Thursday, 23 October 2014

The Law Of The Tendency For The Rate of Profit To Fall - Part 54

Effects On The Rate of Industrial Profit (3)

There is another consequence of the rise in the social productivity of capital, which although it does not increase the general annual rate of profit, does increase the amount of industrial profit available for reinvestment. In Capital II, Marx emphasises that within expanded reproduction of capital, simple reproduction continues to constitute the major part. That is, the majority of the reproduction must necessarily be the reproduction of the existing constant and variable capital. The addition of new capital to it, is only ever a fraction of this existing capital-value.

But, simple reproduction remains important for another reason. That is that the capitalists themselves have to consume in order to survive. Although, the process of concentration and centralisation of capital, means that the number of capitalists relatively falls, Marx also sets out that, particularly during certain periods, the absolute number of capitalists increases. An increased number of capitalists means that the quantity of their unproductive consumption necessarily rises. Moreover, Marx notes that although industrial capitalists were initially marked by their tendency to minimise their unproductive consumption, in order to maximise their accumulation, and in Capital III, he again emphasises that the point of capitalist production is the generation of surplus value and accumulation, not increased consumption by capitalists, increasingly capitalists become torn by this need, and their desire to emulate the conspicuous consumption of previous ruling classes. Even if the proportion of surplus value they devote to accumulation rises compared to that devoted to unproductive consumption, therefore, as the mass of surplus value rises, so the absolute amount of surplus value devoted to unproductive consumption rises inexorably.

The figures provided by Thomas Picketty, and others, recently, in respect of the vast disparity in inequality of wealth and income, are an indication of the extent to which that has occurred. The wealth of the super rich today is so vast that their unproductive consumption, on things such as luxury yachts, aeroplanes, private islands etc., is way in excess of that of any previous ruling class in history, and yet barely touches even their income let alone their wealth.

As Marx points out, therefore, to the extent that the rise in social productivity reduces the value of all those commodities bought by the capitalists, be they essentials or luxury commodities, the smaller the proportion of the surplus value do they have to expend to obtain any given quantity of these commodities. They can maintain or extend their living standard, at lower cost, and thereby retain a larger proportion of the realised surplus value for accumulation.

Wednesday, 22 October 2014

Another 2008 Is Inevitable - Part 5 of 5

What makes another 2008 inevitable, therefore, is that when this process began to unfold, six years ago, it was possible for central banks to rescue commercial banks by printing money to end the credit crunch, official interest rates were slashed, and the bad debts of banks, in the form of grossly inflated asset prices, were once again reflated, allowing the banks to continue a process of extend and pretend, in relation to their loans. But, its clear that the potential to repeat that exercise is greatly limited, whilst the mass of debt, and build up of fictitious capital, is much greater. For one thing, official interest rates are already at their zero bound. For another, the efficacy of money printing has been increasingly diminished as a means of reflating asset prices. The scale of money printing after 2008 has been much greater than during the 1980's and 90's, yet, compared to the 1,300% increase in the DOW, during that earlier period, it has only risen by 70%, in the last 14 years.

As stated earlier, in the Eurozone, the LTRO has been singularly unsuccessful, in increasing bank lending, into the economy, and the desirability, let alone justification, of Italian and Spanish bond yields lower than those in the UK or US, is highly questionable. The UK has ceased its QE programme, and the US is ending its programme this month. Already, the consequence of that has been to increase volatility. The VIX volatility index has risen from around 12 to 27, a level which in the past has again meant that the potential for a stock market crash is greatly increased. Over the last three weeks, stocks have moved up and down violently, responding to comments by Federal Reserve spokesmen about when US interest rates are likely to rise.  As I pointed out, recently, this is similar to the situation, in the 19th century, when UK markets continually looked forward to the arrival of treasure ships, from Australia, that brought back gold, which was then used to increase the currency circulation. 

Meanwhile, as stated at the beginning, although we have record low official interest rates, which presses down on savers, we have record high interest rates paid by an increasing number of people reliant upon pay day lenders. There is a limit to which people can simply cover their debts, by borrowing more from more usurious lenders, under conditions where we have real wages being reduced by more and for longer than at any time in more than 130 years . Even in Germany's much more successful economy, as Paul Mason reports in the article referred to previously,

“As a result, says Professer Fratzscher, the lowest paid 60 per cent of the workforce has actually seen their wages decrease over the last 15 years.”

In the US, property prices having fallen by up to 60%, have spiked in the last year or so, but it seems only as a result of buying by speculators, rather than home buyers. Each spike causes a reaction in the shape of a fall in demand, and whenever interest rates rise it causes demand to fall, and prices to fall back. Meanwhile, the kind of sub-prime lending, and derivatives, that was seen ahead of 2008, in housing, has now been seen in relation to car loans.

In the UK, having thrown everything it could at the property market, short of actually giving people wodges of money in their hand, to put down as deposits, no questions asked, property selling prices, in most of Britain, have continued to weaken, and the number of properties on estate agents books has continued to rise, and remain there for longer. Even London property prices appear to have started to fall. Prices seem to have reached such a level, given the continued fall in wages, that potential buyers cannot now afford even the monthly mortgage payments, let alone raise the required minimum deposit. As interest rates rise, and as the UK economy follows Europe into a new downturn the potential for a significant drop in UK house prices is on the cards.

For the last thirty years, as the secular decline in interest rates underpinned a rise in asset prices, fuelled by liquidity induced speculation, a psychology understandably developed of  “buy on the dips”. A secular rise in stock and bond markets, as well as of house prices, induces the myth that these prices can only move in one direction over the longer term. But, of course, even over the shorter term, buying at the wrong time can seriously affect your wealth. If you held stock in 1929 ahead of the Wall Street Crash, it would have taken until the 1950's, until your portfolio recovered its previous value. In 1947, with lots of people seeking houses after the war, my parents bought a terraced house for £1,000.  Had they waited another two years, they could have bought a brand new semi-detached house for just £250.  As late as 1974, their house had only just reached the same price they paid for it in 1947!

I suspect many people who have bought houses in the last 15 years will find themselves in a similar position, of being burdened with a high level of mortgage debt for another 20 years, but with the market price of their property reduced to a quarter its current level. The fact is that a reversal of the conditions which led to secular bull markets, can also lead to equally prolonged bear markets for shares, bonds and property. Rather than buying the dips, during such a period, it becomes a safer bet to sell the rallies, i.e. each time prices rise, take the opportunity to sell any shares, bonds, or property you still have. There is no reason that US, UK and other stock, bond and property markets, should not follow the experience of Japan since the 1990's, of a sharp sell-off, taking them back to the levels prior to the inflating of the bubbles, followed by only modest increases over the next period.

The other factor, which makes another 2008 inevitable and worse, is the question of who owns the debt, and who has the liquidity? Usually, the “smart money”, the very rich and the true money-capitalists, exits financial markets at the point that everyone else (what has been termed by others as the lumpen investoriat) is piling into them, because that is a sign of the top of the market. The smart money sells their shares, bonds, property, gold and so on to the ordinary punter at the top of the market, and lets the latter suffer the losses, as markets fall. Where they have not been able to do that, for example, in Greece etc., in 2010, they use their political influence to get the state, at a national or international level, to bail them out. So, for example, the ECB and other institutions, bought up peripheral European bonds, and the ECB is proposing to do the same thing again on a larger scale, also buying worthless mortgages and mortgage backed securities from banks, if it has to undertake some form of QE.

But, the current conditions are peculiar. After 2008, and following the Stock Market Crash of 2000, many retail investors have fought shy of throwing their money into the markets, even as over the last five years, those markets have almost doubled. Retail investors have singularly failed to join in the market euphoria, which has, therefore been driven almost entirely by institutional investors. Although, many analyses show that the super rich have benefited considerably from this process, because they own the majority of privately owned assets, even these individuals have not been enthusiastic buyers of the market. In fact, their reluctance to commit large sums to the market is illustrated by the continued high level of bond prices, and more exceptionally by the example of BNY Mellon, which found demand, from large investors, to place money on deposit, in its vaults, so great that rather than paying interest on those deposits, it charged them for doing so! A similar example is to be seen with German Bunds, which on several occasions over the last few months have paid a negative rate of interest.

What we have is banks, that have been stuffed full of liquidity, when what they really needed was capital, using that liquidity, not to lend into the market, but attempting to repair their balance sheets and profitability, by investing into the safest financial assets – government bonds, currently backed by central banks. That pushes up bond prices, and pushes down bond yields. So every time, there is some kind of scare that leads to a suspicion that stock markets might fall, money floods into these bonds, as has been seen over the last few weeks.

However, although the banks have all of this liquidity, it is liquidity that has been provided to them in the form of cheap loans from central banks. That means central banks have vast amounts of fictitious capital on their own balance sheet, as the other side of these loans, as well as in the form of all the bonds they have themselves accrued as part of QE. The banks have liquidity, but they also have huge debts to repay to the central bank, that are currently only sustainable because of the low interest rates the central banks are charging them, and because their own balance sheets are flattered by the high valuations of assets in their possession. The banks are exposed to two related mortal dangers – a rise in official interest rates, which increases the cost of servicing their loans from the central bank, and a sharp drop in asset prices, which would decimate their balance sheets.

The banks do have high levels of deposits, despite near zero interest rates on deposits, made possible because the banks have no need to compensate savers, and encourage them to deposit money, when they can borrow for next to nothing from the central bank. The high level of deposits arises, because large corporations have lots of cash on their balance sheets, that has built up over the last thirty years, as a result of the rising rate and mass of profit. On a global basis, that is manifest in the glut of savings, from such corporations, as well as the savings from surplus economies like China.  In addition, even in the developed economies, sections of the population themselves have large amounts of savings, which they are desperate to preserve rather than risk in speculative activity buying over priced shares, bonds, or property.

For those institutions that do need to obtain some level of income, whilst maintaining a level of security of investments, like pension funds, this means that they have been increasingly forced to search for yield in increasingly risky assets, such as junk bonds. Demand for such bonds has risen considerably, pushing their prices higher, and their yields lower. The problem with these bonds, and the same thing applies to things such as property, or gold, is that they are not liquid. The market for shares not only runs into trillions of dollars, but every day there are billions of transactions, as large numbers of people buy and sell. If you want to sell even a large block of shares, its always possible to find buyers.

But, ask anyone trying to sell a house, in most of Britain today, and the picture is quite different. In many places, houses are up for sale in excess of a year, and for as long as two years before a buyer can be found. The consequence is that, when the number of sellers increases, even by a relatively small proportion, the lack of immediate buyers causes prices to fall sharply. That same fall itself causes others to panic and seek to sell themselves, at lower prices. There is a rush to an increasingly small door, all at the same time, that starts a firesale in which prices collapse. 

In such a period, as 2008 demonstrated, this has a contagious effect on all other assets, especially as those unable to sell, but who need liquidity, are forced to sell even those things that are not particularly over priced. When asset prices collapse, cash is king. During the 1930's when property prices collapsed, in parts of New York, mansions sold at 10% of their previous prices. Those who had sold their shares ahead of the collapse, were able to use the cash to buy up such properties. The legendary investor, Sir John Templeton, is noted for the fact that in the 1930's, when stock markets had collapsed, he bought 100 shares in every company listed on the NYSE, that was below $1 per share. That amounted to 104 companies. Within a matter of years, each of those 10,000 plus shares was worth many times the $1 he had paid for them.

In fact, as set out earlier, it is frequently in such periods of economic stagnation, particularly after a stock market crash, like 1929 or 1987, that share prices do rise sharply, because, during such periods, the rate of profit rises, but the investment of the realised profits in productive-capital remains sluggish. The consequence is that the surplus of loanable money-capital over its demand pushes interest rates lower. The money gets invested into fictitious capital, into shares and bonds, rather than into productive-capital, and so the process described earlier arises, of an increasing quantity of money chasing a limited supply of shares, pushing the share prices higher. That was what happened in the 1980's and 1990's, as the period of long wave downturn ran from around 1974 to 1999. Particularly, after 1987, the rate of profit rose, but economic activity and investment in productive-capital remained relatively sluggish. The excess of money-capital pushed down interest rates, and exacerbated by policies of money printing, following the crash of 1987, it fuelled the resultant bubbles in stock, bond and property prices.

The Spring phase of the long wave, that ran from around 1999 to 2012, has seen a continuation of the rising rate of profit, but coupled with the sharp rise in global economic activity, referred to at the start, it also saw a huge rise in the mass of surplus value, which exceeded even the increased demand for money-capital to finance additional productive-capital, which is why global interest rates continued to fall. As Marx describes, these two periods, when the rate of profit is rising (the period that Marx calls stagnation, and which is the Winter phase of the long wave, and the period that Marx terms prosperity, which is the Spring phase of the long wave) are the two periods when interest rates are falling. In the period that Marx terms the crisis stage, which is equal to the Autumn phase of the long wave (from 1974 – 1987, for example), interest rates are high, and may spike, because firms require money-capital at almost any cost to stay afloat. In the Summer phase (1962-74, for example), which corresponds to the period of boom in Marx's description, the demand for money-capital rises relative to its supply, pushing interest rates up to their normal level.

We are now in such a period, when the annual rate of profit is declining (not of course uniformly everywhere, or in a straight line), which is the basis of steadily rising global interest rates. Rising interest rates means falling share, bond and property prices. Any attempt to reduce interest rates by printing money will fail, and result only in rising inflation, and a sharp sell off in bonds, causing market rates to rise even more. 

However, today, although a large number of people are exposed, because they bought over priced houses during the last 15 years, the real threat, when those prices collapse, is not for their buyers, but for the banks who own all of the fictitious capital, in the form of mortgages for that property. That is why every attempt has been made to delay that collapse in prices. At the same time, large numbers of people frightened by the experience of 2000 and 2008, have refrained from also buying over priced shares and bonds, preferring to at least keep their money safe, as simple deposits, even if it means accepting near zero levels of interest. Those who have these large quantities of liquidity are well placed to pick up these assets when their prices collapse, and this time the losers will be the banks and financial institutions, along with the super rich, left holding increasingly worthless paper.

That is why the state has done all it can to defer that financial panic, even if the cost has been to damage the real economy. But, they have merely, in the process, exacerbated the contradictions, and made a bigger collapse all the more inevitable. It is not a question of if another 2008 occurs, but only of when.

Capital II, Chapter 20 - Part 14

Our model is:

Department I c 4000 + v 1000 + s 1000 = 6000

Department II(a) c 1600 + v 400 + s 400 = 2400

Department II(b) c 400 + v 100 + s 100 = 600

In the above model, the more capitalists from 2a (production of necessities) spend on luxuries, the less they spend on necessities. That means higher demand for luxuries, and more capital allocated to this production. In turn that means more workers employed in luxury goods production, and fewer in producing necessities, but it doesn't change the fact that those workers continue to spend their wages on necessities.

“Every crisis at once lessens the consumption of luxuries. It retards, delays the reconversion of (IIb)v into money-capital, permitting it only partially and thus throwing a certain number of the labourers employed in the production of luxuries out of work, while on the other hand it thus clogs the sale of consumer necessities and reduces it. And this without mentioning the unproductive labourers who are dismissed at the same time, labourers who receive for their services a portion of the capitalists’ luxury expense fund (these labourers are themselves pro tanto luxuries), and who take part to a very considerable extent in the consumption of the necessities of life, etc. The reverse takes place in periods of prosperity, particularly during the times of bogus prosperity, in which the relative value of money, expressed in commodities, decreases also for other reasons (without any actual revolution in values), so that the prices of commodities rise independently of their own values. It is not alone the consumption of necessities of life which increases. The working-class (now actively reinforced by its entire reserve army) also enjoys momentarily articles of luxury ordinarily beyond its reach, and those articles which at other times constitute for the greater part consumer “necessities” only for the capitalist class. This on its part calls forth a rise in prices.” (p 414)

But, dismissing the arguments of the under-consumptionists, Marx demonstrates why crises are not the result of the working-class obtaining too small a share in wages.

“... one could only remark that crises are always prepared by precisely a period in which wages rise generally and the working-class actually gets a larger share of that part of the annual product which is intended for consumption. From the point of view of these advocates of sound and “simple” (!) common sense, such a period should rather remove the crisis. It appears, then, that capitalist production comprises conditions independent of good or bad will, conditions which permit the working-class to enjoy that relative prosperity only momentarily, and at that always only as the harbinger of a coming crisis.” (p 415)

One of the ideas that most Marxists have is a phrase used by Marx that capitalism is production for the sake of production. But, as Lenin comments, in reality, capitalist production itself has to be guided by the needs of consumption. Capitalists can only realise profit if the things they produce are saleable, if consumers want them.

Under simple reproduction, the surplus value is used simply in order that the capitalists can continue to live. As Marx says in Volume III, we should not let this distract us from the real purpose of capitalist production, which is the self-expansion of capital. Yet, as he also says, the more capital develops, and the more capitalists are separated from their social function, the more the allure of unproductive consumption influences them as individuals, even whilst the need to accumulate or die continues to exert its influence on capital itself. 

Capitalist production may be characterised by expanded reproduction, but simple reproduction remains an integral component of it. The circuit may appear M – C – M', and a portion of M' then being reinvested to expand capital, but the reality, Marx says, remains M – C – M. M – C – M' with the accumulated m comprising an additional new capital, with its own circuit m – c – m'. 

“Simple reproduction is essentially directed toward consumption as an end, although the grabbing of surplus-value appears as the compelling motive of the individual capitalists; but surplus-value, whatever its relative magnitude may be, is after all supposed to serve here only for the individual consumption of the capitalist. 

As simple reproduction is a part, and the most important one at that, of all annual reproduction on an extended scale, this motive remains as an accompaniment of and contrast to the self-enrichment motive as such. In reality the matter is more complicated, because partners in the loot — the surplus-value of the capitalist — figure as consumers independent of him.” (p 415)

Tuesday, 21 October 2014

Another 2008 Is Inevitable - Part 4 of 5

Marx explains, in Capital III, how the view is developed that the ability to self-expand, to produce interest, comes to be seen as an inherent characteristic of loanable money-capital, and this is completely divorced from the reality that this interest can only be paid as a result of surplus value being produced. The importance of this in relation to the build up of this fictitious capital is that if interest arises simply because of some magical inherent property of loanable money-capital to expand, then, if the quantity, or “value”, of this loanable money-capital, increases, then the amount of interest itself must increase, all else being equal. If, the total value of shares rises, therefore, then the total amount of dividends must rise and so on. Indeed, this is what is behind the false view that higher stock prices are beneficial for pensions, because if the yield is 5%, and the value of a pension fund rises from £100,000 to £200,000 then the amount of income/dividends rises from £5,000 to £10,000.

But, as was shown in Part 1, the reality is that dividends can only rise, the amount of interest paid out on bonds etc., can only rise, if the total surplus value produced in the economy rises. Otherwise, the amount of industrial profit (the profit after deduction of interest and rent) available for reinvestment must fall. If share prices rise by a greater percentage than the rise in surplus value, then either a smaller portion of that surplus value must be used for accumulation as new productive-capital, so that dividends are paid out with the same yield, or else a smaller proportion must be paid out as dividends, in which case the dividend yield falls, which would, other things being equal, lead to a fall in share prices. If we take the example above, if the mass of profit available to be distributed remains the same at £5,000, then a rise in share prices, causing the value of the fund to double, simply results in the yield being halved from 5% to 2.5%. Moreover, as explained earlier, the doubling of share prices means that only half the previous number of shares can be bought with contributions. So contributions buy fewer shares, and the yield on those shares also falls, providing less income for pensioners, which is why annuity rates have fallen, and why company pension funds have run up deficits, unable to generate sufficient income to cover obligations.

It is this, which is behind the pensions crisis, not the nonsense about people living longer. Higher share prices mean it is easier for the capitalists, who already own them, to hang on to them, and harder for workers to buy those shares from them, and to obtain an income from them.

Earlier, it was argued that during the last thirty years, the amount of surplus value was rising, and the rate of profit was rising along with it. Yet, a look at the growth in GDP of the US shows that it increased by only about a fifth of the rise in the Dow Jones and S&P indices. The rise in stock prices could not be explained by an equivalent growth in surplus value, bringing about a growth of real capital, in the US, therefore. But, it could be explained by a rise in the proportion paid out to existing shareholders, or to fund share buybacks and mergers and acquisitions relative to the investment in real productive-capital.

Another explanation could be the fact that, during this period, the greatest accumulation of capital, and rise in the rate of profit arises, not in old economies like the US or UK, but in China and other dynamic Asian economies. US, UK and other multinational companies, therefore, might have made large profits, across the globe, but used them to accumulate capital in China, and other developing Asian economies. The profits of these multinational companies, therefore, may have been rising rapidly on these foreign investments, thereby pushing up the share price of those companies.

And, indeed the evidence of de-industrialisation of economies, like the US and UK, and relocation of some mature industries to lower cost areas, lends weight to that argument. In a recent article on Germany, Paul Mason notes, quoting Marcus Fratzscher of the DIW Economics Institute in Berlin,

“And while German companies do invest, they’re creating more jobs abroad: 37,000 jobs were created by the top 30 companies abroad last year, compared to only 6,000 in Germany.”

That may be one explanation, and it also provides some explanation of the fact that, for example, in the US, there are some new industries such as in technology, where companies have made large masses and rates of profit, and have also amassed huge money hoards on their balance sheets, whilst other older companies, for example, GM and Ford, not only saw their rate and mass of profit fall, but entirely disappear, as they racked up increasing losses. But, the example of technology companies also provides another explanation. That is that shareholders have been prepared to forsake dividends in exchange for capital gain, in the form of higher stock prices.

Companies may make larger profits, for example, but not increase the dividend, or, as in the case of many technology companies, pay no dividend at all. Instead, they may reinvest most or all of the profits, so as to expand the size of the business, as happens, for example, with Amazon. Provided, the additional investment in productive-capital, thereby results in the production of increased masses of surplus value, the price of the shares may, therefore, rise. Although, shareholders then see no rise in their income, they see a rise in their apparent wealth, because the price of their shares has risen, be it in the form of individual share holdings, mutual fund holdings, or their pension fund. As apparent capital, these shares etc. can then be used as collateral to borrow against, for example, to obtain a mortgage. But, then the collateral provided to the bank increases its bank capital, facilitating its additional lending, whilst the house bought with the mortgage can itself be used as collateral for further borrowing by the house buyer, to the extent that its price rises.

In the same way, banks that hold shares or bonds, see their price rise, and as these assets form part of the bank's capital, they facilitate the bank increasing its own lending, by multiple times the increase in the bank capital.

Another explanation is that companies having made large profits, use those profits to simply buy back stock, or to buy shares in other companies rather than to invest in real productive-capital. That is exactly what happened in the 1840's, as Marx and Engels described, with capitalists using the resources from their companies to speculate in railway shares. If a company has a million shares, each worth £10, and produces a profit of £1 million, all of which it distributes as dividends, it pays out £1 per share, a dividend yield of 10%. However, if the company uses the profits to buy back 10% of the shares, the price of the shares, other things being equal, will rise by 10%. This has other benefits. The current earnings per share is £1, but next year, with only 900,000 shares in issue, a £1 million profit, will automatically appear as an earnings per share of £1.11 per share. Moreover, with very low rates of interest, it is often worthwhile, for large companies, that can borrow most advantageously, to borrow money in the money market, and then use this money to buy back stock.

In addition, such companies can buy the stock of other companies, either as a form of speculation, in the belief that they will make large capital gains, as share prices rise, or else as preparation for taking over those companies, at some point in the future. In all of these cases, the share prices are being driven higher, not because of an increased mass of surplus value, being utilised to accumulate additional productive-capital, that makes possible the future increase in surplus value, but solely because additional loanable money-capital is being used to buy a limited quantity of stock, and in some cases, thereby to reduce the amount of stock in circulation. It is inevitably the case that, if increasing amounts of demand chase a limited or reduced supply of stock, then the average price of that stock must rise.

Moreover, a further delusion arises here. Listen to the comments on CNBC or Bloomberg, at any time, ahead of earnings season, when companies announce their quarterly profits, and you will hear discussion about why stock prices can continue to move higher, because earnings continue to rise, or have beaten expectations. In fact, the latter is meaningless. If I lead the market to believe that my profits for the quarter, are going to be zero, but they come in as £1 million, then I have beaten the earnings expectation, but it matters very little, if the reality is that last year my profits were £2 million! On the basis of expectations my share price might be expected to rise, but on the basis of my profits, this year compared to last year, it should fall.

But, the idea of my share price rising because my earnings have actually risen is not so straightforward either. Suppose, my profit this year is 20% higher than it was last year, £1.2 million rather than £1 million. I may have exactly the same number of shares this year, as last year, so the earnings per share (EPS) rises 20%, meaning the dividend could rise by 20%. But, this profit figure can hide a multitude of sins. Suppose, the original profit of £1 million, is made up as follows – revenue £5 million, costs £4 million. In other words, the profit margin is equal to 25%. Now, suppose that in the second case it is made up – revenue £11.2 million, costs £10 million, or a profit margin of only 12%.

The earnings have still risen by 20%, but the reality is that the cost of producing those earnings has more than doubled. In terms of the company's share capital, nothing has changed. It still has 1 million shares, the earnings per share will have risen from £1 to £1.20, but the reality is that in terms of the company's real capital, its profitability has declined. If it only laid out the same £4 million of productive-capital as in the previous year, its profit would have been only £0.48 million, and the earnings per share £0.48, a fall of 62%. 

Suppose, for example, that the company reinvested its previous year's profit of £1 million, and turned over its advanced capital more quickly. Previously, it may have turned over £1 million of capital four times a year, so that it laid out £4 million in total. Giving an annual rate of profit of 100%. Now, it advances £2 million of capital, that it turns over five times a year, giving an annual rate of profit of only 60%. So, the idea that rising stock market prices are justified by rising company earnings is false, because at some point, this additional real capital, that must be laid out, in order to generate those higher earnings, creates a rising demand for money-capital, satisfied either by new shares being issued, or else by companies issuing corporate bonds, or else results in a reduced supply of money-capital to the money market, as profits are immediately reinvested. In either case, the consequence is then to reduce the earnings per share, and the dividend yield, which undermines the share price, or bond price, as interest rates rise.

Already, in the US, when share prices are measured by the CAPE, they are at levels around 26, which in the past have been associated with stock market crashes. That is despite the fact, that in the preceding period there has been a record high level of share buybacks along with very low levels of share issuance, thereby inflating the effective earnings per share, and dividend yield. In the UK and Europe, stocks look less expensive on the CAPE, but again this ignores any potential change in the rate of profit, which makes it necessary to issue additional share capital, or corporate bonds.

But, as Japan in the 1990's demonstrated, because of the extent to which this fictitious capital, in the form of shares and bonds, sits on bank balance sheets, any significant fall in share prices also reduces that bank capital, causing a sharp contraction of lending, and rise in interest rates. Often a fall in share prices causes money to migrate into bonds, pushing up bond prices, and reducing bond yields. But, in a climate of rising interest rates, as banks curtail lending, bond prices are also likely to fall, causing a general fall in asset prices, including house prices, as buyers find they can no longer meet monthly repayments of double or treble their current levels. That in turn rebounds back on bank capital, as all of this fictitious capital is overnight devalued, causing a further contraction in lending. At the moment, none of the bank stress tests in Europe, the UK or the US factor in the kind of systemic collapse, of these asset prices, on the scale that occurred in Japan, in the 1990's, and which began in 2008, across the globe.

The Law Of The Tendency For The Rate Of Profit To Fall - Part 53

Effects On The Rate of Industrial Profit (2)

Marx sets out two forms of rent – Absolute Rent and Differential Rent, with the latter being subdivided itself. Absolute Rent arises, because land is limited in supply, and its ownership is monopolised. That is why although land has no value, because it is not the product of labour, it has a price. In the same way that capital has no value as a commodity, because its use value – the ability to self-expand – is not the product of labour, it has a price as a commodity – interest – so land, as a commodity has a price – rent, or capitalised rent. The owner of land can sell it as a commodity, and thereby obtain a market price for it. And, if they wish to sell the use value of this land only for a given period of time, in the same way that money-capitalists loan out capital, i.e. to lease it, then the owner of the land will charge a rent for doing so.

The Differential Rent, however, arises because a specific piece of land offers the potential to produce higher than average profits from its use. That may be because the land is more fertile, and so produces a higher quantity or quality of crops for any given advance of capital in their production. This applies equally to where the “crop” is some form of mineral or raw material extracted from the ground. Similarly, the higher profits may arise, because the land has some natural benefits, such as the existence of streams to be used for the production of energy by water-wheels, or exposure to winds for energy production by windmills and so on. Or the higher profits may arise, for example, in the case of land in a high street, where the greater number of passers by, provides a higher potential for customers. The landlord then charges a differential rent, which absorbs this additional profit afforded by the use of this particular piece of land.

The rise in social productivity, can be manifest in the fact that the specific advantages of any particular piece of land, may be minimised or cancelled. For example, improvements in agricultural technology and science meant that capital could be employed to improve soil fertility, on land where it was below average. Capital could be used to improve drainage etc. and thereby raise the productivity of poorer pieces of land. By using capital to even out these natural advantages and disadvantages, the basis of differential rent is reduced. However, the greater potential for profits that arise might cause absolute rent to rise, depending upon the demand and supply of land.

The increase in productivity means on the one hand that a given area of land will produce an increased mass of use values, which is the same as increasing the quantity of land supplied. This will act to reduce rents, and the price of land. On the other hand, this rise in productivity, which increases the quantity of use values produced, thereby increases the mass of surplus value, which can be produced. To that extent, it increases the demand for land in order to be able to extract this surplus value. That acts to raise the price of land, and rent.

Other consequences of the rise in social productivity include the improvement in transport and communications, which also leads to the opening up of new territories. This directly increases the supply of land available, and thereby acts to reduce land prices and rents. Other changes mean that lower cost land can be utilised. For example, with an increased number of people with cars, retailers were able to move to out of town centres, and locate on low cost out of town retail parks. A similar effect arises with virtual land, i.e. the Internet. Retailers no longer need the same number of size of physical stores, because they can sell commodities on line. They only need warehouses to store commodities during the period between production and shipping. The Internet Service Providers then become the landlords, renting out space on the internet. As this space is effectively limitless, it does not have the same monopoly constraints that physical land does that are the basis of Absolute Rent.

It is, of course not just retailers that are able to benefit from this consequence of a rise in social productivity. As an increasing amount of employment becomes that of commercial workers, the need for physical office space also diminishes, as these workers can work from home, with access to a computer, phone and internet connection. Even, more complex functions, for example, that of a surgeon can be performed remotely. Perhaps the most visible example, of that is the use of remotely controlled drones whether by the military, or for more productive purposes, or even Amazon's proposals for their use as delivery vehicles. All of these functions can be performed by a skilled worker who can be located anywhere in the world, thereby reducing considerably the demand for land in any specific location, and consequently reducing rents.

Like interest-bearing capital, land has no value, and can, therefore, add no new value to the products it helps to produce. Unlike merchant capital, land does not facilitate the realisation of value and surplus value either, nor does it facilitate the circulation of money and money-capital, and reduce the costs of circulation. Rent, like Interest is merely a deduction from industrial profit. To the extent that both are reduced, the mass of industrial profit rises, and so the rate of industrial profit rises. In other words, the amount of money-capital available to productive and merchant capital for reinvestment rises.

Monday, 20 October 2014

Another 2008 Is Inevitable - Part 3 of 5

As a result of pursuing a policy of fiscal stimulus, the US has succeeded in raising its level of growth, thereby reducing its expenditure on welfare and increasing its tax revenues. It would have achieved higher and more sustained growth sooner, had it not been for the actions of Tea Party Republicans, in limiting the fiscal stimulus, and creating fear through, the Debt Ceiling, Budget and Sequester political crises. It would have achieved higher levels of growth, also, if it had not been weighed down by the introduction of austerity measures in the UK and peripheral Europe, which undermined global growth. Even so, the fiscal stimulus in the US, enabled it to reduce its budget deficit by higher levels of growth.

But, it is still a deficit not a surplus, and so US debt continues to rise. That is still better than the UK. The policy of austerity means that growth has been less than it should have been, and debt has continued to rise. In the Eurozone, the same policy of austerity has had worse effects. The UK, in the last year, had some growth, as a result of a temporary sugar rush, induced by ephemeral factors such as PPI compensation payments, Help To Buy, and a further increase in consumer debt. But, the economies in Greece, Portugal, Italy and Spain have sunk further. Because of the amount of trade that occurs between countries within the EU, austerity measures, in the UK and periphery, have acted to lower growth in the rest. The Eurozone as a whole looks likely to go back into recession, and to pull Germany down with it.

For countries burdened with debt, the last thing they need is deflation, but the policy of the ECB of saying it will do whatever is required, but actually only ever doing the minimum it believes it can get away with, has caused the Euro to rise sharply against the dollar, and thereby to lead to such deflation. The liquidity injections it has undertaken via LTRO, have simply stuffed the banks balance sheets with cash, rather than increasing the currency circulation. In fact, bank lending from European banks to businesses has fallen, as those banks have used the cash to buy sovereign bonds, that they see, possibly wrongly, as being ultimately guaranteed by the ECB itself.

Throughout history, the means by which the state has dealt with large debts is via inflation, a devaluation of the currency. In a capitalist economy, the basic way it works is this. The state borrows £1,000; it devalues the currency by 10%, by printing more money; there is an inflation of prices by 10%; by the same token the amount it takes in in taxes on wages, profits etc. rises by 10% in nominal terms; with this 10% higher quantity of taxes it thereby pays back the original £1,000 whose nominal value remains the same, but whose real value has fallen by 10%.

But, the opposite applies where there is deflation. The debt of the state in nominal terms remains the same, but, if prices and wages are falling, the amount of taxes also falls. The value of the debt continues to rise in real terms. It becomes harder for the state to repay the debt. But, for the same reason, it also becomes harder for all borrowers, to repay their debts.

As I pointed out a while ago – Volley Firing – the fall in the yield on bonds in the US, UK and Eurozone is an anomaly in an environment of rising global interest rates. Inflation and interest rates in emerging markets have been rising. Money flowed out of those markets into the US, UK and Europe. The banks of peripheral Europe were boosted by the ECB's promise to backstop them, and its action to provide European banks with cheap liquidity, via the LTRO, so that they would buy those bonds.

But, ultimately, the markets must test the ECB's promise to do whatever is necessary. In fact, when Mario Draghi failed to commit decisively to QE recently, the markets already reacted. As interest rates rise in emerging economies, and their currencies begin to find a stable level, money inevitably flows back towards them. The first place it flows out of is those bonds that pay low yields, and are issued by countries with high levels of debt. Not surprisingly then, in the last week or so, the yield on Greek bonds rose from around 5% to over 9%, the yield on Portuguese bonds also rose sharply.

The basis of a new Eurozone debt crisis is easily seen. When the banks went bust in 2008, they were bailed out by the state. The state itself then covered its expenditure, in bailing out the banks, by borrowing. But, who did the state borrow from? The banks. Where did the banks get the money from? The state, via the central bank, which printed the money.

In the case of Ireland, Portugal, Greece and Cyprus the state could not be bailed out by domestic banks that had gone bust, but had to be bailed out by international banks, the ECB and the IMF. But, much like the situation that Marx describes in relation to volley-firing, when it came to the requirement to meet a balance of payments deficit, all that is ultimately at issue here is the order in which payments fall due. The US was able to stem the problem in its banking system by effectively nationalising it and recapitalising it. It funded much of that by printing money. In so doing, it only exacerbated the problem, because, in place of real capital forming the basis of this recapitalisation, it was merely an extension of the fictitious capital, and thereby of the debt that was the basis of the problem to begin with.

The US has not resolved the problem, but only deferred it. A large quantity of debt was written off as part of this process. Equally, a huge part of the debt is now in the hands of the Federal Reserve itself, as a result of bond buying under QE. But, the US banks and financial institutions still hold vast amounts of debt. A lot of this debt is doubly fictitious capital. The point was referred to earlier, that Marx points out that a bond issued by the state to cover its expenditure is not capital, either in the shape of the bond or in the shape of the state expenditure.

But, the same is true of say credit card debt or student debt. The bank has a certificate to say that person A owes them $100,000, but this certificate is not capital. It has no means of self-expanding. However, the interest due on this loan can only be paid in one of two ways; either A must employ the $100,000 productively and pay the interest out of the profits, or else they must pay the interest out of their wages. In other words, their wages must fall below the value of their labour-power.

Because, credit card debt, student debt and other forms of consumer debt, including mortgages are not used as productive-capital, they represent fictitious capital, in the double sense. Yet, it is this fictitious capital that has grown most. The growth of private household debt, for example, has far exceeded government debt. Although US banks wrote off large amounts of mortgage debt, with state help, they still hold large amounts of such debt. They hold around $1 trillion of student debt and a similar amount of credit card debt. In addition, although QE has resulted in a large quantity of government bonds being sold, by the banks, to the Federal Reserve, they still hold a large amount of such bonds, and more importantly they also hold vast amounts of fictitious capital in the form of shares and corporate bonds. For all the reasons set out earlier, about the inflation of these asset prices, this flatters the capital position of even US banks to a huge extent. But, the US banks are in a much healthier position than the European banks.

Marx describes the way the development of capitalism leads to a situation whereby capital is seen as being only money-capital. He quotes extensively from the testimony given by Bank of England governors, such as Lord Overstone to that effect. Overstone not only believed that only money-capital was capital, but also that only the providers of money-capital were capitalists. He believed that the productive-capitalists were only entrepreneurs, effectively simply a form of worker, and profits nothing more than a form of wage. It is the basis upon which rests the division, familiar in orthodox economics, of Capital – Interest, Entrepreneurship – Profit, Labour – Wages, Land – Rent. Following on from this, Marx demonstrates, the notion is developed that the payment of interest flows from the inherent ability of capital to expand.

From this, Overstone developed the idea that the rate of interest rises or falls as a function of the demand for commodities, because he argues, money-capital is only demanded for the purpose of buying these commodities to increase production. The same false notion exists today amongst bourgeois economists, that the rate of interest increases when economic activity rises, and falls when economic activity declines. It is behind the mindless market sentiment, which views bad economic news as good news, because it is likely to lead to lower interest rates, more lax monetary policy, and thereby higher stock and bond prices.

But, Marx points out that the higher demand for commodities only determines the rise in the market price of those commodities, not the market price of money-capital – the interest rate. He points out that in times of rapid economic growth, an increased demand for such commodities can go along with a relative or even absolute decline in the demand for money-capital, because during such periods, capitalists, in their dealings with each other, replace cash payment with commercial credit.

If A buys £100 of goods from B, they require £100 of money-capital to do so. If B simultaneously buys £100 of goods from C, they also require £100. If simultaneously C buys £100 of goods from A, they too need £100. In all, £300 in money-capital must be advanced, which they must either advance from their own funds, or else borrow in the money market. However, when times are good and producers feel confident, they will, Marx says, conduct such business via commercial credit. A buys the £100 of goods from B, and raises a bill of exchange, which promises to pay for them at some future date. B does the same when they buy from C, and so does C when they buy from A. But, at the due payment date, all of these bills of exchange can be set against each other, where it is found they cancel out, so no actual money is required, and no demand for money-capital arises in the money-market. Even if in total they do not cancel out, the only demand for money-capital is that sufficient to cover the balance.

Moreover, as Marx points out, Overstone only considers the increased demand for money-capital, and does not consider its increased supply, which often arises under such conditions. In a period of increased economic activity, usually at the start of such a period of growth, the increased mass of profit is realised as an increased mass of potential money-capital. This increase in the supply of money-capital may well be greater than the increased demand for money-capital, used to finance new investment in fixed capital. As a result, the rate of interest falls rather than rises. Similarly, Marx points out that in a period of crisis, the demand for money-capital rises sharply, not because it is required to finance new investments, but simply by firms that need it to stay afloat. In fact, Marx sets out, its at these points that the rate of interest reaches its highest levels.

But, the rate of interest reaches its next highest, or normal level at that point where although there is still prosperity and rapid growth, the rate of profit itself is beginning to fall. Its that position I believe we are in now, the Summer phase of the Long Wave cycle.

Capital II, Chapter 20 - Part 13

Marx then returns to the contradiction in Adam Smith's argument, in which the value of commodities resolves itself into wages and surplus value.

“This absurdity is indeed found in Adam Smith, since with him wages are determined by the value of the necessities of life, and these commodity-values in their turn by the value of the wages (variable capital) and surplus-value contained in them.” (p 412-3)

Smith forgets, says Marx, that in simple commodity exchange its only the total production cost that counts, and how that breaks down into necessary or surplus labour-time, or paid and unpaid labour, is irrelevant to the exchange value of the commodity. It is also irrelevant to its value whether that commodity is consumed after it has been sold or is used as productive-capital by the purchaser.

“This is in no wise altered by the fact that in the analysis of the circulation of the total annual social product, the definite use for which it is intended, the factor of consumption of the various component parts of that product, must be taken into consideration.” (p 413)

In order for the exchanges to take place in the model above, it is not necessary that the capitalists actually do allocate their spending on consumption goods in the way described. They may, in aggregate, demand more or less luxury goods, or necessities. The Department 1 capitalists may demand more luxury goods than Department 2 capitalists, and Department 2 capitalists in a and b may demand different proportions. Whatever these proportions, the levels of supply will simply be adjusted to correspond. It is the total level of surplus value that is determinate.

“On the basis of simple reproduction it is merely assumed that a sum of values equal to the entire surplus-value is realised in the consumption-fund. The limits are thus given.” (p 413)

This illustrates the interaction of the objective and subjective elements in Marx's theory. The actual value relations are objectively determinable, but no objective basis for determining how capital will be allocated, resulting from that, exists, because that depends, not upon objective value relations alone, but on consumer preferences. There is no objective basis for determining what proportion of surplus value capitalists will spend on luxuries as opposed to necessities. Orthodox, bourgeois economics has spent literally billions on research, to try to uncover the psychological basis of “marginal utility”, largely without success. 

In a sense, it does not matter, and as far as these consumer preferences are concerned, Marxists can simply agree with the Austrian School that “people act”. In other words, consumers make decisions over what to buy, and why they make this choice rather than some other is irrelevant. Unlike the Austrians, however, Marxists do not see these individual consumer decisions as determinant of prices.

Prices are a function of value, which is objectively determined. Consumer preferences only then determine the levels of demand at those prices. Capital is then allocated accordingly so that demand at that price is satisfied. In short, transformed values (prices of production) determine prices, prices in combination with consumer preferences, determine demand, demand determines the allocation of available social labour-time (supply). No general equilibrium is possible because technological change continually alters values (supply), and continually changing consumer preferences alters levels of demand.