Nothing was supposed to go wrong with capitalism after the global update. Version 2.0 was to correct the faults of the various national types of capitalism.

Capitalism 1.0 focused on households and firms. Across the economy, workers spent what they earned to meet household needs, paying for all the goods they produced in the process. Firms made profits out of investment. In recessions, firms quit investing, and their profits disappeared. Workers lost their jobs, and the economy deteriorated.

Prior to World War II, which stopped the Great Depression, Michel Kalecki explained what went on. Workers spent what they earned. Firms collected that. But capitalists only made in profits what they spent on new investment. Capitalists over-invested in good times and then over-withdrew in bad times.

After the war, the industrial economies boomed and sometimes busted. Capitalism 1.5 added the “Keynesian” state as stabilizer, taking money out of the economy when things heated up and stoking the fires when it cooled down.

Since investment is what produces profits, it was natural for capitalists to look for new places to invest, crossing borders in the process. States were to favour global capital flows, insure inward investments against government takeovers, and protect the outward flow of profits against regulation and high taxes. Hyman Minsky showed how stability brought instability, as global investment cranked up, made money for itself, invested again, and was surprised suddenly to discover it had over-extended again. Government activity itself was to be turned over to profit making. Postal services, power generation, drinking water, recreation, and cultural production was all to be profit based, along with agriculture, natural resources, and manufacturing. Global rules for free trade protected investment, and the WTO set itself up as judge and jury. The IMF pushed countries into accepting foreign investment — creating domestic indebtedness to global business — and called it the road out of poverty.

Inherent in the Kalecki, Keynes, and Minsky understanding of capitalism is that the real economy is a monetary economy. As Marx put it, capitalists start with M (money), use it to produce C (commodities), and sell it for M’ (more money). They do not trade a commodity for money and then buy more commodities. That is barter, not capitalism. For a capitalist economy to operate, monetary creation must take place first.

Economists who understand the monetary economy are in short supply. A good number of them were in Dijon, France last week to pool their “Post-Keynesian” understanding of the recent financial crisis and reflect on what to do about it.

The monetary circuit is at the centre of what went wrong, according to the Dijon school of thought. Banks make loans and the loans make deposits. Through double entry accounting, banks create money by putting loans on the asset side of the ledger, and then an equal amount of deposits on the liabilities side. So long as the loans are repaid, money flows out and then back in again, and the circuit is closed without anything going wrong. But when loans go bad, the banks cut back lending, and need government bailouts and support. Without new loans there is no investment, and thus no profits.

What has happened under capitalism 2.0 is that the banks have been lending not only for consumption by workers and new production by capitalists, but to build asset portfolios, such as home investments sold as securities, new issues of shares, and equity holdings by giant hedge funds. When these loans went bad, the earth moved. Conservative central bankers under right wing governments started creating money themselves, led by the U.S., to bailout the banks.

As University of Ottawa economist Mario Seccareccia pointed out in Dijon, government austerity helped speed up the speculative lending. By paying down public debt, like in Canada, governments were taking government bonds — sound assets — out of the market. Instead of buying bonds, banks lent to hedge funds instead.

What we need today is steady increases in public investment funded by public debt and strengthened income for workers, especially those at lower levels, and minimum wage, part-time, and seasonal employees. Investment needs to be socialized, not left to the boom, bust, and speculative operators who pay huge pseudo-incomes and contribute nothing to society.

We should be worried that stock prices have risen so fast, thanks to a renewal of bank credit, without profits to match the anticipated market gains. Indeed, it would be best if banking were to be treated as a classic public utility, producing credit at low cost for socially necessary production.

In short, what needs to be on the agenda is socialism 2.0.

Duncan Cameron writes from France.