Sunday, 10 February 2013

The Bust Without A Boom - Part 1

There is a thirteen year cycle for Stock Market crashes. In the last fifty years, they have occurred in 2000, 1987, 1974 and 1962, but the sequence can be traced back at least to 1929, provided a six year allowance is made for WWII. This year, 2013, is the next year in this sequence, and all the conditions appear in place for a huge Stock Market crash as well as crashes in other financial assets such as Bond and Property Markets. The difference with this crash will be in the conditions under which it occurs. It will be a bust occurring under conditions not only of no previous economic boom, but of extremely low interest rates, and lax monetary policy as an attempt to deal with the lack of economic growth in developed western economies.

An economic boom and a financial bubble are not the same thing. On the contrary, the latter frequently arises in the absence of the former, or as it ends. For example, the 2000 bubble blew up during the 1990's, prior to the new economic boom that started in 1999. The 1987 bubble blew up in the conjuncture between the ending of the Autumn Phase of the 1949-99 Long Wave, and the start of the Winter Phase. The 1974 bubble burst as the 1949-99 Long Wave exited the Summer Phase, and entered the Autumn Phase, and during a period of stagnation. The 1962 Bubble, however, burst under conditions of robust growth, as the 1949-99 Long Wave transitioned from its vigorous Spring Phase into the Summer Phase of the cycle.
George Hudson, The Railway King, presided over
the Railway Mania of the 19th Century, that was pretty
 identical in nature to the Technology Boom of the 1990's.
Most railway companies went bust, share prices bubbled then
collapsed, but masses of capital in the form of railway
lines, stations, hotels, and rolling stock was created.  A few
large profitable companies emerged from it.

US growth started to pick up in the 1990's. A lot of it was based on the Technology Boom. A lot of that boom was fictitious, but no more so than the Railway Boom of the 19th century. A lot of firms went bust, but a lot of capital was also formed in the process. Like the railways before, it now forms an important element of infrastructure.

Likewise, the growth of the US and other developed economies, rose after 1999, partly due to the onset of the new global boom, partly as a result of monetary policy by Central Banks. Between 2000 and 2007, US growth rose from $11226 billion to $13206 billion (2005 $'s). That compares with an increase from $4890 billion in 1974 to $10780 billion in 1999 - i.e. the period of the Long Wave Downturn.

The Financial Meltdown of 2008 brought that boom in the US, UK, and Europe to a halt. Particularly after 2010, with pressure from the Tea Party in the US, the Liberal-Tories in the UK, and their co-thinkers in Europe, the recovery was held back. In the absence of fiscal stimulus, monetary stimulus could only create inflation. It did as it it had done in the previous thirty years, create asset inflationbubbles in shares, bonds and property.

In 2000, the crash of Stock Markets took the DOW back below 10,000 and NASDAQ down by 75%. At the time, the Sunday Times suggested share prices would not recover their 2000 levels for 20 years. But, money printing had taken the DOW back not just above 10,000, but above 14,000 by 2008. The S&P 500 too was now at at an all-time high. But, at least, there had been an economic boom between 2000 and 2008, even if not enough to justify those rises.

Between 2008 and today there has been no such growth. That is particularly true of the UK, and parts of Europe like Spain. Yet, in those countries, stock markets are near record highs, and the property markets are still well into bubble territory. That is despite the UK being in a triple dip recession and Spain being in a 1930's style Depression with unemployment at 26% and youth unemployment at a staggering 60%. Both Spain and the UK have more than a million empty homes. In the UK, the bond market is also in severe bubble territory, despite the country's deteriorating debt, and persistently high inflation.

There is, however, a sharp disjunction between this high consumer price inflation, and the astronomical inflation of asset prices. Inflation is caused by a reduction in the value of money, or in a paper money economy, too much paper money/credit being printed. But, how the excess manifests itself depends on many other factors.

The basic exchange relation between commodities – or their relative prices – was explained by Marx. At root, it depends on the relative amounts of Abstract Labour required for their production. In a capitalist economy this is modified to the Price of Production of each. If the Price of Production of A rises while that of B remains constant, more of B will exchange for A than before, and vice versa. Changes in inflation do not alter this relation. If inflation doubles then, all other things being equal, the price of everything doubles so that their exchange relations to each other remain the same.

The only time this relation should change then is if the Price of Production changes. For example, if the Price of Production of houses rises, then you get less house for a given amount of Labour Power. If a house was equal to say 2 years wages – 2 years of Labour Power – and its price doubles, it will now equal 4 years wages.

But, in reality, things are not that simple. In practice, the Price of Production of all commodities should be falling over time because productivity is constantly rising, reducing the abstract labour-time required for their production. But, it changes faster for some than others, so their relative prices constantly change. They should all fall, but some more than others.

But, modern capitalism does not like falling prices. It encourages people to hoard money, whereas capitalism needs them to spend. It also leads to big firms competing on price which leads to cuts in profits. So, it prevents falling prices – deflation – by printing money tokens to devalue them, thereby keeping nominal money price changes positive.

But, the money when printed can go anywhere. With rapidly falling prices in consumer goods from China keeping consumer price inflation at moderate levels, it went into buying shares, bonds and property that had a peculiar quality.

When the price of bread say goes up, people tend to buy less of it, and vice versa. They switch to potatoes or some other substitute whose price may have fallen. With shares and bonds, and now even property, the opposite can and has happened. They have behaved more like bread, when people think it is running out. It is like a panic that causes them to buy more.

There are two ways you can make money from any of these assets. Firstly, you can make money in yield, and secondly you can make money from Capital Gain. The yield is how much income it can produce as a percentage of its price. If I buy a share for £1,000 that pays a dividend of £100, or a Bond that pays a coupon of £100, or a house from which I get a rent of £100, the yield in each case is 10%. In the past, investors tended to invest in order to obtain income in this way.

However, at certain times, the prices of these assets – in the past only shares – could rise very quickly. People could get rich quick not from the yield they could obtain from investing in some productive activity, but simply from the rapid rise in the price of the shares they had bought i.e. from Capital Gain.

The more these periods occurred, the more this became seen as the motive for investment rather than income. The more money was printed, the more such periods of rapid price increases occurred. But, just as the only basis of a relative increase in the price of a commodity is an increase in its value i.e. the labour-time required for its production, so too there are only two real bases for the price of a share to rise. That is because the capital of the company, which these shares represent has increased. Either, the company expands and produces more, or the value of its production increases.

In reality, shares do not get priced on that basis. Instead they are priced either according to the amount of profit they are expected to earn, which gives the Price/Earnings ratio, or else they are priced according to how much traders believe the price might be pushed up to given the amount of momentum behind the demand for them. The former can be to some extent calculated, but the latter is in reality pure guesswork. It is based on the observed phenomena that with such assets, people will buy them for no other reason than that they are going up, and so although this makes it now more difficult to obtain a yield from them, the hope is instead to make a Capital Gain.

But, of course, in the end, such Ponzi Schemes have to end in tears, when there are no bigger fools left to buy the over-priced assets, and when the ability of the share, bond or property to provide an adequate income is found to be missing. A company that year after year fails to make a profit, will year after year see its capital fail to expand, and so there will be no basis for a change in its share price. If, despite that, its share price rises by 10% a year, ultimately it will have to come back down. The shareholders who sold their shares on the way up, will have individually pocketed Capital Gains, but those who bought these over priced shares from them, will make an equal Capital Loss, when the shares collapse to their true level.

But, that is true also of bonds and property. More so for the latter. A bond should be so priced as to cover against inflation, plus an average rate of interest. Yet, many bonds today, for example those of the UK, Germany, US and Japan do not even provide a sufficient yield to cover inflation. Their buyers are actually paying to lend money to these Governments! What is more, when the holders of these bonds begin to sell, the price will fall precipitously so that those left with them will suffer huge capital losses. I've already pointed out in past posts that some big Pension Funds are already beginning to sell their bonds for that reason. The yield on US and UK 10 Year Bonds has risen by more than 30% in the last couple of months. Now other big investors are making the same bet - Jim Rogers - Short US Bonds and Bill Gross – Beware the Credit Supernova.

But the case with property is even clearer. The price of houses, as with other commodities should have been falling, as productivity rises, reducing their price of production. Even allowing for the monetary inflation referred to earlier, the price should only have been rising modestly. As UK Housing Minister, Nick Bowles, put it recently, if chickens had risen in price as much as houses since the 1970's, they would today cost £47, and a jar of coffee would cost £20! Nor is it due to any housing shortage as is frequently claimed. There is 50% more housing per head of population today than there was in the 1970's, and there are more than 1 million empty homes. The real reason for high house prices is speculation, just as with share prices and bond prices. It has caused people to bid up the price of houses and building land for no other reason than a belief that the price will continue to rise. In other words, a Ponzi Scheme. It has also caused people, on that basis to modify their behaviour. For example, far more people today seek to buy houses than to rent – though astronomical prices mean very few first time buyers can, and also mean existing owners cannot afford to buy a more expensive house. It means more affluent people have bought more than one house, and it also means that many single people seek to acquire houses, whereas they would previously have lived with parents etc.

That change is provided in the data supplied by the Halifax in relation to the change in household composition.

In 1971, 70% of households in the UK were composed of married couples, and a further 9% was made up of co-habiting couples or other multi-occupancy homes. Only 2% comprised lone parents, and a further 19% were one person households. By 2011 those figures had changed dramatically. They were 40%, 19%, 8%, and 33% respectively. Even since 1991 the figure for married couple households has fallen from 55% to 40%, whilst one person households has risen from 27 to 33%.

The real reason for rising house prices is not shortage of housing or land, or rising costs of production, but speculation – hence all the TV programmes that feed off it – causing a massive bubble. As with share prices, each time that bubble has burst, over the last thirty years, it has been reflated. But, with share prices bubbled to all-time highs, with UK and Spanish property prices still near all-time bubble highs (and now speculators are once more driving US property prices back into a bubble - CNBC) with bond prices also in a bubble not seen for maybe 300 years, and yet with interest rates at near zero, in an attempt to raise the economy from its near zero growth, when these bubbles burst, as they appear soon to do, there is no way of reflating them this time, apart from Ben Bernanke's previous suggestion to print money and simply throw it from helicopters!!

I'll look at the consequences of that dilemma, and of the looming financial supernova in Part 2.

Forward To Part 2

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