Thursday, 29 January 2015

Capital II, Chapter 20 - Part 48

3) Results 

“If — all other things, and not only the scale of production, but above all the productivity of labour, remaining the same — a greater part of the fixed element of II c expires than did the year before, and hence a greater part must be renewed in kind, then that part of the fixed capital which is as yet only on the way to its demise and is to be replaced meanwhile in money until its day of expiry, must shrink in the same proportion, inasmuch as it was assumed that the sum (and the sum of the value) of the fixed part of capital functioning in II remains the same.” (p 471)

But, this leads to the series of problems listed above.

“If the greater part of commodity-capital I consists of elements of the fixed capital of II c, then a correspondingly smaller portion consists of circulating component parts of II c, because the total production of I for II c remains unchanged. If one of these parts increases the other decreases, and vice versa. On the other hand the total production of class II also retains the same volume. But how is this possible if its raw materials, semi-finished products, and auxiliary materials (i.e., the circulating elements of constant capital II) decrease?” (p 471)

Secondly, the greater the proportion of fixed capital to be physically replaced, the greater the amount of money that flows to Department 1 to purchase it, i.e. as means of payment rather than as means of circulation. But, then this greater quantity of money in the hands of Department 1 capitalists is unable to find an increased quantity of Department 2 consumer goods to buy with it. On the contrary, the more Department 2 spends on fixed capital the less it has to spend on circulating capital, and so the less it is able to increase or even sustain its level of output.

Department 1 then has an excess of money over the available consumer goods. It can overcome this by buying imported consumer goods. As stated previously, however, if the expenditure on fixed capital falls, this means that less money-capital is advanced by Department 2, whilst the value of wear and tear on fixed capital, continues to accumulate in the depreciation fund. Department 1 is then unable to sell all of its output.

“There would be a crisis — a crisis of over-production — in spite of reproduction on an unchanging scale.”(p 472)

In contrast to the previous situation, one way to resolve this would be for Department 1 to export its surplus production. Yet, as Marx points out, all this does is to extend the problem to a wider international sphere, and thereby create the conditions for a national crisis to become an international crisis.

“Such surplus is not an evil in itself, but an advantage; however it is an evil under capitalist production.” (p 472)

Once capitalism is abolished, the problem does not disappear, Marx says, but the means of dealing with it changes. If more fixed capital has to be physically replaced in one year, less will need to be replaced in the next. To maintain production at a stable level, the quantities of circulating capital have to be maintained. The solution to this problem then simply becomes the production each year of relative surpluses.

“There must be on the one hand a certain quantity of fixed capital produced in excess of that which is directly required; on the other hand, and particularly, there must be a supply of raw materials, etc., in excess of the direct annual requirements (this applies especially to means of subsistence). This sort of over-production is tantamount to control by society over the material means of its own reproduction. But within capitalist society it is an element of anarchy.” (p 473)

Wednesday, 28 January 2015

UK House Prices To Drop 50%?

I nearly bought a house last week, but according to Paul Hodges, Chairman of IeC, and an expert in the economic impact of demographics, in an interview in Moneyweek, it would have been a big mistake.  Hodges believes that property in the UK is vastly over priced, and should fall by 50%. He believes the price falls have already begun, including in London.

I agree with him that property prices are vastly inflated, and should fall, and are falling.  According to Rightmove, even asking prices for houses fell by 3.3%, on the month, before Christmas, the biggest monthly fall on record.  In fact, as I've written previously, I think that prices are likely to fall more like 80% eventually, because the 50% figure is only what is required on average to restore prices to the long-term average relation between prices and average earnings, and prices never simply drop to the average level.  They overshoot to the downside as much as they have overshot to the upside.  A look at what is happening with oil prices demonstrates that.

Its one of the reasons, in the end I did not buy the house I was looking at.  It illustrates the dilemma posed by deflation.  Having kept a close watch on what property prices are doing locally I am acutely aware that whatever all the media hype might claim, the selling prices of houses here have fallen by around 30%, since 2010.  I know that from the fact of detailed studies of sold properties in the area, and of specific knowledge of some of the properties sold.  For example, my own house, that I sold for £150,000, at the start of 2010, can now be bought for £110,000; the house next door but one to where I live now was sold at the start of 2010 for £500,000, and the more or less identical semi-detached house connected to it, sold at the end of 2013 for £340,000.

The house I was considering buying was a 20 year old, large, detached four-bedroom property with en suite, and all the other modern facilities.  It had been up for sale for £195,000 a few months ago, and had now been reduced to £165,000.  The dilemma was to simply take into consideration the fact that the price had already dropped by 15%, and on the basis of current market prices seemed to offer reasonable value, or to take into consideration the fact that if prices do drop by even just 50%, to get back to fair value, that would mean losing £80,000, in short order.  This is the situation that arises where prices get into a continuous falling sequence, because buyers never want to buy, even at lower prices, on the basis that next week, prices will be even lower still.

In fact, as I've been having another round of looking at potential houses to buy, I've noticed that eventually there do seem to be a significant number of large new housing developments occurring around the area.  Again, rather like the situation where high oil prices eventually led to an increase in oil supplies that then caused a glut, which has caused oil prices to drop 60%, this noticeable increase in building could be a sign that property prices, like oil prices, are about to crash.  Already, I've noticed that builders are cutting their prices by around 20%, something which is usually a last resort, after they have tried other methods to shift stock, such as part-exchanges, and other offers.

But, the experience highlighted another fact.  The house I had been looking at to buy, even at that price, had previously been privately rented.  It shows the extent that the property market has been distorted by the government's "Help To Buy" scam, alongside the effect of low interest rates in promoting the development of "Buy To Let" landlords.

In more normal times, money is lent to businesses that intend to use it to actually produce things. They use the money-capital to buy factories, machines and employ workers to make things that people want.  The business makes a profit from the activity, and out of the profit pays interest to the money lender.  But, increasingly money is not lent for that purpose.  Increasingly, the money made as profits from production, or even just the money that swirls around in circulation, is used not to buy capital but simply for speculation.

I was watching an episode of the series "The Super Rich and Us", recently, which featured one of these "Buy To Let" merchants who had progressed on to organising seminars to encourage hundreds of other people to borrow money to become buy to let landlords.  It was an indication of just how much money is going into such speculation.  It creates not one bit of additional wealth, but what it does is to keep inflated already massively inflated property prices, but in so doing only creates a condition whereby the bursting of that bubble, when it does arise, will be even bigger than it would otherwise have been.

What is being seen is a similar thing to what has happened in the bond market.  Normally, Buy to Let landlords would have concentrated on buying cheaper properties, which they could more easily rent out to obtain a steady income, particularly if they obtained the rent or Housing Benefit directly from the local council rather than the tenant.  This is rather like bond investors, who would tend to buy the safer bonds issued by countries like the US, UK and Germany, which pay lower interest rates, but on which you can be pretty sure you will get your money back.

But, "Help To Buy" has meant that people who really could not afford to buy a house, have been subsidised to do so, as happened with the similar sub-prime mortgages in the US, that led to the 2008 financial crash.  That together with the demand for these cheaper houses from Buy To Let landlords, has both reduced the availability of such houses in the market, and to push up their prices relative to higher priced properties, causing a compression of prices in that sector of the market.  It means the potential rental return for Buy To Let landlords is thereby reduced, because although the rent is not increased, and may well be falling as a result of the effect of the reduction in Housing Benefit, the price they have to pay for the house has risen, so the yield on their investment drops.

That is the same as the fall in yields that bond investors have seen on safe haven bonds, which has then resulted in a search for yield, which causes investors to have to then invest in ever more risky bonds.  It is what has led to the increasing share of junk bonds to finance energy production in the US, which are now at risk of default, as oil prices drop, and energy firms are in danger of going bust. But, in the UK housing market, it means that Buy To Let landlords are encouraged to have to move out to more expensive properties, such as the one I was looking at, and for which they have to then obtain higher rents to justify their investment.  As with junk bonds, it is a highly illiquid market, which means that when the owners of the bonds or the property come to sell, there are no ready buyers, especially when, in the case of property, it is large numbers of houses they seek to sell in one go.

As Warren Buffett advises in relation to investment - "If you don't see anything that is a bargain that is worth buying, you don't have to buy."  On that basis, I'm happy to keep renting for a while longer, because there are an increasing number of houses coming up for sale, and each week they seem to keep getting cheaper!

US Retail Sales and False Profits - Part 2 of 9

Say's Law assumes that income and expenditure must always be equal, because income is what every seller obtains from selling their commodity – including workers who sell their commodity, labour-power – and its assumed the only purpose of selling a commodity is to buy another, or several others of an equal amount of value. In describing this view, Marx quotes Ricardo,

“... No man produces, but with a view to consume or sell, and he never sells, but with an intention to purchase some other commodity, which may be immediately useful to him, or which may contribute to future production. By producing, then, he necessarily becomes either the consumer of his own goods, or the purchaser and consumer of the goods of some other person.” 

(TOSV2 p 493-4)

and,

“Productions are always bought by productions, or by services; money is only the medium by which the exchange is effected” 

(TOSV2 p 501)

In other words, it assumes that the market operates on the same basis that it did when all such exchanges took place by barter. Individual commodity owners take their commodity to market, for the sole purpose of obtaining some other commodity or set of commodities of equal value. In that case, every sale must be simultaneously a purchase, because commodities are only exchanged for other commodities. What people obtain as income, therefore, is equal to what they sell, and what they sell is equal to what other people spend, so, in total, income must equal expenditure.

Economists like Smith and Ricardo, had never experienced the kind of crisis of overproduction that arose after 1825, Marx says, and so their theory never had to account for it. The only crises they had seen, Marx says, were the various financial crises that occurred in the previous century, resulting from the fact that banks printed their own bank notes in excess of their capital, and lent money in excess, which caused speculation such as that which arose with the South Sea Bubble, Tulipmania, John Law's Mississippi Scheme and so on.

As a result, these economists, and their followers, believed that there could be no crisis of overproduction, and when their followers came to explain these crises, when they did arise, they were, therefore, led to the argument that it was caused not by overproduction, but by underconsumption. So, for example, when Britain overproduced textiles, which it shipped to China, it was argued that the glut of these textiles on the Chinese market, was not a result of overproduction by British capitalists, but underconsumption by Chinese consumers. The reason for that underconsumption was then that China was not producing enough of the commodities that Britain required, which could then be exchanged for these textiles.

If we relate this back to the US Retail Sales data then, its clear why this fall in the value of sales is understood as being the consequence of reduced demand. The other option, that demand might actually have remained constant, or even risen, whilst the prices of commodities, in aggregate, fell is rejected, because, according to Say's Law, any reduction in prices, caused by increased supply, must be compensated, at an aggregate level, by the resultant increase in demand, i.e. as the price of individual commodity units falls, with a rise in supply, so demand rises, meaning the total expenditure remains the same, and incomes and expenditure are, therefore, the same. The fall in the prices of oil and copper, are similarly viewed in this way, so that when the price of copper fell, this was interpreted as meaning that the demand for copper must be falling, which suggests a slowing of economic activity, falling profits, and so shares sold off.

In Part 3, I will examine why Say's Law is wrong, and why, therefore, the understanding of the falling prices, and lower US Retail Sales data is also wrong.

Tuesday, 27 January 2015

US Data Confirms Conjunctural Shift To Long Wave Summer

Some time ago, I wrote that the Long wave boom that began in 1999, was shifting to its Summer phase, a shift that occurred around 2012.

I wrote at the time that it would be signalled by the sharp rise in primary product prices coming to a halt, as those high prices brought large new supplies on stream.  That part of the analysis has been shown to be correct as oil prices, and other primary product prices have fallen, as supply has risen sharply.

I also wrote at the time that this shift would be signalled by a slowdown in technological innovation, which would have several consequences.  Some time ago, in illustrating this shift, and one of the consequences of this slow down in innovation, I pointed to Apple.  It had in the previous phase been a bell-weather of technological development, being responsible for a range of new products.  I pointed out that, increasingly Apple's new product launches were nothing more than revamped versions of its existing products.  The consequence would be for new launches to cannibalise existing demand for products, especially as basically the same product was sold in cheaper and more expensive versions.  That also happened, and I pointed out that a consequence was that Apple was having to reduce its profit margins to be able to continue to sell in the large volumes it required.

The other consequence of this slow down in technological innovation, I pointed out was that productivity growth would slow down, and this would mean that unit costs would tend to rise, and profit margins would again start to be squeezed.  The only solution to both these problems is for capital to invest in additional productive-capital.  It means it must begin to invest in additional research and development to come up with really new products to sell, rather than merely superficial changes to existing products, and to create new production techniques to raise productivity.  In the first instance, as marx describes of this phase of the cycle, capital must invest in additional productive capacity, as each individual capital seeks to reduce unit costs by producing on a larger scale, and capturing or at least defending market share from its competitors.

The economic data released in the US in the last hour confirms this analysis once more.  The data shows that durable goods output december was down sharply, and the data for November, was also revised down.  Durable goods, here is a proxy for investment in capital.  In part, this reduction is the consequence as I had predicted a few months ago, of the three year cycle, which has already caused a slow down in economic activity in China, the EU, UK and elsewhere.  The data released at a company level also confirms the analysis.

Profit figures from a range of companies from Caterpillar to Microsoft show profit growth slowing, even where revenues have continued to increase.  In other words, it shows that profit margins are getting squeezed.  At this stage of the long wave cycle, the consequence of this is always to require that an increased proportion of profits goes to investment and capital accumulation, and a smaller proportion to the payment of dividends, rents and so on.  The demand for loanable money-capital thereby rises, whilst its supply declines, pushing interest rates and yields higher.

Its no surprise, therefore, that the US stock market has shown a decline of over 300 points in the DOW futures ahead of the market open.  It is the kind of response I have analysed in the series on the long wave, as well as in the series on fictitious capital.

UK Growth Continues To Slow Sharply

At the beginning of October last year, I set out why the UK economy was about to slow down sharply, despite all of the hype that the Liberal-Tories were coming out with about how their austerity measures had performed an economic miracle.   The extent of the slow down was quickly confirmed. GDP grew by 0.7% in the third quarter of 2014, compared to the 0.9% growth in the second quarter of 2014.  That represented an almost 25% reduction in the rate of growth.  Now according to the ONS growth has slowed sharply again, from that 0.7% figure down to just 0.5%, a reduction in the rate of growth of a further 29%.

The figure could be revised down further in coming weeks, but its clear that the prediction made in October is proving correct.  The year or so of faster growth in the UK, after three years of declining or stagnant growth, was not the product of Liberal-Tory austerity, but despite it.  The Liberal-Tories benefited during that year or so period, from the fact that having sunk the economy so low with their austerity measures, it had to have a sort of dead cat bounce at some point.

The growth when it came did not arise from the kind of restructuring and rebalancing of the economy that the Liberal-Tories had promised would be the result of their austerian economic poison, but came from the old sources of debt fuelled consumption, as people were encouraged by Osborne to take on even more mountains of unsustainable debt, as they were bribed with "Help To Buy", to take on mortgages for massively overpriced properties, that are now beginning to tumble in price, even in London, and as the Liberal-Tories got lucky with one off quirks such as around £7 billion of compensation payments for PPI misselling that found its way into consumers pockets.

But, now house prices are tanking, one demographer who has got a number of market predictions right recently told Moneyweek recently that he saw UK house prices falling by 50%, a fall he said had already begun.  I'm seeing the same thing locally, with large numbers of new housing developments where the builders are reducing prices by around 20%.  Whatever the Liberal-Tories say about rising wages, most people do not see it, and the UK like other economies is now going into the three year economic slow down.

The fourth quarter data has come in even lower than the 0.6% quarter on growth that was the consensus of economists predictions, with output actually down by 1.8% in construction and 0.1% in production, the very areas the Liberal-Tories told us would be the engine of growth as the economy was rebalanced.

The trend for growth is now sharply downwards, as predicted.  The annual growth figure still looks reasonable at 2.6%, but the largest part of that growth came in the earlier part of the year.  At 0.5% quarter on quarter growth, with that rate of growth slowing by around 25% per quarter, the annual rate of growth for 2015 looks likely to be substantially less, and beneath 2%, as the three year cycle is likely to see growth continue to slow until at least the final quarter of the year.  In fact, on this trend, 2015 growth could struggle to exceed 1.5%, way below the government's projections.

With the government already failing to meet its targets on the budget deficit by huge margins, and finding itself having to borrow hundreds of billions more than it planned as a result, the UK could face a similar problem to that of Greece, and other countries.  That is that the cost of reducing the deficit, is to crater the economy itself, and thereby to make the proportion of the deficit to GDP, get ever wider, with a subsequent impossibility of even covering the debt interest.

In Greece, for example, a lot is made of the fact that austerity has reduced the budget deficit significantly, but the cost of that has been to eviscerate the economy itself, causing the ratio of debt to GDP to rise.  Prior to austerity, Greece's debt to GDP ratio was around 110%, now having decimate the economy in order to reduce the deficit, the debt to GDP ratio has risen to around 180%!

The austerian economic experiment, which is really a repetition of failed economic policies and ideological dogma from the 1930's, has once again been a disaster, let alone a failure.  The sooner we follow the example of Syriza, and ditch that policy, in favour of developing a co-ordinated, European wide programme for economic growth and investment the better.

Capital II, Chapter 20 - Part 47

The argument that Marx sets out here is basically the phenomenon that orthodox economics refers to as the Accelerator Effect . It goes like this. Suppose each year, firms replace 10% of their machines. If say there are 100 machines, that means orders for machine makers each year for 10 machines. Suppose then that trade improves by 10%, causing firms to need 10% more machines. That means in this year they demand 20 machines rather than 10. But that represents not a 10% rise in orders to machine makers, but a 100% increase!

It means they will have to double their own purchases of materials, labour-power etc. This argument is usually coupled with the multiplier effect to indicate the extent to which this increase in demand for fixed capital will have a disproportionate effect on the level of aggregate demand.

However, the contrary, also applies. If there is a slow down in trade, firms may postpone their usual replacement of equipment. In that case, machine makers suffer not a 10% reduction, but a 100% reduction in orders, with a consequent effect on aggregate demand. In short, the crisis of overproduction, Marx described.

The problem is made worse, as I suggested earlier, because of the synchronisation of equipment replacement cycles. That means large amounts of equipment may become in need of replacement one year, with very little for the next few years. The basis of Marx's assumption, that replacement was evenly spread, was that different firms begin trading at different times, they expand at different rates, and so on. Equipment is bought at varying times and thereby becomes due for replacement at a range of times.

But, Marx was aware that, in practice, this assumption does not hold. The processes of concentration and centralisation of capital mean that the spread of industrial firms is continually reduced; large firms may make existing equipment last, and replace it top to bottom, with the latest equipment, once it has been proved by other, often newer, smaller firms; moral depreciation, in the form of qualitatively newer, more efficient equipment, forces firms to abandon their existing equipment, whether it is worn out or not, and buy the new equipment.

The consequence is that an increasing proportion of equipment is bought at the same time, and subsequently wears out at the same time. Even where it is not physically worn out, it is replaced with the next generation of equipment, as part of a regular upgrade cycle.

This has been particularly marked in relation to new technology. Computer chips essentially double in power every eighteen months. Software developers base their own development cycle on this increase in speed and power, to determine the kinds of products, or development of existing products they can offer. Buyers of computers, then, have tended to gear their own upgrade cycle to when new versions of operating systems etc. are released, buying replacement machines and software together.

Given the increasing role of services within the economy, and given the centrality of personal computers and software, to much service provision, this is one reason that a discernible three year economic cycle has developed over the last 20-30 years. But, microchip technology has become ubiquitous, whether it is in a mobile phone, a car, a washing machine, or the latest jet liner. Consequently, the upgrade cycle for microchips has a far more regularising and synchronising effect on a range of equipment and commodities than simply that on the PC.