – PVFs indeed flow through the economy. (This point is blurred in macroeconomic circuits with only one enterprises sector: the other circuits presented so far).

Second, because banks, and banks alone, create money, it is impossible for them to receive back more money (PVF plus interest) than they created (PVF). This simple fact also contains the solution: macroeconomically, banks create the money for their own interest receipts. This reveals the essence of banking. Banks earn on loans, including on loans to pay interest. The only one requirement is that loans are security backed.

Further, banks earn their profit from net interest (gross interest after deduction of costs for the bank). If, for the sake of simplicity, we assume the cost to be zero, all of the interest streams to the bank are profits of the bank. If all profits are retained, this interest is added to the own capital of the bank. Banks’ financial assets are a form of financial paper. Their financial liabilities are also a form of financial paper (electronic paper for accounts), and especially also the own capital of the bank. All these are ultimately creations of the bank (in reciprocal credit relationships – 2§8).

d1534211e9853Circuit 3.12

Banking entities as financier (‘banks’) and as employer (‘active branch’) (note: this circuit relates to Amplification 3§4-a)

*

Spending: including material investment of the banking enterprise branch.

3§4-a Amplification. ‘Banking entities’ and payment of interest from enterprises to banks

So far ‘banks’ are conceptualised purely as creators of money and as financiers. Any other activities of the ‘banking entities’ are allotted to their ‘production branch’ that is subsumed under the category of enterprises (3§1, heading 2). Henceforth I will continue to do this. However, for one time the ‘production activity branch’ of ‘banking entities’ is made explicit. See Circuit 3.12. The banks as financier internally transfer part of their interest receipts to their ‘production branch’ (costs of leasing and outsourcing). From it, the latter spend with enterprises and also pay wages (for simplicity all these wages are spent). The streams on the left hand side (‘start’) represent a loan from banks to enterprises (one that enterprises intend to use for the payment of interest, but that for banks is just a security backed loan like any other loan – see the main text of 3§4).

Division 3. Ex post substitution for the pre-validating finance by banks

The grounding of the accumulation of capital in the expansion of bank-created money (2D4) was further grounded and so concretised in the finance of enterprises by banks (3D2). The current division sets out how any limits to the grounds of 3D2 are overcome or at least moderated (see 3§6). Preliminary concepts for 3§6 are presented in 3§5.

3§5 Capital owners as financiers: dividend bearing and interest bearing finance capital

Chapter 2 (2D6 and 2D7) introduced the category of ‘owners of passive capital’. These are the ‘internal financiers’ of enterprises (3§1, Figure 3.2a), as further explained below.

Until this stage of the exposition, banks are the sole external financiers of enterprises. The degree of their accommodation of the accumulation of capital via the PVF also operates as a constraint on the unlimited expansion of capital. One consideration for the banks’ accommodation is the quantity and quality of the securities that the enterprise can deliver for the PVF. Another consideration, in terms of the liabilities of the enterprise, is the enterprise’s degree of ‘solvency’, that is, the ratio of internal over total finance capital (see balance sheet 3.10a in 3§3-b). This implies that the expansion of capital is constrained by the growth of the internal (own) finance capital of the enterprise and hence by the retained profits (3§1, Figure 3.2b).15 Any non-retained profit is distrib-uted to the shareholders in the form of dividends. In principle the internal capital of enterprises can so be extended via the issuing of new shares, paid out of dividends from any enterprise. As such we have ‘dividend bearing finance capital’.

Further, via the distribution of profits to shareholders in the form of dividends, their wealth grows. In principle they can further limit and spread their risk and uncertainty (cf. 2§12) by, instead of sharing, lending finance capital to enterprises, perhaps in the form of bonds or direct placements.16|17 Like the banks’ PVF, this is ‘interest bearing finance capital’.

3§5-a Amplification. The level of the rate of interest

Regarding the demand for loans by enterprises, interest is the price for being able to command finance capital for the generation of surplus-value (cf. Robinson 1953, p. 87). As to the supply of loans other than loans provided by banks, the level of the rate of interest is usually considered to be a matter either of ‘time preference’ (in which case interest might also be negative – as Robinson 1953 has argued),18 or of ‘the price for waiting with consumption’ (Marshall’s 1972 [1890] version of Senior’s ‘abstinence’ from consumption) – a rather ideological concept, which was one of the chief targets of Keynes’s (1936) critique of the received view of his day.19 Instead, Keynes posited interest as ‘the reward for parting with liquidity for a specific period’ (1936, p. 167).20 For the supply side I consider the latter to be the best conceptualisation available. In 3§5 I generalised this as the limiting and spreading of risk and uncertainty.

3§6 Pre-validating finance by banks as ex post substituted for by non-banking finance capital (the RPVF)

Banks necessarily provide credit to enterprises, which is a flow of pre-validating finance (PVF). This flow returns to the banks on aggregate full spending, thereby cancelling the pre-validating credit (3§2). However, any non-spending of income interferes with this, and it implies that the bank is (continues to be) the enterprises’ financier for this amount not spent (3§3).

The non-redeemed part of the PVF, which equals the saving by labour and capital owners, is called the remaining pre-validating finance (RPVF). Hence banks provide, in effect, next to a money-creating flow of finance (PVF), a non-money-creating stock of finance (RPVF) – the latter being based on previous money creation, and now equally being based on the triadic debt-credit relationship between the bank, the saver of money and the enterprise (cf. 3§3).21

At the same time, the non-spenders are potential ex post financiers. To the extent that the latter explicitly enter into a (additional) finance relation with the enterprises – thus substituting for the bank RPVF – they become actual ex post financiers, or owners of (additional) finance capital.22 (See Circuit 3.13).

Even stronger, on average, non-bank financiers can be no more than ex post financiers. They do not finance the process of the macro accumulation of capital and so macroeconomic growth – this is what the banks do. They can, on average, merely finance already accumulated capital, that is, ex post, after the deed of accumulation.23 Through the necessary creation of money, banks are always the origin of finance capital. There is no ex ante finance beyond the revolving pre-validating finance by banks (PVF). Because any new investment is so accommodated, any existing investment has been so accommodated.24 (See also 3§7, which expands on banks as the providers of the finance capital for the founders of an enterprise).

A corollary is that actors do not become owners of finance capital by a mere saving of money. In the latter case the bank is the owner of finance capital, whereas these savers are holders, claimants, of account money.

d1534211e10048Circuit 3.13

Ex post substitution by capital owners for ‘Remaining Pre-validating Finance’

Note 1. To keep this circuit transparent, it is assumed that all savings of capital owners from Circuit 3.9 are used to purchase shares or bonds. The latter are newly issued shares and bonds (the so-called primary market).

Note 2. Stream 3: a similar stream applies for the payment of interest to capital owners.

Note 3. In principle workers might also purchase bonds or shares, in which case, for that part, the categories of labour and capital owner would overlap.

However, there is a tendency to incite the capital owners engaged in saving, to substitute, in part, for the bank-provided finance capital. Yet, I repeat, this can only be a substitution ex post, that is, a substitution after the necessary initial provision of finance capital (PVF) by the bank (amplified in 3§6-d).25 This tendency is driven by:

  • first, the degree of actual indebtedness of banks along with the savings-engendered indebtedness of enterprises (cf. Sheet 3.10b in 3§3-b);26

  • second, the banks seeking to limit the saving- and RPVF-engendered risk and uncertainty (so requiring from enterprises a finance buffer, in the form of the latter’s internal capital and non-bank external capital);

  • third, the enterprises seeking finance at a price lower than that required by banks.

In conclusion: A ‘loanable fund’ of current and past saving is no precondition for investment (amplified in 3§6-d). Ex post substitution for the bank’s RPVF by capital owners contributes to the banks’ ongoing accommodation of the accumulation of capital via their PVF.

Finally, it should be remarked that there is no implication of the previous exposition that there should be a macroeconomic equality of investment and the PVF.27 Rather, investment must take off with ‘shots’ of pre-validating finance by banks. (The PVF circulates – see Circuit 3.5).

3§6-a Addendum. ‘Banks are not intermediaries of loanable funds’

When I wrote the first drafts of the current chapter, it was a heresy to consider banks as the initiating financiers of the accumulation of capital (see also Addendum 3§2-e on monetary circuit theory). However, in a 2015 paper, entitled ‘Banks are not Intermediaries of Loanable Funds – and Why This Matters’, Jakab and Kumhof, members of the research departments of the IMF and the Bank of England, distance themselves from the orthodox economics notion of loanable finds (Jakab and Kumhof 2015). To get the main thrust of this 57-page paper, the reader might turn to its summary (ibid., pp. i–iii).28 In the context of 3§6 the latter’s key sentence is: ‘Saving does not finance investment, financing does’ (ibid., p. ii).

3§6-b Explication. The connection between the PVF and the RPVF

New (additional) inputs of production are financed through money-creating PVFs (keeping in mind the last sentence of 3§6). This relates to labour’s wages (that are continuously an additional input) and the growth of means of production (intermediate inputs and investment).

In the absence of any saving we ‘merely’ have a growing PVF flow along with the rate of economic growth (this is serviced out of enterprises’ interest payments to banks).

With any saving, we have this growing PVF flow, as well as a RPVF stock. In case there is no ex post substitution for the RPVF, we have a continuous growth of the RPVF stock (saving period (t) = Δ RPFV period (t) – with the symbol Δ for ‘change’).29 This ΔRPFV is a liability (to banks) on the enterprises’ balance sheet (equivalent to a change of the banks’ financial assets at their balance sheet) and for which enterprises pay interest to the banks.

The banks finance the ΔRPVF ex post by the current accounts of labour (saving from wages) and of capital owners (saving from dividends and interest). This saving by labour and capital owners pertains to money created by the bank via the PVF.

Finally, especially capital owners and rich wage earners may in part substitute for the ΔRPVF through the purchase of newly issued shares or bonds from enterprises.30

3§6-c Amplification. Shorthand summary of the required type of finance

Figure 3.14 summarises the types of finance that are required at each conceptual stage in 3§2–3§3 and 3§6. Recall that PVF is an abbreviation for pre-validating finance by banks, and RPVF is an abbreviation for any remaining PVF (i.e. the non-redeemed part of the PVF upon saving by labour and capital owners).

Figure 3.14

Forms of finance capital along with (non-)saving and (non-)substitution for bank RPVF

Flows of finance capital

Stocks of finance capital

during period t [from (t′) to (t′′)]

at the beginning of period t

1. Absence of saving (3§2; Circuits 3.4, 3.5 and 3.6)

PVF(t) [short-term bank loan]

no other external FC

PVF(t′′) redeemed [Δ RPVF(t′′) = 0]

2. Saving, no substitution for RPVF (3§3; Circuit 3.9)

PVF(t)

other bank-loans =

Σ RPVF(t-1) … RPVF(t-n)

γPVF(t′′) redeemed

Δ RPVF(t′′) > 0

[redeemed fraction γ]

[= (1-γ)PVF(t)]

3. Saving, with substitution for RPVF (3§6; Circuit 3.13)

identical to the previous block

quantity identical to the previous block

PVF(t)

other bank loans

shares

non-bank loans

γPVF(t′′) redeemed

Δ RPVF(t′′) > 0

together equal to

[redeemed fraction γ]

[= (1-γ)PVF(t)]

Σ RPVF(t-1) … RPVF(t-n)

3§6-d Amplification. Ex post substitution for bank-provided finance capital and deferred substitution (the illusion of loanable funds of savings)

Throughout 3D2 and 3D3 I have distanced myself from a ‘loanable funds’ approach to finance, investment and accumulation of capital. (I repeat that by ‘investment’ I always mean what is often called ‘direct investment’ – as opposed to ‘portfolio investment’). Thus I distance myself from the classical and neoclassical view, which holds that generally in a developed capitalist system, the accumulation of capital and any new investment is financed out of a pre-existing money fund of savings, that is, of current and previous savings (a loanable fund).31 This explication is about the qualification ‘generally’. We will see that new investment may at times be financed out of a fund, but that this cannot be on average the case. Consider rows 1 and 4 of Sheet 3.15.

Sheet 3.15

Alteration of banks’ balance sheet (savings case) with various forms of substitution (sheet continued in the text below)

money-creating loans to Enterprises for dividends payment:

1

loans to Enterprises (PVF)

$ x

current accounts Enterprises

$ x

payment of dividends:

2

loans to Enterprises (PVF)

$ x

current accounts Enterprises

0

current accounts Capital Owners

$ x

spending of $(x-s) (hence a saving of $ s):

3

loans to Enterprises (PVF)

$ x

current accounts Enterprises

$ (x-s)

current accounts Capital Owners

$ s

Enterprises cancel part of their loans

4

loans to Enterprises (RPVF*) [x-(x-s)]

$ s

current accounts Enterprises

0

current accounts Capital Owners (RCB)

$ s

*

RPVF: Remaining PFV

RCB: Remaining credit balance flow

The initial loan was called the PVF (pre-validating finance). The current account balances (the right hand side of row 4) are called the RCBF (remaining credit balance flow – remaining from the dividends transfer). I call the remaining part of the PVF (the left hand side of row 4) the RPVF. These are analytical names.

Enterprises may sell bonds for $s to capital owners. If enterprises use the money thus collected (the RCBF) to cancel the RPVF, i.e. the final part of their dividends PVF loan with the bank, we have the analytically transparent case of ex post substitution for the remaining bank-provided finance (RPVF).

5a

loans to E [RPVF(t)]

$ s

CA E (due to sale bond)

$ s

CA CO (due to purchase bond)

$0

5b

loans to E [RPVF(t)] (cancelled)

$0

CA E (cancelling RPVF(t))

$0

*

CA: Current accounts; E: Enterprises; CO: capital owners; (t) is a time indicator (some year)

All credits and debts with the bank for dividend payments have been cleared (awaiting a new sequence). The finance substitution relates to investment (a quantity larger than the dividend sum) that has taken place already: the assets side (active capital) of the enterprises balance sheet grew, and equally so the liabilities side (finance capital), initially through the banks’ finance that is now in part substituted for (the saved dividends).

However, enterprises may not want to sell bonds now (perhaps because of their long-term commitments), or they may not manage to sell bonds (because of the liquidity preference of current account holders). Note that the bank must allow this situation to persist. Thus rows 5 are crossed out.

We now turn to the next period (t+1), row 6, which starts with the end result of row 4. In this case we do seem to have a loanable fund (the RCB of row 4).

start of period (t+1), = row 4

6

loans to E [RPVF(t)]

$ s

CA E 0

CA CO [RCB(t)]

$ s

In this period (t+1) (or later), the RCB of capital owners might be used for a deferred substitution for the bank loan (the RPVF from period t). This would be equivalent to row 5.

However, it might instead be used to finance a new investment. The latter case is to be conceived as a substitution for a pre-validating finance [PVF(t+1)] that would ‘normally’ have been taken on by the bank (see row 7a below).

[following on from row 6]

7a

loans to E [RPVF(t)]

(not cancelled)

$ s

CA E (sale bond for new investment t+1)

$ s

CA CO (due to purchase bond)

0

7b

(previous) loans to E [RPVF(t)]

$ s

CA E (due to sale bond t+1)

$ s

(new) loans to E [PVF(t+1)]

$ x′-s

CA E (new PVF, analogous to row 1)

$ x′-s

(x′= x plus the ‘normal’ rate of growth)

7

7b in sum (analogous to row 1):

loans to Enterprises

$ x′

CA Enterprises

$ x′

In effect the sum of money $s from (t) – row 6 – remained ‘in circulation’. In (t+1), therefore, the ‘normal’ influx of money can be reduced from $x′ to $x′-s (row 7b), in sum resulting in a circulation of $x′ as in row 7 (where x′ = x plus the ‘normal’ rate of growth).

In the situation exemplified in rows 6 and 7 the bank, in effect, ‘allows’ for the (temporary) existence of a loanable fund ($s) by not forcing enterprises to fully redeem the initial loan (PVF(t)).

Note that the enterprises’ expiration of previous non-bank loans (such as bonds) provides no net loanable fund: if the loan is not renewed (reissue of bonds), banks will have to provide a loan for the redemption.

I conclude that on average investment is not financed out of loanable funds of savings and that the specific case of such finance is in effect a deferred substitution for the bank’s pre-validating finance as fully accommodated by ex nihilo created bank account money. Thus generally, and on average, investment is (either directly or indirectly) necessarily accommodated by a pre-validating finance by banks (PVF). Without it, savings and hence also the specific case of a ‘loanable credit balance’ (RCB) could not have existed. The latter is just the remnant of a prior PVF.

3§6-e Addendum. Minsky on the substitution of bank loans for other loans

Enterprises may prefer other financiers to banks insofar as the latter’s charges are higher. Conversely, the reason for (non-banking) ‘potential financiers’ to become ‘actual financiers’ is that enterprises may provide them with a higher yield (interest, dividend) than the interest that the bank might pay them. The drawback is a decrease in (the degree of) liquidity. Minsky (2004 [1954], p. 233) apparently used the term substitution from the perspective of the financier (portfolio investor), linking it to Keynes’s (1936) liquidity preference theory: ‘the liquidity preference relation, which is shorthand for the substitution relation between money and other assets [e.g. bonds that “other financiers” buy from enterprises], becomes the appropriate tool to use in the analysis of the behavior of the monetary system’ (quoted by Toporowski 2006, p. 13).

Division 4. The foundation of banks and enterprises

Grounding of the starting point’s capital accumulated

The systematic entry point to the exposition of the capitalist system (1§1) is the outward bifurcation between households and privately owned means of production. For a systematic-dialectical exposition, it is irrelevant how the capitalist system came into being historically (even if the latter is intriguing), as the purpose is to exhibit the requirements and functioning of the existing system.

Nevertheless it seems broadly within the remit of a systematic-dialectical account of capitalism to set out how enterprises and banks come into being within capitalism. Building on the previous divisions of this chapter, the current brief division (one section) sets out an elementary outline of this. The focus is on the foundation of banks. However, because enterprises and banks mutually presuppose one another, and constitute a separation-in-unity (2§11), the following section starts with a brief look at the foundation of enterprises.

3§7 The foundation of banks and enterprises

It was shown that banks provide enterprises with a pre-validating finance of production and so with finance capital (3§1–3§2). This leaves unanswered the question of where banks get their founding capital from.

1 The foundation of enterprises

The initial production and accumulation of capital of a new enterprise (‘within capitalism’) is in effect generated by labour’s production of surplus-value (1D5), with the pre-validating finance by banks as a condition (see heading 2).

The transparent constellation for the foundation of enterprises is one of an absence of savings (3§2), as well as an absence of ‘hard’ collateral to be offered to a bank. Hence the bank is merely confronted with a ‘business plan’ together with the novice enterprise’s promise that it will pay back the loan with an interest, and that, in the meantime, it offers the collateral of future purchases (means of production) and future profits.32 With merely a ‘business plan’ the bank takes relatively more risk than in the case of ‘hard’ collateral – against it the bank will require a relatively higher rate of interest.

2 The foundation of banks

New banks may originate as offshoots from existing banks or enterprises. However, that position about foundation is regressive, so we need to abstract from existing banks and enterprises. Abstracting from those, the foundation of a bank originates with a loan from that new bank to the founders of that bank.33 This loan is a pre-validating finance (PVF), which is in principle no different from the banking of currently existing banks. From that loan, the founders finance the own finance capital of the bank. The loan is redeemed from the bank’s future distributed profits. The result is the particular type of liability that the own finance capital of any existing bank is, namely a liability to itself. (Explication 3§7-a provides the details).

This initiating process of the foundation of a bank is in principle no different from the extension of the own finance capital of an existing bank via the issue of new shares. This proceeds by a transfer of current account money (of the new shareholder) to the bank’s liabilities entry of ‘own capital’ (equity). However, current account money is always the result of a money-creating loan by the bank. Hence, the extra own capital comes (or has come) indirectly into being by way of money creation by the bank at hand, or another one. (Explication 3§7-a).

This is all there is to it, so setting up a bank appears to be rather simple (though further reflection on this reveals the very essence of what banking is). Nevertheless, the problem – as with the establishing of a new enterprise – is ‘getting clients’. That is, clients on top of the founders of the bank. (Founders acting as clients is not an illusionary matter, because in the actual history of capitalism, some banks – especially cooperative ones – have functioned as founders’ banks). This ‘clients problem’ is a matter of the domain of a single bank (2§8).

Once there are extended domains, a ‘new’ bank will have to cope with the rules set by a Clearing Bank (2§9). However, this is not the point of the current section. Division 2D4 was entered by a mere reference to the actual existence of banks. The brief outline above concerns the systematic coming into being of that existence.

3§7-a Explication: The systematic foundation of banks in terms of their balance sheets

We start with the extension of the own finance capital of an existing bank (Sheet 3.16). This sheet shows alterations of the bank’s balance sheet (a simplified full balance sheet was presented in 3§3-b, Sheet 3.9b).

Sheet 3.16

Extension of the own capital of a bank: alterations of the bank’s balance sheet (Bank Z)

Assets

Liabilities

1. Existing loans to enterprises (non-substituted part) of bank Z

loans to enterprises (RPVF)

€ x

current accounts non-enterpr. (non-bank)

€ x

2a. Case of own capital extension of bank Z by clients of bank Z

loans to enterprises (RPVF)

€ x

current accounts non-enterpr. (non-bank)

€ – x

own finance capital bank Z (shares)

€ x

2b. Case of own finance capital extension of bank Z by clients of other banks (the money

receiving bank always provides a loan to the money transferring bank – 2§9-b)

loans to other banks

€ x

own finance capital bank Z

€ x

3a. Sum of 1 and 2a

loans to enterprises (RPVF)

€ x

own finance capital bank Z

€ x

3b. Sum of 1 and 2b

loans to enterprises (RPVF)

€ x

current accounts non-enterpr. (non-bank)

€ x

loans to other banks

€ x

own finance capital bank Z

€ x

Concerning either the extension or the foundation of the ‘own capital’ of banks, that term should be taken in two senses: ownership and creation. Sheet 3.17 shows the bookkeeping act for the foundation of a bank (starting from scratch).

Sheet 3.17

Foundation of a bank in terms of its balance sheet

Assets

Liabilities

1. money-creating loans to bank founders

loans to bank founders (PVF)

€ x

current accounts bank founders

€ x

2. paying in of the own capital

loans to bank founders (PVF)

€ x

current accounts bank founders

0

own capital (shares)

€ x

The collateral for the loans might be based on a variety of possessions. However, in the ‘pure’ case it is merely based on the bank’s claim on the founders’ future income stream from the bank capital, i.e. the distributed profits. Further, as the founders are the owners of the bank, the future net value of the bank may be offered as collateral.

Next, in the course of time, the loans to bank founders are redeemed out of the bank profits distributed to the holders of the own capital (shareholders).

Thus the main difference between the extension (Sheet 3.16) and the foundation (Sheet 3.17) is the degree of collateral.

3§7-b Explication. Grounding of the starting point

With the previous section (3§7) the starting point’s pre-position of capital accumulated (1§1) has been grounded (hence it is no longer a pre-position). With it, all the previous ‘economic’ pre-positions have been grounded. However, the state (Part Two) is still pre-posited.

3§7-c Addendum. Marx on the historically initial accumulation of capital

At the end of Capital, Volume I, Marx has a famous and interesting chapter on what he calls the initial accumulation of capital.34 It describes the historical transition from feudalism to capitalism. Hence it describes where the initial capitalists got their ‘capital’ from. Even if such a history is important, it does not quite square with a pure systematic-dialectical account of capitalism. Systematically such a history is a deus ex machina, the point being the problematic phrase above: ‘where did the initial capitalists get their capital from’. This is not so much a problem in terms of ‘physical’ entities; though it is a problem in terms of the inward bifurcation of commodities (their physical and monetary dimensions) and next the concept of capital itself. At some point, apparently, non-capital turns into capital. Historically this must be true. Nevertheless, if we were to rely on a historical procedure, this would question the appropriateness of the systematic starting point (this applies for Marx’s Capital and for the current book’s 1§1).

Division 5. Validation of macroeconomic surplus-value by macroeconomic expenditure

Finance, investment, saving and surplus-value

Building on the connection between finance, expenditure and saving (3§3 of 3D2 and 3§6 of 3D2), the current division expands on the macroeconomic interconnections regarding finance, investment, saving and surplus-value. Its last section 3§10 (which bears the same title as the full division) is the key one. It grounds the production of surplus-value (1D5) in macroeconomic expenditure. The earlier sections (3§8 and 3§9) present some preliminaries to it.

3§8 Investment versus finance

  • Primary and secondary substitution: primary and secondary financial markets

The ex post substitution for the pre-validating finance by banks (3D3, 3§6) pertains to the so-called ‘primary market’: the issuance of new shares or new bonds or new direct placements of loans. Again, the purchase of this primary financial paper is necessarily based on a prior money creation by banks; the purchase always involves the transfer of money from one bank account (the substitu-ent’s) to another (the enterprise’s). Appendix 3A (section 3A-3) expands on some contingencies of the secondary financial market: the trade in existing financial paper, or the re-substitution for the banks’ PVF.

  • Investment as against finance: enterprises as against financiers

The distinction between the purchasing investment in means of production by enterprises and the purchase of financial paper by financiers (primary or secondary) is economically crucial. When before and henceforth I use(d) the term ‘investment’, this always means investment in means of production. For the purchase of financial paper I will avoid using the term ‘portfolio investment’ and ‘portfolio investor’; instead I will use the terms ‘finance’ – be it primary or secondary finance – and ‘financier’.

Macroeconomically investment is independent of saving (3§2, 3§6, expanded in 3§9). However, non-bank finance (the purchase of financial paper) is dependent on saving: ‘a’ prior saving is a condition for it.35

3§8-a Amplification. ‘Real investment’ versus ‘portfolio investment’

In English we have ‘real investment’ versus ‘portfolio investment’.36 Economists and the business press often abbreviate these (one of these) in ‘investment’, which gives rise to an enormous confusion (even in the mind of the author – one can see this even in the work of a usually careful writer and thinker such as Keynes). The term ‘finance’ is unambiguous.

3§9 Investment and saving: the macroeconomic inequality of investment and saving (I≠S)

Orthodox economics posits the macroeconomic equality of investment and saving, holding that saving is a precondition for investment. Keynes, Kalecki and post-Keynesian economics hold that saving results from investment, positing nevertheless the ex post macroeconomic equality of investment (I) and saving (S). As far as I know, all economic theory posits the macroeconomic equality of investment and saving (I=S) in one of these variants. The exposition in this section explicitly departs from these views. In fact this was implicit in the exposition from 3§2 onwards.

The previous divisions regularly used the terms expenditure, saving and investment. As the state (Part Two) and international relations (Part Three) are so far abstracted from (bracketed), there are only two forms of expenditure: private consumption and private investment. Given the bifurcation between households and enterprises (1D1), only households consume and only enterprises invest. These are addressed in turn.

1 Consumption expenditure by households

Only households consume.37 Alternatively they may in part abstain from expenditure and hence save part of their income. For their savings there are only two possibilities: keeping it in a bank account or purchasing financial paper.38

2 Investment expenditure by enterprises

Only enterprises invest. This is the enterprises’ form of expenditure. As it is an expenditure, it is not a saving. However, (remotely) similar to households that may in part abstain from spending, enterprises might occasionally do some saving: exceptionally for reasons of pure liquidity preference; or for strategic reasons, whereby they purchase financial paper (perhaps in face of conglomeration).

3 The non-connection between investment and saving

It was shown in Chapter 1 (1D5) that labour, and labour alone, is the source of surplus-value. Apart from the specific argumentation in that chapter, the general thrust of this idea is no different from that of Adam Smith (1776). This is about production.

However, Smith also argued that because ‘the masters’ (capitalists) do the saving, and because in his view saving is a precondition for production (‘advances’), there must be profits for the ‘masters’.39 This is about the distribution of production’s value-added.

From Smith onwards, this idea about saving took root in all mainstream economic theory: saving is a justification for private profits including interest (cf. the Marshall citation in 1§14-b). (Marx would not agree with this, but he nevertheless somewhat uncritically took on board Smith’s notion of ‘advances’ by the capitalist – as do many marxian political economists today).

In fact the mainstream macroeconomic notion of I=S (in both of its variants) can only be defended by way of an utterly strange definition, which functions as an assumption. This is to define the (PVF accommodated) expenditure of investment as saving(!), thereby defining an expenditure as a non-expenditure. More specifically, the investment expenditure equivalent of retained profits is defined as a saving.40 This is categorially odd, though ideologically it does the job of providing the alleged justification mentioned.

It was already explicit that the exposition in this chapter is not based on a macroeconomic ex ante equality of investment and saving (this was explicit from 3§2, and the critique of the notion of saved loanable funds – 3§3-b, 3§6, 3§6-a, 3§6-d). It is now also explicit that the exposition is neither based on a macroeconomic ex post equality of saving and investment. Thus, in general, macroeconomically I ≠ S, and more specifically I > S.

3§9-a Amplification. Keynes’s incomplete break from orthodox theory

Next to Kalecki, Keynes argued – against the orthodoxy of his day (which persists to this day) – that instead of saving giving rise to investment, investment gives rise to saving.41 The greatness of Keynes is that he integrated macro and monetary theory. Neo-Keynesians (in contradistinction to post-Keynesians) soon disintegrated the matter. Nevertheless, Keynes postulated the ex post equality of the two (I→S, I=S ex post). Keynes’s break from prior economic theory in this respect (I and S) is important. Nevertheless it is not a full break. In hindsight Keynes allowed the ex ante equality to sneak back in via the (erroneous) argument that in equilibrium the ex ante and ex post distinction does not matter. Next the whole ideology of loanable funds and of parsimony can be smuggled back in.

The strange definition/assumption of the (ex post) investment expenditure equivalent of retained profits as a saving is not only dominant in economic theory; it is also the national accounts practice.

Without, apparently, explicitly questioning the standard I=S notion, Jakab and Kumhof (2015, p. 4, fn. 6) keenly remark: ‘in a closed economy, macroeconomic (national accounts) saving is equal to investment by accounting definition rather than as a result of equilibrium, and the quantity of that saving is unrelated to the overall quantity of financing’.

Simply as a definition (in effect that of ‘saving = non-consumption’) the ex post equality of investment and saving does not do much analytical harm – and in what follows in this book nothing hinges on their equality or non-equality. The mainstream notion is indeed ‘merely’ an ideological matter about the ‘justification by definition’ of profits and interest by parsimony, and often also a ‘justification by definition’ of a skewed distribution of income.

3§10 Validation of macroeconomic surplus-value by macroeconomic expenditure

In the exposition of the finance of enterprises, the focus in Divisions 2–3 was on the pre-validation of production by banks. This final section focuses on the macroeconomic validation (realisation) of production, and especially of surplus-value. It explicitly connects the exposition of Chapter 1 to macroeconomic implications of the exposition in Chapters 2–3 so far. After an introductory subsection, the exposition focuses on the interconnection of the three sequential processes of production (subsection 2), of the macroeconomic validation of production and of surplus-value in particular (subsection 3), and of the distribution of surplus-value (subsection 4).

1 The previous exposition

This subsection sums up the relevant stages of the exposition so far.

A. In Chapter 1 (1D5), production in general was presented, and hence the production of surplus-value in general.42

B. In Chapter 2, enterprises and banks were distinguished. Even so the two were presented as a separation-in-unity (2D5).

C. In 3§1 the production activities of banking entities (as against the bank’s financing activities) were subsumed under the enterprises – thus ‘banks’ as money-creating financiers do not produce, produce no value-added, and thus no surplus-value. The same section outlined the interest flow from enterprises to banks and other financiers as a share in the surplus-value of enterprises.

On this basis the remainder of this section presents a pure macroeconomic account.

2 Macroeconomic production

In 1D5 it was pre-posited that capitalist production requires pre-validating finance by banks (PVF) as treated in 3D2–3D3. The exposition in 1D5 (1§14, heading 6) set out how the production of capital is generated by labour’s production of surplus-value.

Xt 🢔 = [(δ +μ)K + mLα]t [micro account] (1.4)

For a macro account the μK cancels out as intermediate deliveries; thus macroeconomically μ=0. When considering net production (as in NDP) instead of gross production (as in GDP) δK is abstracted from. Thus we have for net production (Y):

Y 🢔 = mLαt [micro and macro account] (1.8)

Πt 🢔 = mLαt – wLt [idem] (1.5)

In 1§14 it was indicated that mLα is the actual monetary value of labour, with ‘m’ being the actual unit monetary value of labour, and that ‘m’ measures the validation, the sale, of the product of labour. (Recall that ‘w’ is the wage rate and that 🢔 indicates right hand side to left hand side determination.)

The wages sum (W) is defined as

Wt = wLt [idem] (3.1)

It is now made explicit that the constellation presented in 1D5 is such that the validation of production as planned by enterprises on average squares with the actually validated production. However, in the current section we allow for a deviation between the production as planned by enterprises, and the actual validation of production (the adaptation taking time).43 Therefore the equations for production (X), value-added (Y for net production) and surplus-value (Π) presented in 1§14 are now rewritten in terms of planned production vari-ables (superscript p). Especially relevant is the possible deviation between the planned unit monetary value of labour, ‘mP’, and the actual unit ‘m’.

We so have (time subscripts (t) are omitted):

XP 🢔 = (δ +μ)K + mPLα [macro account for μ=0] (3.2; cf. 1.4)

YP 🢔 = mPLα [micro and macro account] (3.3; cf. 1.8)

ΠP 🢔 = mPLα – W [idem] (3.4; cf. 1.5)

All variables (above and below) without the superscript p denote actually validated variables.

Macroeconomically a deviation between the planned validation of production and the actual validation is determined by macroeconomic expenditure deviating from the planned one.44 Section 3§3 introduced the ‘savings’ aspect of this expenditure on which I now expand.

3 Validation of macroeconomic production by expenditure

In this subsection the main focus will be on the macroeconomic categories of investment (I) and consumption (C). As for production, the validation of production by expenditure requires accommodation by the PVF provided by banks. Most of this accommodation coincides with the PVF of production. The PVF for investment results in investment expenditure, and the PVF for wages results in consumption expenditure by wage earners. However, the PVF for the payment of dividend and interest to capital owners occurs after production (Circuit 3.9 in 3§3), and so does not coincide with the PVF of production. (See heading 4 on the distribution of surplus-value Π).

Regarding the economic domain treated, it is noted that at the current stage of the exposition (with the state bracketed), macroeconomic income (Y) consists merely of the two categories of surplus-value realised (Π) and of wages paid by enterprises (W):

Y = Π + W [macroeconomic domain] (3.5)

Π = Y – W (3.5′)

Similarly for the current domain, macroeconomic net expenditure (E) consists merely of the net investment by enterprises (I) and consumption by households (C).

E = I + C [macroeconomic domain] (3.6)

Equations (3.5) and (3.6) do not represent a ‘determination’ but rather the formal definition of the domain at this stage.

Given production (XP and YP), the validation of production results in income as determined by expenditures (also called ‘effective demand’):

Y 🢔 = E (3.7)

Y 🢔 = I + C [implication] (3.7′)

The investment expenditure (I), i.e. the purchases of means of production, is the investment concomitant of the current production XP (3.2). At this stage its determinants are merely provisionally made explicit, without further amplifying on these (expanded in Chapter 5).

It 🢔 = f(ωt-1; Xdt; PVFt) (3.8)

Thus current investment (and current investment expenditure) is determined by the rate of integral profit realised in the previous year (ωt-1) and the desired current production (Xdt), as conditioned by the current pre-validating finance by banks (PVFt). Generally investment applies, on the one hand, to a possible gap between the planned unit monetary value of labour, mP, and the actual unit ‘m’ (as indicated above), and, on the other hand, to enterprises’ expectations about the future (Keynes called such informed guesses ‘animal spirits’).

For consumption a distinction is made between consumption by capital owners (Ck) and by wage earners (Cw):

C = Ck + Cw [definition] (3.9)

On average the consumption by capital owners (Ck) autonomously depends on their standard of living. That is, it is independent of the ebb and flow of the level of the surplus-value distributed (expanded in Chapter 5). However, the consumption by wage earners is dependent on the wages (W), and the degree of consumption out of wages is dependent on the level of wages and changes thereof (expanded in Chapter 5). Given the payment of wages out of the PVF, we have (substituting 3.9 and 3.7′ in 3.5′) for the surplus-value realised (Π):

Π 🢔 = I + Ck + (Cw – W) [implication] (3.10)

Thus the validation of surplus-value is determined by, on the one hand, the investment expenditure of enterprises (I) and the consumption expenditure of capital owners (Ck), and, on the other hand, the consumption expenditure by labour (Cw) minus wages (W).45 Note that the validation of surplus-value is thus determined by three distinct categories of actors: enterprises (I); capital owners (Ck); and wage earners (Cw–W). It is emphasised that – as before – the determination in (3.10) runs from the right hand side to the left hand side. None of the right hand side current expenditure factors is determined by current surplus-value (Π); it is indeed the other way around. Restricting to investment: the act of investment expenditure by enterprises (via the banks’ PVF) determines the validation of surplus-value of other enterprises. Even so, the validation of surplus-value in the current period (year) may affect the plans for production and investment in the next period.

The saving out of wages (Sw) is by definition equal to wages (W) minus consumption out of wages (Cw).

Sw = W – Cw [definition] (3.11)

Substituting 3.11 into 3.10 we have

Π 🢔 = I + Ck – Sw (3.12)

Thus the validation of surplus-value (Π) is positively determined by the expenditures of enterprises (I) and capital owners (Ck) and negatively by labour’s saving. In terms of validation of surplus-value, this affirms what was presented in 3D2 and 3D3 in terms of finance. That is, rather than being a macroeconomic benevolence, saving burdens enterprises. Saving hampers the validation of surplus-value (integral profit), the accumulation of capital and economic growth. (Nevertheless, as indicated before, saving may make sense for individual actors).

4 Distribution of surplus-value

The distinction between the three sequential processes of production, validation and distribution of surplus-value is essential to the exposition of the capitalist economy. These processes are distinct, though interconnected. Production of output, and hence of surplus-value, inevitably precedes the validation of output and surplus-value. Similarly, the validation of surplus-value inevitably precedes the distribution of surplus-value. Therefore, there is no investment out of surplus-value (integral profit), as much of orthodox economics would have it. (Investments are not ‘advances’ by enterprises or capitalists or ‘masters’, as mainstream economics since Adam Smith has proposed; rather, banks ‘advance’ PVFs).

Only after the validation of the surplus-value produced can it be distributed, namely in the three forms of:

  • interest to banks (from which banks’ finance capital is fed);

  • dividends and interest to capital owners;46

  • retained profits, as already embodied in the capital assets during the pre-validated process of production via investment purchases (on the enterprises’ balance sheet this appears as addition to its equity).47

Thus these are the three ex post shares in surplus-value.48 In hindsight Figure 3.2b, from which we started in 3§1, is to be interpreted in this way.

5 Concluding summary

We have three distinct, though interconnected, sequential processes: (1) production of surplus-value; (2) validation of surplus-value; and (3) distribution of surplus-value. The production of surplus-value (1D5) and the accumulation of capital (Ch. 2) are grounded in the pre-validating finance by banks (3D2–3D3). The redemption of this finance, as well as the validation of surplus-value, is conditioned on the macroeconomic expenditure. There is no investment out of surplus-value distributed (including the retained part). Rather, surplus-value is a result of the first two processes. The first process establishes (for all enterprises) any additional investment via the banks’ PVF. The second process validates the production of investment goods via their sale (for producers of investment goods), and it validates the production of consumer goods via their sale (for producers of consumer goods).

3§10-a Addendum. Michał Kalecki

Recall equation (3.9): Π 🢔 = I + Ck + (Cw–W). Equations (3.9) and (3.12) are inspired by Kalecki (1935; 1942) – who, working in the marxian discourse, was a contemporary and precursor of Keynes. Kalecki’s view is aptly summarised in Kaldor’s (1955/56, p. 85) well-known paraphrase of Kalecki: ‘capitalists earn what they spend, and workers spend what they earn’ – that is, pending the distinction between enterprises and capital owners, and pending saving by workers.49 In the article from 1942 he remarks that capitalists ‘may decide to consume and to invest more in a certain short period than in the preceding period, but they cannot decide to earn more. It is therefore their investment and consumption decisions which determine profits, and not the other way round’ (Kalecki 1942, p. 259).

For an overview and appreciation of Kalecki’s work, see, for example, López and Assous (2010), Toporowski (2013), and various essays in Bellofiore, Karwowski and Toporowski (eds) (2013, 2014) and in Toporowski and Mamica (eds) (2015).

3§10-b Addendum. Surplus-value and the Operating Surplus (SNA) – a preliminary note

The System of National Accounts 2008 (UN 2009) adopts the macroeconomic surplus concept of ‘operating surplus’. Its starting point is output minus intermediates (purchases and sales between enterprises) and minus wages. Taking this for all enterprises together (production and financial enterprises) that starting point for the operating surplus (OS) would be equivalent to our concept of surplus-value. However, the SNA also adopts a number of arbitrary imputations, which mean that the two concepts deviate. I mention the two most important ones. First, imputations regarding the interest margin of banks (via which value-added is imputed to banks), and second, the imputation of rental income regarding owner-occupied dwellings. (I expand on this and related matters in Appendix 3C, section 3C-1 under point 6, and in 8§6-d).

Summary and conclusions

The first section of this chapter provided guidance for the reader, distinguishing between ‘active capital’ (enterprises’ assets) and ‘passive capital’ (the finance of the assets). Along with it surplus-value (the result of production) is qua distribution decomposed into ‘internal profit’ (the sum of dividends and retained profit) and ‘interest’ (as distributed to banks and other financiers) (3D1).50

In the type of macroeconomics developed in this chapter – as inspired by the Monetary Circuit theory – the distinction between enterprises and banks is essential. Bank-provided pre-validating finance (PVF) for enterprises is not only unconditionally necessary to the capitalist system; it is also fundamentally different from any other type of finance. One fundamental feature is that this PVF is a pure ex nihilo accounting money operation, and another is that it requires no saving, neither prior to nor after the investment that it accommodates. Generally saving is not necessary to the capitalist system (3D2).

Nevertheless, savings are ubiquitous and their existence necessarily gives rise to forms of finance other than the PVF. From a systematic point of view, all other types of finance are derived from the bank-provided PVF. All these other types are ‘ex post’ types of finance, that is, these serve to finance already accumulated capital, or ready investments on the basis of the PVF. Therefore, generally, saving does not precede investment; investment is not financed ‘out of’ saving. Only the bank-provided PVF finances the accumulation of capital. Other types of finance may, ex post, substitute for a non-redeemed part of the PVF, the non-redemption being caused by savings (3D3).

Whereas macroeconomic investment is independent of saving, the purchase of financial paper (often misleadingly called portfolio ‘investment’ rather than finance) is not independent of saving. Not only is there no macroeconomic ex ante equality of saving and investment; there is also no macroeconomic ex post equality of saving and investment (the positing of such an equality in most of economics is a categorial mistake, confusing expenditure and saving) (3D5).

The sequential character of the interconnected processes of pre-validation, production, validation and distribution of output and surplus-value is essential to a capitalist economy. Production and the pre-validating finance of production precede sales and so the validation of surplus-value. The degree of redemption of this pre-validating finance, as well as the validation of surplus-value (integral profit), is conditioned on macroeconomic effective demand. In line with a Kalecki type of approach, it was posited that – at the stage of exposition of Chapter 3 (with the state and international relations bracketed) – the macroeconomic validation of the surplus-value produced is determined by investment (+), the consumption by capital owners (+), and the saving by labour (–). The distribution of surplus-value (to banks, capital owners and as retained profits) inevitably follows after the validation, whence there is no investment out of a pre-existing surplus-value. In this way the investment-saving matter is connected to the investment-surplus-value matter (3D5).

The brief 3D4 on the foundation of banks is simple and may not warrant summarising. However, it deserves mention in terms of ‘conclusions’. That division grounds the starting point’s capital accumulated (1§1). At that point of the exposition (3D4), all prior pre-positions regarding the capitalist economy appear to have been grounded within the exposition (3§7-b). However, regarding the capitalist system as a whole, the capitalist state is still being pre-posited (exhibited in Part Two).

Appendix 3A. Two contingencies of the finance-capital market: intertemporal trade and re-substitution trade

The main text of Chapter 3 presented the necessities of the finance of enterprises in face of the reproduction of the capitalist system. The contingencies of this finance are ubiquitous and this book generally does not treat outright contingent constellations. This current appendix nevertheless very briefly expands on pension funds (that is, the intertemporal trade in savings – section 3A-2) and the secondary markets of shares and bonds (that is, re-substitution trade – section 3A-3). The introductory first section makes a systematic distinction between the finance-capital market and the financial market at large.

3A-1 The finance-capital market

The main text of Chapter 3 dealt with, what I now call, the finance-capital market, that is, the market for the finance of production enterprises. It was indicated that there is a tendency for capital owners to substitute, in part, for the bank-provided finance capital (3§6). It is contingent whether this substitution takes place via the direct intermediation of banks (the banks bringing the parties together) or via other credit brokers or via a public or private issue of ‘finance capital titles’ (shares, bonds and other loans).

On the demand side of the finance-capital market we have only enterprises. On its supply side we have:

  1. Banks. All of the following (2–4) may substitute ex post for the pre-validating bank finance (see 3§6).

  2. ‘Other financial institutions’, that is, other savings channelling institutions: pension funds, insurance companies, other financiers’ companies (i.e. portfolio ‘investment’ companies, including hedge funds). Next to banks, especially the pension funds are a major vehicle for channelling savings by labour (3§3).

  3. ‘Private financiers’, i.e. individual capital owners operating on this market (including rich wage earners).

  4. Enterprises (especially large corporations) as financiers of other enterprises. This category is today especially important amongst the enterprises quoted at the top of the equity market (i.e. shares market). (Because of such finance, the adding up of the assets of all enterprises would involve double counting).

I make a systematic distinction between the ‘finance-capital market’ (the main text of Chapter 3 together with the current appendix) and the ‘financial market’ at large. The latter includes the ‘finance-capital market’ together with the contingent market for loans to labour and to capital owners (briefly treated in Appendix B). All of the institutions listed above may also operate on the financial market at large.51 These distinctions are a matter of perspective. For the financier, the several variants of the finance of enterprises, households (or governments) may be just a matter of degree of security in face of expected (uncertain) revenues. However, the starting point of our exposition in Chapter 3 is not the individual financier (portfolio ‘investor’), but rather the investment of enterprises in face of the accumulation of capital (cf. 3§1), which requires finance. The distinction between the finance-capital market and the financial market is relevant for this perspective.

3A-2 Pension funds: intertemporal trade – premiums, pension and degree of recollected surplus-value for labour

The income distribution between capital and labour (surplus-value and wages), as well as the distribution of surplus-value into interest, retained profit and dividend, is called the primary distribution of income. From these we may have a derived intertemporal redistribution of income. Pension funds are one of the main vehicles dealing in this derived redistribution. They collect premiums today (such as out of wages), and with these they purchase financial paper or other assets. From the revenues (or perhaps in part from their liquidation) they redistribute pension benefits. Indirectly labourers so intertemporally recollect some share of the surplus-value that they produced – basically the rate of revenue (such as interest) on their premium. (Thus, merely as a very rough indication, if the premium is 2% of the wage and the average revenue (e.g. the real rate of interest) is 3%, then the recollected surplus-value is 0.06% of the wage – neglecting compound interest. At compounded interest – and depending on the pension scheme – the recollection of SV is, averaged over the wage earning premium years, most often under 1% of the yearly wage).

3A-3 Re-substitution trade in financial paper

Section 3§8 introduced the distinction between dealings on the ‘primary’ shares and bonds markets and dealings on the ‘secondary’ shares and bonds markets. The current section expands on this distinction. I will mainly refer to the shares market. The same applies most often to the bonds market: only the differences will be indicated.

Substitution for the banks’ RPVF: the primary market’s flow of shares

The primary flow of shares is the net addition to the stock of shares. The primary flow of shares concerns the issuance of new shares by enterprises. In the light of 3§6 the purchase of newly issued shares is merely an ex post substitution for the banks’ remaining pre-validating finance (RPVF) out of the capital owners’ savings. (The enterprises’ buying back their own shares is in effect the reverse).52

The purchase of new shares can stem from: savings by capital owners (out of their dividends or interest); savings by labour (out of their wages); or, in each case, non-bank financial institutions that collect these savings (see the more detailed list in 3A-1); incidentally, banks may also substitute between their RPVF, thereby substituting loans for shares or bonds.

Re-substitution for the banks’ RPVF: the secondary market’s trade in the stock of shares

The trade in the stock of shares effectuates the spread of risk and uncertainty for shareholders (referred to in 3§5). However, it also opens up the possibility for liquidation of the share’s value. That is, for an individual shareholder. It is important to note that macroeconomically there can be no exit from the stock of shares (the exceptions being the enterprises’ buy back of shares, or the final liquidation of an enterprise). For most types of bonds this is different as these are usually time-limited loans (e.g. 10 or 30 years). Microeconomic (individual) liquidation is always a matter of re-substitution between an existing shareholder that exits value (acquiring a current account addition) and a novice shareholder that enters value (current account deduction). That is, the novice in this respect: the novice shareholder might own other shares already. Note that even if this novice shareholder buys existing shares out of dividends that the novice received, this is still a re-substitution (a deduction from the current account of the novice from dividends, and a current account addition for the liquidating seller of shares).

Appendix 3B. Contingent lending by banks to labour and to capital owners

Next to the validation of production, the main text of Chapter 3 focuses on the finance of enterprises and especially the key role of banks in this finance. However, banks not only (pre-)finance enterprises. As a corollary to the main text, this appendix briefly expands on banks’ lending to labour and to capital owners. Although such lending is contingent (it is not necessary to the existence of the capitalist system), it nevertheless seems logically inherent to the systemic necessities treated so far.

3B-1 The lending power of banks: money dealing and interest paid by banks

Banks not only create money (2D4, 3D2); they also deal in their own creation. In order to improve their lending power, banks are out to keep their existing clients and to attract clients from competing banks. In other words, they are out to collect money created by competitor banks, and to prevent their ‘own’ account money being collected, via account transfers, by competitor banks.

The main mechanism is that of offering clients an interest. This tends to be accomplished via interest on time accounts, or ‘savings accounts’ (and perhaps current accounts). Note that this may improve the lending power of an individual bank, but not that of the banking system as a whole.53

The lending power of an individual bank may also increase via the sale of bank-issued bonds or via the issuance of new shares.54 Whether in this case the lending power of the banking system as a whole increases will depend solely on whether these additional bonds (or shares) operate on the margin of rules set by the Clearing Bank (ClB) regarding liabilities’ reserve ratios, perhaps in face of the ClB’s standards regarding the composition of the assets (2§9–2§10).

3B-1-a Amplification. Level of the rate of interest offered

In order to consolidate their liabilities, the offering of interest by banks to their clients seems necessary (for common current accounts this may also take the form of non-charging for bookkeeping services, i.e. transfers). However, the level of the interest paid is highly dependent on the competitive or collusive structure of the banking constellation.

3B-2 Generalisation of the form of money lending

The interest bearing ‘money-creating lending’ by banks for and to enterprises is a systemic necessity. It is also a (potentially) profitable activity for banks. Because this is profitable, banks tend to generalise the form of money lending vis-à-vis any social actor. In particular they may lend money to labourers and to capital owners. They so create money in a reciprocal credit relationship similar to the money creation for enterprises (2§8). Although the generalised form of lending is contingent, the generalisation seems inherent to the form of lending to enterprises.55

3B-3 Lending to labour

1 Loans for durable commodities and other consumer loans

For lending to labourers the collateral will be some asset that they own (such as a house or another durable consumer good) or an expected future income stream (wages). This lending facilitates the enterprises’ sale of relatively expensive and durable commodities.56 More important for enterprises is that consumer loans affect the net profit of enterprises, as such loans are an ex ante substitution for the pre-validating finance requirement for the enterprises’ payment of wages. This is so because in terms of credit, enterprises receive ‘for free’ revenues from consumption that they otherwise would have had to pre-finance upon wages payment. Hence enterprises pay less interest to the banks (instead labourers pay interest). Circuit 3.18 illustrates this. Thus, whereas the saving by labour is a ‘nuisance’ for enterprises (3§3), non-saving and consumer credit is a pleasure.

This ex ante substitution is also a main distinction between loans to capital owners and loans to labour. Whereas loans to labour do affect the finance capital requirement of enterprises (decrease), loans to capital owners have no such effect.

d1534211e12471Circuit 3.18

Enterprises’ saving on PVF for wages due to consumer credit: case of zero saving out of wages

Note: For simplicity and transparency it is assumed that the consumer credit (stream 1) is equivalently redeemed (stream 6). In fact stream 1 might (temporarily) be larger than stream 6. (For the latter case see Chapter 5, Appendix A).

2 Interest as a share in surplus-value or as a share in wages

Macroeconomically, the interest paid by labour on loans may or may not outweigh the interest received by labour (3B-1). Any macro or micro net interest from labour is paid out of wages income. This is analogous to the interest on finance capital being paid out of the enterprises’ net income, that is, out of surplus-value (3§4).

Although this is analogous, it is nevertheless conceptually different and so systemically different. The interest that enterprises pay to banks is a share in the surplus-value produced by labour. Should it be the case that labourers are macroeconomic or microeconomic net recipients of interest paid by the bank, then they indirectly reclaim a slice of the surplus-value.57 (Whether this is the case is an empirical matter).

3B-4 Lending to capital owners: finance doubling

Individual capital owners, or institutions in which they participate (3A-1), may want to increase their ex post financing potential (on primary or secondary financial markets – 3§8) by borrowing from banks on the basis of, most often, financial paper collateral. Especially for bank loans regarding secondary markets (existing financial paper), this means that, in sum, the lending power of banks is allocated away from enterprises.

It was indicated that, because the lending of money to enterprises against an interest is a (potentially) profitable activity, banks may apply the form of money lending vis-à-vis any social actor (3A-2). Remarkably this may also include the lending by banks to capital owners. Banks may grant loans to these potential ex post financiers on the basis of financial paper (shares, bonds) as collateral security. (Explication 3B–4a shows the possible leverage mechanism of such loans in cases of so-called ‘margin buying’).

By itself this leverage is a mere consequence of the constellation in which banks do grant loans on the basis of financial paper. That by itself is not remarkable: we may have analogous leverage mechanisms for loans to enterprises. What is remarkable about it is that (to the extent that banks are contingently allowed by the Clearing Bank to open up this constellation) we have a doubling of the credit system. Consider Sheet 3.19.

Sheet 3.19

Finance doubling

balance sheet enterprises

balance sheet capital owners

assets

liabilities

assets

liabilities

(material)

(financial)

assets

1. bank loans (60%)

assets

2. bonds (20%)

2. bonds

2. bank loans

(the doubling)

assets

3. shares (20%)

3. shares

3. bank loans

(the doubling)

Recall that banks necessarily provide pre-validating finance to enterprises (the left panel of Sheet 3.19). The collateral securities for these loans are the assets of the enterprises (‘material’ means of production). Ultimately banks might perhaps be willing to grant loans of up to, say, 60% of the total material assets (the number does not matter).

However, there is a balance sheet liabilities side to the remaining value (say, 40%) of these assets (bonds and shares).58 The finance doubling occurs when not only the enterprises call on the bank for credit, but also the non-bank holders of the enterprises’ bonds and shares. This is indeed credit on the basis of financial paper (entries 2 and 3 at the right hand panel of Sheet 3.19). Because of the lending on the basis of financial assets (and especially so with margin buying) there may be a self-reinforcing inflationary boosting of especially the shares market. (Suppose the bank is willing to grant loans to the enterprise up to 60% of the assets of the enterprise, and at a rate of 80% to bond and shareholders. Then, integrated, the bank – or different banks – in fact grant loans up to 92% of the underlying material assets of the enterprise).

3B–4a Explication: The leverage of margin buying

‘Margin buying’ is the exemplary pattern for bank loans to dealers in financial paper (individual dealers and portfolio financiers companies). Suppose the dealer owns, e.g. €10,000 in shares, which is offered as collateral security to the bank for lending money.

the bank lends, e.g., on a margin of 80%:

€8,000

for which the dealer buys additional shares, and then borrows anew on a 80% margin:

€6,400

and again:

€5,120

and again:

€4,096

et cetera:

.............

In total (on top of the initial €10,000)

€40,000

(At a 70% margin the leverage is factor 2.3; at a 90% margin the leverage factor is 9).

This boosts a booming stock market in a self-reinforcing way (rising prices, rising credit, rising prices). This also works the other way around: with falling prices there is enforced selling when the margin ceiling is reached. (The same pattern may be applied to portfolio dealings in commodities and real estate).

This margin buying also applies for hedge funds. For the latter this is also an instrument to exert (temporary) power over a corporation (given that for quoted shares often only a small minority of the shareholders appears in shareholders’ meetings). The fund may so impose its will on the corporation for short-term purposes, and next jump on to another corporation.

3B–4b Amplification. The doubling of finance and the (in)dependency of non-bank finance and saving

Recall from 3§9 that macroeconomically investment is independent of saving in the sense that saving is no condition for investment. (Rather, saving dampens investment, both in terms of expenditure and in terms of credit limits set by the bank.) In 3§8 it was posited that non-bank finance (purchase of financial paper) is not independent of saving, in the sense that ‘a’ prior saving is a condition for it. We can now see the reason for the qualification of ‘a’ prior saving. Because of the doubling of finance, and so the granting of credit on the basis of financial paper, even this finance may require merely ‘some’ prior saving (its degree depending on the leverage that banks allow for).

Appendix 3C. Rent as a contingent share in the production enterprises’ surplus-value

Lease as a particular way of finance

This appendix presents the concept of rent. For its treatment I introduce the term ‘production enterprises’, that is, enterprises producing surplus-value through the production of commodities (including commodified services). Generally rent is the price for the use of something, for a period of time stipulated by contract (instead of the price for the purchase of something). In the history of economic theory, and especially Classical Political Economy, rent has predominantly been associated with the ownership and lease of land.59|60 For many, the rent of land is something of a sacrosanct category and I agree that the private ownership of the earth is a core issue (1§1). Nevertheless, for production enterprises, ‘land’ is merely a capital asset serving the production of surplus-value, like any other capital asset. I will treat it as such in this appendix. I consider the actual payment of rent.61 I will conclude that lease is a particular way of finance and that rent is not a distinct final income category. Instead it is taken account of as the profit of enterprises. More specifically: any net rent that production enterprises pay originates from surplus-value.

3C-1 Rent as a contingent share in the production enterprises’ surplus-value

1 The ‘pure concepts’ presented so far

In the main text of Chapter 3, the concepts of ‘enterprises’ and ‘capital owners’ were mostly treated as pure categories. That is, enterprises (now called production enterprises) only engage in production (whence K is production capital) and capital owners only own financial paper (mainly shares and bonds). ‘Banks’ were presented purely as money-creating financiers, as against ‘banking entities’ that may produce various services, the latter constituting part of production enterprises (3§1). Appendix 3A introduced ‘financial enterprises’. Pure financial enterprises own only financial paper (shares, bonds, direct placements), that is, next to their premises. In the current appendix, banks have been included in the financial enterprises. This is summarised in Figure 3.20, rows 1a–c. Recall that, so far, internal profit is equal to surplus-value after the payment of interest (3§1, Figure 3.2b).

2 Hybrid enterprises and hybrid capital owners

So far we considered the purchase and sale of commodities and of financial paper. This appendix introduces the lease of commodities and, with it, the category of rent. Along with it ‘hybrid entities’ are introduced (production enterprises, capital owners, financial enterprises) that combine various activities of the pure entities, as well as the renting out of assets. Note, however, that all of this hybridity is contingent.

3 The concept of rent as a way of finance (user) and profit opportunity (owner)

I consider rent as the price for the lease of means of production, including land and buildings (this pertains to enterprises) or for the lease of durable consumer goods, including dwellings (this pertains to households, foremost labour households). For the user (lessee) of means of production or durable consumer goods, the decision to lease instead of purchase is a matter of finance (and sometimes a matter of speculation, that I will neglect in this appendix). For the owner (lessor), renting out is a matter of profit opportunity.

Thus, for example, for a low-paid worker it may not be possible to finance the ownership of a dwelling, though out of wages it might finance its lease. A starting enterprise may be able to get finance for the running production process, though not for all the means of production, whereby it leases the latter. A mature enterprise may see new investment opportunities, for which it is prepared to give up ownership in part of its means of production – so leasing these.

4 The merging of rent income into the profit of enterprises

Surplus-value is produced within production enterprises, and production enterprises only. Hypothetically, all means of production could be leased by one set of production enterprises (in which the surplus-value is produced) and leased from a second set of enterprises that owns the means of production without producing. The rent that the latter secure is a share in surplus-value (like interest as a share in surplus-value).

Actually, regarding means of production it is immaterial whether or not production enterprises lease means of production from other (hybrid or non-producing) enterprises. If they do, the users (lessees) pay rent out of their surplus-value; the owners (lessors) receive rent which for them (after the deduction of costs of maintenance) results in their profit. Thus the latter profit derives from the surplus-value produced in the lessee’s (user’s) enterprise. (This is summarised in Figure 3.20, rows 2a–2b).

Regarding durable consumer goods, the rent for their lease is paid out of wages (or if capital owners lease, out of their capital income; in what follows I will neglect this). The owners of the durable consumer goods (lessors) receive rent, which for them (after the deduction of costs of maintenance) results in their profit. (See Figure 3.20, row 2c).

d1534211e12983Figure 3.20

Original and final income from rent: non-rent case (rows 1); renting out of means of production (MP) and durable consumer goods (DCG) by specialising lease enterprises (rows 2); renting out means of production by hybrid enterprises (rows 3). (sv is an abbreviation for surplus-value)

5 The income of hybrid enterprises – a more detailed presentation

Rows 3 of Figure 3.20 present a more detailed conceptualisation of the treatment of rent for hybrid entities (mentioned in subsection 2 above). Below I expand on each of the three hybrid categories.

A. Hybrid production enterprises. The category of hybrid production enterprises owns means of production for its own use and has its labour producing surplus-value. However, groups of enterprises within this category also deal in financial paper, and also rent out means of production to other enterprises. For this part the latter share in the surplus-value produced elsewhere. (Figure 3.20, row 3, top three sub-rows). Another group within this category leases out durable consumer goods (DCG) to workers (mainly). (Figure 3.20, row 3, bottom sub-row).

Overall, however, all surplus-value is produced within or among these hybrid production enterprises.

B. Hybrid financial enterprises. Hybrid financial enterprises deal not only in financial paper (as the pure financial enterprises do), but also in the lease of means of production (MP) and of DCG. (See Figure 3.20, row 3b).

C. Hybrid capital owners functioning as enterprises. Enterprises own the means of production (1§1). Capital owners thus far owned financial paper (shares and bonds – 3§5), thereby in part financing ex post the enterprises’ ownership of the means of production (3§6). Now ‘hybrid capital owners’ are introduced. These may also own means of production (MP) that they rent out to production enterprises. They may also own and lease out DCG. Consistency requires that such MP-owners are treated as (non-producing) enterprises – and often such ownership is actually converted into corporate form. As a result these capital owners can be treated in the same way as the ‘hybrid financial enterprises’. (See Figure 3.20, row 3b). However, any final distribution of income in the form of dividends ends up with capital owners (row 3b, column 10).

In conclusion. Any rent that enterprises pay (and particularly also any rent that hybrid production enterprises pay) is a share in their surplus-value. (See Figure 3.20, row 3c).

6 Capital, investment and durable consumer goods – the SNA treatment

Capital is a form of wealth. However, this does not mean that any wealth is ‘capital’. Capital is a form of wealth geared to production, with the purpose of selling that production so as to make a profit (this makes the mainstream economics denotation of labour capacity as ‘human capital’ a rather ideological one). Investment is an addition to the capital stock (I = ΔK).

Therefore, ‘durable consumer goods’ (DCG) are indeed what the term indicates; these are consumer goods and the expenditure on these is ‘consumption’. Having said this, it must be observed that the classification under DCG is rather arbitrary. For example, many households use their cutlery for over 50 years. Nevertheless, cutlery and similar items are in the statistics usually not considered as DCG.

On the other hand, in the SNA (the System of National Accounts – the official international standard for national accounting and national account statistics – UN 2009), the purchase of dwellings is not treated as the purchase of a DCG at all. Instead it is treated as an investment! In order to accommodate for a lurking inconsistency about their own (SNA) treatment of ‘investment’, the owner-occupied dwellings of households are treated as an artificial branch of enterprises! (Around the year 2015, this statistical ruse includes, depending on the country, 50–70% of the labour households as part of capital-owning enterprises).

The SNA’s counterpart to this artificial treatment of households is that an artificial rent income is imputed to these households. (The argument is that this treatment makes the macroeconomic income indifferent to who owns dwellings. This is true – if the imputation were reliable; however, these households do not have this income, just as they do not derive an income from their cutlery or from all kinds of DCGs that they might lease but do not lease. Thus, even this artificial treatment is not a consistent one).62|63

In the conceptualisation of Figure 3.20 I restrict the focus to actually paid rent. Then, as a counterpart, the purchase of an owner-occupied dwelling would be an act of consumption even if its use were spread out over many years (like cutlery).

The SNA treatment has the effect that the actual macroeconomic income is upgraded. That apart, macroeconomically the rent payments and receipts between the total of enterprises (non-financial and financial) cancels out. The remaining rent payments from wage earners to enterprises are indeed expenditures out of wages.

List of figures of chapter 3

Scheme 3.1 Systematic of the finance of enterprises (outline chapter 3)

3§1. Finance of enterprises, passive finance capital and the distribution of surplus-value to financiers

Figure 3.2a Active capital and forms of passive finance capital

Figure 3.2b The distribution of surplus-value to passive finance capital

Sheet 3.3 Balance sheet of enterprises

3§2. The monetary circuit of pre-validating finance by banks: the pure case of non-saving

Circuit 3.4 Macroeconomic pre-validating finance by banks for wages payment and for purchase of means of production and their full redemption in case of full expenditure of the wage (capital owners being implicit)

Circuit 3.5 Pre-validating finance by banks for the purchase of means of production, and its full redemption in case of full expenditure of the wage; two macroeconomic enterprises’ sectors (capital owners being implicit)

Circuit 3.6 Pre-validating finance for wages, means of production and dividends; no saving by labour and by capital owners

Figure 3.7 Numerical example of a simple two-enterprises-sector model

Figure 3.8 Bank-provided PVF for wages payment: full redemption

3§3. Saving by capital owners and labour: triadic debt-credit relationships

Circuit 3.9 Pre-validating finance for wages, means of production and dividend; saving by labour and by capital owners

Sheet 3.10a Integrated balance sheet of enterprises

Sheet 3.10b Integrated balance sheet of banks

Sheet 3.11 Alteration of banks’ balance sheet: case of saving by labour

3§4. The payment of interest by enterprises to banks

Circuit 3.12 Banking entities as financier (‘banks’) and as employer (‘active branch’)

3§6. Pre-validating finance by banks as ex-post substituted for by non-banking finance capital (the RPVF)

Circuit 3.13 Ex post substitution by capital owners for ‘Remaining Pre-validating Finance’

Figure 3.14 Forms of finance capital along with (non-)saving and (non-)substitution for bank RPVF

Sheet 3.15 Mutation of Banks’ balance sheet (savings case) with various forms of substitution

3§7. The foundation of banks and enterprises

Sheet 3.16 Extension of the own capital of a bank

Sheet 3.17 Foundation of a bank in terms of its balance sheet

Appendix 3B. Contingent lending by banks to labour and to capital owners

Circuit 3.18 Enterprises’ saving on PVF for wages due to consumer credit: case of zero saving out of wages

Sheet 3.19 Finance doubling

Appendix 3C. Rent as a contingent share in the production enterprises’ surplus-value

Figure 3.20 Original and final income from rent

When I use the term ‘investment’ I always mean ‘direct’ or ‘real’ investment (mainly in means of production) as opposed to ‘portfolio investment’.

Marx and much of marxian political economy use the term ‘profit of enterprise’. This term does not fit the conceptualisation in this book as ‘surplus-value’ is the ‘integral profit’ of the enterprise. The concept of ‘internal profit’ will be expanded on in 5§1.

This is even so when wages are paid at the end of the production period. Wages cannot be paid out of sales without a prior influx of money for those sales. They could only be paid out of sales if there were a sufficient influx stemming from money creation for the payment of means of production (cf. Explication 3§2-b).

See 2§10 under heading 3 for the case when enterprises make losses (expanded in Chapter 5).

For incorporated enterprises retained profits are reflected in the value of shares.

It could perhaps be argued that these dividends or interest payments might be settled out of monetary inflows to enterprises from sales. It might, but that would merely mean that the redemption of PVFs for wages and/or means of production would be postponed. It is insightful, and analytically pure, to separate these flows.

This type of model derives from Marx’s Capital, Volume II, Part Three (see Reuten 1998 for an appreciation).

In order to keep the example concise, I have neglected interest. The simplest way to include interest to banks (a deduction from surplus-value) is via the introduction of a sub-sector of sector 1: banks spend the interest on means of production.

This is Kalecki’s insight: ‘labour spends what it earns’ (¤200) and ‘capital earns (¤160+¤40) what it spends’ (that is, given the production of surplus-value). See e.g. Kalecki 1942 (amplified in 3§10-a).

This idea in fact stems from classical political economy, and it is widespread – also beyond strict economics. In his influential The Protestant Ethic and the Spirit of Capitalism (1968 [19041]) Max Weber argued that the Protestant (esp. Calvinistic) inclination to thrift contributed to the rise of capitalism. On the other hand, within economics there has always been a side stream of heretics in this respect from Bernard de Mandeville’s Fable of the Bees (1714) onwards that is still vivid in current discussions about Keynes’s (1936) ‘paradox of thrift’.

The Central Bank will be systematically introduced in 7D2.

See Gnos 2003 for a comparison and for an atttempt to accommodate the post-Keynesian concerns within a Circuitist framework; cf. Rossi 2003 and Seccareccia 2003.

Positing these as contingent by no means denies that for individual actors within a capitalist economy, it may make sense to save for precautionary reasons.

The commercial bank books at the assets side ‘holding of CB-notes’ and at its liabilities side ‘borrowed from the CB’. The CB books at the assets side ‘loans to banks’ and at its liabilities side ‘banknotes issued’, which is how it finances the loan to the commercial bank. When (or if) a worker or capital owner collects CB-notes from the commercial bank (for which its current account is debited), they become the anonymous holder of CB debt (‘banknotes issued’) and so become a financier of the CB.

At this point retained profits are solely the surplus-value that is not distributed to banks in the form of interest, and the part that is not distributed to the owners of the enterprise in the form of (quasi) dividends.

The risk and uncertainty is further spread to the extent that the interest rate is fixed, and the payment of interest is prioritised before the payment of dividend.

Systematically the category of ‘capital owners’ – as separate from the owners of enterprises – was introduced with the introduction of the corporate enterprise. Historically the category of lending by capital owners emerged before the emergence of the corporate enterprise.

For example, one might wish to command over sums of money at some retirement age, even if the net interest over the period leading up to that time is negative.

The disputed idea is that savings are seen to be evoked by interest. Instead, actors save because they want to save (for old age or some expense or precaution). This can be seen especially in times of deep recession when, for (middle) layers that can afford it, savings go up for reasons of precaution even when the interest goes down.

Relatedly, apart from any other actors, banks may offer such rewards for tempting actors to keep their account money with their particular bank. (If savings are kept with another bank, then the investment-loan providing bank is, for the amount saved, in debt to another bank, not to the saver – cf. 2§12).

In comparison with 3§3, I now have introduced the terms of ‘flow’ and ‘stock’. Although these terms are correct, it should be kept in mind that the time-weighted-average of a flow has a stock character.

The precise form of the ex post finance is not important in this context. These can be loans (bonds or direct placements), or the enterprise may also issue additional shares.

The qualification ‘on average’ is expanded upon in explication 3§6-d.

That is, systematically at least: the mechanism for any remnants of banknote circulation may be different, although the principle is the same.

These other actors are the money savers themselves, or institutions channelling these savings (institutional portfolio investors, such as pension funds – cf. Appendix 3A, section 3A-1). Recall that the term ‘actor’ or ‘social actor’ is used in a general sense (2§14-a).

Cf. 2§10 (heading 3) on crediting rules set by the ClB. At this point of the exposition, banks lend to enterprises only (lending to other actors is introduced in Appendix 3B).

First, the PVF serves various purposes (including wage payments); second, the degree of actual circulation of the PVF through the economy is dependent on the degree of savings along that process.

Available at: http://z822j1x8tde3wuovlgo7ue15.wpengine.netdna-cdn.com/wp-content/uploads/2015/02/wp529.pdf.

Thus whereas generally the macroeconomic PVF < investment (the last sentence of 3§6), macroeconomic saving = Δ RPFV (prior to substitution for it).

Some of this substitution takes place via savings channelling institutions such as pension funds (Appendix 3A, sections 3A-1 and 3A-2).

Note that I distance myself from any bank intermediated ‘loanable funds’ notion, including those versions in which banks combine ex nihilo credit with loanable funds intermediation.

Note that this also happens in current practice, even if exceptionally. Note also that a bank that itself is new (heading 2) has no option but to choose between such business plans.

Quite apart from my concern to present the systematic foundation of banks, Lavoie correctly states the following in respect of the own capital of a bank in general: ‘The own capital of the bank constitutes a liability to itself. It represents the funds which the firm [the bank] owes to its owners. In general, the own funds play a role similar to deposits [current accounts] that would be in the hands of the owners. … The own funds are an accounting entry, but in contrast to deposits [current accounts] they cannot be drawn on by the owners’ (2003, p. 512).

Chapter 24 of the German edition, Part Eight of the English edition (English translation of the title amended).

Appendix 3B (sections 3B-4 and 3B–4b) shows that in fact merely ‘some’ saving is a major condition for it.

In many other languages, the terms have different roots. For example, German has investieren (verb), Investition or Investierung (noun) for ‘direct’ investment and anlegen (verb), Anlage (noun) for the portfolio meaning. Dutch has, respectively, investeren and beleggen. French has investissement and placement.

This includes durable consumer goods, which again includes (e.g.) owner-occupied dwellings. (See Appendix 3C-1, under point 6).

Recall from 2§8 the positing of unique bank account money. In the case of circulating remnants of bank notes (as is still the case today), the third possibility is to substitute account money in ClB-notes (which is in fact to purchase current zero-interest paper (‘currency’) from the ClB via an ordinary bank).

Smith: ‘The value which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced. He could have no interest to employ them, unless he expected from the sale of their work something more than what was sufficient to replace his stock to him; …’ (1776, Book I, Ch. 6, para. 5, emphasis added). On saving specifically: ‘As the capital of an individual can be increased only by what he saves from his annual revenue or his annual gains, so the capital of a society, which is the same with that of all the individuals who compose it, can be increased only in the same manner. Parsimony, and not industry, is the immediate cause of the increase of capital. Industry, indeed, provides the subject which parsimony accumulates. … Parsimony, by increasing the fund which is destined for the maintenance of productive hands, tends to increase the number of those hands whose labour adds to the value of the subject upon which it is bestowed.’ (Book II, Ch. 3, paras 15–17, emphasis added).

In 3§10 this assumption will be criticised from a different perspective.

Bellofiore and Realfonzo (2003) argue how Marx is a precursor of this view.

The macroeconomic concept of surplus-value is in principle no different from the concept of ‘operating surplus’ as adopted in the current System of National Accounts. However, I refrain from using the latter concept in order to evade the specific imputations that go along with the SNA’s concept of the operating surplus – see 3§10-b.

The previous sentence (about 1D5) means that sector deviations (or deviations within sectors) roughly cancel out. The last sentence allows for divergences. These divergences must be moderate in order to prevent that (from one period to the other) the economy spirals into overheating, prompting the next recession. This implies that we are in something of a steady-state phase of the business cycle (amplified in Chapter 5). Even so, the equations presented in the remainder of this section do apply in each phase of the business cycle.

In what economists call ‘equilibrium’, the planned unit mP is equal to the actual unit m, whence mPLα = mLα. Usually there is some degree of disequilibrium whereby we have some degree of deviation between the two, the deviation being adapted for by changes in investment and production in the next period of production.

This insight is inspired by Kalecki – see 3§10-a.

Immediately after equation 3.9 above it was stated: ‘The consumption by capital owners (Ck) autonomously depends on their standard of living. That is, it is independent of the ebb and flow of level of the surplus-value distributed’. Even so, with part of the validated surplus-value being variously distributed throughout the year to capital owners, some variable ex post saving from distributed surplus-value results (expanded in Chapter 5).

In the penultimate sentence above, it was stated that there is no investment out of surplus-value. However, ex post we have an equivalent of investment in retained profits, that is, for that part of the investment for which PVF loans have been redeemed.

These are the three shares in surplus-value with the state bracketed. In Chapter 8 we will see that taxes constitute a fourth share in surplus-value.

In Capital II Marx wrote: ‘In relation to the capitalist class as a whole … the proposition that it must itself cast into circulation the money needed to realize its surplus-value … is not only far from paradoxical, it is in fact a necessary condition of the overall mechanism’ (Marx 18851, 18932; Fernbach translation p. 497).

See the summary in Figures 3.2a and 3.2b.

Anticipating Chapter 8, public finance is also part of the financial market.

For the enterprise this action is either one of a reshuffling of their liabilities, or one of (relative) disinvestment resulting in a positive current account balance with the bank, the latter being transferred to shareholders.

This can easily be seen when the banks are analytically integrated.

Note that the issuance of bank bonds (or also additional share capital) in effect directly decreases the amount of money in circulation (current account money is substituted for the bank bond). For enterprise-issued bonds this is so indirectly, that is, in case the enterprise uses the bond proceeds to cancel a loan with the bank.

Even so, the Clearing Bank (or at a later stage of the exposition the state or the Central Bank) might put limits on such lending.

It may also facilitate the ‘saleability’ of labour-capacity in case (higher) formal education is financed by loans.

The following merely serves as an indication. Suppose that for labourers the macroeconomic interest bearing net loans to banks were 5% of wages at a real-interest rate of 2%, then, neglecting compounded interest, they would reclaim 0.1% of the wage in surplus-value.

If the bank is the first, agreed creditor in case of a failure, then the bank may not care much about the composition of these liabilities.

Adam Smith (1776) posits: ‘The whole of what is annually either collected or produced by the labour of every society, or what comes to the same thing, the whole price of it, is in this manner originally distributed among some of its different members. Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from someone or other of these.’ (Book I, Ch. 6, para. 17, emphasis added).

Karl Marx (Capital III) posits: ‘The value freshly added in a year by freshly added labour – and so also the part of the annual product in which this value is expressed … can … be divided into three … parts … three different forms of revenue, … one part … accruing to the owner of labour-power, one part to the owner of capital and a third part to the owner of landed property.’ (Ch. 51, para. 1, emphasis added – next he expands on the relations of production behind this distribution).

See, for example, Campbell (2002b) for an appreciation of Marx’s theory of rent.

I have no intention to impute rent where no rent is paid – see below on the SNA.

To be sure, many heterodox economists have resisted, and do resist, this SNA treatment.

Piketty notes that: ‘durable goods (not included in official wealth accounts) generally account for between 30% and 50% of national income, and that this level seems to be relatively stable: during the period 1970–2010 as well as on the long the run, from the 18th to the 21st century’ (2014 [2013], pp. 179–80 and technical appendix p. 30).

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The unity of the capitalist economy and state

A systematic-dialectical exposition of the capitalist system

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