Derivatives, Money, Finance and Imperialism

Koninklijke Brill NV, Leiden, 2013 DOI: 10.
1163/1569206X-12341296
Historical Materialism 21.2 (2013) 149168 brill.com/hima
Derivatives, Money, Finance and Imperialism:
A Response to Bryan and Rafferty
Tony Norfield
School of Oriental and African Studies, University of London
tonynorfield@gmail.com
Abstract
This paper contributes to the debate on the role of financial derivatives for capitalism. It responds
to Bryan and Raffertys defence of their analysis and their critique of my own. The paper argues
that their analysis confuses what a financial derivative does, and mixes together different kinds of
derivative and non-derivative that play very different roles. After detailing these points, the
paper discusses the relationship between gold, money and derivatives, rejecting their notion that
derivatives are some kind of new commodity money. An important theme absent from Bryan
and Raffertys analysis is the relationship of financial trading and derivatives markets to parasitism
in the imperialist world economy. To illustrate this, the paper notes advantages enjoyed by the
major financial powers the US and the UK that are the main centres for the origination of
derivatives and for derivatives trading.
Keywords
derivatives, Marxist theory of money, gold, fiat currency, exchange rates, imperialism
My article Derivatives and Capitalist Markets explained how the growth of
derivatives trading should be seen in the context of the capitalist crisis. The
argument was that the boom in derivatives was a sign of the decrepitude of
modern capitalism and I noted that, for the US and the UK especially, the
financial sector was a key dimension of their economic power as imperialist
countries.1 Here, I will highlight some important issues on derivatives and
for financial dealing in general that illustrate the operations of the imperialist
world market. These issues will also bring out the differences between my
analysis of derivatives and that of Bryan and Rafferty.
The response of these authors to my article2 deserves a reply in two
respects. Firstly, and most importantly, one always hopes that debate will
1.Norfield 2012a, p. 129.
2.Bryan and Rafferty 2012.
150 T. Norfield / Historical Materialism 21.2 (2013) 149168
lead to a clarification of positions and a development of understanding, if not
necessarily to agreement. Secondly, while Bryan and Rafferty appear to have
included me in differences they have with other authors on this topic with
little or no justification in some cases they do also raise specific objections to
my analysis that need to be answered. In footnote 11 of my original article, my
comment on their major book on the derivatives market was that by failing
to place derivatives in the context of capital accumulation and crisis, they
present a misleading idea of the role that derivatives play in the system.3 They
have added to this misleading impression in their reply to me.
Definitions, derivatives and money
Bryan and Raffertys reply begins with a discussion of definitions of money
and they claim that I, among others, reject their thesis largely on definitional
rather than analytical grounds.4 I do not speak for other critics of Bryan and
Rafferty, but my objections are based on an analysis of the role of derivatives,
not on whether derivatives correspond to a tight, unchanging definition of
money. They sum up their core position as follows:
Our proposition is not that derivatives are money, as if they have jumped inside
some pre-given definition of money. It is that derivatives have moneyness and
the conception of money needs to be loosened to take account of how financial
markets are working. What do we mean by moneyness? Essentially, we mean
liquidity the ability to be converted to something else with minimum loss of
value or time. Cash is therefore the core measure of liquidity for goods and services,
but asset markets may be different. Because derivatives involve an exposure to
the performance of an underlying asset, but are unencumbered by the necessity
of legal or physical ownership of the underlying asset, they are innately readily
transferrable; that is, highly liquid. So liquid, indeed, that they embody money-
like attributes.5
I agree with the need to analyse how financial markets are working, rather
than to get sidelined into a debate over definitions. But the problem is that
their analysis of how derivatives work in relation to money is wrong quite
apart from the instances where they do actually say that derivatives are money,
albeit in phrases such as distinctly global money or distinctively capitalist
money (as cited in my article). In the paragraph just cited, they compare
the liquidity of cash to the liquidity of derivatives contracts to argue for one
3.Bryan and Rafferty 2006b.
4.Bryan and Rafferty 2012, p. 98.
T. Norfield / Historical Materialism 21.2 (2013) 149168 151
money-like attribute of derivatives. The time-limited character of derivatives
contracts means that this is stretching the point somewhat, but I will examine
that issue further below. Later, they argue that
derivatives on exchange rates and interest rates offer some inter-temporal
guarantees of a unit of measure they are a store of value in a world without
a stable unit of measure. They may only store value for a short time perhaps
three months; or only for hundredths of a second in high-frequency electronic
trades. They may also have their own vulnerabilities to crisis. But, however brief
and fragile, they provide in aggregate an important, liquid store of value. That
sounds like a money role.6
The previous two citations illustrate the two conceptions about financial
derivatives that pervade their analysis: firstly, that derivatives involve an
exposure to the performance of an underlying asset and secondly that they
provide a liquid store of value. I have no objection to the first interpretation
that is more or less what derivatives do. However, their analysis extends
this aspect of derivatives, through the link with the term liquid, to the view
that derivatives somehow store value. It is this, in particular, that I consider
to be wrong, but it also appears to underpin their conception that financial
derivatives are a form of money, as I discuss below.
To begin with, however, I will deal with what Bryan and Rafferty call my
money-theory howler. In the article, I wrote that there is no derivative-
currency unit of account, measured in pages of contract-terms, or with
denominations determined by how far it is from the underlying asset-value.
I agree that this statement is wrong, and it does, as they say, conflate money
with money of account.7 This was a mistaken phrasing; a correct one to better
express what I meant would have been that there is no derivative-currency
money, with units of account measured in pages of contract-terms, etc. They
declare in their reply that, [o]f course, there is no derivative currency. Good, I
am glad we agree. But I must say that I did not get that impression when reading
their work on derivatives! That was why I made the comment in my article. For
example, part of a summary of key points in their book on derivatives says:
2. In the context of floating exchange rates, financial derivatives now anchor the
global financial system in a role comparable to that played by gold when exchange
rates floated freely before the First World War.
3. In performing this anchoring role, derivatives take on the characteristics of
global money. They are money that transcends the conventional national system
of money.
4. The foundation for derivatives-as-money is not state guarantees, but a commodity
basis. The last hundred years has not seen a shift away from a commodity basis to
money, but the re-discovery of a new commodity basis.8
That was one place where I found the derivative currency concept, but there
are others. If all they are really saying is that derivatives have been a growing
part of the mechanism for comparing, trading and hedging financial market
currency values, interest rates, equity prices, etc., then that is not controversial.
However, they seem to be going much further than this with their third, related
notion of how derivatives commensurate different forms of capital:
... Norfield misses the key issue of derivatives and the analytical challenge they
entail. By framing an exposure to the performance of an underlying asset as itself
tradable, things which have not hitherto been priced relative to each other are
now presented in a form where critical dimensions of their relative values can be
mutually recognised. The consequence is that derivatives represent a process of
continual across-capital commensuration in the active process of accumulation,
while Norfield can only conceive of commensuration as a static process, in
exchange: in a sense after accumulation.9
This is heady stuff, and it left me feeling that even the particles whizzing around
CERNs Large Hadron Collider would appear to be pretty static compared
to the continual across-capital commensuration in the active process of
accumulation that derivatives seem to perform. However, the fact that in my
original article I located the explosion of derivatives trading in the process of
capital accumulation and crisis should give cause to question the validity of
their argument that I had a static approach to these issues.
In the following sections I will show that Bryan and Raffertys analysis
confuses what is really going on with derivatives. Although in many places
they make perfectly valid and useful points on how derivatives are used and
the roles they play, they end up casting derivatives as the actors in the process,
rather than seeing them far more simply, and far more accurately, as forms of
financial transaction that have developed in response to volatility in capitalist
markets and problems in capital accumulation more generally.
8.These are summary notes at the start of Section 2 of the book. See Bryan and Rafferty 2006b,
p. 103.
9.Bryan and Rafferty 2012, pp. 1045.
Special FX derivatives
Much of Bryan and Raffertys analysis of derivatives is founded on their
observation of the foreign exchange forward market, on a misunderstanding
of this market and on an attempt to generalise this view to other financial
transactions using derivatives. In this section I will explain why foreign
exchange forwards are a special kind of derivative, one with characteristics
clearly different from interest rate swaps, futures and options.
In their book, and in other articles, they note how the unpredictable
nature of foreign exchange rates (and interest rates) following the breakdown
of the Bretton Woods system made capitalist calculations of value more
troublesome.10 In the wake of this, derivatives rose to prominence by acting as
a means of providing a basis for valuing assets in different countries. More than
this, they claim derivatives provide a valuation method that is independent of
national currencies and that they were a means of overcoming the limitations
of national fiat money. For example:
Derivatives provide what nation-state fiat money could not provide on a global
scale: they secure some degree of guarantee on the relative values of different
monetary units.11
and
Derivatives claim to a general role as money comes not so much from their
enormous daily usage, but from the role they play in commensurating a wide
range of financial (and physical) assets, including diverse forms of money. They
are, in this sense, behind the scenes money, ensuring that different forms of asset
(and money) are commensurated not by state decree (e.g. fixed exchange rates)
but by competitive force.12
This sounds intriguing, but it is wrong. The forward foreign exchange market
does not provide a separate means of valuing assets compared to national
currencies. It is based upon a calculated link between the current exchange rate
10. I do not underestimate the importance of this episode as a benchmark event for new forms
of financial turmoil and for the growth of financial derivatives in subsequent years, but it would
of course be a mistake to presume that before 1971 capitalist calculation was a simple, risk-free
process. There had already been currency realignments within the Bretton Woods system among
the major capitalist powers from the late 1940s and, with growing frequency, into the late 1960s. The
growth of the eurodollar market and the eurobond market, developments that accentuated
the process by which international capital movements more easily overcame national barriers,
are also dated from the late 1950s.
11. Bryan and Rafferty 2006a, p. 87.
12. Bryan and Rafferty 2007, p. 153.
of one national money for another and the prevailing level of money-market
interest rates in each of the two currencies. Once the latter are given, so is the
forward exchange rate. A company, or bank, trading in foreign exchange might
deal in the forward market, so that one could argue that it is the forward rate
that drives the spot rate, but there is still a determined link between spot and
forward exchange rates that is given by the interest rate differential between
the two currencies.
For a simple example, consider that currency A is worth 100 units of currency
B in the spot market, and the 1-year money market interest rate is 2% in country
A and 1% in country B. In that case, the 1-year forward exchange rate is 99.13 In
other words, given these interest rates (where As rate is higher than Bs), in
one years time one unit of currency A will only buy 99 units of currency B,
representing a 1% gap based on the interest differential. If the 1-year forward
exchange rate were different, for example, higher at 99.5, then this would lead
to a market arbitrage deal. In this case, it would pay a dealer to sell 100 B at the
spot rate and buy one unit of A, then invest the A at 2%, and at the end of the
year get 1.02 units of A, including interest. The dealer would do a forward deal
at the same time as the spot deal, agreeing to sell the 1.02 units of A and to buy
B back in one years time at the quoted forward rate of 99.5. This would give
the dealer 1.02 99.5 = 101.49 units of B, so that the return on B is close to 1.5%,
not the 1% interest rate on B in the market. This kind of trade would end up
raising the spot exchange rate value of currency A compared to the forward
exchange rate, and so restore the gap between the two to the 1% interest rate
differential.
Forward FX deals do provide a fixed future exchange rate for the parties
involved, but one that is tied to the current spot rate of exchange of the two
currencies and the interest rate differential on them. The forward exchange
rate derivative does not overcome national currencies and interest rates, nor
does it stand as a separate entity. To believe that it does is like believing that a
pantomime horse is really a horse, not a costume with two individuals inside.
The forward FX deal in fact generates the same values as doing the transaction
now, at todays spot exchange rate, and then depositing the funds (e.g. to deposit
US dollars that have just been bought with euros) at the relevant interest rate
until they are required (e.g. to pay a future invoice in US dollars). That the
forward deal is more convenient for capitalists lies in the fact that no funds
(euros) need be advanced now, when such funds may not be available, only
on the maturity of the deal. However, there is an obligation to advance the full
13.The example avoids precise calculations with day counts in order to illustrate the basic
mechanism.
funds later (and also to receive the other currency). This usually happens with
forward deals, although the transaction can also be reversed before maturity,
at a profit or loss compared to prevailing interest rates and exchange rates.
Forward FX transactions are only modified forms of a spot transaction. In
these cases, the spot exchange rate and/or the forward exchange rate is used to
compare the values of the two sets of funds in different currencies, so that, for
example, $130 million is exchanged for 100 million if the euro-dollar exchange
rate is 1.30. But it is the exchange rate of the two fiat monies that is doing the
commensurating, not the forward derivative. All the derivative is doing
as Bryan and Rafferty recognise, but confuse with other issues is to fix the
forward rate at a particular level consistent with the prevailing spot rate and
interest rates.
The reason I have gone into some detail on forward FX deals is that these
are not typical of other financial derivative operations, such as interest rate
swaps and options. In these latter, there is no future advance of all the funds
underlying the deal at any point.14 Furthermore, the latter derivatives are
normally valued on the basis of the differences between contract prices and
prevailing market prices. This difference is multiplied by the notional amount
of funds involved to result in a settlement sum. These notional amounts are
not exchanged.
Another type of FX derivative deal that is different from other derivatives,
but in a similar way to FX forwards, is the FX swap. In this case, as the Bank
for International Settlements explains, there is the actual exchange of two
currencies (principal amount only) on a specific date at a rate agreed at the time
of the conclusion of the contract (the short leg), and a reverse exchange of the
same two currencies at a date further in the future at a rate (generally different
from the rate applied to the short leg) agreed at the time of the contract (the
long leg).15 In more normal language, one can say that this kind of deal occurs
when one party to the transaction needs funds in a currency that it does not
own for a particular period of time. It then buys the currency it wants, handing
over the currency that it owns in exchange, but reverses the deal at an agreed
time later, buying back its original currency. The two deals are usually done
14.Except in the case of actually exercising an in-the-money option, rather than closing it
out at a profit. Commodity and bond futures contracts have further complications on delivery
of the underlying commodity or security if the contract is not closed out, but these need not be
discussed here.
15.BIS 2010a, p. 32. There is yet another currency-related derivative along these lines called a
currency swap, in which, among other things, it is usually agreed to exchange principal amounts
in different currencies at a pre-agreed exchange rate at maturity. The currency swaps market is
only around 67% of the size of the single-interest-rate swap market, however, and I will not
discuss it here.
at exchange rates based again on the spot exchange rate and the relevant two
interest rates. This kind of deal is common for capitalist companies that have
business in foreign exchange. It is important to stress here that the actual funds
are exchanged, since that is the whole point of the deal. This is something quite
different from interest rate swaps, etc.
Bryan and Rafferty refer to the recent use of large-scale liquidity swaps
between major central banks. These are similar to the FX swaps just noted.
They argue that these show how liquidity itself is drawing away from being
defined with reference to cash or any particular stock of money, and moving
towards the diversity of asset forms provided in derivative markets.16 Well,
the point can be made much more simply and accurately: these are essentially
just short-term collateralised loans! The US Federal Reserve lent dollars to the
European Central Bank, the Bank of England, etc., and got collateral in the
form of the other banks currency. Then, the other banks repaid the dollars
at the agreed time, plus interest, and got their own currencies back again.
These transactions were significant for illustrating the scope of the financial
crisis that took place and they also show the key role of the US dollar and
the powerful position of the US in the global monetary system but Bryan and
Rafferty are too enthralled by foreign exchange derivatives, or perhaps the
fact that foreign exchange rates are not fixed, to see that this is merely a short-
term currency loan between central banks.
Foreign exchange forwards and swaps are longstanding forms of financial
dealing, predating by far the breakdown of Bretton Woods in the early 1970s.
Prior to 2010, the BIS used to include both spot transactions and these forms of
dealing under the heading of traditional foreign exchange markets to separate
them from the more evidently derivative deals such as options and currency
swaps, and many central banks still make this distinction. This reflected the
reality that FX spot rates, FX forwards and swaps are part of the same market,
linked by the relevant money market interest rates. All that is happening in
these markets is that the gap between the spot and forward exchange rate is a
function of the interest rate differential between the two currencies involved.
None of the rates is fixed, and all that is done is to set a particular forward FX
rate today, based on the currently prevailing spot rate and interest rates.
Derivatives and non-derivatives: what they do and what they do not
In this section, I take issue with some other examples Bryan and Rafferty use
to back up their understanding of derivatives. I will first examine interest rate
swaps, then I will look at some other financial products, ones whose description
as derivatives is suspect. This risks getting into a debate over definitions (this
time for derivatives), but I hope instead that this discussion highlights further
what is actually going on.
Bryan and Rafferty claim that Derivatives, especially through swaps...
establish pricing relationships that readily convert between (we use the term
commensurate) different forms of asset. Derivatives blend different forms
of capital into a single unit of measure.17 Elsewhere, they also make a more
explicit, general claim that for any corporation, at any time and any place,
derivatives present a real-time measure of asset values.18 But this is just wrong.
It confuses the degree to which foreign exchange rates measure the value of
assets (in other currencies) with the operations of an interest rate swap and
other derivatives.
Take a simple example. In an interest rate swap, a company may agree to
receive a fixed 1% rate of interest on a notional sum of $50 million and to pay a
variable rate of interest on the same sum over the next five years. The notional
value of the swap is $50 million, but the market value of the swap will vary
according to the difference between the 1% fixed rate and the variable rate.
This value could be positive, negative or zero. The swap derivative is not a
store of value for the $50 million, even though that is its notional amount.19
All the swap represents is a way of changing the form of interest rate exposure
for the company. In this case, the company wants to have a fixed rate for its
income and agrees to pay the floating rate, for example whatever six-month
LIBOR happens to be every six months for the next five years.
Derivatives such as interest rate swaps can be used to hedge against moves
in financial market prices, but that does not make them a store of value. As
explained in my original article, all derivatives have a time limit to expiry.
During its life, the derivative will be valued in relation to the difference
between the contract price and the price in the market, perhaps in a complex
manner. On expiry, this difference value, plus or minus, is fixed. After expiry,
this function is no longer performed. Bryan and Rafferty obscure this by
appealing to derivatives in aggregate, presumably to assert that another
derivative will come along and take up the role of store of value when the
first one has expired.20 However, this only admits the fact that the derivative is
not a store of value. Even during its fleeting existence in the realm of financial
17.Bryan and Rafferty 2006b, p. 12.
19.I leave out of account amortising swaps and step up swaps, where the principal is reduced
or increased according to an agreed, predetermined formula.
market transactions, the market value of the derivative contract does not
store anything other than a calculation of the difference between the contract
price and the relevant market price, multiplied by the notional value of the
contract. It does not store the value of the underlying asset, financial security,
etc. Bryan and Rafferty flip between this erroneous store of value concept and
a (slightly) more correct one that derivatives measure the performance of an
underlying asset something that can be done because they are a difference
measure.
Turning to some other financial products, Bryan and Rafferty argue that
these show both a blurring of the concepts of money, commodity and capital,
and the way that derivatives can become a store of value in a world without a
stable unit of measure.21 There are, indeed, financial products like convertible
bonds that blur the categories of debt and equity, etc., and some may also have
features related to options. But it is a bit odd of them to include preference
shares in their list of examples, since these are not derivatives at all, only a type
of equity security.
Collateralised debt obligations (CDOs) and mortgage-backed securities
(MBS), also cited by Bryan and Rafferty, are another problem. These are very
similar to normal bond securities, rather than being derivatives. With CDOs,
the only difference is that the interest and principal payments they offer
might be based on the returns from other securities (the fact that CDOs may
be divided up into different tranches with different degrees of credit risk is a
separate issue). This makes them a derivative only in this respect, because the
CDO is still basically a bond in its payment structure, though one whose credit
risk will depend on the risk associated with getting the returns from the other
underlying securities. A normal bond, by contrast, is one where the credit risk
is on the company or country that floated the bond and which is responsible
for the interest and principal payments.
The CDO is nevertheless not a derivative security in the way that swaps,
options and futures are. In the latter cases, the value of the derivative security is
a function of the difference between the contract price(s) and market price(s),
which could then result in a positive, zero or negative market value. A CDO
is only worth zero if all the underlying assets have defaulted and there is no
prospect of recovering any funds. With mortgage-backed securities (MBS) they
are even closer to a regular bond, since the payments on the MBS are usually
made up directly from a range of mortgage interest and principal receipts.
In my original article, I was cautious about labelling securities such as CDOs
and MBS as derivatives for this reason and left their status unclear. On further
consideration, I would not put these securities under the heading of derivatives
except where they also have other features, as in so-called synthetic CDOs.
This essentially non-derivative status of MBS is the reason the US Federal
Reserve could purchase MBS from the private sector in an effort to provide
liquidity to the financial markets. These purchases cannot be described as
the Federal Reserve buying derivatives, as Bryan and Rafferty claim. They are
the Federal Reserves, and other central banks, purchases of bond securities,
as the BIS article to which they refer notes.22
Money, gold, derivatives and value theory
In this section, I will discuss my conception of global money and its relationship
to financial derivatives. This will introduce some other aspects of derivatives
and imperialist finance to which Bryan and Raffertys analysis pays little
attention. I will not comment on their implicit attribution to me of views I
do not hold; for example, that a core definition of money is as a means of
exchange.23 The issue I will focus on is what is global money, and whether
derivatives have taken over the previous role of gold in some fashion.
Gold has an intrinsic value as a commodity because it is a product of social
labour. Its physical characteristics have made it suitable for acting in the role
of money, but the degree to which it does this depends especially on the role
of the state in organising the monetary system. Golds actual use as money has
long been restricted within nation states, but it has more often been used for
dealings between them when payment by national fiat monies is unacceptable.24
Despite its own intrinsically changing value, gold was seen as a stable measure
of value, at least compared to fiat money that could be undermined by state
authorities. However, this did not mean that only gold was used in exchanges
between countries. Even in the classical Gold Standard period of the nineteenth
22.They refer to Chen, Filardo, He and Zhu 2011, after stating that the worlds leading central
banks now have massive holdings of a range of securities and derivatives on their books, all in
the name of managing market liquidity and securing forms of monetary stability (Bryan and
Rafferty 2012, p. 102). However, Chen et al. do not refer to central banks buying derivatives, but
buying bond-type securities (Chen, Filardo, He and Zhu 2011, p. 235). One might argue that the
Federal Reserves Maiden Lane assets, resulting from the demise of Bear Stearns and AIG, are
derivatives, but they are also made up from mortgages, loans and various MBS and CDOs.
23.They spend half a page discussing in their Reply to Tony Norfield how for some analysts
the core definition of money is a means of exchange and that this is a mistake (Bryan and Rafferty
2012, pp. 99100). However, there is nothing in my article to suggest that I hold such a view, and
I reject this and other examples of guilt by association as a way of debating.
24.See, for example, Frances demands in the late 1960s for payments in gold from the US,
rather than France being willing to accept increased dollar balances.
century and up to 1914, Britain managed a gold-sterling standard. Then, the
pound sterling was promoted to be as good as gold, so a bill on London was
seen to be as good as actually having the shiny yellow metal. In fact the bill
was even better, being readily exchangeable in financial transactions and
offering an interest yield. This worked for as long as there was international
confidence in British economic strength and policy, things that would maintain
the value of sterling in relation to gold. This position, of course, came under
pressure during the First World War and in the inter-war crisis.
In the post-1945 period until the 1960s, with the US clearly the dominant
economic power, the US dollar also became as good as gold. The Bretton
Woods system had the US dollar as its foundation, with other currencies
values being fixed in relation to the dollar and only the US dollar being
exchangeable into gold by the US central bank, and then only on request from
foreign central banks.25 The dollar, like sterling before, was a fiat currency. But
governments and capitalists worldwide accepted its role of having a claim on
value produced, not simply in the national arena. It was through the 1960s,
however, that the dollars role was undermined by the recovery of rival powers
to the US. Although none of these was individually a significant challenge to
US economic power, together they ended up owning far more dollar assets
in their reserves than the US had in terms of gold.26 Through the 1960s, the
Bretton Woods equation that one troy ounce of gold was worth $35 was slowly
undermined. It was broken completely by 1971.
We should look upon the dollars value, or any other fiat currencys value,
both pre- and post-1971, as the degree to which it represents a claim on social
labour. This cannot be represented directly as a certain amount of socially
necessary labour time, but only in the form of an exchange value. The exchange
value with gold is neither a unique nor a necessary reference point. The fiat
currencys value is clearly contingent upon a range of different factors. Within
the national sphere, the dollars value will be judged in terms of its purchasing
power, its exchange-value with a myriad of commodities. Internationally, the
extent of its claim on resources will also depend on its ability to be used as a
means of purchase for commodities, or to be exchanged at a particular rate
for the monies of other countries. This is affected by the rules each country
has for exchanging national monies, rules greatly influenced by the dominant
power(s) in global financial markets. Fluctuations in the dollars exchange rate,
or the exchange rates between third currencies, obviously disrupt capitalist
25.See Eichengreen 2011 for a useful and concise summary of international monetary
developments.
26.This imbalance first occurred in 1960 (cf. Eichengreen 2011, p. 50).
calculations for international deals. This is the uncertainty (among others)
that derivatives can address.
Bryan and Raffertys analysis of derivatives is based around these
developments, and they argue that there has been a problem ever since the
decline of gold as global money, because the use of national currencies (even
under the Bretton Woods system) could not rule out exchange rate instability:
Our argument is that, following the decline of gold as global money, capital has
gravitated towards an alternative basis to the global financial system, and it
shows this tendency for one basic reason: national currencies...cannot meet the
requirements of both domestic monetary policy and global monetary stability.
The threat of exchange rate instability is on going.
Accordingly, products emerged (financial derivatives) to deliver what pure
exchange processes could not. By forming a network of anchors, derivatives are
permitting capital and commodities to flow as if there were a single anchor.27
Later in their book, elaborating on this point, they argue:
They are not therefore a fixed single anchor, but a flexible series of many small
floating anchors. Critically, they can perform this function because they exist at
the intersection of money and commodities: derivatives themselves are money
(they perform a money function in pricing) and commodities (they are traded
products) at the same time.
... Derivatives, in their anchoring function for global finance, play the role
of a commodity money. While commodity money is usually associated with
emphasising the commodity characteristics of money (gold); derivatives also
highlight the monetary characteristics of all commodities.28
But here, and elsewhere, they are mixing up two things: the role of gold as
a measure of value and the inherent instability of exchange processes.
Derivatives can provide a temporary fix for an exchange rate or interest rate
what they call an anchor, or, more accurately, a floating anchor essentially
by providing a form of future price insurance based on todays prices. However,
that does not mean (as I showed above) that the derivative measures or stores
asset values.
Nor does it mean that derivatives play the role of commodity money in
place of gold. Here, Bryan and Rafferty get themselves caught on a barnacle
with their anchoring metaphor: Financial derivatives are produced (as
contracts) and offered on the market as products of the labour of financial
28.Bryan and Rafferty 2006b, pp. 1312.
institutions and operatives that stitch up the deals.29 Possibly in deference to
a Marxist view of commodities as products of social labour, Bryan and Rafferty
want to extend the status of commodity to derivatives by arguing that labour
is expended on their production. However, here they commit what one might
call a value-theory howler.
Capital operating in the sphere of circulation may offer all kinds of financial
services to companies or individuals, as products that it sells. Such products
may even be derivatives, used as a means to limit interest rate or exchange
rate risk. However, such capitalist operations can only exchange one form of
existing value for another, they cannot produce any new value or transfer value
from the resources they use. They are simply a cost to the overall capitalist
commodity system, even if paying that cost may be beneficial to the capitalists
who are in the productive sphere of the economy. All the costs to make the
products and the revenues the financial sector gains from them represent a
deduction from the total surplus value that the capitalist system produces. This
makes the financial sector a burden on society as a whole, although it can still
be very profitable for individual companies, and also for countries, as I will
discuss in the next section. The financial sector can assist the production of
value, and the raising of productivity levels, but these things are actually done
by the productive sector of the economy. These points are made to summarise
the role of the financial sector from the point of view of capital investment and
accumulation.30
But how can we understand what Bryan and Rafferty call the commodities
produced by this unproductive financial services sector, in particular those
things called derivatives? To say the least, these would be weird commodities.
Their costs of production are irrelevant to their value, which remains zero
in terms of any value transferred or created.31 FX forward and swap deals do
imply an actual transfer of funds, as noted earlier, but the commodity value
of this deal is only a difference measure based on changes in market prices
(and the value of the transferred funds is determined by the value represented
by the fiat currency, not by the value of the derivative). In the case of interest
rate swaps, etc., as discussed before, there is no direct transfer of funds, and
the derivative commodity money could have a positive or negative value, not
29. Bryan and Rafferty 2006b, p. 153.
30. See Norfield 2013 for a discussion of these issues related to capitalist profitability and the
role of finance for imperialism.
31. Of course, financial companies will pay attention to their costs and to their volume of
dealing, and it is also true that a more efficient dealing operation will tend to be more profitable.
However, an ability to appropriate a portion of value produced elsewhere does not make this
activity productive.
based on anything to do with the amount of sweat from the brow of derivatives
traders. The world of derivatives is full of wonder and torment, but Bryan
and Rafferty too often try to render it sublime through a mystifying mode of
expression, as Marx once wrote.32
Finance, imperialism, parasitism and derivatives
The biggest problem with Bryan and Raffertys view of derivatives, however,
is that it pushes into the background the role of the US dollar and the role of
finance for the major imperialist powers. While derivatives have obviously not
replaced national money, they argue that they have effectively transcended
the national basis of contemporary money.33 The point I would stress by
contrast is that a small group of major powers have privileged positions in the
global financial markets, something that greatly modifies for them what Bryan
and Rafferty call the new, more dynamic (and ruthless) edge to capitalist
competition that comes from derivatives. Here I would single out the US
and the UK, which can use their positions at the centre of the global financial
system as a means of appropriating value from other countries.
Two examples will illustrate this point. As a way of introducing these, first
note that simple models of exchange rate determination usually focus on some
version of purchasing power parity, based on the idea that relative productivity
and price competitiveness set the fundamental value for one currency versus
another. If the value of one currency is too high, a trade deficit results, and
the supply-demand balance for the currency turns negative, so reducing its
value in the market, and vice versa. However, the total picture for the demand/
supply of a currency is quite different in reality. It has less to do with the value-
productivity of national capitals and much more to do with their position in the
global economy. I do not want to go too far in making this point. A country will
need to have some position of economic strength in order then to be able to
gain power in international economic relations. However, the examples I give
next indicate how financial strength can bring its own rewards for particular
imperialist countries.
My first example is for the US. Aside from trade flows, the determination
of the US dollars value is impacted significantly by the demand for and
supply of dollars driven by the flows of finance. For all currencies, banking
flows, together with direct and portfolio investment flows, can easily be more
important influences on the exchange rate than trade in goods and services.
32.Marx 1974, Chapter 24, p. 397.
However, if a country is a major financial power like the US, it can attract
flows of foreign funds into its equity and bond markets, or can benefit in other
ways from countries keeping assets denominated in US dollars. Although by
the 1970s US economic strength had clearly declined compared to other major
countries and the dollar had devalued, this did not lead to a lasting setback for
US financial strength. The ensuing financial turmoil actually boosted the role
of the US dollar in global markets, given the inability of any other country to
offer an alternative world money. The dollar remains by far the major global
currency for international trade deals and financial flows, with dollar-based
asset markets being the largest and most liquid for international investors.
There were various attempts by continental West-European powers to build
an alternative system to protect them against what they saw as US-based risks,
and also to gain some of the US advantages, culminating with the euro project.
China has much more recently been building up the international role of the
renminbi. However, China is starting from a minuscule position. In 2010, the
US dollar was on one side of 85% of all foreign exchange deals, compared to just
39% for the euro and a mere 1% for the renminbi.34
This is how the US was in the position to do the FX swaps that Bryan and
Rafferty cited. It was a case of central banks outside the US having a desperate
demand for US dollars to prop up their banks and companies international
liquidity positions. This had nothing to do with derivatives per se. Aside
from the power accrued from this role of essentially being in charge of global
liquidity, the US of course gains a great deal of value from it. In 2011, the US
gained a net $235bn in 2011 from foreign investment income, more than double
the amount in 2007, based on its ability to pay close to zero interest rates on
US government debt owned by foreigners.35 This ability is founded on the role
of the US dollar as the main global currency. Having a net foreign investment
income is extraordinary, given that the US is a big net debtor country, but this
is because it earns much more than a near-zero rate of return from its foreign
investments, especially from its direct investments abroad.
Notably, the UK is the only other country in the world with a net investment
earnings surplus despite having a net debt position. Britain manages this feat
helped by its ability to attract low-cost funds via the banking system,36 given
that the UK is the location of the worlds biggest international banking centre.
This is another sign of the economic privileges accruing to those powers
dominant in finance.
34.BIS 2010a, Table B4, p. 12.
35.Net foreign investment income figures calculated from BEA 2012, lines 13 and 30 in Table 1,
p. 59.
36.See Norfield 2011 for a discussion of this mechanism.
My second example is a different aspect of privilege in value appropriation:
financial services. A question Bryan and Rafferty do not ask is why more than
half of the global derivatives market is based in the UK (principally London)
and the US (principally New York and Chicago) if derivatives have transcended
national money systems. Take foreign exchange: the UK is the base location for
global dealing, having 37% of the total turnover; the US has 18%.37 London has
by far the biggest share of the global FX market in spot, forward, swaps and
options transactions. The bulk of UK-based trading is in currencies other than
sterling, so the dealing has indeed gone beyond the national money system.
But this perspective overlooks one critical role that British imperialism plays:
it is the broker for global capitalism. Britain takes a cut from the value of more
than a third of foreign exchange deals in the world economy. It is even more
dominant in the so-called over-the-counter (OTC) interest rate derivatives
market, made up of direct deals between banks and their customers, accounting
for 47% of turnover in 2010, while the US had 24%.
Evident advantages for the UK economy are the large earnings from
financial services trading. Net financial services earnings amounted to nearly
40bn in 2011, covering almost 40% of the UKs 100bn trade deficit in goods
in that year.38 The UK has the second biggest surplus on financial services in
the world, usually just behind that of the US. If insurance services are added
to the reckoning on this account, then the UK surplus is the highest. These
net foreign revenues are a measure of what value is deducted from the world
economy by financial operations based in Britain. US politicians have been
angered by the way that trading derivatives in London has led to big financial
scandals hitting their own pockets, from the collapse of AIG in 2008 to the 2012
loss of over $6 billion by JP Morgans London Whale. However, this overlooks
the fact that an Anglo-American partnership designed this system, with at least
implicit government support and approval, and it has been mutually beneficial
to both powers.39
While the US is top dog in world finance, the UK is top leech. Both countries
have exceptional positions in their ability to appropriate surplus value from
the rest of the world via the financial system. It is a big mistake to look upon
the growth of financial markets, and certainly the derivatives markets, as
something that occurs as a transnational phenomenon outside of the interests
of these major imperialist powers and outside of their political influence,
37.Figures quoted here and below are from BIS 2010a and 2010b. See Norfield 2012b for a
review of the location-based statistics for global finance.
38.ONS 2012, Table 3.6.
39.Helleiner 1996 gives a valuable analysis of the evolution of the modern financial system,
but in my view he greatly underestimates its contemporary importance for British imperialism.
though that is not to say that they can control these markets. As I noted in my
original article, it is no wonder that these powers have done so little to curb the
financial sector, despite the unprecedented financial crisis!
Derivatives, imperial economic power and the crisis
In this section I will briefly discuss the relationship between derivatives and
the capitalist crisis. Bryan and Rafferty say that in my original article my
agenda was that an understanding of derivatives be placed at the service of
theories of crisis and the falling-rate-of-profit tendency.40 That is true, but it
is not the whole story. My principal aim was to show how derivatives were
one expression of parasitism under contemporary imperialism, exemplified
by Anglo-American finance. But to do this I also felt it was important to
understand the dynamic behind the growth of derivatives trading. In my view,
that dynamic could only be explained by problems of capital accumulation
and crisis, underpinning which was a crisis of profitability. It is worth spelling
out where I did indicate the link with profitability to show that there is no
analytical leap here, as Bryan and Rafferty claim.
In my derivatives article I drew attention to the way in which trading of
these financial instruments boomed in response to low yields on financial
assets and pressures on bank profitability. I also argued that these low yields
were related, although not in a straightforward manner, to low profitability
on productive capital investment. The logic was that one would expect lower
profitability on productive investment to lead to lower dividend yields and
equity price increases, together with lower bond yields, although there may
be exceptions to this. In terms of empirical evidence supporting this view, two
relevant facts were noted: yields had been falling (in both nominal and real,
inflation-adjusted terms) and profitability was weak in the late 1990s and early
2000s. Citations from reports of a number of asset managers documented the
falling yields; a chart with a measure of the US rate of profit illustrated the
relevant trend. The causal links from low profitability and low yields to
the propensity for increased financial trading (and speculation) with derivatives
should be clear, though it is true that such trading is not only driven by low
yields.
However, one important feature of global capitalism that developed
through the first decade of the twenty-first century was not included in the
40. Bryan and Rafferty 2012, p. 107.
previous logic.41 This is how increased exports from China and other low-wage
countries to the US and other rich, consuming countries helped produce the
Greenspan conundrum, whereby long-term US Treasury yields were lower
than previous economic/financial relationships would have suggested. In
addition to anything directly resulting from the question of low profitability
on productive investment that I noted before, this also helped reduce bond
yields in major countries.
This happened in two related ways. Firstly, cheap imports had helped lower
US (and other countries) inflation rates, and, given the common central bank
policy of focusing on inflation, this helped to reduce nominal yields. Secondly,
a counterpart to the Asian trade surpluses with the US and other countries
was their large-scale purchases of major country bonds a means by which
they tried to stabilise their exchange rates. The end result was lower yields
on US Treasuries and in other major government bond markets. For the US,
this effect was documented in an important article published by the Federal
Reserve.42 These developments show how a combination of economic power
control of supply chains, etc. and financial power the role of the US dollar
as a reserve currency can combine both to give an imperialist power many
privileges and also to sow the seeds of the next crisis.
Conclusion
I did not plan to write about derivatives markets any further after my original
article in Historical Materialism, except to the extent that this would assist my
research into finance and contemporary imperialism. I look upon derivatives
markets as being essentially rather dull from a theoretical perspective, once
the basic relationships have been grasped, despite the exponential growth of
trading in these markets and their role in the crisis. However, my motivation
for spending extra time on this issue has been to throw more light on financial
transactions, ones that are important but which, not surprisingly, remain a
mystery to many people who might otherwise have a good knowledge of the
global crisis that engulfs us all.
My differences with Bryan and Raffertys analysis of the financial derivatives
market are many. However they deserve credit for highlighting the importance
41. I noted that trade with China and other countries could have boosted US profitability
beyond what otherwise it would have been (Norfield 2012a, p. 115), but I did not examine this
issue in any more detail.
42.See Warnock and Warnock 2005.
of these markets that Marxist theory had previously ignored, and for stressing
that contemporary forms of capitalist finance must be addressed, and not
just dismissed as speculation or in other ways that avoid a serious analysis.
Nevertheless, the key message from my original article, and from this reprise, is
that one cannot understand financial markets today, or indeed the crisis, except
by situating developments in the context of contemporary imperialism.
References
BEA 2012, Survey of Current Business, US Bureau of Economic Analysis, July.
BIS 2010a, Triennial Central Bank Survey: Report on Global Foreign Exchange Market Activity in
2010, Bank for International Settlements, December.
2010b, Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity
in 2010 (Final Results), Bank for International Settlements, December, available at: <http://
www.bis.org/publ/rpfxf10t.htm>.
Bryan, Dick and Michael Rafferty 2006a, Money in Capitalism or Capitalist Money?, Historical
Materialism, 14, 1: 7595.
2006b, Capitalism with Derivatives: A Political Economy of Financial Derivatives, Capital and
Class, Basingstoke: Palgrave Macmillan.
2007, Financial Derivatives and the Theory of Money, Economy and Society, 36, 1: 13458.
2012, Why We Need to Understand Derivatives in Relation to Money: A Reply to Tony
Norfield, Historical Materialism, 20, 3: 97109.
Chen, Qianying, Andrew Filardo, Dong He and Feng Zhu 2011, International Spillovers of Central
Bank Balance Sheet Policies, BIS papers No. 66, available at: <http://www.bis.org/publ/bppdf/
bispap66p.pdf>.
Eichengreen, Barry 2011, Exorbitant Privilege: The Rise and Fall of the Dollar, Oxford: Oxford
University Press.
Helleiner, Eric 1996, States and the Reemergence of Global Finance: From Bretton Woods to the
1990s, Ithaca: Cornell University Press.
Marx, Karl 1974 [1894], Capital, Volume 3, London: Lawrence & Wishart.
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available at: <http://economicsofimperialism.blogspot.co.uk/2011/05/economics-of-british-
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2012a, Derivatives and Capitalist Markets: The Speculative Heart of Capital, Historical
Materialism, 20, 1: 10332.
2012b, The City of London: Parasite of the World Economy, Economics of Imperialism,
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Warnock, Francis E. and Veronica C. Warnock 2005, International Capital Flows and US Interest
Rates, Board of Governors of the Federal Reserve System, International Finance Discussion
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