December 10, 2007
Gordon Smith on Larry Mitchell, The Speculation Economy: How Finance Triumphed Over Industry
Posted by Gordon Smith

Like the other reviewers, I quite enjoyed Larry's detailed description of the "formative era of American corporate capitalism" from 1897-1919. While Larry obviously is concerned about some of the effects of American corporate capitalism -- most importantly, the ways in which industry responds to the demands of finance -- this book is not a polemic. In the end, the power of Larry's telling lies in the simplicity of his thesis: "The speculation economy was a common stock economy." (193)

Larry sets the stage in Chapter 1 with an account of the founding of the American Economic Association as an attempt to encourage "perfect freedom in all economic discussion." The founders were breaking away from what Larry calls the "orthodoxy of laissez-faire," and the proposed platform -- drafted by Richard T. Ely, who as a professor at the University of Wisconsin was the object of a "trial" that became one of the great landmarks in academic freedom in the United States -- read as follows:

We regard the state as an educational and ethical agency whose positive aid is an indispensable condition of human progress. While we recognize the necessity of individual initiative in industrial life, we hold that the doctrine of laissez-faire is unsafe in politics and unsound in morals; and that it suggests an inadequate explanation of the relations between the state and the citizens.

Even though the condemnation of laissez-faire did not survive the inaugural meeting of the AEA, this proposed platform sets up the tension that Larry wants to explore: the role of the state in channeling the market. He spoils the punchline in the Preface: "The story of the formative period is a story of problems misperceived, transformations not yet understood and misguided regulation."

The portion of Larry's story that most fascinated me was the merger wave of the 1890s, which made "the business of America into the business of finance." (56) Contemporary observers were consumed by the issue of "overcapitalization," though the nature of that problem is difficult to pin down. As Larry reminds us, "capitalization" was a formal concept, referring to the nominal value of the stocks and bonds issued by the corporation. "Overcapitalization" meant simply that "the corporation was capitalized in an amount that was greater than the cash value of the assets that appeared on its balance sheet." (58) To modern eyes, this seems like a rather silly thing to be worried about because modern theories of valuation make the nominal values of value of stocks and bonds irrelevant. Larry acknowledges this, but notes that he is not much concerned about the substance of overcapitalization. Instead, he is interested in the fact that legislators believed that is was a real economic problem.

This belief led to an exaggerated concern over the potential for monopoly because, the reasoning goes, only through monopolization could promoters obtain the profits necessary to support their excessive issuances of stock. By focusing on the potential for monopolization, rather than on the market's need for information to produce accurate valuations, regulators encouraged expansive issuances of stock. Thus, "corporate promoters introduced the new middle class to the stock market, and it is here that both investor and market were transformed."

This is a bizarre tale, but one that must be understood to fathom capitalism as it is currently practiced in the United States and, increasingly, elsewhere in the world.

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