The Cash Nexus:Money and Power in the Modern World, 1700-2000

by Niall Ferguson
552 pages,
ISBN: 0465023258

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Disproving Economic Determinism
by Brad Walton

Money makes the world go round. Or does it? Both Marxists and neo-classicists have their own versions of economic determinism. Niall Ferguson rejects economic determinism in general. In The Cash Nexus Ferguson re-examines the link between economics and politics and argues that political institutions have shaped modern economics, not vice versa.

Ferguson's analysis is based on theoretical foundations laid by the historian and economist Douglass C. North. North integrated institutional analysis into economic theory to show how institutions (the rules of the social game, the humanly devised constraints that shape human interaction), affect economic performance. He argued that the institutions that provide the context for economic activity are not always economically efficient. Social and political institutions affect both motivation and interpretation of the environment, generally in ways that are not only more complex than, but also frequently inconsistent with, neoclassical concepts of 'utility'.

Ferguson, drawing on North, regards sociopolitical institutions as generally more determinative of economics than economics is of sociopolitical institutions. In other words, money does not make the world go round. Various impulses, including political ones¨the desire for security and the will to power, both frequently expressed in irrational violence¨tend not only to override economic motives, but also to shape economic institutions. The illustrative case is early-modern and modern western Europe and America. Here political reality, and most particularly war, has shaped modern economic life.

A commonplace notion in historiography is that the principal function of the early-modern and modern state, at least until the late nineteenth century, was to raise money for the purpose of waging war. Accordingly, Ferguson's basic thesis seems not only plausible, but also hardly controversial. It is in the details of Ferguson's analysis that the reader is likely to find much of interest.

The first half of Ferguson's study describes the political origins of the institutions of state expenditure, revenue (especially taxation), and public debt. Until about the middle of the twentieth century, war was the chief influence on state budgets. The primary means of financing war was, of course, taxation. The early-modern state generally relied for its revenues on state assets and indirect taxation. In times of war these sources were problematic and insufficient. Taxation through import tariffs¨protectionism¨was a convenient and politically popular source of revenue, but economically questionable. A general income tax in time of war, and later in time of peace, was found to be not only lucrative, but also the least politically and economically problematic form of taxation. However, to secure the ever-larger sums required by war, it was necessary to increase the tax base by extending the vote. This necessitated amplified parliamentary representation and civil services, a process obviously tending to augment non-military expenditure. The consequent growth of state bureaucracy and state spending was a matter of concern as early as the 18th century. While France adopted a costly system of tax-farming, the British Department of Excise developed a more economical device: a professional civil service. The British model was adopted by other European states, including France, after the 1790s. However, as the voting franchise was extended to supply war money, so was the amount¨and proportion¨of state revenues diverted from war and devoted to civilian employment and redistributive transfers.

Government debt incurred by war spawned the defining economic and financial institutions of the modern world. Ferguson's discussion of the history of public debt will interest many who remember how, during the 1990s, the supposed crisis of the welfare state, after exciting hysterical apprehensions of decades of unwieldy debt and even national bankruptcy, mysteriously vanished within a few years. Historically, immense public debt has proven far from disadvantageous, provided the indebted nation's financial system has had the ingenuity to manage it. Great Britain overcame economically and demographically superior adversaries in both the eighteenth and the twentieth centuries, avoided the internal debt-related crises that broke France and Germany, and emerged as the "first industrial nation," despite carrying a public debt of unparalleled size and duration. Indeed, it would appear that, in Britain, increased public debt assisted capital formation and fostered economic growth by encouraging the development of financial institutions and creating markets for private sector bonds and shares. Many eighteenth-century British economists considered public debt benign, if not beneficial. Large public indebtedness was for some nineteenth-century countries a proud badge of national sovereignty. Although debts crippled and even destroyed some early modern states, the development of financial institutions since the eighteenth century has meant that debt charges as a percentage of government expenditure have generally fallen. British, French and German debt charges during the 1980s and 1990s were among the lowest in the histories of those nations.

When debt crises did occur states sometimes availed themselves of the time-honoured remedy of currency debasement, resulting in taxation by inflation. Although some have supposed that the spread of the gold-standard during the nineteenth century was intended to eliminate debt reduction by currency depreciation, the practice continued into the twentieth century (post-World War I Germany being the most stupendous example). In fact, the gold standard evolved as a system designed to limit the discretion of central banks to lend too freely during peace time. After a series of crises during the 1830s and 40s caused by excessive lending by smaller banks, the Bank of England (originally formed in 1690 to lend money to William III), was given the responsibility of controlling note issue in amounts limited by its gold reserves. The Bank of England effectively became the only institution in the country with the right to issue bank notes. In time its functions included acting as banker to the government and to other banks, management of the national debt, and execution of government money policy. Poor performance during the 1920s put central banks in clear subordination to governments. In response to the stagflation of the 1970s, however, central banks were practically liberated from 'political interference.' Their autonomy continues, though arguably dependent on the political will to repress inflation.

The bellicose necessities of the modern state thus led to the development of four institutions which, Ferguson argues, constitute the four pillars of modern political organization: a tax-gathering bureaucracy of salaried officials; parliaments, through which tax-payers are granted representation in return for taxation; a system of national debt, which allows the state, in anticipation of tax revenues, to borrow money for meeting immediate expenditure needs; and finally a central bank, which manages debt and monopolizes the issuance of money. This 'square of power,' first realized in Hanoverian Britain, explains England's eventual economic and military triumph over France with the latter's inferior system of privatized tax farming, minimal representation, fragmented and expensive methods of borrowing, and no central monetary authority. The 'square of power' also had unforeseen benefits. The need for a supply of bureaucrats led to a system of formal education. Wider representation in parliament probably enhanced the quality of property-rights legislation. Government borrowing expanded capital markets. The central bank stabilized the credit system.

Ferguson's emphasis on the 'square of power'¨and, presumably, the experience of the past twenty years¨suggests a reinterpretation of traditional social-conflict models. Whereas the early classical economists and Marxists understood social conflict as due chiefly to the relations between landowners, capitalists and workers, Ferguson sees the contest as existing, first, between state employees, tax-payers, bond-holders and welfare recipients; and second, between generations (who pass national debt from older to younger members of society). These tensions are a source of weakness for the state, since, if it attempts to service its debt through indirect taxation, it faces opposition from the vast majority of consumers. Conversely, if it defaults on its debt or attempts to evaporate it through inflation, it must reckon with the wrath of the bond holders.

Another source of state weakness is the tendency of governments, including ideologically laissez-faire governments, to manipulate the business cycle in order to enhance popularity and power. It is commonly accepted by politicians and the media, a sort of political version of economic determinism, that economic growth ensures re-election. Ferguson argues, by contrast, that this clichT is, at best, an unreliable oversimplification. The evidence of the last forty years indicates that voter response to economic change is immensely complex and apparently unpredictable. The moral? Governments should not try to manipulate economic cycles; too often this results in unanticipated negative consequences without securing re-election.

In the last part of his book, the part that has understandably received the most attention in the popular media, Ferguson turns from intra-state to international institutions. He outlines the history of the international bond market, and indicates how, after 1815, there was a gradual diffusion of the British system to other countries. The loans made by Britain to other nations were attended by what are now called 'conditionalities,' prescribing an assimilation of the British state models: London bond holders regarded constitutional monarchies a better credit risk than absolutist ones.

The current era of globalization was anticipated by the 'first period of globalization,' ca. 1870 to1914. How do the two eras compare? Global markets for goods and capital, although impressive in the late nineteenth century, have been outstripped (and, in the case of capital markets, dwarfed) by current numbers. Direct investment is also greater now owing to the growth of multinational corporations. Information flows are now, of course, more copious and rapid. On the other hand, the global labour market is far less open than it was a century ago. Today there is nothing comparable to the massive migrations of the nineteenth and early twentieth centuries. The fact is notable and deplorable. It was the vast migrations of 'first age of globalization' that did most to reduce income inequalities between countries. Now, the predominance of capital flows and the stifling of migration are creating unprecedented levels of international inequality. In 1999 the United Nations estimated that the assets of the world's three leading billionaires were greater than the combined GNPs of the world's poorest countries, representing 600 million people.

The manner of global hegemony has also changed. Probably the most significant difference is that, from 1870 to 1914, Britain, the world hegemonic power, was a net exporter of capital. Since 1972, the United States, the current dominant economic power, has used its supremacy in the bond market principally to import capital, leaving it with far less financial leverage for its foreign policy, and far less formal and informal control over the world economy, than Britain wielded. Markets have effectively been removed from significant political supervision, being left to their own autonomy, not to say volatility. The resulting risks include bubbles in some asset markets and investment-starvation in others.

The apparent reluctance of the U.S. to undertake a world-policing role comparable to that of Imperial Britain is one of Ferguson's principal anxieties. He reads British history as a cautionary tale: it was not the costs of empire that undermined Britain's power, but her failure to prepare adequately for the defense of empire. Germany and Japan were neither institutionally nor economically equal to Britain, but their military performance during World War II indicates what damage authoritarian states can inflict on ill-prepared democracies. The moral for the U.S? While not facing a threat comparable to that faced by Britain in World War II, the U.S. should still make a precautionary use of its power to impose both democracy and market economy on rogue states 'while the going is good.' Not doing so may be judged by future generations as irresponsible.

Ferguson's historical analysis is thus intended to disprove economic determinism in order, finally, to caution against economic fatalism and invisible-hand mysticism. Economic motives can be, and generally are, subordinated to other motives. Ferguson regards homo economicus as 'a rarity, and to most of us a rather monstrous one.' Economic principles have never been, nor need now be, the sole basis of decision-making in democracies. Nor should democracies, in some mistaken faith in the beneficent providence of free capital, renounce political control (certainly Britain, the greatest capitalist power of the nineteenth century, never did). So far as Ferguson is concerned, there is no necessary connection between economic growth and democracy. Rather, both seem more dependent on the good standing of education, the rule of law and financial stability than they do on one another.

Ferguson's style is lucid, elegant and, generally, a pleasure to read. He is fairly conscientious about explaining the arcane language of economic and financial history, although some readers will probably require an economic dictionary (J.L. Hanson's Dictionary of Economics and Commerce is likely the most helpful for reading The Cash Nexus). The text is sprinkled with (not always perfectly informed) references to literature and the arts, though I'm not certain whether this is to counteract tedium or to convey an impression of the author's cultural interests.

The statistical and factual evidence that Ferguson adduces to support his argument is abundant, and sometimes excessive. Much of it ought to have been confined to footnotes. It is unfortunate that the thematically fundamental first chapter inundates the reader with a veritable sunami of hard-to-absorb and frequently superfluous facts, figures, graphs and catalogues, creating a sort of scholarly self-parody. To give the most absurd example, when Ferguson asserts the incontrovertible fact of progress in nineteenth-century military technology, he inflicts on the reader (by this point already glutted with quantitative history), a long catalogue of weapons, complete with the names of the engineers and firms that designed them. In the remainder of the book, fortunately, this tendency to excess is controlled. When it does occur, however, it conveys an unsettling impression of erudition at the service of ostentation.

I do not know how many economic determinists or reductionists will be converted by Ferguson. At some crucial points arguments are lacking. That war, for example, is always in essence a political rather than an economic act is assumed rather than argued. Presumably Ferguson accepts the liberal view that war is always economically irrational. On the other hand, that homo sapiens is not fundamentally homo economicus, and that human passions are prior to, and not necessarily in the service of, economic self-interest, seems nothing if not plausible. At other points definitions are missed. There is no definition of the difficult term, 'state,' which Ferguson sometimes identifies with, and sometimes distinguishes from, 'government.' Also, it is not always clear which democratic controls Ferguson thinks appropriate, and which inappropriate, for commercial and financial activities. Finally, there were some gaps in the historical exposition. There was virtually no account of the development of the welfare state, which Ferguson seems to regard as little more than a parliamentary acquiescence to an increasing, and increasingly vulgar, tax base (i.e., the voters)¨surely an oversimplification.

The Cash Nexus is not so much the product of original research as of ingenious synthesis. If Ferguson has seen far, it is because, like most scholars, he has stood on a mountain of other people's research. His forty-page bibliography (specialist students may consider this the book's most valuable asset), contains about 1,000 items, and his reasonably dense text averages just less than four footnotes per page. In producing The Cash Nexus, Ferguson has performed a public service by assimilating and presenting so much recent academic research and discussion, which otherwise might have remained inaccessible to most readers.

Whatever reservations one may have about Ferguson's analysis and conclusions, I doubt that there are many readers who are so well schooled in economic and political history that they will learn nothing new and valuable, or so determined in their views that they will not be stimulated to think again about the relationship between politics and money. ˛


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