Monday, 8 April 2013

The Long Wave Summer Has Begun

The Long Wave cycle lasts on average 54 years. It has four phases, described as with seasons. The Spring phase, is a phase of vigorous growth, the Summer phase sees continued but slower growth, the Autumn phase, sees growth falter and plateau, whereas the Winter phase sees it fall (relative to the long term trend). Each phase lasts around 12 – 14 years. The Spring phase of the current Long Wave boom began in 1999. It saw a powerful global economic boom, during which global trade rose sharply, economic growth doubled in the first decade, and fixed capital formation doubled during the same period. The economic indicators now seem to suggest that the global economy has moved out of this Spring Phase, and into the Summer phase of the boom.

Looking at what this means can best be achieved by looking at the entire last cycle, starting with the start of the previous Summer phase, which started around 1961.

The Summer Phase ran from around 1961 to 1974.  During that period, the rise in the prices of primary materials and food is halted, as new supply matches demand.  The excess supply of labour is used up.  At the same time, the rise in productivity that flows from the new technologies introduced during the Spring Phase, and which brings in new high value, high profit industries, begins to run out of steam.  The rise in real wages made possible out of that rise in productivity, continues but now increasingly has to be paid for at the expense of the rate of profit.  The Rate of Profit falls, and growth shifts to consumption from investment.  Demand for capital now causes interest rates to rise.

The Autumn Phase runs from around 1974 to around 1987.  It is characterised by a plateau in growth.  The standard of living and cultural shifts brought about in the previous phases become established and incorporated.  As growth slows, and the rate of profit is squeezed further, the ability to increase real wages disappears.  But, workers remain confident and well organised, based on their development during the previous boom phases.  They resist attempts by capital to reduce real wages, including the social wage, but increasingly the reality of economic conditions turns against them.  The demand for labour-power falls, undermining the position of workers.  In the past, it has been during such periods that revolutionary struggles have taken place, for example the 1917 Russian Revolution.  But, if workers fail to make such a revolutionary leap, the conditions increasingly turn against them, and demoralisation sets.  That happened in the 1920's, and happened again in the late 1970's, and more specifically in the early 1980's.

The Winter Phase runs from 1987 to 1999.  The workers having been defeated, capital benefits from lower wage shares to increase the rate of profit.  The value of constant capital - both circulating and fixed capital - falls.  Although, lower growth means that revenues grow more slowly, and profit volumes grow more slowly along with it, the fall in the cost of the capital required to produce it brings about an increase in the rate of profit.

The Spring Phase ran from 1999 to 2013.

In the Spring phase of the boom, which we have just gone through, and which happened also during the 1950's, the powerful economic boom, creates significant demand for raw materials, required for the expansion of production, and for all of the construction of new fixed capital that occurs. Because, such demand has previously been weak, their production has been allowed to decay, and supply of these materials cannot be rapidly expanded. The consequence is that their prices rise sharply. This in itself provides a powerful boost to those economies that are based on the provision of those raw materials, and in turn stimulates demand in those economies for manufactured goods being produced in increasing volume in the manufacturing centres. This is one of the drivers for the increase in global trade.

It takes around 7 years to develop a new mine, and time is also required for exploration of new sites. Even when a new mine is developed, it takes several years before it is up to its optimal production. In short, it can be around 12-14 years from the time that the initial surge of demand occurs, until supply has risen to meet it. This is one of the objective factors that determines the periodicity of the Long Wave. During the Long Wave Spring, the rise in prices of raw materials does not hold back the development of the boom for several reasons. One is the power of the boom in its Spring Phase. Another is the fact that during the Winter Phase, Capital in its search for means of reducing costs, develops a series of new techniques and technologies capable of increasing productivity, and of utilising materials more efficiently.

In the last Spring Phase, running from 1999 to today, for example, we have seen this same huge increase in demand for raw materials, and consequent run up in raw material prices, yet it has not hampered the boom. Once again, the catastrophists have been refuted, as demand for oil has risen sharply on the back of the growth of China and other rapidly growing economies, but supply has risen to meet it, as a result of the introduction of new technologies, such as shale oil production, and the same developments in technology have also meant that oil and gas are used far more efficiently than they were in the past. Similarly, over the last 10-12 years, there has been a massive increase in exploration for metals, also using the latest technology in satellite imaging and so on, to reduce the labour-time required to locate new resources. On the back of that, massive mining developments have taken place in Central Asia, in Africa and Latin America. In Africa too, that same process has seen large scale development of industrialised agriculture prompted by similar high prices for food, caused by rising demand in economies like China and India, where living standards have risen sharply on the back of the same boom.

But, as all of these developments start to achieve their optimum production levels, and because these new mines, quarries, farms etc. tend to have lower production costs, because they are producing on virgin sites, using the latest technology, so the excess demand that drove higher market prices erodes, and prices begin to stabilise or fall. When the previous Long Wave Summer began around 1961, that could be witnessed, and it appears to have arrived now. In the previous cycle, Gold hit its highest point relative to other commodities in 1960. It made a nominal high in 1980, of $800 an ounce, but that was a nominal high against the dollar driven by inflation, and the money printing in the US during the 1960's and 70's. Gold hit its low point, along with other metals at the end of the last Long Wave Winter. It had fallen to $250 an ounce in 1999, as the new Spring Phase began. Along with those other metals, oil, and food prices, it has continued a long secular rise throughout the Spring Phase of the Boom, reaching almost $2000 an ounce in September 2011.

But, the fact that Gold has not been able to rise to that level again since, despite more massive money printing in the global economy, despite large amounts of fear and uncertainty in the world, which frequently drives money into Gold as a safe haven, is another indication that the Spring Phase of the Long Wave Boom has ended. If Gold rises to a new peak from here, it is only likely to be on the same kind of basis that it did so in 1980 i.e. of spectacularly higher inflation, and a potential collapse of the global monetary system.

But, the other industrial metals, as well as the prices for oil and gas also seem to have followed the same pattern as in previous cycles. We may well have reached a situation of “Peak Oil”, whereby the potential for expanding annual production has ceased, but that is not the same as being unable to maintain current levels for some considerable period into the future. As in the past, the Malthusians have been proved wrong, as technology has simply made it possible to extract oil that previously could not be economically drilled. It now looks likely that the US will once again become a bigger oil producer than Saudi Arabia.

Similarly, the global economy now has a surfeit of cheap natural gas, which has been made possible by the same “fracking” technology. US natural gas prices have fallen from over $10 per BTU, to around $3 in the last 10 years. Moreover, technological developments mean than this same plentiful gas can be used as a replacement for oil. This abundant, cheap energy in the US, is proving a powerful stimulus to its economy.

Copper is sometimes called Dr. Copper, the metal with a Ph.D. In Economics, because it is such a good indicator of the economic cycle. When the global economy is in a boom phase, demand for copper and hence its price rises sharply. It is used in a lot of manufacturing products for electrical wiring, but it is also used extensively in construction for boilers, for pipes, and for electrical circuits. Its price can also be closely linked with gold, because gold and copper are frequently found and mined in the same location. The price of copper has been soaring since 1999, but in the last year it has stalled.

1 Year Copper Prices - Copper Price Chart

A year ago it stood at around $3.90 per lb. Today it is down to $3.30, a fall of around 15%. Although, its price has moved up and down during that period, its chart is characterised by a series of lower lows, and lower highs, signifying a downward trend in its price. That is hardly a large fall in its price given the run up, and is consistent with current levels of production now having reached sufficient levels to meet demand, rather than any significant reduction in demand. Any such fall in demand is likely to be due to the 3 year cyclical slow down that began at the end of 2011. In the Summer phase of the cycle, demand should continue to rise, but at a slower pace.

There are other significant features of the Summer Phase of the cycle. If the supply of raw materials is inadequate, and cannot be readily increased, as the Spring Phase begins, the opposite is true for labour-power. The Winter Phase of the cycle means that growth has been below the long term trend, and so the relative demand for labour-power has fallen. That in itself puts downward pressure on wages, as workers bargaining power falls as the demand-supply balance turns against them. That was witnessed in the Long Wave Winters of the 1920's and 30's, and the 1980's and 90's. Moreover, for the reasons Marx sets out in Capital, such periods of lower wages also see an increase in the relative surplus population. Lower wages, mean that workers seek to make up for it by working longer or more intensively. The longer or more intensively they work, the fewer workers Capital requires. Its estimated that compared to 1980, US workers today work the equivalent of 2 weeks a year longer! A similar picture appears in the UK.

But, also as Marx points out, where wages are low, there is less incentive for Capital to replace it with capital in the shape of new machines etc. So, when the Long Wave Spring Phase began after WWII, and similarly after 1999, Capital initially finds it has a pool of labour, a latent reserve army of labour, available to be exploited. The balance of demand and supply during this period continues to favour capital, and so wages rise, but not to any extent that threatens the rate of profit and accumulation of capital. On the contrary, rising real wages during this period, facilitate capital accumulation, because they provide the necessary market for the increased volume of consumer goods being produced.

In the Winter Phase of the cycle, seen during the late 1920's and early 1930's, and again witnessed from around 1987 until 1999, the Rate of Profit rises, because the value of capital falls. That is both the value of Constant and Variable Capital. The relative slow down in growth means that production of raw materials, food etc. is now in excess of demand, so prices fall, reducing input costs for producers and living costs for workers. As the least efficient companies go bust, there capital is acquired at knock down prices by their more efficient competitors, again reducing the value of the fixed capital employed. The overall rate of growth may be lower, and with it the growth in company revenues and profits, but the cost of producing those profits grows even slower or even falls, so the rate of profit rises.

There is no reason faced with sluggish economic growth, why companies, especially monopolistic companies organising their activity around long term business plans, should increase their investments on the back of these higher rates of profit. Instead, the money profits get spent in higher unproductive consumption by capitalists, and/or accumulated as money hoards. The increased supply of money-capital, and relatively lower level of demand for money capital that results, means that interest rates necessarily fall. That was witnessed during the 1930's in particular, but the global economy has witnessed a similar secular fall in interest rates from around 1982.

That secular trend appeared to be ending around 2007. The current low interest rates have been the result of the financial meltdown that occurred in 2008, which itself was in part a consequence of the ending of that long term trend in interest rates, and the credit crunch that ensued. That provoked unprecedented money printing to keep interest rates low, but that process seems to have hit the buffers itself. It has failed to spark any real increase in economic activity, in the absence of corresponding fiscal stimulus, and has merely led to the maintenance of asset price bubbles that stand in the way of any real sustainable economic recovery. It can only be a matter of time, before market interest rates rise, as Bond prices collapse, which will in turn collapse other asset prices such as property, and shares. Only then will capital in western economies begin to flow into real productive assets, setting the stage for the continuation of the boom.

But, even when the economy enters the Spring Phase of the Boom, the Rate of profit continues to rise, because during this phase, a number of factors are combined. One reason for the start of the new boom is that a series of new products and new industries arise on the back of technologies developed as part of the Innovation Cycle. In the late 1930's, these were things such as electronic consumer goods, pharmaceuticals, motor cars. They were the high growth, high value, high profit areas that formed the basis of the post-war boom. In the late 1990's, it was the development of products based on the microchip such as mobile phones and other mobile technology, the personal computer, and the Internet, as well as developments in biotechnology and genetics etc.
These developments not only give rise to powerful new high profit industries, but also create new productive technologies that raise productivity, and reduce the value of capital. So a combination of sharply rising profits, and falling costs of capital, brings about a rising rate of profit that more than offsets the rise in the prices of raw materials, and labour-power that operates in the opposite direction.

But, just as the lack of supply of raw materials is reversed as the Summer Phase begins, so the over supply of labour-power tends to be used up. That has been markedly noticeable in China. Despite, its huge reserves of peasant labour, China has soaked much of it up, in its frantic pace of growth over the last 20 or so years. The consequence has been a relative strengthening of the position of labour as against capital, an objective fact more important for Chinese workers wages than the lack of independent Trades Unions. But, that relative strengthening of Chinese workers position, has at the same time made it more possible for them to also demand the right to such independent organisation, and given them the confidence to begin such organisation even illegally.

A similar development occurred in the post war boom. The strengthened position of workers meant that their wages rose, and were able to rise as capital expanded rapidly. That in turn led them to develop their own rank and file organisations. The 1950's and 60's were the period in Britain of the rise of the shop stewards movement, for example. The Summer Phase then is marked by these characteristics.

  1. The sharp rise in raw materials prices ends, as new, lower cost supply matches demand.
  2. The excess supply of labour-power starts to be used up, shifting the demand-supply balance in favour of workers.
  3. The increases in wages previously paid for out of sharply rising productivity, now begin to be paid for at the cost of the rate of profit, as demand shifts from investment to consumption.
  4. The Rate of Profit falls, but the total amount of profit continues to rise, as the economy continues to grow.
  5. Accumulation continues to rise on the back of this growing volume of profit. As Marx puts it, a small rate of profit on a large Capital can create more accumulation than a high rate of profit on a small capital.
  6. The shift in the demand-supply balance towards workers gives them more confidence, their militancy and organisation rises, and a shift, therefore occurs increasing the wage share, and reducing the profit share, as witnessed in the Summer Phase that began after 1961, and described by Glyn & Sutcliffe.

The combination of these factors has other consequences. The fall in the rate of profit undermines the tendency for there to be a secular bull market in share prices. Global Stock markets entered a secular bull after 1982. The Dow Jones rose from 1,000 in 1982, to over 10,000 in 2000, and over 14,000 in 2007. In part that rise has been driven by the massive amount of money printing that has juiced asset prices, but in part it has been driven by the rise in the rate of profit enjoyed by Capital from around 1987 onwards. That process is now likely to be reversed, and equity markets enter a long secular bear market. Increased money printing seems to have increasingly lost its potency.

As the US enters its first quarter earning reporting season today with the issuing of figures by Aluminium producer Alcoa, we are likely to see that reflected in continued growth in sales revenues, but with lower rates of profit. Current US stock market valuations are only compatible with continued strong growth in rates of profit, which are unlikely. To achieve the projected profits, the US economy would have to grow at around 7% p.a., which is about twice its likely growth rate.

US employment data was appalling last Friday, reflecting a slow down in growth, as the effects of the Fiscal Cliff, the Sequester etc. take effect. With equity prices stretched, and the problems of Europe not resolved, and with history on the side of the start of a secular bear market, as well as 2013 coinciding with a 13 year cycle of stock market crashes, Jim O'Neil's forecast that the old adage of “sell in May and go away”, may signal the start of a big sell off in shares looks to have the balance of probability on its side.

At the same time, any large sell of in shares, could have the same effect as the Credit Crunch in 2008. That is, with large amounts of speculation conducted via leverage, a big equity sell off could see large numbers of speculators scrambling to raise cash from wherever they can to meet margin calls. In 2008, as I predicted at the time - Severe Financial Warning – that led to a sell off in oil, gold and other assets, as banks and other financial institutions sought to hold on to and gather in what cash they could.

The events in Cyprus, show that the EU Bank Stress Tests were a sham. They failed to give any suggestion that banks in Cyprus were in any danger, despite the EU and IMF now all claiming that it should have been obvious! Yet, the Cypriot banks are a sideshow compared to the exposure of banks in Luxembourg, and there are many other economies such as Slovenia, Malta, and others that are now in the firing line. Any big scramble for cash is likely to see the banks in these economies, and then the economies themselves coming under intense pressure.

But, under those conditions, and with the rate of profit falling, the demand for money is likely to send interest rates sharply higher, crashing Bond Markets in the process. Those economies that have based their economic model on low wages and high debt, such as Britain, will get crushed in what ensues. A crash in Bond prices and higher interest rates, together with a rush to gather in cash, will cause a rapid increase in bank repossessions, crushing the property market in places like the UK and Spain, where artificially low interest rates have kept the bubble from bursting.

On the bright side, the collapse of those uber inflated asset markets, and destruction of vast amounts of fictitious capital, is the necessary condition, for the renewed accumulation of real productive capital. It will form the basis of the continuation of the Long Wave Boom, during its Summer Phase.

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