The Flow Of Money and Fictitious Capital
Here I want to look at the
money flows into Share Capital, and Bonds etc. (which includes also
property, art and other forms of speculation), i.e. fictitious capital.
I will start by looking at share capital. It will be seen that share capital also has a dotted
line connecting it to K, the productive capital. This is to indicate
that there is an indirect link between the value of share capital,
and the value of the underlying productive-capital. It is only an
indirect link, precisely because, although the value of the
productive-capital is objectively determinable, the value of the
share capital is not. The value of a lathe, or a factory is
objectively determinable, in the same was as for any other commodity.
But, the value of shares moves up and down, by the millisecond, as a
consequence of billions of shares being bought and sold by computers.
Share capital is, in theory, a
share of the actual productive-capital of the firm, equal to the mount the firm borrows by the issue of shares, to be able to purchase the productive-capital, but in reality,
the value of that share capital is measured not by its capital-value, but
by its potential profitability, i.e. what rate of return it is likely
to bring. Moreover, Marx points out that, even during the 19th
century, capital had developed to the stage where the capitalist was
no longer the entrepreneur. That role had been taken over by the
professional manager. The function of the actual capitalist was now simply
the provider of money capital. The modern day capitalist is
precisely that, especially where that capitalist is a collective
capitalist, in the form of a bank, insurance company, or pension fund.
There is no longer any tie, or link, to the particular firm, to which
money-capital is provided, and the concern is no longer, necessarily, with maximising the rate of profit of productive-capital, but only
maximising the total return on money, which may or may not be invested as money-capital. In fact, a
maximisation of the rate of industrial profit, may be of little
concern for speculative money capitalists seeking to make quick
capital gains, rather than long-term income.
The only direct link, between share capital and productive-capital, is where a public offering of
shares is used as a means of providing money-capital, with which to
buy productive-capital. But, the diagram is still correct in this
regard. The money spent by investors/speculators to purchase such
shares comes from, and goes into Bank Deposits as money not capital, and flows out of
it to the company, which issues shares in exchange. So, the money
flows out of bank deposits, not as money, but as money-capital
destined to purchase productive-capital. The nature of the indirect
link between share capital and productive-capital is again
highlighted here, and is significant.
The more shares a company
issues, the lower tends to be the price of each share, simply because
each individual share represents a smaller share of the underlying
productive-capital. When companies issue additional shares – for
example, through a “Rights Issue”, where
existing shareholders get the right to buy additional shares in some
determined proportion to their existing shares – this dilutes the
existing share value, causing the prices of the shares to fall.
The
reason this is important at the present time, is because of the
effect I have written about elsewhere in relation to interest rates.
When the rate of profit is high, the supply of new capital relative to
the demand for capital tends to be high. Companies can generate
funds for their own expansion easily from their own profits. So,
they will tend to issue fewer new shares, or bonds to raise
additional capital. Interest rates will fall, as will the dividend yield on the shares. That together with the increased profitability
will mean that share prices tend to rise. The demand for shares
rises, because anticipated future earnings from them rises, whilst
the supply of new shares fails to rise to meet that demand. During
such periods, there also then tends to be a “re-rating” of shares
i.e. the price-earnings ratio expands. The p/e ratio is the measure
of the price of a share against the amount of profit made by the
company per share. On the other hand, the increased rate of profit, can also then lead to firms seeking to expand faster to take advantage of an expanding market and profits. If this leads to the demand for capital rising faster than the supply of new capital from profits, then interest rates will rise, firms will issue more shares and bonds in order to borrow. Share and bond prices will fall, yields will rise.
Over
the last period, what has also been seen is that with surplus cash,
many companies have not only failed to issue new shares, but they
have used company funds to buy back existing shares. In fact, with
very low interest rates, many large companies have even borrowed
money in order to use it to buy back shares. By reducing the number
of shares in circulation, this automatically increases the amount of
profit per share, thereby making the existing price-earnings ratio
look lower than it otherwise would be. In fact, new share issuance
in recent years has been at record lows, whilst the amount of share
buybacks has been at record highs. When, market analysts talk about
existing p/e ratios, therefore, not being extended, in order to
justify bullish comments, about the possibility of share prices
continuing to rise, this gives a very distorted picture of the
underlying reality.
The
important thing to remember about share capital is that it is not, as
many bourgeois apologists try to portray it, a measure of financing
of productive activity. The amount of financing of new
productive-capital, done via the issuing of new shares is minimal, compared to the volume and value of shares traded on stock markets.
A look at most Initial Public Offerings of shares is an indication of
that. Most companies, like for instance, Facebook or Google, were
trading long before their shares were listed on the Stock Exchange.
Stock Exchanges, in the main, exist only for the existing owners of
shares to exchange them one with another. When the price of Google
shares rises, for instance, this does not directly benefit Google.
It is not money going to Google. It only means that the owners of
Google shares can sell those shares for more money than they could
have done previously.
On
the other hand, there is more of a link, between the
productive-capital and share capital, than there is between say
productive-capital, and commercial bonds, issued as a means of raising
capital. If companies' profits are rising, share prices will tend to
rise with them, and vice versa. But, a bond, once issued, will
continue to pay interest, at the specified rate, whatever happens to
the company's profits. The value of the bond may rise or fall, on the
secondary market, but, if held to maturity, will still repay its face
value.
That
brings us to bonds, which can be commercial bonds, as above, or
Government Bonds, or Municipal Bonds. Once again, what buys these
Bonds is money not money capital. The money only becomes
money-capital, when it flows out of Bank Deposits, to be used to buy
productive-capital. So, for example, as stated above, a company
might take advantage of low interest rates to issue bonds, and then
use the proceeds not to invest in productive-capital, but only to buy
back existing shares. That would not constitute a capital flow, but
only a flow of money.
As
Marx points out, neither shares nor bonds constitute capital. They
only represent a claim to assets, or to future income, i.e. a claim
to a share of future production. They are fictitious capital.
Unlike, the productive-capital, or indeed the commodity-capital, whose
value can be objectively determined, there is no objective basis for
determining their value, which is why they are prone to speculation.
A common dictum of traders be they of shares, bonds or commodities is
“The trend is your friend”. In other words, if the price of some
share etc. is rising in a trend, the safest bet is to buy it on the
expectation the trend will continue. That is particularly, true
where there is momentum trading, where large amounts of demand for a
particular share or asset class, causes its price to keep rising.
But, there may be nothing material underlying such a trend, which
simply then results in an asset price bubble, which collapses far
more quickly than it took to inflate.
The
more money exists within the system, with less of it being demanded
for use as productive-capital, the greater is the potential for money
to flow into this kind of speculation. Unfortunately, where such
speculative periods exist, they can also crowd out demand for real
productive purposes. If capitalists see the potential for buying
shares or bonds that might rise by 50% in a year, there is less
incentive to use that money as money-capital, to purchase
productive-capital. That has been one of the problems facing US, UK
and European economies over recent years, largely caused by the
intervention of central banks and governments to underwrite such
activities.
Its
notable that one of the fastest growing economies on the planet is
China, and yet one of the worst performing stock markets on the
planet is also China. It has gone almost nowhere, and part of the
reason for that is that the vast amounts of surplus value produced in
China have been reinvested in productive-capital rather than buying
shares and bonds. In fact, where they have gone into such purchases,
they have largely been of those in western economies.
The
other main class of “assets”
included under Bonds etc. is property. In reality, most property
should not be considered in this way at all, but should be considered
no differently than any other such commodity, like a car or a washing
machine. Like those other commodities, the value of a house is
objectively determinable by its Price of Production. But, any
commodity can be made the object of speculation, particularly where
its supply cannot be easily and quickly expanded. In the 17th
century it was tulips, for example –
Tulipomania.
In those cases, the market price can be driven up way beyond any
rational measure, let alone the price of production.
I
have set out in many other posts the extent to which property prices
have been driven up into a massively inflated bubble, so I will not
repeat that here. Suffice it to say that according to the IMF and
OECD, UK property prices are estimated at 40% above their long-term
average. All such bubbles eventually burst and when they do, prices
always overshoot in the other direction. Similar property bubbles in
the US and Ireland have burst with prices falling by up to 70% in
places. In the US, however, there is evidence that continued low
interest rates and money printing is creating a secondary bubble with
property prices rising by around 10% p.a., driven mostly by
speculative buying rather than buying by actual home buyers. Even in
Germany, which has usually escaped property bubbles, because of the
high level of renting, there are signs that money searching for a
home has started to blow up a property bubble there.
The
point about these money flows is that they can continue to circulate
within their own domain, blowing up such bubbles, and separated from
the circuit of capital, and of commodities for some time. That is
particularly true given the role of credit.
The
value of commodities, including capital can be objectively
determined, but the value of shares, bonds etc. contains a sizeable
subjective element. Speculators buy a share on what are largely
subjective grounds e.g. an expectation that the company's profits
will rise, or that the share price itself might rise. The same is
true of bonds, or art, or wine, or gold bought for speculative
purposes. The same thing can be true of property. In conditions
where its thought that the price of property will continue to rise,
and interest rates and lending conditions make it possible for people
to buy, few potential house buyers will give much consideration to
whether the price they are paying for a house has any kind of
rational foundation. The main consideration will be a concern to
“get on to the housing ladder”,
before prices rise further. Even when prices are falling, they may
have to fall hard and for a prolonged period, before this enters the
general psyche, that house prices can go down, and that a decision to
purchase should be based upon whether what is being bought offers
real value or not.
Where
money flows within this circuit of money, it can act to blow up such
bubbles very easily, precisely because of this subjective element.
If A owns a share in Microsoft, B owns a share in Apple, C a share in
Google each with an initial value of $100, then A can sell their
share for $200, provided, for example, its bought by B, who sells
their Apple share to C for $200, who sells their Google share to A for $200. No
additional money had to be thrown into the circuit to effect these
purchases, because all that really happened is the price tag on each
share was changed, and the ownership of those shares was simply
rotated.
Not
one iota of additional value was created by these transactions, only
$300 of fictitious capital. Its truly fictitious nature is
illustrated by what happens if the money tied up within this circuit
begins to leave it. Not only can money prices of shares, bonds,
property etc. be inflated by the price tag simply being adjusted
within the asset class, as money flows from one share to another, one
bond to another, one house to another, but that process can occur as
a consequence of money flows from one asset class to another. In
recent months, there has been discussion of “The Great Rotation”.
That is a move of money out of bonds, and into shares. The basis of
the idea is that bond prices are at several century highs, and its
thought that QE will end, and interest rates begin to rise. But,
this is still a movement of money within this circuit of money,
within the realm of financial assets. It is no different from a
situation where certain classes of shares might fall, whilst others
rise.
What
has been unusual about the situation existing over the last 30 years,
is that all these asset classes have risen. The prices of houses
have been inflated, and on the back of that, banks were enabled to
lend more money, using these inflated prices as collateral. The
additional money could then flow into shares, for example, pushing
share prices higher overall. Moreover, the fact that over the last
30 years, the rate of profit has been rising, means that the supply
of capital relative to demand was high, providing the basis of low
interest rates. That led to a thirty year bull market in bonds that
appears now to have ended.
But,
when money flows out of this circuit entirely the consequences for
these financial assets can be catastrophic. If the demand for
capital rises relative to supply, interest rates rise. As I
demonstrated recently, this demand for capital cannot be dealt with
via money printing, precisely because money is not capital. The
demand for capital, as Marx sets out, must first assume the form of a
demand for money-capital in the money market. This is true even if
firms use internally generated surplus value to finance a greater
portion of their capital needs, a smaller portion then being
available for distribution as dividends etc.
Firms
then begin to issue more bonds, thereby lowering their price, and
causing interest rates to rise. They borrow more from the bank with
the same effect, or else they issue additional shares. In the last
case, the additional shares dilute the share value of the individual
firm's shares, but it also means that an additional supply of shares
exists in the market overall to soak up investors/speculators funds,
thereby putting downward pressure on share prices in total. Once
markets begin to move in a downward direction for any prolonged
period under such conditions, the same kind of mentality of “The
trend is your friend”, can then operate in the opposite direction.
Momentum trading can send share prices sharply lower. The collateral
they represented on banks' balance sheets becomes drastically
undermined, meaning they have to curtail lending to comply with
capital adequacy limits.
But,
the effect of rising interest rates affects all of these financial
assets. When bond yields rise this also puts downward pressure on
share prices, because shares then have to offer investors a higher
return for the higher risk they represent, and because higher
interest rates mean that less money is likely to be available out of
profits to distribute to shareholders. But, in conditions of a huge
housing bubble, they will have a much more pronounced effect on
property prices. There is considerable evidence that a majority of
home buyers are struggling to meet their payments even with such
historically low interest rates. Outside London, house prices are
already falling, and demand is non-existent. As interest rates rise,
the number of defaults will rise, the number of forced sales will
rise, and despite the Governments schemes to promote additional debt,
fewer people will be able to afford to buy. Property prices will
have to collapse, but that again impacts banks' balance sheets, once
again leading them to curtail lending. That in turn leads to
limitations on lending to zombie companies.
The
basis of this collapse of financial asset prices is that money leaves
this circuit in order to enter the circuit of capital, or at least
remains in the circuit of capital rather than leaking into the
circuit of money. Although this can appear catastrophic, for the
reasons I have set out elsewhere -
What Happens If Greece Defaults
– in fact, both for workers, and for big industrial capital, it can
be quite the reverse.
Take
the removal of funding to zombie companies. In fact, that means that
money going down the drain to these companies becomes available for
better use. As the zombie companies go bust, their capital is bought
on the cheap by bigger, more efficient companies, raising their rate
of profit, and providing a more rational basis for the use of the
capital, including the ability to employ workers on higher wages and
with better conditions.
A
collapse in house prices means that workers can buy them where
currently they cannot, and in any case, it means an overall reduction
in workers housing costs, thereby providing the basis both for an
increase in workers real living standards, and a reduction in the value of labour-power, thereby raising relative surplus value. It
provides the basis for a further accumulation of capital, raising
employment levels.
If
bond and share prices fall, workers pension contributions go much
further. If the average price of a share is £5, then a workers'
pension contribution of £100 a month will buy 20 shares a month, 240
per year. If the average dividend on that share is £0.50, this
provides a potential income out of which to pay a pension of £120.
However, if the average share price falls to £2, the worker's £100
a month contribution will buy 50 shares a month, 600 a year. The
fall in the share price has no effect on how much profit the firm
makes, and so it should continue to pay £0.50 per share in
dividends. That means £300 becomes available out of which to pay
future pensions, an increase of 250%!
The
other aspect of these money flows is their use for the purchase of
commodities, including the use of credit for that purpose. I will
examine that in Part 3.
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