Another 2008 Is Inevitable - Part 2 of 5

In Part 1, it was described how loanable, money-capital (bank loans, shares, bonds etc.) is only fictitious capital. It can only earn interest to the extent that productive-capital creates surplus value. Yet, large amounts of this loaned money-capital is loaned, not for the purpose of buying productive-capital, but to finance consumption by households, the state etc. It drains surplus value without facilitating the creation of additional productive-capital, required for the generation of such surplus value.

However, the owners of these bonds, shares etc. can use them as though they were real capital. They can be used, for example, as collateral, against which to borrow money. For banks, such collateral can not only be used to borrow money, but it can be used as bank capital, which means that the bank can itself lend money against it. Because banks can make loans that amount to many times the value of this “capital”, that sits on their balance sheet, their capital can expand by many multiples more still.

As 2008 showed, these banks and financial institutions can then take this fictitious capital and bundle it up into other commodities – derivatives – that can be sold on the market, and each of these appear for the owner as capital too.

If we look at US GDP between 1980 and 2000, it rose from $2,788 billion to $9,951 billion, a rise of 257%. However, the Dow Jones, in the same period rose from 824 to 11,723, a rise of 1,323%! The S&P 500 rose from 107.94 to 1469.25, or 1,262%. The increase in GDP is not an accurate measure of the extent to which US real capital expanded during the period for the reasons set out elsewhere, that the way capitalist economies calculate output is inadequate from a Marxist perspective, being really only an expression of the growth in the consumption fund. However, the relative proportions do give an indication of the extent to which fictitious capital grew in relation to the expansion of real capital during that period.

But, in fact, this does not itself give the full picture, because this only reflects the bubble that was created in stock prices; it does not reflect the bubble in bond prices, or the growth of bank capital. A look at property prices, in the US and UK shows that it was during this period, also that the bubble in house prices was initially inflated. In 1970, the average house price in the UK was £4,900. Despite a house price crash in 1974, and a period of stagnation until the latter part of the 1970's, by 2000 it was £101,500, a rise of 1,971%.

If we take just one bank, Deutsche Bank, for example, its reported that its total global exposure to derivatives is €55 Trillion!!! To put that in perspective, Germany's annual GDP is only €3 Trillion. That is an exposure equal to 20 times German GDP, or about the same as the total global GDP! By contrast, the Cyprus Banks' assets were 8 times annual GDP, when they went bust. Deutsche Bank's exposure to these derivatives is on the same scale as the Luxembourg banks' ratio of assets to GDP, and Luxembourg is likely to be one of the next economies to go the way of Cyprus. If the banks in Cyprus were deemed to have been dangerously over exposed, what does that say about the over exposure of the much larger, German banks? Moreover, this situation has not been improved since 2008, it has been made worse.

The US banks were, at least partially, recapitalised by the state, and by the introduction of additional private capital. A large part of their bad debts was wiped off, because the state introduced measures to bail out home buyers who could not repay their mortgages, and whose property had fallen to a more realistic price, often 60% below its peak 2008 level. Even UK banks have had additional capital provided by the state, and some additional private capital, but nowhere near enough, given their exposure to this mountain of debt, founded upon grossly inflated assets. The European bank stress tests have widely been regarded as a sham. On each previous occasion, within a few months of banks being given a clean bill of health, some of those same banks have gone bust, as happened with the banks in Cyprus. Its not likely to be different with the current Asset Quality Review (AQR), though already its being suggested that a number of EU banks will fail it, and be allowed to go bust. The decision, after Cyprus, to make bondholders, as well as shareholders suffer a loss of their capital, as well as the precedent, set in Cyprus, of expropriating the deposits of savers, means that there are a range of unintended consequences, that could spread contagiously from any future such bank collapses.

Rather than recapitalising banks, which would be near impossible, given the actual amount of capital that global banks require to remedy their insolvent position, the European banks have been stuffed with liquidity. The Long Term Refinancing Operations (LTRO) do not provide European Banks with capital, but only with money, in the shape of cheap loans. With these cheap loans, they have been encouraged to buy the bonds of the peripheral states. Its partly on that basis that the price of those bonds has risen, reducing the yield on peripheral European bonds, even down to levels lower than on the bonds of the UK and US. This gives an indication of just how surreal the situation is that all of this debt has created.

On the one hand, we have more wealth, in the shape of use values, than at any time previously in history, but, the cause of that, the huge rise in productivity over the last thirty years, is also the reason that the individual value of commodities has fallen significantly. That would have caused a deflation of consumer goods prices had it not been for a devaluation of money by money printing and an increase in credit money.

Whenever any particular currency is not expanded relative to the value of the dollar, the value of that currency rises, and it suffers a relative deflation of prices, particularly where its economy is more dependent on trade, and the role of dollar denominated prices. For example, oil is denominated in dollars, so if the value of your currency rises against the dollar, the price of your oil imports falls in your own currency. But, this same process puts downward pressure on domestic prices, forcing producers to seek to become more efficient. This, in turn leads to a further rise in the currency based on these rising proportional levels of productivity. Its why Japan, for example, has had a problem sustainably reducing the level of the Yen against the dollar, despite action by the Japanese central bank, but its also why Japan has had difficulty breaking out of the deflationary spiral it found itself in during the 1990's, when not only did consumer prices begin to fall, but the previous bubble in stock, bond, and property prices also burst. The NIKKEI rose six fold during the 1980's, reaching its high of 38,957 on December 29^th 1989. It fell by 82%, down to around 7,500, thereby wiping out nearly all of its gains for the 1980's. Japanese property prices fell by similar amounts.

Many emerging economies saw the same phenomenon. Their import prices fell, pushing their inflation and interest rates lower. As, the US began to taper QE, an opposite reaction set in. The currencies of these economies fell, their import prices rose, their inflation rate rose, their bond prices fell, pushing market interest rates higher, and in order to defend the currency, and ward off inflation, the state also raised official interest rates. As the bonds from these economies sold off, the money flooded into safer bonds, such as the US, UK, and even peripheral Europe, where they were seen as being backed by central banks. It was on this basis that the process described at the beginning, of a situation where rates are both rising and falling is created. Interest rates in large parts of the globe are rising, and the funds released from these sources, wash into the bonds of other economies, pushing their prices higher, and their yields lower. It is a process I described previously – Volley Firing.

Now, as predicted, in that article, this process, of ratcheting up global interest rates, has once more reached Europe, as Greek and Portuguese bonds have fallen, with Greek yields rising from around 5% to over 9%.

The US, massively devalued the dollar, by printing more of them. It did not suffer large scale commodity price inflation, because the individual value of commodities has fallen in equally massive proportions, due to rises in productivity, and a shift of production to China, and other low cost areas. But, its not true to say, as the Keynesians do, that the US or the UK has not suffered from inflation, as a result of this devaluation of the currency. The deflation of commodity prices is mirrored by a massive inflation of the price of land, property and fictitious capital.

Ask someone trying to buy or rent a house in London or New York whether there has been inflation! One reason the consumer price indices show low levels of inflation is that they exclude these prices, for things which constitute a major element of people's real cost of living. Nor does the cost of servicing a mortgage give a fair indication of that cost. Its true that if you bought a house, in 1990, that cost £30,000, with a mortgage rate of 15%, then the £4,500 a year of interest, on that, would be more than if you bought the same house today, at £120,000, with an interest rate of 3%, or £3,600 in interest per year.

However, you still have to repay the additional £90,000 of capital sum borrowed, and the current 3% interest rate is likely to rise, just as the 15% rate of interest in 1990 fell. Something like Robert Schiller's Cyclically Adjusted Price Earnings ratio used for measuring stock prices, by taking some historically determined average rate of interest over the life of a mortgage, would give a better measure of affordability.

If the inflation of property prices were taken into consideration, the situation would be seen as significantly different over the last thirty years. In a addition, a similar situation exists with pension provision. In 1980, had someone saved £100 a month in a pension fund, invested wholly in Dow stocks, it would have bought thirteen times more shares than the same amount in 2000. Put another way, to have maintained the same purchase of shares into their pension, they would have had to have saved £1300 per month rather than £100 per month.  As the price of shares bubbled up, so the yield on those shares (the ratio of the dividend to the price) fell, as also happened with bonds.  As pensions are paid from this interest, pension savers were hit doubly, as the number of shares and bonds they got for their money fell sharply, and the interest they got on the shares and bonds in their pension fund also fell, which is why annuity rates have collapsed.

Moreover, a look at the UK, where money was printed, as in the US, shows that even consumer goods prices rose. In 2007, just ahead of the financial crisis, Alistair Darling appeared on TV to warn against excessive pay rises (Oil tanker drivers had just struck and won a 14% pay rise), as inflation rose sharply. Even after 2008, the Bank of England failed to keep inflation within its 2% limit, with it being between 4-5% for much of the time. Only in the last year, after the Bank of England ended its QE, causing the Pound to rise against the dollar, has inflation fallen. The Pound went from around £1 = $1.50 to £1 = $1.70 a few months ago. Now, as US QE ends, the Pound has fallen back to £1 = $1.60, and continues to drop, threatening to push UK inflation higher once more.

In China, which pegged its currency to the dollar, there has been continuous inflation. It countered that by rapidly rising levels of productivity, but now with productivity gains waning, and with Chinese wages having risen considerably over the last 30 years, one of the main factors in reducing the value of commodities has been removed. As indicated at the beginning, commodity prices did not rise significantly, despite a lower value of money, only because commodity values fell significantly. If now, commodity values do not fall so rapidly, but the vast amount of money that has been printed continues to circulate in the global economy, the consequence can only be for those prices to rise sharply. Inflation will increase unless liquidity is taken out of the system, but a reduction in that liquidity, will cause all those asset prices that were previously inflated to collapse. The bubbles blown up over thirty years, in stocks, bonds, and property will burst, just as happened in Japan in the 1990's. In the same way that emerging economies have seen their interest rates rise, as their currencies fell and their inflation rates rose, so a failure to reduce liquidity generally will have a similar effect. As inflation rises, bond buyers will demand higher yields, they will offer lower prices for bonds; interest rates will rise; higher interest rates necessitate lower share prices, and for those that have taken on vast amounts of debt for unproductive purposes, such as house buying or speculation, they will be crushed between higher debt servicing costs, and lower asset prices.

The basic reason another 2008 is inevitable can be summed up in one word – debt! Debt is the other side of the coin to the growth of all this fictitious capital, whether it be in the form of astronomically inflated property prices, share prices, or bond prices, and a range of other speculative assets such as art, wine and so on whose prices have risen way beyond any rational concept of value, solely on the back of excess liquidity, which fuelled speculation. Every such speculative bubble going back to the Tulipmania eventually bursts, and, as in 2008, everyone, after the event, asks why no one saw it coming, when, in fact, lots of people did see it coming, but no one, caught up in the mania, wanted to listen to the warnings.

And, in fact, after 2008, far from the actions of of governments and states reducing that problem of debt, they have increased it, alongside the further expansion of the fictitious capital. Rather than recapitalising the banks, they have been stuffed full of additional, freshly printed and thereby devalued currency. Instead of pursuing measures to increase investment in additional productive-capital, which is the only means of creating the surplus value that can service the debt, and produce the real capital, needed to recapitalise the banks, the needs of financial capital have been given priority once more. In some cases, the very opposite of what was required has been pursued. The policy of austerity in the UK and parts of Europe, is rather like the situation Marx describes, in relation to the 1844 Bank Acts, that in order to protect fictitious capital, real capital was destroyed. Austerity not only destroyed real social capital, but, in the process, it undermined real productive-capital dependent upon demand from the state. In order to maintain aggregate demand, from consumers, instead of providing the basis for a growth of wages, based on a growth of real capital, the same policies, that led to the crash of 2008, were simply repeated, encouraging yet more consumer debt, via policies like Help To Buy etc.

Back To Part 1