What follows is a descendant of the paper I presented at Historical Materialism in London about a year ago. It’s an attempt to introduce a post-Keynesian conception of liquidity into Marx’s theory of credit-money. It has gone through a few versions. After the conference I was invited to present a longer version as a seminar at SOAS to a bunch of post-Keynesians, including the eminent Victoria Chick, Emeritus Professor of Economics at the University of London, whose work I love and draw in the paper. I reworked it quite a bit: at HM I was explaining what I thought Marxian economics can get from Keynes, this time I reversed it to explain what Marx does that Keynes doesn’t. Back in Sydney I reworked it again to turn it into a thesis chapter, which is why you see references to other chapters, etc. I have been meaning to clean it up and submit one version or another to a journal at some point, but thesis has taken over. I’m putting it up here now because what it deals with came up in conversation over at Duncan Law’s blog.
Commodity money, state money, capitalist money
5306. If there should not be currency to settle the transactions at the clearing house, the only next alternative which I can see is to meet together, and to make our payments in first-class bills, bills upon the Treasury, and Messrs Smith, Payne, and so forth.’ — ’5307. Then, if the government failed to supply you with a circulating medium, you would create one for yourselves? — What can we do? The public come in, and take the circulating medium out of our hands; it does not exist.’ — ’5308. You would only then do in London what they do in Manchester every day of the week? — Yes.’
- Chapman, a banker, testifies before the Bank Acts Committee in 1857, quoted in Marx [1981: 671]
In some respects, Marx and Keynes appear at opposite poles of monetary theory. Marx is the theorist of commodity-money, for whom “the money-form is merely the reflection thrown upon a single commodity by the relations between all other commodities” [Marx, 1976: 184], and “gold confronts the other commodities as money only because it previously confronted them as a commodity” [ibid: 162]. Keynes, on the other hand, is patron saint of modern cartalists, writing that “the Age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account – when it claimed the right not only to enforce the dictionary but also to write the dictionary.” [Keynes, 1930: 5] Commodity-money versus state-money: this disagreement does indeed stem from deeper, fundamental differences of vision regarding the place of the state within capitalism.
Yet, from these different starting points, both Marx and Keynes enter the same territory when they come to write about the financial system. Naming the essence of money only gets each one so far, and far greater space in both Capital and the Treatise on Money is given over to analysis of what happens to money when structures of credit are built upon it, and when the bulk of actually-circulating money is neither gold nor fiat currency, but credit-money (Marx) or Bank Money (Keynes). A large and sprawling swathe of the third volume of Capital is given over to tracing patterns of credit rising out of the circulation of commodities and the circuits of capital, patterns which coalesce and centralise into a banking system, with a central bank at its centre. In Keynes’s Treatise, it quickly becomes clear that while the state might print numbers on bills, it cannot control the corresponding numbers on price lists. To show how the purchasing power of money is determined, Keynes follows the money through the banking system and into the sphere of commodity production – divided, in a manner similar to Marx’s second volume, into consumer goods and investment goods sectors. The central bank, it transpires, must manage the banking system so as to stabilise the value of money in terms of commodities.
The theorists meet, then, in the banking and broader financial system, a zone which borders on both the state and on the sphere of commodity production and exchange. In this chapter I establish a framework for analysing the evolution of this system, drawing on both the Marxian and Keynesian traditions. Given that my thesis covers a forty-year period of history, it is essential that the framework be able to deal with institutional evolution. I believe that Marx’s vision is more attuned to structural change, and also treats the central bank as a strategic actor within the financial system. Keynes, in contrast, tends to treat the state as an exogenous, rational force above it, particularly in the General Theory. However, Marx’s analysis of the financial sphere is fragmentary and incomplete, and I argue that a variant of Keynes’s concept of ‘liquidity preference’ can fill some of the gaps.
A large part of this chapter deals with so-called structuralist post-Keynesian monetary theory, in particular that of Hyman Minsky. I see Minsky as providing a bridge between Keynes and Marx. Keynes introduces the crucial ‘liquidity preference’ concept in the General Theory , but in that work the entire banking system, discussed insightfully in the Treatise, drops out, leaving an all-powerful central bank in direct control of interest rates. Minsky sees himself as an interpreter of the General Theory, but restores the private financial system, with all its complexity of innovation and evolution over time, and in doing so comes closer to Marx’s vision. Minsky provides the tools to update it for a modern financial world in which banks interact with other financial intermediaries in a dense net of interdependent financial markets, all embedded in circuits of capital with a basis in commodity production.
Stretching money: liquidity, credit and credit-money
One of the peculiar insights of Marx’s theory of money is that money is more than what money does. Though he begins his analysis of money with two passages on the functions it is called on to perform in circulating commodities – as measure of value and means of circulation – the following section is called simply ‘Money’. Money emerges as a means of circulating commodities, but emerges as an independent thing – “an external object, capable of becoming the private property of any individual” [Marx, 1976: 229-30] – and therefore capable of adaptation to new ends.1 Because it is always capable of being exchanged for its value in commodities, it can be hoarded as a store of value, remaining outside circulation to be spent at an uncertain later date. Credit contracts begin to separate purchases and payments, and money moves to new rhythms. This is the basis for Marx’s rejection of both Say’s Law and the Quantity Theory: sales without subsequent purchases, purchases without sales and movements of money unconnected to either.
This simple fact about money, that the patterns in which it circulates through society are capable of change, whether through conscious strategic innovations or blind systemic evolution, does not end there. Norms of credit shift. Institutions emerge to specialise in money and credit dealing – banks, brokers, discount houses, and so on, and financial markets form new channels through which money flows. Certain debt instruments – already a store of value – begin to function as means-of-payment also, becoming credit-money. This capacity for private innovation in the use of money and credit periodically undermines previously predictable relationships and complicates or thwarts modes of state intervention predicated upon them.
How to conceptualise such changes? The first instinct is still to think in terms of the quantity identity: the quantity of money and the velocity with which it circulates. Financial developments do leave their traces in both variables, though they sometimes raise questions about what is an increased quantity of money and what is an instrument which economises money use. But for Marx the quantity of money is not directly related to either of the ultimate points of interest: flows of income-expenditure through the channel of commodity circulation, and flows of value through circuits of capital and revenue.2 He is explicitly a theorist of variable velocity3, but arguably the dynamics of credit rather than money are more directly important to the explanation of cyclical and crisis phenomena which concern the central bank. This is both because of the importance of credit as a source of expenditure – implicating it in the circulation of currently-produced commodities – and because of its pre-validation of inherently uncertain future revenue flows – involving it in the varied rhythms of the reproduction of capital, labour-power, rentiers and so on. Credit is able to stretch the circulation of a given quantity of money because it can restructure when payments are ultimately made, sometimes make actual payments unnecessary (when credits cancel one another out), and, in some forms, circulate directly as means-of-payment in itself, credit-money. The quantity of money and its modes of circulation are important at one remove, inasmuch as they limit credit relations and ultimately validate credit as ultimate means-of-payment.
Marx’s focus on credit rather than money is especially clear in his discussions of the determinants of the interest rate. He insists that the interest rate reflects supply of and demand for money capital and not money as such. The supply of money capital in a period reflects the quantity of money which its holders are willing to exchange for future repayment plus the going interest rate, which is clearly a more restrictive category than the quantity of money in the economy. The supply of money capital in a given period reflects the willingness of holders of money to exchange it for a debt instrument, sacrificing the purchasing power of money for the term of the debt (or at least, until the debt instrument is sold to someone else). (See Harvey  or de Brunhoff  for an overview of Marx’s theory of interest, which is somewhat scattered through the second and third volumes of Capital.)
At first sight this appears very similar to the classical theory of interest in which the interest rate adjusts to equate savings and investment. A high interest rate encourages those who earn money to convert more of it into money capital, rather than spend it on goods, even as it discourages capitalists from borrowing new money capital to expand investment. If this were Marx’s view, little seems to be gained from having a monetary theory of interest at all; saving and investment are all you need. But in fact Marx’s theory was an important departure from the classical theory, because he recognised that the supply of new money capital was not limited that coming from savings: it could be augmented by the mobilisation of idle money hoards by the banking system, and once banking liabilities themselves circulate as means of payment, the banks could expand the supply of money capital even further. The banking system’s ability to expand in this way is limited by the convertibility of banknotes into the money-commodity (or, at least, notes of the central bank, themselves convertible into gold); the banks must always be ready to redeem their liabilities. The flexibility of the credit money supply, and therefore the capacity of the banks to extend credit, is based on the fact that at any given time few holders of bank liabilities will in fact seek to redeem them.
The possibility for instability here is obvious, and it is out of the need for the banks to borrow base money to meet these convertibility obligations from time to time that the central bank emerges – as lender of last resort. The rate at which the banks can borrow reserves from the central bank – the Bank Rate – becomes the basic interest rate over which the private banks’ own loan rates are marked up. The central bank’s gold reserves being finite, in normal times its governors raise the Bank Rate up and down to discourage or encourage the expansion of credit. For Marx, the central bank emerges out of the private banking system, and the potential for state manipulation through it is limited, mainly confined to the prevention and alleviation of crises.
Keynes and liquidity preference
Keynes, like Marx, criticised the classical theory of interest. By his time, neoclassical loanable funds theory recognised the possibility that part of the supply of loanable funds might come from new money – created by banks or the state – or from the activation of ‘idle balances’, rather than from savings alone. But Keynes  goes further, implying that the modern loanable funds theory still overestimates the importance of new savings in determining the interest rate. The interest rate mediates supply of and demand for money, and the latter schedule is dominated by wealth holders, because potential sales of non-monetary financial assets accumulated in the past outweigh the increment newly saved in the present period. The decision to save has a negligible impact compared with the decision about how to hold savings. [Chick, 1983]
This is a very different line of argument from Marx’s. First, Marx is explicit that the interest rate is about supply of and demand for money-capital, which is neither money nor savings. For Keynes it reconciles supply of and demand for money. Second, Marx’s argument is all about how financial institutions economise on the use of money, while financial intermediaries are curiously absent from the discussion of interest rates in Keynes’s General Theory. Keynes focuses on changes in the demand for liquidity, and assumes its supply is fixed by the central bank. Marx sees both supply (of credit, not money) and demand as variable and beyond the tight control of the central bank.
These separate focuses are in my view complementary rather than incompatible. Marx’s attention to the institutional specificities of the financial system and its evolution is vital, and highlights the slippage between the Bank Rate under the control of the monetary authorities and the interest rate facing borrowers. However, he is vague on the limits to this flexibility, on the macroeconomic relationship between money and money-capital. This is where the Keynesian concept of liquidity preference helps, even though we must drop Keynes’s assumption of a fixed money supply. In fact, writers of the so-called structuralist school of post-Keynesianism (as labelled by Pollin ), in elaborating Keynes’s concept of liquidity preference for a more complex vision of financial institutions and markets, move the analysis towards some of Marx’s concerns. In the remainder of this section I introduce a structuralist conception of liquidity preference and suggest how it integrates with Marx’s concerns.
For Keynes [1936: 167], the rate of interest is “the inverse proportion between a sum of money and what can be obtained by parting with control over the money in exchange for a debt for a stated period of time”. This is the basis for the concept of ‘liquidity preference’: money and debt are substitutable within units’ portfolios. The money-value of the income stream from holding a debt is its present value; against this is weighed the subjective value of the liquidity service of money itself, which is for Keynes related to the three uses of money for transactions, precautionary and speculative purposes. In Chapter 13 of the General Theory discussing “the general theory of interest”, Keynes sets up a pure dichotomy between debt and money, though he acknowledges in a footnote that in reality the distinction is blurry and that the line should be drawn “at whatever point is most convenient for handling a particular problem”. [ibid: 167] Later, however, in Chapter 17, discussing “the essential properties of interest and money”, the dichotomy is replaced by a more general discussion of asset valuation, including not only money and debts, but even productive capital assets and commodities. The value of everything held as an asset derives from the present value of (1) its expected yield minus (2) its carrying costs plus (3) the implicit value of its liquidity services. For assets of equal value, what one lacks in liquidity it must make up in net yield, generating the spectrum pattern of interest rates in which short-term securities normally have lower interest rates than long-term securities. Now ‘liquidity’ is no longer an either-or property, but something which assets can have in greater or lesser quantity. The valuation of liquidity itself presumably still depends on the three motives of Chapter 13, but now there is the additional complication of variations in the ‘quantity’ of liquidity inherent in different assets.
This complication of Chapter 17 is welcome, because beyond means-of-payment itself, which could be said to be absolutely liquid, there is indeed a kind of spectrum of liquidity, with some assets more liquid than others, in the sense that they can be more readily exchanged for means-of-payment at a more-or-less certain rate. But this raises major complications for the earlier ‘general theory of interest’. First, it is problematic for the ‘speculative motive’ for holding liquidity. The rationale for this in Chapter 13 is that speculators will hold money when they expect capital losses on bonds and hold bonds when they expect capital gains. The motive for holding money here is more about capital certainty – the store of value function of money – rather than money’s liquidity – deriving from the means-of-payment function. But in a more realistic institutional setting, a number of assets provide capital certainty without liquidity (e.g., bank term deposits), and, with the possibility of inflation and exchange rate movements, it cannot be taken for granted that the most liquid asset – means-of-payment – is also the most capital certain. While the transactions motive and precautionary motive are unambiguously linked to liquidity, the speculative motive is not necessarily so. In reality, the speculative choice between different non-monetary assets can be more relevant than the choice between money and other financial instruments: for example, ‘bears’ buy bonds and ‘bulls’ buy shares.4
A second problem concerns the supply of liquidity. In Chapter 13, Keynes assumes that the money supply is fixed by the authorities. This need not mean that private liabilities cannot function as money, but it does require a predictable relationship between these and the instruments whose supply the state does control, e.g., because of a constant bank reserve ratio. This is an institutionally-specific condition, not a general one, and not one which always holds in the historical period I am discussing, as we will see in later chapters. When liquidity is a property inhering to greater or lesser extent in a wide range of assets, private and public, theory needs to address the more general determinants of their supply.
Minsky’s [1986, 2008] reinterpretation of Keynes deals with these two problems in ways that take us quite a distance from the Chapter 13 theory of interest, and even further from the familiar neoclassical Keynesian IS-LM model based upon it. It incorporates a theory of banking and financial intermediation more generally, hence taking us closer to Marx’s concerns, and most importantly, it points the way towards a more realistic picture of the place of the central bank within the system as a whole – not as a power above the financial system controlling the money supply or interest rate, but as a strategic actor within a contradictory system, though certainly a powerful one. Minsky’s starting point is Keynes’s Chapter 17, but he argues that this discussion of the valuation of assets in general, “though perceptive, is flawed because [Keynes] does not explicitly introduce liability structures and the payment commitments they entail at this point, even though this entered into his definition of the precautionary demand for money”. [Minsky, 2008: 77] This comment actually signals a striking twist of Keynes’s argument, because for Keynes, the precautionary demand for money relates the volume of present transactions to the present interest rate, whereas Minsky is linking future payment commitments to present liability structures arising from debt contracts entered into in the past and present. This implicitly switches the determinant of the interest rate away from the portfolio demand for money and towards the present demand for credit. We are now one step closer to Marx and his relation of interest to money-capital rather than money.
For Minsky, every economic unit can be characterised in terms of its cash inflows and outflows over periods of time and its balance sheets at points in time. The stocks of assets and liabilities have present values based on the expected cash flows they entail over future periods (as well as the implicit value of their liquidity, as with Keynes). These stocks include not only financial instruments but also the physical capital assets firms need to generate cash flows from production. Every unit inherits its balance sheet from the past, but makes decisions in the present to buy and sell assets in the present based on expectations about future cash flows. This framework leads to quite different senses of the transactions, precautionary and speculative demands for money.
First, cash flows are unambiguously related to means-of-payment, rather than any broader form of money. A unit must have an adequate stock of means-of-payment to meet its outgoings in any period. For the most part, cash outflows are funded from cash inflows in the same period, whether from (wage or profit) income from the productive sphere, or from financial inflows. If such inflows are not enough to meet mandatory outflows, the unit must adjust its balance sheet, selling assets or taking on new liabilities (i.e. borrowing). Minsky terms this ‘position-making’, the position being the units’ liability structure and ‘position-making instruments’ being the relatively liquid instruments units typically have on their balance sheet to meet such contingencies – whether they be liquid assets or readily available sources of credit. Besides the mandatory outflows from contractual payment commitments, consumption needs, operating costs, etc., units make decisions about what to do with ‘excess’ cash inflows (savings) and have the option of rearranging their balance sheet of existing liabilities and assets.
Keynes links transactions and precautionary money demand to income, and speculative demand to the interest rate. Minsky’s schema is different. Transactions demand concerns means-of-payment specifically, and is linked not only to income from production, but also to contractual financial payments and to transactions arising from portfolio adjustment. Precautionary and speculative motives are closely linked and relate not only (in fact not much) to means of payment, but to the whole range of assets, including shares as well as bonds, and even physical means of production and real estate. Precautionary and speculative motives are linked because they are essentially the inverse of one another; for Minsky speculation is all about sacrificing liquidity to earn a better return. In the terms of the Chapter 17 framework, the implicit money-value of liquidity rises and falls relative to the present money-value of expected net yields with confidence or appetite for risk. (In fact since confidence is partly a view about future yields, expected yields would usually be rising even as the value placed on liquidity falls.) When a unit’s confidence rises, liquidity preference declines and a unit adjusts its balance sheet away from liquid assets. At a macro-level, this means a fall in long-term interest rates relative to short-term.
The heart of the difference is that in Keynes’s presentation bonds are the only alternative to money, whereas Minsky deals with the whole range of assets. Keynes takes no account of the liability side of the bonds, of whose obligation it is to pay the interest and principal – they appear only as assets. In fact, he refers to them as ‘consols’, a particular kind of government bond. This leads to a certain arbitrariness about the interest rate, because there is no sense interest is paid for out of other kinds of cash flows. Speculators buy and sell bonds based on their views about departure from the ‘normal’ interest rate, but Keynes deliberately does not attempt to explain the norm itself. This, I think, reflects an implicit assumption that the monetary authorities can intervene to achieve whatever rate they wish. This may be true in certain institutional conditions for certain short-term rates, but it does not hold in reality for the longer rates.
Minsky’s is a more general theory which is able to deal with rate spreads, not only ‘the‘ interest rate, and this problematises state control in a more realistic way. This is because in his framework, one unit’s financial assets are always another unit’s liabilities, and the analysis integrates these financial linkages with the cash flows of income and expenditure in production. For Minsky, as for Marx, there is no split between the ‘real’ and the ‘monetary’; transactions in goods and services necessarily involve real flows of means-of-payment, and the financial structure of promises-to-pay is built on this structure. The structure of interest rates reflects the interaction of all kinds of units given their expectations of the future and their liquidity preferences.
So far we have talked in terms of undifferentiated units, but of course the system involves the interaction of different kinds of units with different sources and uses of cash and different balance sheets. Within the productive sphere are firms and worker and rentier households. The distinction between worker and rentier households is a blurry one; we can say that individual households are workers insofar as their incomes come from wages and rentiers insofar as their incomes come from interest and dividends; a higher proportion of rentier income than wage income is saved. At any rate, cash-flows from production flow between firms and households in a familiar fashion, as both wages and profits flow ultimately to households and are spent on consumption goods and saved. Savings, except to the extent that cash is held, always involves the purchase of an asset.
As with Keynes, Minsky treats firms’ investment decisions as the autonomous driver of macroeconomic fluctuations. But, unlike Keynes, he takes seriously the financial constraint on investment. The analysis thus takes a step in the direction of loanable funds theory. Investment in physical productive assets is treated as a balance sheet decision, though one that happens to feed back into the circular flow of cash through the productive sphere rather than remaining within the realm of financial instruments, because these assets are produced by firms employing labour. A firm decides to invest in means of production when the supply price – the cost of purchasing such an asset, including the cost of borrowed funds – is below the demand price – i.e., its value to the firm, as derived from the Chapter 17 schema (i.e., the present value of expected yield minus carrying costs, plus the liquidity value). An investment good being generally much less liquid than most financial assets, investment is a function of (i) expected profits, (ii) firms’ liquidity preference, (iii) the purchase price of investment goods, and (iv) financing costs.
The first two factors being volatile, cyclical ‘animal spirits’ variables, and the third being relatively stable (though tending to rise in a boom), the fourth depends on the financial system, and is of course the factor through which monetary policy must work. In the absence of financial intermediation, the demand schedule for credit becomes the supply schedule of financial assets. Unless new means-of-payment are introduced into the system by net government asset purchases, the funding for a net increase in the stock of financial assets (i.e. new credit minus repaid credit) comes from either (i) new savings or (ii) purchases out of savings previously held as cash. The second possibility depends on some combination of a change in the average value placed on liquidity by asset holders and a rise in interest rates. In the now-familiar Chapter 17 framework, both of these things raise the present value of the yield on interest- or dividend-bearing financial assets relative to the liquidity value of cash.5 Minsky expects the liquidity preference of asset-holders, like those of firms, to move cyclically with confidence about future cash flows. Some of the decline in cash balances may arise out of increased efficiency in the payments system rather than portfolio decisions. But these sources of credit are ultimately limited by the quantity of means-of-payment circulating around the system, which is under the control of neither firms nor households. In such an economy, states would have a tighter monetary influence, though still not complete control due to private decisions about liquidity holdings and liability structures.
Financial intermediation greatly increases the degree of freedom, especially when some liabilities of intermediaries themselves function as means-of-payment, as in a modern banking system. Minsky treats financial institutions as units in some ways like any other, with cash inflows and outflows and balance sheets linked to future flows. Yet they are also fundamentally different in that their inflows are not income in the sense of money earned from production: inflows are borrowed, outflows are lent. The typical intermediary makes a profit from maintaining a balance sheet in which its liabilities are more liquid than its assets – borrowing short and lending long – and therefore exploiting the yield differential.6
Intermediaries exploit the fact that individual units hold liquid assets for precautionary purposes: they want to be able to quickly convert them into means-of-payment should the need arise, but most of the time most units do not actually exercise the possibility of conversion. An intermediary whose liabilities are the liquid assets of a large number and wide variety of units can be reasonably confident that only a fraction of these liabilities will be redeemed and require a cash outflow in any given period. The intermediary itself manages its balance sheet portfolio to cover contingencies, holding a reserve of means-of-payment and also developing position-making practices on either asset or liability sides of the balance sheet. Position-making assets are liquid instruments an intermediary can itself quickly convert into cash; position-making liabilities are readily available sources of credit.
The fact that banks’ liabilities circulate as means of payment puts the banking system in a unique position at the heart of the payments system and as custodians of precautionary balances. A bank can, and usually does, lend its own liabilities, so that when the borrower spends the money with another customer of the same banking system, the liability changes hands without reserves leaving the system. Thus while banks, like other units, must manage their balance sheets to be able to meet outflows when necessary, the relevant flows for banks are reserves (balances with the central bank and central banknotes) rather than cash, because ‘cash’ includes bank liabilities which they can create at will (regulations permitting). Individual banks lose reserves to other banks when their customers’ payments to customers of other banks exceed the reverse flow, so that the expansion of the system as a whole limits the expansion of individual banks. But the system as a whole loses reserves only through (i) net transactions with the central bank (ii) net transactions abroad7 or (iii) net hoarding of central banknotes outside the banks (generally unimportant outside of bank runs).
Once banks, in extending credit, are able to create the means-of-payment used by non-banks, a much wider gap opens up between previously accumulated savings and new borrowing. Now, new credit (the net new financial liabilities of non-financial units) can come not only from (i) new base money (from central bank asset purchases), (ii) new savings or (iii) a decline in the liquidity of non-financial units’ balance sheets, but also from (iv) a decline in the liquidity of bank balance sheets (in terms of base money reserves), or from (v) a decline in the liquidity of non-bank intermediaries. In each case, the change of liquidity for each type of unit will be associated with some combination of interest rate changes at the relevant part of the spectrum and changes in liquidity preference. It is possible, in other words, for banks and other intermediaries to stretch the liquidity of the system as a whole without any change in the liquidity profiles of non-financial units’ balance sheets – except, of course, that of the ultimate borrower. The systemic cost is focused on bank/intermediary balance sheets, where a decrease in liquidity means the institutions take on a greater risk of a mismatch between future inflows and outflows – the possibility a costly position to make (from forced asset sales or borrowing) or, in the worst case, insolvency.
In such a situation, a central bank which operates in the at the short end of the interest rate spectrum (with open market operations and/or lending reserves to the banks) has an influence on, but not control over, rates further up, which also depend on the changeable liquidity preference of banks, intermediaries, households and firms. Chick and Dow  and Dow  model this in terms of multiple levels of liquidity preference. Bank liquidity preference and non-bank demand for credit determine the long-term interest rate and money supply, which meets non-bank liquidity preference to determine the short-run interest rate in the money market. This in turn affects the cost of funds to banks, feeding back into the long-term interest rate. Thus although the bank money supply is flexible, the portfolio choices of non-banks, as well as the intervention of the central bank, affect the liquidity and cost of funds to banks, which affects their decisions about credit extension. Competition and other interactions with non-bank intermediaries complicates the story further.
The complex of interrelations between institutions of different types are clearly historically specific, and so must be the analysis. The structuralist post-Keynesians are focused on the evolution of the system as much as (or more than) its workings as a relatively stable configuration. Minsky [1986, 2008] focuses on the rapid succession of financial innovations since World War II and their impact on monetary policy. Chick  goes further back in time, discussing the emergence and development of the capitalist banking system. She emphasises that the function of bank liabilities as means of payment was an historical institutional development which happened to fundamentally alter the macroeconomic system, and argues that it was a material precondition for Keynes’s theoretical reversal of the classical causal relationship between savings and investment.
Back to Marx
This brings us back to Marx, because his analysis of money, credit and credit-money is a response to precisely this historical development, still underway in his own time. Discussing it in terms of ‘liquidity preference’ may appear to do violence to Marx’s analysis, since the term carries a connotation of methodological individualism – as a set of psychological preferences, so that a macroeconomic liquidity preference schedule appears as the average across a whole society of all individual liquidity preferences. A Marxian approach to the question must be systemic.
The ‘portfolios’ themselves, ‘hoards’ in Marx’s terms, form for two major reasons: first, within circuits of capital, accumulating and spent to various rhythms, from the week-to-week circulation of wages and raw materials to the very slow turnover of means-of-production. We can also include a certain level of ‘precautionary’ hoarding to meet the unexpected. Secondly, hoards form out of revenue income not spent (including wages) and the accumulation of money-capital not (or not immediately) reinvested in the circuit of capital that generated it – ‘savings’ and ‘retained earnings’. The extent to which these hoards will be kept in liquid form depends on the frequency and predictability which which they need to be turned into means-of-payment and spent, and the expected alternative reward available for sacrificing liquidity, including interest, dividends, capital gains, etc.
Alongside hoard formation, credit needs congeal in various parts of the system. Some form within circuits of capital: rolling credit can substitute for the need to accumulate hoards for regular spending on wages, raw materials, etc., and long-term loans can finance capital equipment. Others come from the possibility of new capital formation, investing borrowed money-capital in new or expanded circuits. Credit can fund consumption, durable good, or dwelling expenditure, capitalising future wage or other revenue income.8 Finally, credit can fund asset purchases for speculative or other purposes.
Thinking in terms of liquidity provides a way of systematically relating these two ruptures Marx identifies in the link between the quantity of money and expenditure: hoarding and credit. These two practices are related because in the extension of credit, the lender converts a money hoard into a less liquid store of value. Both money and the debt instrument function as stores of value to the holder, but the former can be readily spent while the latter must first be converted into means-of-payment, through sale or redemption. Interest, of course, is the compensating reward, with the spectrum of interest rates corresponding to the spectrum of liquidity (modified by perceived credit risk). The development of a credit system changes the relationship between hoarding and the money supply, because hoarding itself no longer governs the amount of money held outside circulation, but the amount hoarded in liquid form. Interest rates mediate between the system’s demand for liquidity and the demand for credit. Portfolio adjustment, and therefore speculative demand, will be a substantial determinant of this systemic demand, because wealth portfolios are carefully managed. But as Minsky demonstrates, there is a disconnect between the liquidity profiles of non-financial units’ balance sheets and the liquidity of the system as a whole. Financial institutions, in managing their own balance sheets, create, destroy and shuffle around the system’s means-of-payment ‘behind the backs’ of the ultimate wealth-holders. This is not methodological individualism.
Where does this leave the central bank? Marx, as we saw above, sees the central bank as exercising its influence through the bank rate. In Minsky’s terms, it operates on the cost and availability of credit by affecting the cost of bank position-making. Its effectiveness depends on the major position-making practice of banks involving borrowed reserves from the central bank. But Marx noticed that in periods of tightness, the banks developed what Minsky would call innovatory position-making practices. They began to settle payments imbalances among themselves not only with gold or banknote reserves, but with “first class bills, bills upon the Treasury, and Messrs. Smith, Payne and so forth” [quoted in Marx, 1981: 671]. Marx could see the importance of this emergent practice, but did not quite know what to make of it. It only came to light when it was implicated in the 1857 banking crisis: the interbank market for these bills froze up, and suddenly insolvent banks and brokers demanded that the Bank of England temporarily exchange them for fully-fledged central banknotes to halt bank collapses and all the unemployment they would lead to. Ultimately, Marx concluded, the Bank of England was not able to avert crisis because of the limitations on its own gold reserves, which were rapidly draining overseas. English prices had stretched away too far from the gold anchor in the boom, and there were limits to the banking system’s capacity to maintain convertibility in such conditions; credit-money was therefore over-extended, and had to be jerked back in one way or another.
With the gold anchor fading away gradually under Bretton Woods, and definitely a thing of the past by the mid-1970s, Marx’s ultimate limit no longer held, at least not for the American central bank. The same period was one of rapid financial innovation, which Minsky  shows to be linked to the evolution of bank position-making practices. Without the ultimate anchor of gold, there was no reason to dismiss the possibility of continual inflation, and the problem of central banking was more open-ended, with two sometimes incompatible goals – the traditional one of avoiding financial over-extension and crisis, and a new one of limiting the pace of price inflation. [Minsky, 1982] But in both cases private finance’s ability to stretch systemic liquidity on any given reserve base means that the central bank is often in a reactive position, far from being the setter of ‘the money supply’ or even ‘the interest rate’ of Keynes’s General Theory.
1 See also Harvey [2006: 241] on money “as the incarnation of general social power, independent of and external to particular production processes or specific commodities”, though also “a contingent social power, ultimately dependent upon the creation of real value through the embodiment of social labour in material commodities.”
2 The conceptualisation of prices and output with reference to income-expenditure flows rather than monetary quantities and velocity was already a current within mid-19th century political economy. The ‘income approach’ was most clearly stated by Tooke , who was highly influential on Marx’s monetary theory. See Schumpeter [1954: 708-10] who writes that Tooke’s formulation opened new paths of monetary analysis, “one of which ends at Keynes’s General Theory.”
3 In the analysis of the first volume of Capital, this is due to the possibility of hoarding money outside of the channel of circulation. In the Volume III analysis, a more complex treatment emerges once credit and credit-money are brought into the picture.
4 Chick  presents liquidity differently. For her, prospective capital gains and losses are a part of liquidity rather than yield. Thus capital security and the rapidity with which an asset can be converted into means-of-payment are both ‘dimensions’ of liquidity. This is a difference in terminology but not a difference in substance from my argument.
5 We could expand this into a more complex story, given financial instruments with a range of liquidity-return profiles. In the more general case, funds for net increases in the stock of less liquid financial assets can come from net decreases in the stock of more liquid financial assets if liquidity preference declines or if long rates rise relative to short rates.
6 Intermediaries may also specialise in spreading risk, but here I have focused on liquidity rather than risk throughout. The concepts of liquidity and risk are related in a complex way; I have limited the discussion to liquidity because it is more relevant to the question of monetary policy.
7 This generally refers to transactions with customers of foreign banks, but banking systems need not coincide with national borders. A banking system is properly defined in terms of the intertwining payments of its customers, and could possibly be sub- or trans-national.
8 For a discussion on the increased importance of household credit in recent decades, see Lapavitsas .
Victoria Chick : Macroeconomics After Keynes, Philip Allen, Oxford.
Victoria Chick : “The evolution of the banking system and the theory of saving, investment and interest”, in Philip Arestis and Sheila Dow (eds.), On Money, Method and Keynes: selected essays by Victoria Chick, Macmillan, New York.
Victoria Chick and Sheila Dow : “Monetary policy with endogenous money and liquidity preference”, Journal of Post Keynesian Economics, 24:4, Summer.
Suzanne de Brunhoff : Marx on Money, translated from 1973 French original by Maurice J. Goldbloom, Urizen Books, New York.
Sheila Dow : “Endogenous money: structuralist”, in Philip Arestis and Malcolm Sawyer, A Handbook of Alternative Monetary Economics, Edward Elgar, Cheltenham.
David Harvey : The Limits to Capital, Verso, London.
John Maynard Keynes : Treatise on Money, Macmillan, London.
John Maynard Keynes : The General Theory of Employment, Interest and Money, Macmillan, London.
Costas Lapavitsas : “Financialised capitalism: direct exploitation and periodic bubbles”, http://www.leftlibrary.com/lapavitsas1.pdf
Karl Marx : Capital, vol. 1, Pelican Books, London.
Karl Marx : Capital, vol. 3, Pelican Books, London.
Hyman P. Minsky : “The Federal Reserve: between a rock and a hard place”, in Minsky, Inflation, Recession and Economic Policy, M. E. Sharpe, Armonk.
Hyman P. Minsky : Stabilising an Unstable Economy, Yale University Press, New Haven.
Hyman P. Minsky : John Maynard Keynes, 2ed., McGraw Hill.
Robert Pollin : “Two theories of monetary endogeneity: some empirical evidence”, Journal of Post Keynesian Economics, 13:1, Spring.
Joseph A. Schumpeter : History of Economic Analysis, Oxford University Press, Oxford.