Justice Is an Option: A Democratic Theory of Finance for the Twenty-First Century

By Robert Meister

More than ten years after the worst crisis since the Great Depression, the financial sector is thriving. But something is deeply wrong. Taxpayers bore the burden of bailing out “too big to fail” banks, but got nothing in return. Inequality has soared, and a populist backlash against elites has shaken the foundations of our political order. Meanwhile, financial capitalism seems more entrenched than ever. What is the left to do?

Justice Is an Option uses those problems—and the framework of finance that created them—to reimagine historical justice. Robert Meister returns to the spirit of Marx to diagnose our current age of finance. Instead of closing our eyes to the political and economic realities of our era, we need to grapple with them head-on. Meister does just that, asking whether the very tools of finance that have created our vastly unequal world could instead be made to serve justice and equality. Meister here formulates nothing less than a democratic financial theory for the twenty-first century—one that is equally conversant in political philosophy, Marxism, and contemporary politics. Justice Is an Option is a radical, invigorating first page of a new—and sorely needed—leftist playbook.

• Language: English
• Publisher: University of Chicago Press
• Release date: Apr 19, 2021
• ISBN: 9780226734514

Book preview

JUSTICE IS AN OPTION

CHICAGO STUDIES IN PRACTICES OF MEANING

A series edited by Andreas Glaeser, William Mazzarella, William Sewell Jr., Kaushik Sunder Rajan, and Lisa Wedeen

Published in collaboration with the Chicago Center for Contemporary Theory

http://ccct.uchicago.edu

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JUSTICE IS AN OPTION

A DEMOCRATIC THEORY OF FINANCE FOR THE TWENTY-FIRST CENTURY

ROBERT MEISTER

The University of Chicago Press

Chicago and London

The University of Chicago Press, Chicago 60637

The University of Chicago Press, Ltd., London

© 2021 by The University of Chicago

All rights reserved. No part of this book may be used or reproduced in any manner whatsoever without written permission, except in the case of brief quotations in critical articles and reviews. For more information, contact the University of Chicago Press, 1427 E. 60th St., Chicago, IL 60637.

Published 2021

Printed in the United States of America

30 29 28 27 26 25 24 23 22 21    1 2 3 4 5

ISBN-13: 978-0-226-70288-9 (cloth)

ISBN-13: 978-0-226-73448-4 (paper)

ISBN-13: 978-0-226-73451-4 (e-book)

DOI: https://doi.org/10.7208/chicago/9780226734514.001.0001

Library of Congress Cataloging-in-Publication Data

Names: Meister, Robert, 1947– author.

Title: Justice is an option : a democratic theory of finance for the twenty-first century / Robert Meister.

Other titles: Chicago studies in practices of meaning.

Description: Chicago : The University of Chicago Press, 2021. | Series: Chicago studies in practices of meaning | Includes bibliographical references and index.

Identifiers: LCCN 2020039759 | ISBN 9780226702889 (cloth) | ISBN 9780226734484 (paperback) | ISBN 9780226734514 (ebook)

Subjects: LCSH: Finance, Public—United States. | Debt—Political aspects—United States. | Liquidity (Economics) | Social justice. | Marxian economics.

Classification: LCC HJ257.3 .M45 2021 | DDC 332/.04150973—dc23

LC record available at https://lccn.loc.gov/2020039759

This paper meets the requirements of ANSI/NISO Z39.48-1992 (Permanence of Paper).

CONTENTS

Preface

INTRODUCTION

ONE: FINANCE AND MARX

TWO: MARKET LIQUIDITY AND FINANCIAL POWER

THREE: TRAUMA OR INJUSTICE

FOUR: IS JUSTICE AN OPTION?

FIVE: JUSTICE AS AN OPTION

SIX: CAN CAPITALISM SHORT ITSELF?

SEVEN: FUNDING JUSTICE

CONCLUSION

AFTERWORD: SPRING 2020

ACKNOWLEDGMENTS

NOTES

BIBLIOGRAPHY

INDEX

PREFACE

Ten years after the Great Recession of 2007–9, it was common for opinion leaders to blame the rise of both left- and right-wing populism on the perceived injustice of the government bailout of Wall Street. As Bloomberg Businessweek reports:

It’s clear Obama was foolish to think public sentiment could be negated or held at bay. Financial crises are every bit as much about politics as economics. How could they not be? . . . Wages were stagnant when the crisis hit and have remained so throughout the recovery. . . . A bitter irony dawning on Geithner at the time . . . was that a substantial number of Americans saw the rising stock market not as a gauge of economic revitalization but as an infuriating reminder that the financial overclass responsible for the crisis not only got off scot-free but was also getting richer in the bargain. The iniquity stung. One complaint voters at campaign rallies still share . . . is that no Wall Street figure of any consequence served jail time as a result of the meltdown. By contrast, the U.S. Department of Justice prosecuted more than 1,000 bankers after the savings and loan crisis of the 1990s.

The story of American politics over the past decade is the story of how the forces Obama and Geithner failed to contain reshaped the world. The day-to-day drama of bank failures and bailouts eventually faded from the headlines. But the effects of the disruption never went away, unleashing partisan energies on the Left (Occupy Wall Street) and the Right (the Tea Party) that wiped out the political era that came before and ushered in a poisonous, polarizing one. The critical massing of conditions that led to Donald Trump had their genesis in the backlash. And the rising tide of economic populism among Democrats makes it all but certain that the next presidential election, and Trump’s possible successor, will be shaped by it, too.

The biggest effect of the financial crisis and its aftermath was a loss of faith in U.S. institutions. Initially, and not surprisingly, this loss of confidence was concentrated in the financial sector. . . . Antipathy toward Wall Street eventually became distrust of the government, which not only struggled to mitigate the effects of the meltdown but also began producing its own crises, including a debt default scare in 2011 and a shutdown two years later. In 2013, five years into the recovery, Gallup discovered that Americans no longer considered economic issues to be the most pressing national problem: Government had replaced them as the top concern.¹

Bloomberg is far from the only business publication that takes such a view. On the same day the Financial Times published a lead opinion piece with the headline Populism Is the True Legacy of the Global Financial Crisis,² and the New York Times Nobel Prize–winning columnist Paul Krugman praised two Democratic senators for introducing legislation requiring the federal government to collect and report data on who benefits from GDP growth.³ At the same time, the New York Times columnist Andrew Ross Sorkin looked back and praised the Bush and Obama administrations for their courage in putting the rescue of Wall Street first despite the inevitable populist anger that this aroused.⁴

The central actors in the bailout were at least somewhat conflicted about its possible political repercussions. President Barack Obama, who rejected the Swedish option of nationalizing the banks, nevertheless urged executives of all banks that were too big to fail to curb their compensation, saying that he was all that stood between them and the pitchforks. But the fact remains that, notwithstanding Obama’s awareness of the pitchforks, he looked the other way when his Treasury secretary, Timothy Geithner, slow-walked (i.e., resisted) his order to break up Citibank. Neither did he stop Geithner from using the Troubled Asset Relief Program (TARP) money, originally appropriated to purchase the toxic assets of big banks at deep discounts (trash for cash), to simply recapitalize the banks and thus restore market confidence that they were safe. Looking back on Geithner’s apparently unauthorized use of presidential power, The New Republic noted, Every action fit Geithner’s worldview: The financial system must be stabilized at all costs, as the only way to heal the economy so real people benefit.⁵

Such retrospective accounts of the financial crisis implicitly agree that Obama and Geithner did not know at the time whether the bond markets were at their mercy or vice versa, and that their policy was not to find out. Their highest priority was, rather, to avoid doing or saying anything that would further threaten the liquidity of financial markets, and they measured the success of their policy by the restored ability of failing banks to raise funds on private capital markets.

Writing in 2019, the self-proclaimed rescuers of the financial system—Geithner along with former Treasury Secretary Henry Paulson and Federal Reserve Chair Ben Bernanke—could still imagine the financial system’s end in the form of fire sales of the assets in which global wealth had been accumulated. For them, the financial system’s awareness of its imminent apocalypse—the ever-present possibility of death by fire—lies at the heart of that system itself. Its inherent flammability is the very reason why it must be saved by government intervention. They are thus able to portray themselves in hindsight as the heroic firefighters who put out the flames before they spread, destroying everything.⁶

The paradox of 2007–9 is that the financial system became politically invulnerable at the very moment when its survival was otherwise in doubt. The reasons for this paradox are not obvious; the Great Depression made the interests of the financial sector within capitalism politically controversial, and its opponents extracted their price in the form of a welfare state. Following the Great Recession, however, the growing belief that the financial system must not be attacked when its weakness might have been leveraged suggests that financialized capitalism may have ultimately trumped the project of historical justice.

The thus far definitive history of the Great Recession by Adam Tooze largely supports this point of view while lamenting its accuracy. Tooze’s careful assessment is that the pitchforks were all on the political right—the Obamians lacked pitchforks of their own—and that the new regime of stress tests, despite carrying the whiff of federal interference in capital markets, in effect made the government responsible for any subsequent bank failures, and this in turn made it easier for banks to raise capital. Tooze is here directly describing a policy of financial stabilization through guaranteeing liquidity that has greatly exacerbated economic inequality while simultaneously stoking right-wing narratives that the system is rigged by liberal elites in favor of the rich.⁷ As he says in his introduction,

The Fed’s liquidity provision was spectacular. It was of historic and lasting significance. Among technical experts it is commonly agreed that the swap lines with which the Fed pumped dollars into the world economy were perhaps the decisive innovation of the crisis. But in public discourse these actions have remained far below the radar. . . . The technical and administrative complexities of the Fed’s actions no doubt contribute to their obscurity. But the politics go beyond that . . . to the analytical agenda of reimagining international economics, forced on us by the crisis and articulated by the proponents of the macrofinancial approach.

. . . This is hugely illuminating. It gives economic policy a far greater grip. But it exposes something that is deeply indigestible in political terms. . . . If in intellectual terms the crisis was a crisis of macroeconomics, if in practical terms it was a crisis of the conventional tools of monetary policy, it was by the same token a deep crisis of modern politics.⁸

As Tooze regretfully points out, it was the right-wing populists in 2008, and they alone, who professed their willingness to call the bluff of the financial sector when it threatened the larger economy with capital market illiquidity. He does not disagree, however, with the view of mainstream opinion leaders that their opposition to the bailout was intellectually irresponsible and politically reckless.

Unlike that of the right-wing populists in the Tea Party movement, my project is to transform the concept of financial market liquidity from an assumed precondition of capitalism to an object of political contestation. I hope thus to show that the development of vehicles through which capital market liquidity can be materialized, priced, and shorted might also serve as a signifier through which historical injustice—the effect of past evil on present inequalities—can be interpreted and made actionable. This is to say that a new analysis of capitalism’s vulnerability to liquidity crises can for its opponents become a source of new ideas, tactics, and demands.

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* * *

Why did a heightened awareness of the fragility of the financial system in 2008 result in a political consensus in favor of supporting it at all costs, even when this meant allowing economic inequality to increase rather than intensifying efforts to reduce it? The reasons run deep and go beyond the skill of Geithner, Paulson, and Bernanke in managing the egos and fears of the elected officials with whom they dealt. Today’s sense of capitalist realism is widely seen as an effect of capitalism’s passage from an industrializing phase into an era of globalized finance.⁹ This view is only partially true, but to the extent that it is, we need an analysis of capitalist financialization that is comparable in breadth and depth to Marx’s account of capitalist industrialization.

What, then, is capitalism’s financial turn? It is, at least, the well documented political dominance of the financial sector over other sectors of capital that indisputably occurred following the stagflation and global turbulence of the 1970s.¹⁰ This dominance has arguably resulted in lower public investment in industry and infrastructure and stagnant real wages, even as asset markets soared. But, if this were all, then the capture of state power by a financial elite would be weakened by a severe financial crisis, leading to its recapture by other sectors of capital that could have demanded greater state investment in industry and infrastructure. Much of the writing on this period by progressive economists, like Paul Krugman, complains that this did not happen, but without addressing the paradoxical fact that the political power of finance over the economy and the state was, if anything, strengthened by the weakness of the financial sector.¹¹ The real question is why relative gains of financial actors were not at least partially reversible, especially during the largest financial crises since the Great Depression.

This question arises because today’s financialization is something more, and different, from the capture of the commanding heights of both the economy and government by financiers who can thereby advance interests presumed to be narrower than those of capital as a whole.¹² The financialization that has occurred since the 1970s must be understood, beyond this, as a generalization and extension of financial ways of thinking to all sectors of capitalism, and also as a set of technologies for financializing activities that are otherwise outside the financial sector. It is the pervasive growth of financial ways of thinking and of financial technologies that has made the financial sector hegemonic, and the alternatives to its political power much more difficult to imagine and bring about.¹³

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* * *

My thinking on this topic began in collaboration with the late Randy Martin, whose work has enabled scholars in the humanities and social sciences to see the social logic of derivatives, hedging, and portfolio management operating everywhere.¹⁴ The cultural studies literature on commodification had recognized by the late twentieth century that the financial sector had taken control of large portions of the so-called real economy dominated by the commodity form.¹⁵ Randy’s twenty-first century intervention was to identify a cultural shift in which the idea of self-ownership that grounded neoliberal theories of human capital was superseded by a conception of the self as, essentially, a strategy for creating and rehedging its options in a world of ever-changing risk.¹⁶ For Randy, the fully financialized self is a portfolio of assets with ever-changing exposures to risk and opportunity that must be actively managed over the course of a lifetime in response to inherently uncertain future conditions. Describing this sense of selfhood as essentially precarious—the self is always struggling to stay on its feet—Randy, as a choreographer, saw this new subjective orientation as a mode of embodiment—what he called a kinestheme—because in the dances he loved, the performers are never not falling down. His conception of sociality as itself a precarious dance—and of dance itself as a derivative sociality—is, of course, the contribution to cultural studies for which Randy is best known.¹⁷

Perhaps fewer of his readers know that in the last four years of his life, Randy moved from discovering cultural analogues to financial derivatives (what he called the derivative form) to exploring how his social understanding of derivatives could be deployed in political struggles for historical justice. Justice, he thought, can be made more present—more embodied, more actionable—if it is reframed through a new social and political understanding of the manufacture and pricing of options. I was saying something similar, and this was the point at which our collaboration began.

The distinctive feature of our approach was to consider together the ideas of value (supporting life) that Marx developed and of liquidity (supporting markets) that are stressed in modern finance.¹⁸ We saw these conjoined concepts, value and liquidity, as social emanations of the institution of money as it develops within capitalism.¹⁹ The value form had thus been identified by Marx as the materialized abstraction that allows the ready substitutability of one thing for another in social transactions based on monetarily equivalent exchange. A preference for holding cash itself, value in its money form—the liquidity preference identified by Keynes—is based on the equally abstract assumption that in a market-based economy, holding cash is desirable in itself because it embeds an element of optionality that commands a premium. Keynes’s liquidity premium was the prototype of what Randy and I called the option form in the sense that any asset embodying value that isn’t money has to be turned into money (liquidated) for one to have the option of converting it into another asset. The universal equivalence promised by the value form thus makes the optionality provided by the money form, its liquidity, intrinsically desirable in and of itself.²⁰

We were both aware, however, that this view of the relation of liquidity to value could be reduced to an observation that the exchange of money is simply a social precondition for using markets to support and reproduce life. This observation, accurate in itself, is often taken to imply that the liquidity that results will then be viewed as a positive externality, or free good, thrown off by the existence of markets themselves. The Chicago School of economics could thus be paraphrased as thinking it’s a good thing that markets happen to support life and that life happens to support markets.

Unlike the Chicago School, however, Randy and I believed that a focus on liquidity could highlight the political vulnerability of the financial markets themselves, which may disappear almost instantly, reducing the accumulation of value they contain to zero. We thus saw in finance’s paradoxical capacity to create new wealth from an awareness of potential threats to liquidity the key to making its continuing existence politically contingent and thus subject to subversion, manipulation, and sabotage.

We had no doubt that, in thus repoliticizing financial technologies of wealth, we were also talking about historical justice. This is the dimension in which the aftereffects of past injustice, such as interracial gaps, compound rather than dissipate with the passage of time. Not all past injustices ramify and intensify over time; many are not deepened by the machinery of capital accumulation. But those that are become historically more important for that very reason and must be a central concern for a Marxist politics today. Our approach was thus to show how modern financial concepts fit into Marx’s ideas in ways that once again connect them to the pursuit of historical justice.

INTRODUCTION

Does historical justice have a chance in today’s financialized form of capitalism? On the one hand, the accelerated appreciation of financial wealth may well compound the inequalities arising from past injustice. Insofar as adding to an earlier injustice is itself unjust, the rise of financialization is on its face a setback for the justice-seeking subject under capitalism. On the other hand, however, the tendency for inequalities of unjust origin to concentrate rather than dissipate provides an occasion, and a provocation, to question the justice of the institutional processes through which this happens. Insofar as preexisting disparities do not become more legitimate when widened by financialization, its rise can provide new arguments for justice-seeking subjects under capitalism that Marx could not have foreseen.

Financialization can also provide new opportunities for reversing historical injustice because the socially created wealth that is held in the form of financial instruments is more abundant, transferable, and liquid than capital accumulated in the form of industrial plant and materials. Marx recognized, as chapter 1 will show, that the extraction of surplus from the labor process would necessitate investment vehicles in which the surplus could be preserved and then accumulated. Increased investment in producer goods could fill that need, he said, provided that the price realized by selling the end product was sufficient to validate such investments. But accumulating capital in form of producer goods could also undermine capitalism’s ability to support the rising population that would demand its rising output, thereby generating greater poverty and inequality; and it would also create new opportunities—both technological and political—for collective resistance. Today, the principal vehicles of capital accumulation are distinctively financial products that do not do double duty as producer goods. Because investment in these products does not directly increase total output, many Marxists point out that it is unproductive, and conclude that the wealth thus accumulated is unreal—indeed, fictitious.¹ For me, however, it is more important to point out that many but not all of these assets can have value because there are options embedded in them, and that the valuation of options arises from their ability to lock in and thus preserve, and also leverage and thus expand, preexisting value. When options are thus understood, the elements of optionality that are explicit or implicit in all financial instruments makes it possible for them to function as vehicles of capital accumulation, and implies that any vehicle of accumulation, including Marx’s producer goods, must also embed an element of optionality in order to function as such. Capital accumulated in a purely financial rather than material form is thus not usefully described as fictitious to the extent that the options it embodies can be valued—even and especially when what is being valued consists of an enhanced capacity to preserve and expand preexisting value, and thus to perform the specific function of vehicles of accumulation. Accumulated wealth in my view consists largely, and increasingly, of financial options that have a present value. This is why my project in the chapters that follow is to theorize historical justice in today’s financial language as also an option that has a present value.

Finance is not, of course, the only level at which cumulative effects of bad history are preserved, magnified and contested: there is also an underlying politics about which I have previously written. In After Evil, I described how modern regimes can come to understand themselves as survivors of specific evils that preceded them (e.g., feudal, racial, religious, tribal, communal, colonial). The idea that a time of evil has been placed firmly in the past can then be used, I argue, to discredit demands for redistribution in the present as dredging up an earlier stage of history that is better left submerged. This claim, which the transitional justice literature embraces, would effectively remove historical justice from the agenda of democratic politics so that society can move forward.² If we view financialization and transitional justice together, it becomes clear how capitalism can perpetuate and augment historical injustice without appearing to do so.

This is my retort to the common, but rarely defended, assumption that the differential benefits of bad history are somehow cleansed to the extent that they are attributable to the ordinary working of capital markets that would operate in the same way whether the wealth invested in them was justly acquired or not. Historical injustice is not in my view reducible to an unjustifiable past followed by a run of good luck regarding how the benefits proceeding from it have been reinvested. I rather hope to show how the widening disparities that arise from bad history can no longer be rationalized as mere good fortune once political democracy reintroduces the question of historical injustice.³

Democracy matters, in my view, when and because it can politicize the relation of bad history to present disparities of fortune, which can then appear as an ongoing injustice that has been wrongly deemed to be past. If this is the political meaning of historical injustice, the promise of democracy is that those who continue to be disadvantaged can derive present value from it and increase that value going forward, thereby mitigating or eliminating its cumulative aftereffects. This is why I see new opportunities for historical redress in an age of finance, and why I believe that today’s financial theory—much more than democratic theory—provides conceptual and practical tools for bringing heterogeneous times and spaces into the present.

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* * *

My approach in the chapters that follow will thus require a departure from the way today’s literatures on democratization and financialization have been made to fit together. Mainstream political scientists have been preoccupied with explaining why democratization can be compatible with high levels of wealth inequality and can be imperiled by demands to reduce it.⁴ For them, democracy is a way to legitimate social inequalities of many kinds, especially financial, that would otherwise threaten political stability. In contrast, the mainstream literature on financialization has been about investment vehicles that derive their value from how much and how rapidly contrasting inequalities widen and narrow with respect to each other. But reducing socioeconomic inequality is rarely if ever a direct aim of finance, which addresses and evokes a liquidity-seeking subject rather than a justice-seeking subject.

In contrast with these approaches, I will argue that liquidity is the abstract form of power specific to globalized financial capital—the normative and empirical ground of its existence—in the same way that sovereignty was the abstract form of power specific to the national development of capitalist modes of production. For me, the imperative to link liquidity and sovereignty is the presumptive basis of communal solidarity in a capitalist state—the universal expression of class power that is potentially threatened by the pursuit of justice through democracy. By reintroducing the question of historical justice into financialized capitalism, I mean to test the limits on conceivability that states and capital markets, and especially the market in public and private debt, have imposed on democratic politics.

Of course, I am not the only writer dealing with these themes. Other recent books have shown the links between the liquidity of debt and capitalist class power: Governing by Debt, Capital as Power, and Debt as Power are important titles that address financialization through the lens of Marx.⁵ Another is a long-awaited book by the French political economist Michel Aglietta, who argues that money embodies the link between liquidity and sovereignty in market-based states because, for any form of public or private debt to be incurred, there must also be a conventional form of finality, a settlement of accounts, that is universally accepted as such. By paying the correct amount of money, one can satisfy a debt without incurring another debt. Because the fundamental norm of capitalist societies is that final payment must be in money, Aglietta regards money issued by the sovereign state as an externalized expression of their underlying unity—the social bond connecting debtors and creditors. As the guarantor of social unity, the distinctive fiscal role of the state thus lies in its ability to issue funds, money, that it distinguishes from its own debt, but that it can then use to pay its debt after removing an equivalent amount of money from circulation by collecting it as taxes.

A money-creating sovereign is thus defined as having the power to monetize its own debt, thereby canceling the distinction between issuing money and borrowing it. But its voluntary forbearance in exercising the power to monetize its debt becomes the basis for confidence in the currency it issues as a means of settling privately created debt, and thus for the liquidity of such debt in the secondary markets that comprise the financial system. This socially accepted use of state money to settle—extinguish—the privately created debt that circulates in the financial system gives that money what Aglietta calls absolute liquidity and thus absolute value. By this he means that, without the liquidity of money, relative value reflected in price could not exist, and neither could a secondary market in privately issued debt that by definition cannot be repaid in money issued by the private debtor.

It follows, for Aglietta, that the state’s relation to capital markets through the medium of money is itself culturally normative.⁶ He thus says, citing both Émile Durkheim and René Girard, that money is . . . the intergenerational bond that guarantees the immortality of society (63) and that it is the institution of collective belonging that lies at the foundation of value (64).

The instrumentalisation of money goes hand-in-hand with the unleashing of individual desires for liquidity. The modern collective value able to challenge this is the political autonomy of the nation, conferred on what becomes a national currency (69).

Aglietta here portrays the sovereign monopoly on defining the money-convention as the Durkheimian ground of solidarity (the unanimously held value) that allows social differentiation down the line to further strengthen, rather than destroy, the whole.⁷

A problem with Aglietta’s account of the conventional unanimity surrounding money is that the relative liquidity of financial markets has always been a product of political contestation. In the history of capitalist states, this typically occurs through various discursive and commercial practices that can question, invalidate, or otherwise interpret the fiscal and monetary discretion of the sovereign.⁸ In financialized capitalism it now occurs, also, through the issuing and pricing of financial derivatives that reference, profit from, and insure against uncertainty about the relation between publicly created and market-based liquidity guarantees. These derivatives themselves signify another relation to this relation. That relation is one of optionality, based on the ultimate contingency of whatever happens next to disturb market liquidity, and on whether it will be perceived to be a better guide in moving forward than the known past.

I would thus qualify Aglietta’s argument by saying that the sovereign has the option to support the currency or not, but that this is only one meaning of liquidity. A separate and related meaning is that the sovereign has the option to support asset valuations in the capital market—the form in which cumulative wealth is held—and that there is an inherent political risk that this will not occur in time to prevent a disaccumulation of capital held in that form. Supporting the currency and supporting asset valuations, however bubbly, are thus two related but distinguishable forms of governmentally created liquidity for capital markets. And there can be considerable slippage between the state’s willingness to do one and its willingness to do the other, especially across all financial sectors. So, while I see the point when Aglietta and others equate the social power of debt with the social power of state-created money, I believe that Aglietta’s approach forecloses important questions about the creation and valuation of options preserving surplus value accumulated as financial assets. I will thus argue in chapter 5 that we can reopen these questions by defining how the option of the state to provide liquidity (or not) could be continuously valued in the market for financial derivatives.

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The link between sovereignty, liquidity, and optionality that I propose to develop was first explored by John Maynard Keynes. He argued in The General Theory (1936) that people have a preference—a liquidity-preference—for receiving non-interest-bearing cash as a payment to begin with—rather than, for example, an interest-bearing and equally liquid short-term bond issued by the same government.⁹ Responding to the General Theory’s critics one year later, Keynes focused even more sharply on the element of optionality that underlies the liquidity preference by asking rhetorically, Why should anyone outside a lunatic asylum wish to use money as a store of value? He answered:

Money as a store of wealth is a barometer of the degree of our distrust of our own calculating and conventions concerning the future . . . the possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude.¹⁰

For Keynes, the value of optionality embedded in cash thus lies in the differential ability it confers to derive gain or avoid loss from changes in one’s degree of certainty that the future will be like the past. A holder of a stable currency, for example, can respond instantaneously to unforeseen price changes without first having to liquidate some other asset, the price of which may also have changed in some unforeseen way. Keynes’s liquidity premium thus isolates the element of optionality embedded cash itself, the value of which is not reflected in the price of the commodity for which cash is exchanged, but rather in the variable difficulty of funding a purchase for which the commodity would be pledged as collateral.

Building on Keynes’s insight about the premium commanded by the liquidity of cash as the quintessential option, modern financial theory generalizes the ability to price options separately from the market prices underlying commodities, beginning with the idea that liquidity premiums associated with any asset other than cash can and should be split off and valued as a distinct asset class.¹¹ It also essentializes Keynesian uncertainty—the fact that markets cannot distinguish in the moment between noise and information—as the very reason that optionality as such has a marketable value as a measure of the impact of new information on liquidity. So, having the future option to purchase or sell at a price known in advance as a response to information that cannot be known in advance is an additional, potentially valuable right for which one can be expected to pay a premium above the liquidity premium that is provided by holding on to cash.

How much one should pay for this additional optionality? How much cash one should relinquish, for example, to lock in a future buying or selling price, regardless of how the market moves? The answer is clear if the option can be immediately exercised. The option to buy something for $100 that has a current price of $110 will today cost $10; this is its intrinsic value. But the option to buy something for $110 that is currently worth $100 today has only time value. The financialization of capitalism that began in the 1970s was triggered by an innovation in the way that the premium for financial options that have only time value was calculated. To do this—and here’s the innovation—the issuer of an option could ignore the asset’s average return (such as expected profit) and focus only on the degree of expected variance in its price above or below $100 (expected volatility) relative to the time left before the option expires (time decay).¹² This is demonstrated in the seminal paper of modern finance, The Pricing of Options and Corporate Liabilities by Fischer Black and Myron Scholes (1973).¹³

To grasp the importance of pricing options based on underlying volatility, we must step back and consider how this approach to valuing options could provide a new foundation for the rest of finance. The Black-Scholes paper is based on the idea that an investment is always an exchange of a fixed quantity of funds—liquidity—for something that is less liquid, such as a stock, that can vary in price. Through giving up liquidity, the buyer of a stock thus gets financial exposure to future movements in its price, gaining if it rises and losing if it falls. Owning a stock for a fixed time period could thus be described as

• buying the right to gain from the stock’s appreciation during that period (this would be a bought call option, exercisable at its initial purchase price), or

• selling the obligation to undergo a loss from the stock’s depreciation during that period (this would be a sold put option that is exercisable at its initial purchase price).

But from a financial perspective, the purchase of a stock is never not an investment of the initial purchase price—perhaps in borrowed funds that would have to be repaid. So, in addition to the bought call and the sold put, a portfolio replicating the outright purchase of a stock must include an element of debt—here considered as a risk-free loan made to the government for the same period of time—the repayment of which would return one’s purchase price plus any gains arising from the call, or minus any losses arising from the put. By definition, the return on this portfolio, assuming that the put and call are correctly priced, is identical with the return one could get from owning a fully financed portfolio of a stock.¹⁴

Behind this idea lie two further distinctions that are fundamental to options theory: whether the option is a call or a put (a right to buy or sell?), and whether the call or put has itself been bought or sold (an asset or a liability?). The buyer of an option, whether a put or call, is thus said to have taken a long position on it as an investment; the seller is said to have taken a short position that eventually may have to be covered by being bought back at a loss.¹⁵ In the illustration above, the stock buyer is long the stock but short a debt (who owes the purchase price) in the same position on the date the stock is sold to pay the debt as an investor who is long a call, short a put, and long a debt that will pay the initial purchase price of the stock at that later date—and that this will be true regardless of the price at which the stock is sold, provided that the payoff of the put, the call, and the loan is calibrated to the stock’s initial purchase price.

The foregoing exposition is purely conceptual. It illustrates the financial idea of put-call parity that makes options interdefinable with equity and debt, so that we can say, for example, what it would cost to make debt incurred to purchase equity risk-free by also requiring the borrower to purchase a put guaranteeing the equity can be resold at its initial price to cover the debt. But put-call parity is merely an accounting identity that allows us to solve for the price of the put, the call, or the stock if one knows the risk free rate of interest and all the other elements.¹⁶ The question is whether puts and calls can be priced when they have only time value—that is, when their respective future payoffs (plus or minus) cannot be realized from the current market price of the stock, but relate to the ever-changing likelihood of prices that the stock has not reached.¹⁷

By solving this pricing problem, at first for calls, Black and Scholes showed how to break down other purely financial assets, like stocks and bonds, into the more basic components of options and risk-free government debt as defined by put-call parity. Market participants would then be able to separate their exposures to directional risk and volatility risk by paying a premium for doing so.¹⁸ Through paying the premium for the option to purchase a house in the future at a price that is set today, for example, I could potentially benefit from a future rise in home prices by selling my option at a profit while limiting my potential loss to the original premium I paid for the option to purchase in the event that home prices fall. And even if home prices trend downward, my option to purchase a home could still rise in value merely because home prices become significantly more volatile (change more rapidly or widely) during the period before it expires. Expected price volatility of the option’s underlier, and changes in that volatility during the life of the option, are the key to option pricing, according to Black and Scholes—and volatility is the only parameter in their formula with an exponential rather than a linear effect.

Fischer Black’s biographer, Perry Mehrling, rightly describes this contribution as a revolutionary idea of finance.¹⁹ He has in mind, mainly, the ways in which financial theory could claim to subsume the rest of economics under a more parsimonious theory that relied only on shared epistemic assumptions about the inherent unknowability of information that has yet to appear and the inherent impossibility of profit without risk, and eliminated more questionable psychological assumptions about the transitivity of preferences and diminishing marginal utility²⁰ Because of Black’s revolutionary theory of finance, financial institutions can manufacture options in whatever quantities are demanded without thereby exposing themselves to market risk, and buyers and sellers of options can now trade those options to hedge or leverage their exposure to directional changes in the market, and to benefit or hedge against changes in market volatility no