The Madness Of Crowds

In the last couple of weeks, there has been turmoil in markets. Its not the kind of turmoil that most people notice. Its not the kind of turmoil seen a couple of years ago, when prices, on the major indices, fell day after day by large amounts. This turmoil is what is known as Volatility, that is prices moving up and down, by large amounts, both from day to day and within each trading day.

In particular, the prices of many commodities, things such as Oil, Copper, Gold, and particularly Silver have moved up and down like a fiddlers elbow. Yesterday, Silver, which has soared in the last few months, fell by a whopping 17%. It has fallen by 35% in the last week. Part of the reason for the move in Silver has been the introduction of new regulations and requirements for margin trading.

Back in the late 1970's the Hunt Brothers – who are barely disguised characters in the film “Trading Places”, starring Eddie Murphy and Dan Aykroyd– attempted to corner the market in Silver using their already huge large fortune.

They accumulated one million ounces of Silver, and saw their gain increase to around $4 billion as the price rose from $11 an ounce, to $50 an ounce. But, the authorities as they did last week changed the rules – see Silver Thursday. Within two months Silver was back down to $11 an ounce.

But, that was then, and this is now. The rise in the price of Silver in 1980 was partly, if not largely due to the Hunt Brothers attempts to corner the market.

But, not entirely. After WWII, as a result of the hegemony of US Capital, the settlement made at Bretton Woodsthat established the global financial infrastructure, made the dollar the global world currency. It fixed the price of Gold against the dollar at an official rate of $30 an ounce. Individuals were banned from owning gold bullion, and so this rigged price of the dollar and gold could be sustained.

That is until strains on the global financial system began to appear with the end of the Long Wave Boom, and the attempts by the US to deal with that by printing money to deal with its debts, and to shove the burden of the crisis on to its Capitalist partners and competitors. As Marx set out, Money is more than just currency. It acts as a measure of Value, a Unit of Account, and Store of Value. But paper money, or any other money token really just stands in the stead of this real money commodity. Historically, the money commodity has been either Gold or Silver – sometimes in so called bi-metal systems both have fulfilled that role, though usually one has really dominated the other. During the late 1960's, this led the US's trading partners, particularly France, to demand that their dollars be converted into Gold at the official exchange price of $30 an ounce.

After large amounts of Gold were drained from the US, it soon became obvious that this fictitious price could not be sustained. Back door methods of holding Gold, such as the buying of Gold Coins such as Kruggerrands, were found by those with money to begin to accumulate Gold, and so a growing unofficial price for Gold began to be formed, once again illustrating a phenomenon described by Marx of the divergence between appearance and reality. In 1971, Richard Nixon, broke the agreement that had been established in 1947 at Bretton Woods, by ending the dollar's convertibility with Gold.

A global currency crisis ensued that many thought could have led to the collapse of the global financial system. It didn't. After a series of crises, and attempts to develop a new global exchange rate system, the system we have today, of freely floating exchange rates emerged.

In the meantime, it became apparent that even if a currency, such as the dollar, could act as currency, as a means of exchange, in times of rapid inflation, a paper currency cannot fulfil the other functions of money. Very high rates of inflation mean that its function as a unit of account are undermined, because the price of good A is different tomorrow than it is today. Although, payments in these paper dollars might nominally remain the same, the actual payment really amounts to a lower amount, because the purchasing power of those dollars has fallen.

Still less can they act as a store of value. It was not surprising then that people, and organisations began to hoard Gold, which because it has intrinsic value as a commodity - as opposed to paper money which only has value because it is a representative of Gold, and has the backing of the State to that effect – can act as a store of value, and thereby can still carry out the function of money as a unit of account, and means of payment. After the ending of dollar convertibility in 1971, and the fixed price of Gold with it, Gold rose during the 1970's from $30 an ounce, to $800 an ounce in 1980. Silver, has always had a long term relation to Gold, because it too has intrinsic value. Like Gold, it is limited in supply, and requires large amounts of Labour time to find it, mine it, and purify it. That is what gives it, its high Exchange Value.

After 1980, and especially after the introduction of Austrian economic policies in Britain and the US, to limit inflation, and as the new system of floating exchange rates settled in, restoring the dollar to its position as global reserve currency, the demand for Gold fell. During the period of the Long Wave downturn, through the 1980's and 90's, the price of Gold and Silver like other such commodities fell steadily. By 1999, Gold had fallen back to $250 an ounce.

Once again as huge printing of paper currencies, has taken place, and renewed fears of financial turmoil have resurfaced, with the likelihood of debt defaults by states such as Greece, and by millions of massively indebted individuals, Gold has risen again reaching almost $1600 an ounce a week ago. In part, that is also due to the fact that, again like other such commodities, during the Long Wave decline, low prices lead to underinvestment in new gold mines, meaning that Supply does not respond quickly to new demand.

The so called smart money investors, and certainly the “Gold Bugs”, the people who made billions from Gold's rise in the 1970's, have been buying Gold for most of the last decade. It is also why there has been a mushrooming of the firms offering to buy your Gold from you at knock down prices, just as in the past similar companies offered to buy your house from you at a knock down price, in order to rent it back to you. The smart money knows that when the majority of people realise that they would have been better hanging on to their Gold, and start buying it back, then Gold will go parabolic, soaring perhaps to as much as $7,500 an ounce, and certainly to somewhere between $3,000 - $5,000 an ounce. That is when the smart money will be selling, probably to many of those who are now selling their gold for next to nothing.

But, the rise in the price of Gold and Silver presents problems for the Global financial system, which is reliant on people continuing to accept the paper money printed in large amounts by Governments. If people begin to treat Gold and Silver as real money, then conversely it means they will have lost confidence in paper money, and it is only the retention of confidence in that money that enables it to function, to have any value whatsoever, over and above the value of the paper on which it is printed. The rise in the price of Gold and Silver has not been because of manipulation as happened with the Hunt Brothers, which is why, attempts to drive its price down last week, soon failed.

In the Keiser report, this week, Max Keiser spoke to Eric Sprott, about the attempts of authorities to stop the rise in the price of Gold and Silver.

The video at the link above is worth watching.

What this demonstrates is another aspect of Marx's economic theory. Many people are familiar with the idea developed by Marx, that Competition leads to the concentration and centralisation of Capital, leading to the creation of larger and larger firms, of monopolies and oligopolies, and ultimately, as Engels described, its logical conclusion, the development of State Capitalism as the Capitalist State concentrates economic power in its hands through the nationalisation of the means of production, of banks and so on, with the Capitalists simply drawing their income from their State in the form of interest – becoming as Engels puts it “coupon clippers”.

Less well known is that, Marx at the same time as making this point, also argued the opposite. Competition leads to Monopoly, but Monopoly also leads to competition. It was the old Feudal Monopolies that led to the development of Competition from private Capital. Where large Monopolistic firms stop providing good value, or fail to provide consumers with what they need, this facilitates the development of new smaller firms that do respond to those needs. We see the same thing in relation to State Monopoly Capitalism. People provided their own alternatives to Public Transport systems, for instance, that people found did not meet their needs and provide them with good value. An increasing number of people dissatisfied with the NHS, are even prepared to pay additional amounts on top of what they already pay in Tax, in order to access private healthcare in a variety of forms.

In reply to Proudhon, Marx wrote,

“In practical life we find not only competition, monopoly and the antagonism between them, but also the synthesis of the two, which is not a formula, but a movement. Monopoly produces competition, competition produces monopoly. Monopolists are made from competition; competitors become monopolists. If the monopolists restrict their mutual competition by means of partial associations, competition increases among the workers; and the more the mass of the proletarians grows as against the monopolists of one nation, the more desperate competition becomes between the monopolists of different nations. The synthesis is of such a character that monopoly can only maintain itself by continually entering into the struggle of competition.”

The Poverty Of Philosophy.

It wasn't until the 1980's that Marxist economists got over the approach taken by Lenin in Imperialism, which was largely taken from the Liberal, Hobson. Lenin talked about all of those elements of Monopoly that are often cited, such as its excess profits, tendency to restrict innovation etc. In fact, by the 1980's Marxist economists had realised that this was largely false, though some continue to talk in these terms. In fact, as Marx says above, what developed was Monopolistic Competition.

Monopolies had just as much incentive to innovate in order to reduce their costs, and thereby increase their profits. If innovation was held back it was only due to the practice of protecting new developments via patent laws and so on, in order to prevent competitors enjoying the same benefits. In fact, the period after WWII, and certainly over the last 20 years or so, which have seen the greatest increase in the size of firms, and of concentration of capital, have in fact, seen the most rapid period of innovation in both productive techniques and of new consumer products the world has ever seen, and in large part, it has been accompanied by increased competition, accompanied by extended co-operation – for example, as firms spread the costs of development by co-operating to develop new engines for cars etc.

But, as Marx sets out in this section of the Poverty of Philosophy it is not possible to simply take the good bits of Competition, and remove the bad bits. One consequence of competition is precisely the kind of swings of prices in markets that have been seen over the last week or so. The reason for that is simple. Although Marx, like the other Classical Economists explains why the Exchange Value of commodities is an objectively measurable quantum, determined by the average amount of socially necessary labour-time, required for production, under Capitalism, these Exchange Values become transformed through Competition, and the movement of Capital, in search of higher rates of profit, into market prices.

Moreover, as Marx sets out, contrary to the static equilibrium models of orthodox economics, which posit the idea of a balance between Supply and Demand, determining a market price, in reality, Capitalism is a system which is based on a dynamic disequilibrium. In other words, if Supply and Demand ever do balance, it is a pure coincidence. Most of the time they will not. Shortages will result in prices rising above the equilibrium price, and persistent shortages, will result in higher prices, leading to higher rates of profits, which attract additional Capital, raising Supply and reducing profits.

It is this chaotic movement that defines the Capitalist Market, and which leads to periodic crises.

Moreover, orthodox economics – apart from the Austrian School, which simply asserts that “people act” - is based on the idea that market participants act rationally. Yet, repeated incidents such as the Tulipomania, the Railway Mania, The South Sea Bubble, John Law's Mississippi Scheme, the Technology Bubble of the late 1990's, and the repeated Housing Bubbles, shows that individuals actions are frequently determined not by rational calculation, by by emotion. Today being Friday 13th., when, more people than you would think, simply stay in bed, all day, to avoid potential catastrophe, is a good example, of a wider phenomena of huge numbers of people, even now, in the Age of Science, who every day read their Horoscope thinking it in some way can tell you what is going to happen, who go through various rituals – Sportsmen, and gamblers including those on the Stock Markets are particularly prone to such behaviour – and act in many, many ways that have nothing to do with rational calculation.

Given that few people have any understanding about basic finance – as many TV programmes, showing that many people do not even understand things like APR, let alone know what interest rate they are paying on their credit cards, store cards etc., demonstrate – it is little wonder that this is the case. Of course, in a certain sense people's actions are not totally irrational.

If you see house prices rising, then its rational to think that its better to buy now rather than wait until they have gone up further. Yet, time and again, it becomes obvious that the majority of people only jump on to the bandwagon, at that point when the biggest part of the rise has taken place, and when, therefore, the probability is that prices will fall. As many commentators have said, when New York Taxi drivers were giving Stock Market tips in 2000, it was a sure sign that the market was overbought, and due for a fall.

But, for the reasons that Marx sets out, Competition has been a massively, revolutionising force. Moreover, competition exists for very real, material conditions. For so long as Mankind is subject to the Law of Value ,in its decisions over the allocation of resources for production, i.e. for so long as there is not abundance, under Communism, then Competition will continue. Marx sets that out most clearly in his Critique of the Gotha Programme. That Competition may not be Price competition via a market, but it will, nontheless be competition. And history tends to demonstrate that competition, outside the market, tends to bring with it all kinds of evils.

In the days of rationing, during and after WWII, it led to profiteering by spivs and speculators, which creates the conditions for all kinds of criminals gangs to develop. The same thing could be seen during Prohibition in the US, and can be seen today in relation to recreational drugs. In the USSR, market price competition was replaced by bureaucratic competition between the various Ministries, who sought to win more resources for their particular industrial sector, or geographic area. Usually, these kinds of competition not only bring these other kinds of social problems, but are massively inefficient in economic terms.

Nor is the idea that Competition could be administratively abolished, and replaced by democratic planning a solution. To a certain extent, we have a system of democratic planning of State Capitalism in Britain today.

The contending parties, put forward their proposals for how much they want to spend on things like the NHS, and Public Services at election times, and voters elect the Government that most closely matches their own views on how they think these resources should be allocated. But, having made that democratic choice, it does not stop those who disagree with the outcome of that vote continuing to argue their case, does not stop them protesting, or taking industrial action to win more resources, higher wages, better conditions for their particular industry, service etc. That is what we see today over the Cuts. And, of course, as is seen in many other similar instances, even those who voted for a particular allocation of resources, when confronted with the reality of what it means for them individually, when their kids school closes etc. find that they have voted for something they didn't really intend, or desire.

It is inevitable that, in a society where such democratic planning pervaded all areas of life, that, so long as relative scarcity continues, those who do badly out of the allocation decided upon, will likewise strike, or take other forms of action to resist the decisions taken, democratic or not. That is why, competition and the market cannot simply be abolished.

In the section of the Poverty of Philosophy cited above, Marx says,

“M. Proudhon talks of nothing but modern monopoly engendered by competition. But we all know that competition was engendered by feudal monopoly. Thus competition was originally the opposite of monopoly and not monopoly the opposite of competition. So that modern monopoly is not a simple antithesis, it is on the contrary the true synthesis.

Thesis: Feudal monopoly, before competition.

Antithesis: Competition.

Synthesis: Modern monopoly, which is the negation of feudal monopoly, in so far as it implies the system of competition, and the negation of competition in so far as it is monopoly.

Thus modern monopoly, bourgeois monopoly, is synthetic monopoly, the negation of the negation, the unity of opposites. It is monopoly in the pure, normal, rational state.”

But, in the same way, existing Capitalist, Monopolistic Competition can only be transcended not administratively abolished. Under Socialism, it will be the pushing of that Competition beyond its existing limits that will lead to a new synthesis. The basic elements of that can be seen today. Alongside Competition we see increasing Co-operation, for example, as stated above, between car companies in the development of new engines, to share the huge costs of research and development. In fact, in addition to Open Source software we now have the world's first Open Source Car.

But, under capitalism such Co-operation remains in a dwarf state. Even now, the development of Workers Co-operatives, could proceed on the basis of competition of quality, and efficiency, whilst the element of Co-operation could be extended to ensure that bench-marking was used extensively, and that all new technical innovations were shared within the Co-operative sector, as opposed to the limitation of that by Private capital via the laws on patents, Copyright and so on.

Such competition would continue to drive innovation, whilst increasing levels of co-operation, between Co-operative firms, would extend the principles of concentration and centralisation of Capital, ensuring that each Co-operative firm, and industry, increasingly integrated its plans, shared its information with others within the sector. The more this asserted the superiority of Co-operative production, the more this integration and co-operation protected it from market vagaries, the more Competition itself becomes superseded, and co-operative, planned production takes its place, reducing relative scarcity in the process.

The most powerful aspect of Marx's economic analysis is to show the underlying objective logic of the laws that determine Exchange Value, and lie at the heart of how scarce resources are allocated, as well as to show how the application of those laws under Capitalism leads to periodic crises, including the periods of market mania, that have been called the Madness of Crowds.

It shows that even within the confines of a system that still has to operate on the basis of some form of market, and of competition, to allocate resources, a rational basis exists outside the capitalist form of the market, through which these kinds of mania, market panics, and crises occur, could be achieved, and thereby avoid those inefficiencies and disruptions. In fact, a look at the charts of any market illustrates the point. Over a period it will be seen that although there are periods when prices rise substantially, these periods are mirrored by similar periods when prices fall substantially. Although, this is referred to as a return to the mean, in reality it never is, because there is always, and has to be equal and opposite overshoots from the mean.

The chart, provided by Deutsche Bank, on house prices is a good example of that, which is why I am confident that just as it shows that previous periods where prices were 20% higher than the mean were mirrored by periods where they were 20% below, then equally the fact that they re currently 40% above the mean will result in a period when they are 40% below i.e. a fall of around 80% from current levels.

But, although there is an objective, logical core to this, although, in the long term, every chart shows that these fundamental economic laws assert themselves, in the short term, it is the emotions and non-rational behaviour of individuals, what Keynes described as “Animal Spirits”, which are determinant.

Keynes, who was a very successful investor as well as brilliant economist realised this. He once said that markets could remain irrational for far longer than individuals could remain solvent. That is the basis of the high levels of market volatility over the last few weeks.