Financial Crises and the Political Economy of Speculative Bubbles

Introduction

Finance has traditionally been conceptualized on the basis of what could be labelled a credit model. This model theorizes finance as a functional actor in the process of capitalist accumulation. From this perspective, the main role of finance is to extend credit to capitalist producers in order to help overcome problems of liquidity or profitability. This structural model has entertained a specific understanding of the contradictions of finance which emphasizes the imbalances in its relation to production. For those who ascribe to it, finance is dependent on production for it is profits in the real economy which support its growth (e.g. dividends or interest rates). Financial expansion thus relies ultimately on a corresponding development of production.

This article argues that the credit model has contributed to a distinct conception of speculation which is loaded with problematic assumptions. This bias stems in part from a history which has seen this term invoked in order to criticize financial activities that were deemed unacceptable because they did not respect the ‘true value’ of assets as determined by production or the state (Knafo, 2010). ¹ The term was thus often used pejoratively to criticize what were perceived to be manipulative practices that distorted prices and were of little use to the broader needs and well-being of society. While there has been a sustained attempt in the 20th century to modify this perception of speculation, mostly as a campaign to legitimize certain types of investment, ² the term ‘speculation’ still retains many of its traditional connotations. But precisely because it is based on a normative account of how the economy should operate, it has distorted our understanding of speculative practices which do not fit with this preconception.

The main objective of this article is to show why the dominant paradigm used to analyse finance (i.e. the credit model and its emphasis on the real economy) cannot account for such practices. Too often, it has led scholars to dismiss speculative practices as dysfunctional, irrational and/or unviable because they are disconnected from production. This divergence is then interpreted as a sign that speculation is bound to collapse. As will be shown, this assumption highlights the limits of a political economy based on production. For the fact that financiers are no longer conforming to the expectations of the traditional credit model has been too often interpreted as a sign of irrationality. In reality, speculators appear ‘out of touch with reality’ only because they are assessed through inadequate theoretical lenses.

This article refers to speculation when discussing financial practices focused primarily on the market value of given assets (e.g. currency, shares, bonds, real estate) rather than on the way in which these assets will be used (e.g. owning a company, constructing a production unit or living in a house) or on the yield that one expects from them (e.g. dividends). ³ This article focuses more explicitly on a specific form of speculation: financial bubbles. This type of speculation refers to a social dynamic animated by a specific rationale rather than to a predetermined set of actors or a specific financial market. ⁴ Unfortunately, the importance that such speculative dynamics can have on the broader economy has too often been underestimated because of the assumption that they are necessarily unsustainable. Yet in an age of financialization when the links with production have become more tenuous, it is the very nature of accumulation that is coming under scrutiny (Lipuma and Lee, 2005).

To overcome the limitations in the literature, a conception of speculation is developed here based on the idea of agency. Assessing social changes under capitalism requires a more dynamic approach which leaves open the issue of whether speculation is indeed changing accumulation or not. This agent based approach, which has been developed in previous work (Knafo, 2002, 2010), essentially requires that we divide the analysis of speculation into two moments. ⁵ The first seeks to capture what are the specific imperatives which apply to speculation, or more specifically the conditions which need to be met for speculation to be sustained. This is important because one can only assess the significance of new practices by first identifying what is the problem that they seek to address. As will be argued, financial bubbles are foremost monetary phenomena which rely on sustaining the inflation of a specific asset. Once this is specified, it is then possible to take a second step and analyse speculation from a historical perspective by looking at the different ways in which agents have sought to address this imperative. On the basis of these methodological steps, an agenda of research for analysing speculation will be proposed. Instead of focusing on the drift towards irrational optimism as it is often the case in the literature on financial speculation, it will be argued that the social construction of speculation should be analysed by looking at the role specific agents played in making institutional and discursive innovations which helped address the specific imperatives of speculation. In that respect, the article seeks to put the emphasis on the socially constructed nature of these practices rather than their irrational aspect.

The article is divided into three sections. First, the article deconstructs the pervasive notion that production establishes limits on the development of finance. In doing so, this section highlights why speculation has to be understood on its own terms rather than in relation to capitalist production as intimated by the credit model. The second section shows how one can rethink the idea of crisis from the perspective of agency. This is important since the idea of speculation has become tied up with an image of crisis which serves to reinforce the supposedly unsustainable and irrational nature of speculation. By reconceptualizing the relationship between agency and crisis, the article seeks to take a different viewpoint on the issue of financial bubbles and their crises. The objective here is to point out that these crises are interesting because they provide an insight into the difficulty speculators have had in sustaining financial bubbles. This helps to place in better perspective the innovations which are then made to consolidate speculation. The last section discusses how to problematize speculation by examining its specific imperatives. The purpose is not to propose a new ‘theory of finance’, but to suggest key principles for historicizing speculative practices. This section thus contributes to the project of developing a political economy of speculation and leads to the conclusion that there may be grounds to believe that speculation is transforming the nature of accumulation in ways that are often underestimated in the literature.

Speculation and the Political Economy of Capitalism

The idea that the purpose of finance is to offer credit for the production of goods and services is a pervasive assumption in the literature on finance. This comes from a long history of thinking about finance in terms of its functional role in economic growth (mainstream economics) or capitalist accumulation (Marxist economics). From this perspective, speculation represents a problem because it involves commercial or financial activities which appear disconnected from production. These practices seem to serve no clear purpose for the production of goods and services. While one may agree to define speculation in those terms, the challenge is to reflect on what this gap implies. This disconnect has too often been interpreted as a sign of irrationality on the part of speculators. The basic idea generally put forth, in one way or another, is that these investments are unfounded because they cannot be validated by production. For this reason, speculation is generally presented as an inflated superstructure which is bound to collapse under its own weight because it neglects the foundations upon which it rests (production). In this section, two problematic propositions that have become pervasive in this type of analysis of speculation are criticized.

The first is that speculation should be characterized in terms of its irrational exuberance. This idea rests on the observation that people make outlandish bets on the future of the economy because they neglect economic fundamentals. It is an argument which has been made in different ways, but it generally rests on the observation that speculative investments focus primarily on market prices rather than the actual claims that are associated with specific assets (e.g. dividends). The main concern for speculators seems to be their ability to sell assets at a higher price than what they paid for them. Prices of shares, for example, can thus rise far above what dividends seem to warrant. One can thus easily conclude from this perspective that such investments demonstrate a level of irrational exuberance. For speculation does indeed appear as a case of credit gone wrong when assessed on the basis of the so-called real economy, or production. As most indicators demonstrate, the price speculators are willing to pay for their assets often seems disproportionately high in relation to the value of the underlying assets when measured on the basis of the income stream they actually provide.

The assumption that speculation is irrational has been reinforced by a historical trajectory that has seen speculative bubbles being closely linked to financial crises. As speculative bubbles repeatedly lead to financial crises, many scholars have often been comforted in their belief that speculation is indeed irrational. This has led to a second proposition: speculative bubbles are unsustainable because they inflate expectations of profits to a point that can no longer be sustained by productive activities. According to this view, people can act irrationally for a time, but there is still a structural limit determined by the so-called real economy or more precisely the production of wealth which will re-assert itself at one point. One can only stretch the limits of the possible for so long. At one point, speculators will be brought back down to earth because of the increasing discrepancy between their expectations and reality. From this perspective, financial crises are ‘corrections’ which bring finance back in line with production.

This type of argument has been made in different ways. ⁶ A good example can be found in the work of James Crotty. A prominent scholar of financialization, Crotty presents finance as a set of credit practices which establish commitments for the future in the form of debt (Crotty, 1985). According to him, the contradictions of capitalism are accentuated by two incompatible tendencies: the exuberant and rising profit expectations of finance and the declining ability of production to generate these profits. As he argues, credit practices are a source of instability in the context of declining profit rates because they ‘lock’ capitalist production into commitments of future profitability. In this analysis, one finds the two classic themes associated with speculation. On the one hand, these investments are cast as irrational because they cannot be met by production. In other words, speculators fail to ‘properly assess’ the real economy. On the other hand, they are bound to collapse because of the limits that production sets on finance. The crisis is thus ultimately the product of structural limits that are determined by production. Both conclusions are based on the idea that speculation is a misguided attempt to transcend the structural conditions set by production and both rely on the assumption that production should remain the main referent point.

The problem with these ideas is that they make it impossible to understand speculative bubbles on their own terms. By casting speculation as an irrational and unsustainable process, they make it impossible to properly explain why these bubbles appear in the first place and how they can sustain themselves for significant periods of time. More specifically, this section highlights how the two propositions that result from applying a credit model to speculative bubbles make it impossible to properly assess whether speculation is transforming the nature of accumulation because they imply that speculation is necessarily unviable. Instead of assessing whether speculation is changing capitalism on the basis of a historical analysis, we conclude that such an eventuality is impossible from a theoretical standpoint.

The credit model is ultimately based on the idea that production sets limits on financial investments. But while proponents of the credit model continue to emphasize limits, the striking feature about speculation seems to be its growing ability to suspend them. With each financial bubble, the discrepancy between the price of speculative assets and economic fundamentals seems to be stretched further. This raises serious questions about the explanatory power of a model which rests on the idea that the real economy sets limits on speculation. For how can one determine the point that speculation needs to reach before it becomes unsustainable if this ‘limit’ keeps changing historically? Why should one assume that there is a necessary limit to speculation in the first place?

There is ultimately an important contradiction rooted in this assumption about the limits of speculation. For how can one explain why speculation takes flight precisely when the structural limits imposed by production seem to become tighter? Consider for example the fact that speculative frenzies tend to occur in periods of downturns such as the late 1920s (Brenner and Glick, 1991) or the late 1990s. How could speculative assets gain in value precisely when lower profits accruing from production were supposedly restricting the margin of manoeuvre of finance? If production was really setting limits on financial speculation, should we not expect precisely the opposite historical trend? Logically, exuberance should accompany periods of great productive profits, being fuelled by fat earnings distributed through finance, and the opposite would occur in the downturn.

One common argument is that people are motivated to move to speculation because of low profit rates in production (Mattick, 1981). This may be true, but the real difficulty is to explain how speculation can sustain itself and reach high levels of development despite tightening structural conditions. Hence, even if declining rates of profit can explain why more people would want to turn to speculative finance, it remains to be explained how they can do it.

It is a particularity of the literature on speculation that it continues to emphasize the limits to speculation and how unviable it is without ever turning the problem around to consider what makes it possible in the first place. As a result, we too often assume that speculation is an easy phenomenon to produce as long as one can generate enough hysteria on the markets. This explains why discussions of speculation tend to rely so much on the idea of irrational exuberance. If one characterizes speculation by the fact that it ignores its own broader structural context, then the idea of irrationality becomes attractive to account for a world that does not respect the fundamental laws of economic gravity. Resorting to psychology or subjective factors is an easy way to account for the fact that the objective laws of capitalist development seem to be suspended (Knafo, 2009). Scholars can thus psychologize speculation by referring to ‘confidence’ and ‘exuberance’, and thus use subjective features to account for an anomaly. The more speculators disregard these structural limits, the more they are said to be irrational. ⁷ The irony at the heart of this conception is that it generally ends up packaging the very gap that exists between theory (i.e. the model) and history as a proof for the irrationality of speculators. It is no longer an issue of understanding how speculation develops, but rather a matter of explaining why speculators are not acting as they should as investors.

What makes this move particularly convenient for its proponents is that it seems to explain, in turn, the crisis. Indeed, the more speculators disregard productive indicators, the more the moment of ‘reckoning’ (crisis) will appear inevitable. In other words, the idea that a correction in the form of a crisis is inevitable often rests on the very observation that speculators are not respecting what theorists have defined to be ‘economic fundamentals’. Hence, the past 15 years have been replete with warnings about the supposedly unsustainable levels of speculation. We keep being told that somehow the real economy will reassert itself (Fine et al., 1999). Speculators will have to take stock of the ‘reality’, as defined by scholars (of these ‘fundamentals’), and when they do there will be a crisis (Carchedi, 1991; Wolf, 1978).

For scholars who follow such a template, the idea of limit guarantees that ‘reality’ can only deviate from what theory tells us for so long. ⁸ Used in this way, the notion of limit protects theory from history more than it enlightens the latter. One can thus protect a theory of the ‘objective’ determinants of the economy by justifying any discrepancy observed under speculation as the product of ‘subjective’ factors which would ‘distort’ reality. ⁹ Bridging the gap between theory and history in this way mostly allows scholars to fit history and speculation into a predefined theoretical framework based on production.

This conception not only makes speculation appear as a subjective (irrational) phenomenon, but it risks construing the crisis as a contingent development. When the emphasis is put on financial ‘exuberance’, it is difficult to grasp why and when people would actually step out of this ‘irrational’ mind set. Would it not be possible, for example, to set a virtuous cycle in motion in which the very exuberance of investors would generate the wealth expected (Boyer, 2000)? How can we explain that the reality shut off from consideration becomes again relevant to their decision? This is why crises often end up being construed as contingent events which can only be accounted for by sudden shifts in confidence generally explained by external shocks.

It is interesting to note that speculative bubbles were historically characterized by soaring confidence as people gained a feeling of invulnerability. While there are always critics who warn speculators about the unsustainable nature of speculation, the crises which result from these speculative bubbles hardly seem to be brought about initially by a loss of confidence. It is rather the opposite that is striking. Studies have shown, for example, that economic forecasts in the USA remained sanguine just before the financial crash of 1929 and remained so into 1930 (Hamilton, 1987). Similarly, the talk about ‘the new economy’ that preceded the crash of 2000–2001 exemplifies how crises in confidence cannot be taken as an obvious explanation for why financial crises occur.

This leads to the main argument of this section: the idea that the real economy sets limits on the development of speculation is of little analytical value. It should be made clear here that the existence of limits per se is not necessarily being denied, but rather the conceptual role the notion of limit generally plays in discussions of speculation is being challenged. For one can agree that this notion has a descriptive role if we mean by this that it points to a rupture in a social dynamic. However, the notion itself cannot explain what it is supposed to. The reason for this is that it essentially promotes circular explanations. Indeed, the notion of limit suggests that a crisis was caused because the system reached a limit which we know existed because a crisis occurred. In other words, the assumption that such a limit exists and can explain the breakdown is proven by the very fact it is trying to explain. References to a limit thus essentially rest on circular propositions that can neither be proven nor falsified, and which are always introduced post hoc as a means to account for something left unexplained. A descriptive statement about something that happened is thus parlayed into an analytical one. For this reason, the concept of limit does not say anything beyond the obviousness of what it describes. It basically turns an observation about crisis into an explanation for it.

In order for this concept to hold any value, one would have to demonstrate the existence of a limit independently from the occurrence of crisis and thus show that the economy did indeed encounter a limit which provoked the crises. However, the argument always runs in the other direction with the occurrence of crises being used to prove the existence of limits which are then explained in terms of production. Such limits are thus never demonstrated as historical facts. They are used as a justification to move into the realm of abstract and formal theorizing. The concept of limit then generally justifies theory more than it explains history.

If the idea that production sets limits on speculation cannot be demonstrated, then the two classic propositions about financial bubbles criticized earlier become untenable. One can no longer hold on to the view that speculation is based on irrational decisions or that crises represent corrections which realign finance with production. As will become clearer in the next section, this illustrates how the reliance on a political economy based on production or the real economy has hindered our ability to understand speculation on its own terms. It has perpetuated the notion that speculation cannot fundamentally change the nature of accumulation because it implies from the outset that speculation is unsustainable. There is no way then to properly assess the impact of speculative strategies on capitalist accumulation.

Towards an Agent-Based Analysis of Speculative Bubbles

In the previous section, it was argued that the notion of speculation is bound up with a structural conception of capitalism which puts the onus on production. This model relies on a notion of limit set by production which leads scholars to characterize speculation as both irrational and unviable. By contrast, it is argued here that financial crises and speculation should be conceived from an agential perspective rooted in the Marxist notion of social relation. There have been few attempts to think of finance from an agent based perspective within the tradition of Marxism. Although the emphasis on class struggles and social relations has generated important works that highlight agency, this has been confined to specific fields of study. By contrast, finance has generally been conceived from the perspective of crisis theory and embedded within a highly structuralist framework (Gotham, 2011). This bias can be partly explained by the traditional role assigned to crisis theory in Marxism which is to show the internal contradictions of capitalism and its unsustainability. It is no surprise that those who wish to turn crisis theory into an indictment of capitalism find the notion of limit appealing (see for example Clarke, 1994). This idea conveys a strong image of the contradictions of capitalism because it posits a clear boundary that cannot be overcome. But those who labour to demonstrate that, regardless of the circumstances, capitalism will necessarily lead to crisis, are forced to build formal theories of little use because they are constructed in abstraction from the concrete history of these crises (Knafo, 2007). Without a proper account of the social forces that shape crises and an assessment of their practices, it is simply impossible to understand finance and its crises from a historical perspective. ¹⁰

In order to disentangle speculation from this structuralist framework, it is important to rearticulate the idea of crisis which has left such a strong imprint on traditional conceptions of speculation. Instead of seeing crisis as the unavoidable consequence of speculation or as the ultimate Signifier which overdetermines everything we might have to say about financial speculation, this article is interested in what these crises tell us about the challenges that speculators face. More specifically, it is argued that Marxists working on crises have too often sought an answer to the wrong question. The fact that social crises occur in all societies is of certain interest. Indeed, crises are not something distinctive to capitalism even if they evolve into different forms under it. If one takes this into consideration, why then should we be adamant to demonstrate the existence of some sort of iron law of capitalist accumulation that transcends agency, as if this idea was necessary to demonstrate that crises are unavoidable? Being provocative, one could argue that ‘proving’ the necessity of crises is somewhat trivial. While it might serve the narrow purpose of refuting the illusory assumption of economics that markets lead to equilibrium, this endeavour generally pushes Marxist theory in the wrong direction. With the overriding desire of establishing the objective necessity of crisis, and the inevitable downfall of capitalism, one thus reifies the tendencies of capitalism within a highly structuralist approach that leaves little room for agency and history. Hence, in focusing simply on the structural contradictions of capitalism, one tends to emphasize the ‘objective’ laws of capitalism but neglect class struggle and agency. ¹¹ In short, a common problem with crisis theories is their tendency to close off any conceptual space for grasping what difference people can make through their agency. ¹²

Ultimately the challenge is to show how a conception focused on agency can be compatible with the fact that financial speculation often ends up in a financial crisis. For this fact does not mean that agency is irrelevant. On the contrary, when we start from the specific problems or limitations that social agents face we can better assess the significance of their innovations. ¹³ In fact, one can even go further and argue that what makes crisis an irremediable aspect of social life is not the existence of structural limits but the fact that people constantly exert agency. If capitalist societies followed a mechanistic and deterministic dynamic there would be ways to organize them in order to avoid crisis. But since people exert agency in ways that cannot be predicted, institutions can never offer the perfect ‘fix’ in order to ensure a ‘smooth’ reproduction of social systems. The key point is that institutional changes (such as those that shape social property relations) always challenge established practices and oblige social forces to change their own strategies. As social forces make adjustments in order to circumvent the constraints imposed by institutions, or to use these institutions in a different way, they undermine the ‘regulative’ effects of institutions. Hence, one could argue that it is people’s adjustments to institutional change that produce crises. In this way, social crises do not reflect a congenital weakness of a specific system (e.g. the inherent contradictions of capitalism). They are the product of a more fundamental problem that concerns the nature of social organization and the struggles over power that this nature engenders.

The contradictory nature of agency is rarely highlighted in the literature but constitutes a fundamental aspect of social life; one that is key to any attempt to historicize social dynamics such as speculative bubbles. ¹⁴ The best way to grasp this contradictory role is to point out that innovations are generally geared towards protecting vested interests and thus have partly to do with avoiding abandoning practices that are increasingly unsustainable in a given social context. As emphasized by Political Marxists, ¹⁵ social changes are often driven by the adjustments social forces make in order to protect given practices and the forms of power they already have (Brenner, 1987; Wood, 1994). ¹⁶ For example, agency under capitalism generally has to do with the way in which people transform their practices when constraints, such as the imperative to remain competitive, force them to make innovations. As they make innovations to become more competitive, they accentuate the pressure on other capitalists. Hence, social problems result from these innovations because they generally help sustain the position of given agents at the cost of accentuating social imperatives on others (in this case market imperatives).

This idea is central to Brenner’s discussion of the downturn, which illustrates how overproduction is only a problem because of agency. According to him, the problem lies in the intensification of competition which makes it more difficult for capitalists to make a profit. Brenner points out that there would be no problem if producers who competed less efficiently were swiftly pushed out of business. Any overcrowding would thus be resolved at the expense of weaker capitalists. However, Brenner’s central argument is precisely that these less competitive producers are not easily pushed out of business. Various adjustments incite and allow them to stay in business thus intensifying the competition over market shares. By overcrowding the market, these capitalists fuel the process of overproduction and thus limit the flexibility of all. They make it increasingly difficult for all to mark up and get sufficient profits. In other words, it is the agency of individual capitalists that allows them to stay afloat and makes it increasingly difficult for capitalists in general to make profits.

This conception of social imperatives as being inherently tied to agency provides a more dynamic conception of capitalist development than the static and highly formal conception suggested by the notion of limit. Indeed, imperatives cast a light on the social consequences of innovations and how adjustments made by individuals pose constraints for others. In this way, the notion of imperative has the advantage of recognizing in a dynamic way how social constraints take form yet without ignoring the concrete role actors play in this process (Konings, 2005). Imperatives are directly connected to the idea of agency because having to remain competitive does not determine how one wishes to go about it (Knafo, 2002). Hence, problematizing the nature of capitalist competition and the forms of imperatives that emerge from it provides an open ended template to problematize social development. In contrast to the notion of limit, which suggests a highly structural perspective and encourages formal readings of capitalism, the notion of imperative provides a rich vista on the nature of social struggle and obliges us to focus on history in order to analyse capitalism.

Having proposed a new template to think of agency and social constraints, it is now possible to take a first step to reconceptualize speculative bubbles without relying on the idea that they represent the product of irrational exuberance. The key here is the proposition that capitalist production and speculative bubbles respond to different forms of imperative which condition agency in different ways. What has been perceived as the irrational dynamic of speculation is rather the product of the fact that speculation faces different types of challenges than capitalist production (and credit finance based upon it) and this helps to explain the specific historical trajectory of speculation and the ways in which it develops.

Capitalist production is driven by the need to transform production in order to cut down costs and gain greater flexibility to mark up. The more capitalists enter a same sector, the narrower this margin becomes thus reducing profits in the sector. For this reason, capitalism is marked by long periods of downturn marked by declining rates of profits. In the downturn, it is increasingly difficult to create a differential between a producer’s costs and the average costs of other producers which could be exploited in order to mark up prices and make profits. ¹⁷ One can say that this trend sees an intensification of competition which increases the imperative of the market.

Speculation operates almost on the opposite basis. The more people go in the same direction and invest in similar assets, the more their respective profits will increase. Speculation is thus driven by a distinct form of competition since investors actually capitalize precisely on the advent of new entrants who push up prices in what is essentially a bidding war fuelling the inflation of speculative assets (Toporowski, 2000). These speculative investments are not governed by a market imperative in the same way. On the contrary, profits here depend on the constant growth of investments in a particular speculative market and the coordination of these investments in order to channel them towards similar assets. This explains why speculation tends to gather speed in an exponential way. With few investors, speculation is of little interest. Hence, it starts slowly and emerges from activities which are generally pursued for other reasons than speculative ones. A stock market, for example, might operate initially on the basis of the dividend that shares provide. Similarly, speculation on real estate can take off in markets which do not necessarily follow a speculative dynamic at first. But when these markets gather speed, they offer opportunities for profit that become increasingly more interesting than productive investments. As investors move into speculative lines of activity, the profit rate of speculators increases and attracts, in turn, more and more people. Hence, the defining feature of speculative activities is that competition does not reduce opportunities for profit, but rather tends to increase them. This is why speculation tends to pick up at an exponential pace. Hence, it is no coincidence if capitalist production and speculative bubbles generally follow separate, if not opposite, trajectories. As is often pointed out, speculation offers an attractive exit option in a context of over-accumulation.

It is true, as some might object, that the financial intermediaries who manage and sustain speculative investments, such as investment banks or mutual funds, are still subjected to market imperatives. They compete with one another to attract investors. It is usually this very point that is raised by the post-Keynesian literature on speculation which emphasizes how competition among such financial intermediaries tends to introduce an ‘irrational’ element into financial markets (Borio, 2004; Harmes, 1998; Minsky, 1982). As this literature points out, the increasing risks financial intermediaries take in order to face competition, notably by manipulating their balance sheets and following herd behaviours, create volatile conditions on speculative markets. Hence, from this perspective, irrational exuberance combined with competition among financial intermediaries leads to an increasingly volatile and unstable financial market which becomes primed for a ‘correction’.

But while this competition and its effects are certainly significant, a focus on the market imperative of competition cannot, in itself, capture the distinctive nature of speculative bubbles. To begin with, even the competition to attract investors is predicated on the overall logic of speculation outlined here. This explains why these strategies are so often seen to be destructive in their effects precisely because investors tend to ignore what is happening in the so-called real economy. For these decisions seem shaped more by what investors think the impact of various decisions or disclosures will be on the market, rather than by the ‘fundamentals’ of speculative assets. They are thus also predicated on the inflationary logic of speculation outlined above. More importantly, this focus on market competition to attract investors is insufficient to explain the crisis for the same reasons that Marxist approaches which rely on the notion of limit are often unable to explain speculative crises. Since the practices of speculators seem to contribute to the reproduction of speculative bubbles, it is difficult to specify why suddenly the situation would change. We are then still left with the problem of explaining why processes which can generate speculative value by their own movement suddenly fail to sustain them. Facing this problem, post-Keynesian authors often smuggle back an external limit in order to account for the breakdown; one which often involves again characterizing these speculative practices as exuberant and out of line with reality (see for example Kindleberger, 2000).

As many scholars have pointed out, financial speculation is related indeed to the downturn (i.e. a fall in the profit rate). It represents an exit option in times of economic difficulty. However, this connection is not simply based on the fact that finance can sustain fictitiously the old profit rates by pumping credit in the economy. Instead, the argument presented here was that speculative bubbles offer a means to escape competitive pressures because they follow a different logic. The reason why speculation collapses is not the growing chasm between the expectations of investments and what production can actually generate. Rather, as is argued in the following section, it stems from imperatives which are specific to the inflationary logic of financial bubbles. Clarifying the difference between both spheres of activity will make it possible to properly conceptualize finance on its own terms, rather than derive it simply from the logic of capitalist accumulation. For as innovations are made to address the shortcomings of speculative inflation, this mode of accumulation is consolidating itself and transforming the nature of capitalist accumulation.

Historicizing Speculation and its Social Construction

In this final section, the problem of financial speculation is addressed from a historical standpoint. As argued elsewhere (Knafo, 2009), financial speculation has not been constructed as a proper object of research. This has made it difficult to historicize its practices because it is always analysed as something dysfunctional, that is as a divergence from what should be the norm. To reconceptualize speculation as a proper object of study, it is important to grasp what drives the development of speculation. In the previous section, it was pointed out that social innovations generally emerge as a response to distinct imperatives (Wood, 1994). People change their reality because they are forced to develop new strategies in the face of specific imperatives. Hence, to understand how practices are socially constructed, it is necessary to grasp the problems that propel innovations. If speculation has been historically attractive in periods of significant over-accumulation, what then are the specific imperatives that spur its development?

To understand what is at stake in the emergence of a financial bubble, it is important to see it for what it is: that is primarily a monetary phenomenon. It is, after all, an organized process of inflation which aims to systematically increase the market value of specific assets in relation to others. If the prices of these assets were increasing at the same rate as inflation, there would be no point in speculating. Because speculation requires sustained inflation – the incessant and differential increase in the value of speculative assets – one needs to start thinking about the imperatives of speculation from a monetary perspective. For its contradictory nature comes out of the fact that such bubbles require constantly growing amounts of monetary resources to sustain this inflation. Bubbles require an exponential growth. Indeed, from a purely quantitative standpoint, speculation faces an uphill battle because the addition of new investments will have decreasing marginal effects on the value of speculative assets. For example, the amount of new capital needed to ensure a 5 percent increase in the value of financial assets will augment as the bubble inflates. For assets with an initial value of $100 you need $105 to be paid, that is an addition of five new dollars. For $1000 you need $50 and so forth. Hence, the greater the value of the assets exchanged on a speculative market, the greater the amount of new investments that is needed to sustain the same rate of profit. Rapidly the monetary resources required to sustain speculative bubbles can thus become insufficient. Considering that investments in such bubbles increase radically when speculation becomes profitable as more and more people enter the fray, thus raising even quicker the required resources needed to sustain the process, one can see how quickly this can generate stress in the financial system.

Such a ‘pyramid’-like structure requires a constant increase in investments and this explains why the dynamic of speculative inflation is so difficult to sustain. Historically, such dynamics have only appeared for short periods of time. Most financial bubbles were limited and had little impact on the wider economy (Knafo, 2009). Before the mid-19th century they mostly occurred in informal markets and often involved peripheral financiers. Established merchant bankers were often careful to avoid what they saw as dangerous and irrational practices. ¹⁸ As for state officials, they were generally keen to clamp down on such destabilizing practices. For this reason, speculative bubbles remained rare and generally marginal within the economy.

This observation opens up a new research agenda for it emphasizes how difficult it is to engineer a speculative bubble. Speculation is not something that can be taken for granted or simply ascribed to irrational investments. It requires financial markets which are institutionalized in such a way as to address this monetary imperative. What is striking about financialization is not only the repeated waves of speculation to which it has given birth in the past 25 years, but also the breadth that it now covers (Krippner, 2005). This growth is difficult to explain from a traditional perspective. Too often, scholars are reduced to emphasizing ‘liberalization’ as the explanation instead of providing a social and institutional account. It is as if speculation follows from the ability of financiers to free themselves from institutional constraints. This only naturalizes speculative bubbles as a normal product of finance when it is left to itself. Hence, this emphasis on the freedom to invest and the various elements that encourage investors to be irrational neglects the fundamental question of how these financiers can sustain speculative drives in the first place.

In order to address this problem, this article argues for a political economy of speculation which seeks to problematize financial bubbles as socially constructed. Elsewhere (Knafo, 2009), a preliminary historical account of the development of speculation on this basis has been offered. One of the important conclusions that emerge from this foray is that the recent financialization has to be located in a gradual transformation of finance which occurred in the USA since the late 19th century before being exported abroad in the 1980s and 1990s. The real novelty here does not stem from deregulation, but on the contrary from crucial institutional innovations which helped to generate and sustain speculative bubbles in a radically new way (Konings and Panitch, 2008).

Three types of institutional innovation were crucial in this transformation and each of them addresses, in different ways, the specific imperative of speculative bubbles. The first is the sheer increase in the mass of investments made on speculative markets which was made possible by an unprecedented popularization of finance. American finance has made numerous innovations to help integrate new investors into the fray. There is indeed a long tradition within financial markets in the USA to reach out and popularize finance, in order to make it accessible and convince people to take part in it (Aitken, 2007; Konings, 2008; Seabrooke, 2001). Perhaps the most important channel for investments was the rise of institutional investors which helped people navigate these markets and created great leverage to fuel inflation. Such a process of extending access has also occurred at the international level. Various scholars have emphasized, for example, the distinct ability of US finance to absorb foreign capital and the vital role this plays in sustaining speculative bubbles on US stock markets or in the housing market (Konings, 2010; Schwartz, 2009)

A second type of strategy, once more distinctive of US finance, has been the rise of rules and institutions for coordinating investments and steering them in a certain direction. The use of similar investment models or the recourse to rating agencies (Sinclair, 1994), for example, has helped maximize the movement in the prices of speculative assets. These offer signals and templates to direct the flow of transactions. For example, they help concentrate investments on specific assets and thus increase the inflationary leverage of a given amount of money. While these are often seen to be responsible for herd effects and irrational mood swings on the market, they can be seen as vital cogs in such speculative dynamics, for they help investors push in the same direction. Despite their often tragic social consequences, these discursive institutions provide a template for socialization in a speculative environment and help sustain the tenuous equilibrium of speculative markets.

Finally, financial innovations of various sorts have made it possible to increase leverage and thus the purchasing power of finance. In particular, the practices linked to securitization have contributed in accelerating turnover time and in creating new speculative assets which can be monetized to fuel asset inflation. In the housing market, for example, securitization has helped banks extend subprime mortgages to people unable to get on the property ladder and provided higher mortgages than people could previously afford by offering them adjustable rate mortgages. This has been a key element stoking the housing markets in the 2000s. More generally, securitization has made it possible for speculators to tap into the savings of more conservative institutional investors willing to buy assets-backed securities but not to invest directly in such speculative markets. Such developments provide examples of the ways in which new financial innovations in the USA have helped leverage speculative markets.

These changes have in turn forced important innovations in governance which have consolidated these structures. It is indeed one of the striking features of recent responses by the American and British governments that they seem to consolidate the structures of financialization rather than undermine them. This suggests that changes in finance are more important than often assumed and that economic governance is progressively getting in line with new forms of speculative accumulation. These changes can now be seen in the striking ability of financial systems and governments to channel and control inflation in order to sustain speculation without generating inflation in other sectors of the economy (Konings, 2008). It is striking, for example, that the supply of money in the USA (M3) could grow annually by 8.6 percent from 1994 to 2000 without apparently fuelling inflation (Brenner, 2002: 144). Furthermore, changes in governance have helped to widen access to speculative markets, notably with the shift towards institutional funds (Harmes, 1998) and the move towards defined contribution pension systems, which makes workers responsible for building their pensions through investments in such funds (Harmes, 2001). These have all contributed to the consolidation of speculative dynamics. They suggest that the future of speculation is more open than is conventionally accepted and highlight the growing importance of speculation for capital accumulation.

Conclusion

Marxists have had difficulty living up to Marx’s dictum that people make their own history even if not under the conditions of their own making. Given their tendency to focus on the laws of motion of capital, they often address the question of crisis in a highly structuralist perspective that is anathema to proper historical analysis. In the present author’s work, a historicist approach has been emphasized aimed at specifying the significance of history. Theory, this approach argues, can never stand in place of history by defining a logic of development in abstraction from it. In that sense, theory does not provide a substitute for history, a more abstract template of historical processes that could be distilled from all the impurities that exist in the form of ‘historical complexity’ and which supposedly cloud our understanding of social dynamics. It provides rather a means for problematizing history, for making the significance of historical events more precise.

In this spirit, this author has criticized accounts of speculation that are based on a structural perspective and that rely on a credit model which assumes that production sets limits on speculation. This implicit concept of limit has meant that Marxists have mostly theorized about finance in derivative ways. They end up seeing finance as being dependent ultimately on the surplus value pumped into finance by capitalist producers. Such a view only reinforces the problematic assumption that financial crises are ‘corrections’ through which financial markets are being realigned with the real economy. It amounts to seeing reality being realigned with our models. Speculation and financial crises are then never discussed on their own terms.

Capturing the partial autonomy of finance requires that we understand the specificity of speculative imperatives, and particularly those that govern financial bubbles. The contradictions of speculation are fundamentally different from those that drive capitalist accumulation and require a different, even if connected, analysis. This distinction helps us not only to understand how capitalist downturns are related to speculation. It also highlights how institutional developments in financial markets contribute to sustaining and transforming speculative dynamics. For this reason, we need a historical approach to speculative bubbles which can properly grasp the development and gradual institutionalization of their form of accumulation. Moving forward in the study of these dynamics requires an analysis of the institutional structures which shape these practices, a comparative assessment of various forms of speculation and the study of the political struggles that surround them. Only in this way can one determine whether or not financial innovations and changes in governance are profoundly transforming the nature of capitalist accumulation.