Fictitious Capital and the New-Fangled Schemes of Public Credit

The following is a talk given by Michael Egoavil at the Left Forum 2009 panel “Marx’s ‘Capital’ and the Economic Crisis”. Michael can be reached at [email protected]. It was originally posted at http://marxisthumanistinitiative.org/2009/05/06/fictitious-capital-and-credit-schemes/

Today I’m going to be discussing Marx’s theory of fictitious capital and its relation to real capital accumulation. Along the way I’m going to focus on Marx’s seldom-read analysis of a French bank known as the Credit Mobilier, in which this theory played a fundamental role. I’ll conclude with some thoughts on how this relates to socialist politics today.

In the third volume of Capital, Marx discusses what he calls “fictitious capital” – what we know as “securities.” Essentially these are titles to streams of income, which are treated as commodities and bought and sold on financial markets. There are significant differences between types of securities. Some represent corporate debts, as with bonds, some represent consumer debts, as with mortgage backed securities, and others represent capital investments, as with shares of stock. But the common aspect of all these different securities is that they all give their owners a right to a stream of income, hopefully leaving them with more money than they started off with. The security owner therefore looks upon his security as capital.

While securities might seem like capital, there is a key difference. Unlike an investment in real capital, by which I mean, means of production and labor-power, an investment in a security is just the purchase of a legal title. The legal title gives its owner a claim on a stream of income, but doesn’t itself produce any income. The income is produced elsewhere.

Furthermore, this legal title can be resold on a secondary market. So for example, a shareholder might sell his share to a third party. When he does this, no money passes through the hands of the enterprise that originally issued the share of stock. The same thing can be done with a bond or a mortgage-backed security. No new loan or capital investment is made by these subsequent transactions; there is only a transfer of a claim on income to a new person. But because others are willing to pay for these claims on streams of income, they continue to circulate on the market long after their issuers have actually received their capital or their loans.

Marx has three reasons for calling securities “fictitious capital”.

1. The first reason is specific to shares of stock. With the creation of shares of stock, it appears as if capital has doubled; as if capital is not only the real capital that firms possess, but also the property titles created to represent that capital. So for Marx, shares of stock are fictitious capital because while they merely represent real capital, they also seem to multiply that capital.

2. The second reason Marx calls securities “fictitious capital” is that their value can fluctuate in ways that are entirely independent of the real capital that they represent. A change in interest rates, a rise or fall in profits, the inability of a borrower to repay debt – all of these things lead to a change in the market-value of fictitious capital without at all effecting the value of a firm’s real capital – the cash the firm has on hand, its machinery, buildings, and so forth. The value of all those things can remain constant while the value of a firm’s stocks and bonds rise or fall.

3. And lastly, a security may never have represented any capital at all. Take the case of residential mortgage-backed securities. The income that accrues to their holder is derived from the repayment of a home loan. The home was not capital for the homebuyer – he did not create surplus-value with it. It was just a dwelling. So the initial sum of money advanced was never used as capital at all, although the holder of the security views it as his “capital”.

The ideology of the St. Simonians

Now I’m going to turn for a moment to Marx’s writing on one of the world’s first investment banks, the Credit Mobilier. In 19th century France there was a school of socialism based on the thought of Henri de Saint-Simon. St. Simon had a utopian, almost religious view of credit and the way in which it could be used to create socialism. His chief complaint about capitalism was its blind and accidental distribution of the means of production. Essentially he was getting at what Marxists refer to as the “anarchy of the market,” or the fact that production in capitalism does not occur in accordance with a plan. For St. Simon, this lead to inequality and economic crises.

St. Simon’s solution to these problems was to direct investments and distribute means of production in accordance with a plan. For the St. Simonians, the body that would actually distribute the means of production would be what they called a “general system of banks.” Essentially this would be a top-down organization of banks, functioning both as government and as economic planner, owning the means of production and distributing them in the interest of all (or at least what it thought was the interest of all). To this end it would direct credit to industry. It would keep interest rates low, increasing the profits of the industrial capitalists and promoting industrial development. The bankers would react quickly to changes in demand, allocating capital where it was needed and removing capital from industries in which there was an oversupply. Economic crises would be eliminated through bureaucratic oversight.

The Crédit Mobiliér

The founders of the Société Générale du Crédit Mobilier, the brothers Isaac and Emile Pereire, were at one time prominent members of this movement. They had already left it by the time they founded the Mobilier in 1852, but they still retained much of its ideology, especially with regard to credit.

And it is basically with St. Simonian goals in mind, and with Napoleon Bonaparte’s approval, that they created this joint-stock bank. The bank’s name, which translates to the General Society of Mobile Credit, was derived from the notion that it would “mobilize” society’s savings, or “floating capital.” These idle savings were called “floating capital” because they were not tied up (or “fixed”) in any specific enterprise, and therefore could be invested at short notice. At that time in France, the banking and credit systems were relatively underdeveloped. There were large savings, but they were not deposited in banks that could then loan the money where it was needed. The savings were simply hoarded, making credit scarce and interest rates high. So at the same time as there were large amounts of idle savings, capitalists complained of a lack of money with which to fund their investments. The Pereire’s wanted to remedy this situation by directing this “floating capital” into the Mobilier and then advancing it to industry at low rates of interest, using the Mobilier as a conduit between French savers and French industrialists. To do this, the Mobilier would issue stocks and bonds, as well as accept deposits, and then use this borrowed money to buy up the stocks and bonds of industrial enterprises. French savings would thus be “mobilized,” lifting France out of its industrial backwardness.

By purchasing all of French industry’s outstanding stocks and bonds the bank hoped to become the main creditor and proprietor of all of French industry. In place of all the old securities issued by industrial enterprises, the Mobilier would issue its own bonds. There would be no more securities held by the public except those issued by the Mobilier itself. All of the old capitalists would therefore become mere rentiers, receiving the interest payments from the money they loaned to the Mobilier, which would now be France’s sole industrial capitalist.

Marx on the Mobilier

Marx wrote a series of articles on the Mobilier for the New York Tribune in 1856. He argued that because the Mobilier was only allowed to become involved with other joint-stock companies, its influence would hasten the development of new joint-stock companies. He wrote that these companies further developed what he called “the productive powers of association.” They pool together the capital of many individual capitalists, or “associate” them, and place it into the hands of the Board of Directors. This centralization creates the possibility of giant new productions that are beyond the means of individual capitalists.

Furthermore, the Mobilier was an implicitly state-supported bank – while not owned by the government, it was generally assumed that the government would support it if necessary, something like the case of the government-sponsored enterprises today. Marx even predicted that Napoleon would eventually have to nationalize the bank to prevent its collapse. He therefore argued that this centralization of industry into the hands of the Mobilier was simultaneously the centralization of industry into the hands of Bonaparte.

It is worth contrasting Marx’s attitude toward the prospect of nationalization with a view common on the left today. Marx’s view was very common-sense: he was hostile to Bonaparte, so he was hostile to the prospect of nationalization. As the French state was a bourgeois state, its reasons for nationalization would have nothing to do with socialism. In fact, Marx argued that Bonaparte’s reason for nationalizing the credit system would be “to save property from the dangers of Socialism!” (Marx 1856: 16, emphasis added).

On the other hand, much of the left goes in a very different direction. While you’re hard pressed to find supporters of the American state on the left, it’s not at all uncommon to find supporters of the American state nationalizing industry. And while it’s rarely imagined that the state-controlled army and police serve the working class’ interest, there is a common belief that a state-owned banking system would.

But I digress.

As it so happens, the Mobilier’s goal of seizing upon all of French industry never came to fruition. Napoleon never gave the bank the authorization to issue large sums of long-term bonds, and so the bank never obtained enough money to buy up the bulk of French industry. But it nevertheless did play a major role in the French economy, promoting the development of French industry and credit.

In his articles on the Mobilier, Marx used his theory of fictitious capital to explain its economic role. Key to Marx’s analysis is his claim that the bank would not actually “mobilize” France’s floating capital, but would do the opposite, fixing it. His reason for saying this is inherent in his understanding of fictitious capital.

As we’ve seen, the way in which the Mobilier would promote industrial development was through investment in joint-stock companies involved with heavy industry. The Mobilier would buy up stocks and bonds of industrial enterprises, especially railway companies. But because money was invested in industry through the medium of securities, or fictitious capital, there was an illusion that the capital thus invested was “mobile,” or to use the modern terminology, “liquid.” The individual investor can always transform his share of stock into a sum of money – all he has to do is sell it. But Marx pointed out that this has nothing to do with the “mobilization” of society’s real capital. Money invested in heavy industry is fixed. This money only returns as the fixed capital wears out, as it depreciates. This process can take years. The fact that the investor can sell the bonds or shares of stock that represent that fixed capital does nothing to change this fact. The sum of money given to the seller of a share of stock does not come from the capital that the share represents but rather from someone else’s floating capital – from another saver. All that is mobile is the property title, the share of stock. Therefore, the so-called “liquidity” of capital investment arising from the development of joint-stock companies means nothing more than that a large part of society’s floating capital is pressed into the stock exchange.

For Marx, this stock exchange was inherently speculative. Because a share’s price fluctuates completely independently of the real capital it represents, a shareholder has no inherent interest in his company’s real capital. He is primarily concerned with his shares’ price. In the Mobilier’s case, the directors created new enterprises purely with the intent of speculating on the price of the new shares issued. Real capital investment was thus subordinate to securities speculation.

Altogether, then, the role of the Mobilier was to sink all of French society’s floating capital into heavy industry, for the purpose of speculating on the stock prices of the new companies created.

Marx therefore writes:

“[The Crédít Mobilier’s] tendency is to fix capital, not to mobilize it. What it mobilizes is only the titles of property…The whole mystery of the Crédit Mobilier is to allure capital into industrial enterprises, where it is sunk, in order to speculate on the sale of the shares created to represent that capital.” (Marx 1856: 133)

For Marx, this sinking of French society’s floating capital in order to speculate on the stock market played a fundamental role in the French economic crisis that began in 1856. The savings of small agricultural producers were increasingly transferred to the Mobilier, which pressed this money into the stock and bond markets. This removed capital from agriculture, causing a decline in agricultural productivity. This was exacerbated by bad seasons, causing a spike in the price of agricultural products, and raw material shortages in certain spheres of production. This entire process therefore resulted in disproportions between industries and an overexpansion of fixed capital.

So for Marx, while the development of joint-stock companies did serve to increase overall investment insofar as it associated many individual capitalists, it did not serve to allocate capital in a more flexible or mobile way. It in fact it served to misallocate capital, and to turn real capital investment into nothing more than an accidental byproduct of stock market speculation.

Fictitious Capital today

The way in which the credit system and the development of securities (or fictitious capital) tends to misallocate capital is fundamental to understanding the most recent collapse. The development of fictitious capital based on housing loans – the infamous mortgage-backed securities and collateralized debt obligations – these were promoted as a means of making society’s investment in housing more liquid. Banks would be more willing to extend credit to homebuyers, keeping credit cheap, because they wouldn’t have to worry about the long-term prospects of their loans – they could just sell them off to other enterprises. These enterprises would then pool the mortgages together and issue securities on their basis. Other institutions would buy these mortgage-backed securities and create new securities on their basis – the so-called Collateralized Debt Obligations (or CDOs). Other institutions would sometimes buy these CDOs and create CDO2s, or CDOs based on CDOs. And occasionally the process would go even further, giving rise to CDO3s, or CDOs based on CDOs based on CDOs. And here we see what Marx meant when he said in the third volume of Capital that:

“With the development of interest-bearing capital and the credit system, all capital seems to be duplicated, and at some points triplicated, by the various ways in which the same capital, or even the same claim, appears in various hands in different guises.” (Marx 1981: 601)

“… everything in this credit system… is transformed into a mere phantom of the mind.” (Marx 1981: 603)

And we also see why he referred to interest-bearing capital as “the mother of every insane form” (Marx 1981: 603).

All of this “duplication” and “triplication” certainly made the position of the mortgage lenders more “mobile” and “liquid.” The mortgage lenders were able to continually extend loans and then sell them off to other enterprises, giving them money with which to extend more loans once again. Combined with a housing price bubble, this greatly increased the allocation, and as it turns out, misallocation of capital to the housing industry. Huge numbers of houses were built, the prices of all sorts of fictitious capital soared, and the savings of not only the capitalists, but also the workers, were pressed into the speculative bubble. Today, after the collapse of this bubble, it is obvious that much of this “fictitious capital” was a claim on wealth which never existed and never was to be created. Mortgage-backed securities have been severely devalued, many of the riskier CDOs are literally worthless, and stock prices have fallen by nearly half, while the real capital invested in home construction still sits there in the form of unsold homes clogging the housing market and preventing a recovery in housing prices. The nature of the tremendous “mobilization” of capital in the last several decades can now be seen in its full glory.

The “New-Fangled Schemes of Public Credit”

And lastly I’d like to focus on an idea that has become rather common on the left today, even amongst Marxists, that we need to demand that the US government nationalize the banking system and create new banks run as “public utilities.” The case of the Credit Mobilier provides a lot of insight into this issue.

We should not assume that there is anything inherently socialistic about the nationalization of industry. As Marx pointed, this nationalization may very well represent an attempt to save capitalism. This is what is on the agenda today. While the US government is currently shying away from nationalization, there is no doubt that if it does end up nationalizing major banks this will be nothing more than attempt to save the capitalist system as a whole. It will not represent a creeping socialism. The enterprises will simply be cleaned up and resold. At most it will represent an infringement on the rights of individual share and bondholders, but only to the extent necessary to keep the financial system as a whole from collapsing. Whether or not you support this, there can be no doubt that this has nothing to do with socialism.

As regards the idea that the state should start new banks which lend directly to industry – this is also a misguided goal. There is nothing about a government-backed bank which makes it less inclined toward speculative pursuits than private enterprises. The history of government-backed banks shows this. The Credit Mobilier, as well as Fannie Mae and Freddie Mac, were started with the support of the state to promote certain goals which weren’t being accomplished by the free market – whether industrial development or homeownership. The way in which this was done, in both cases, was to increase the liquidity of the lenders by promoting securitization – or in other words, the creation of fictitious capital. This is the way in which interest rates are kept low and there is an abundance of credit for social purposes. But in both cases we see that the markets in fictitious capital are inherently speculative, and that government-backed enterprises act similarly to private enterprises, contenting themselves with participating in the bubble until its inevitable collapse.

This is why the supposedly socialist demand for a re-creation of the credit system is misguided. It completely ignores the inherently speculative nature of fictitious capital, and the fact that fictitious capital arises naturally on the basis of the credit system. It imagines that we can have a credit system without speculation and crises. It commits the same error as the St. Simonians, which Marx said “deluded itself with the dream that all the antagonism of classes must disappear before the creation of universal wealth by some new-fangled scheme of public credit” (Marx 1856: 15). The present crisis is only the most recent demonstration that this dream is in fact a nightmare.

References

Marx, Karl. Capital: A Critique of Political Economy, Volume III (Harmondsworth,
Penguin Books, 1981).
Marx, Karl. “The French Crédit Mobilier” (1856), in vol. 15 of Marx and Engels,
Collected Works (New York: International Publishers, 1986) 8-24.