Tuesday, 21 October 2014

Another 2008 Is Inevitable - Part 4 of 5

Marx explains, in Capital III, how the view is developed that the ability to self-expand, to produce interest, comes to be seen as an inherent characteristic of loanable money-capital, and this is completely divorced from the reality that this interest can only be paid as a result of surplus value being produced. The importance of this in relation to the build up of this fictitious capital is that if interest arises simply because of some magical inherent property of loanable money-capital to expand, then, if the quantity, or “value”, of this loanable money-capital, increases, then the amount of interest itself must increase, all else being equal. If, the total value of shares rises, therefore, then the total amount of dividends must rise and so on. Indeed, this is what is behind the false view that higher stock prices are beneficial for pensions, because if the yield is 5%, and the value of a pension fund rises from £100,000 to £200,000 then the amount of income/dividends rises from £5,000 to £10,000.

But, as was shown in Part 1, the reality is that dividends can only rise, the amount of interest paid out on bonds etc., can only rise, if the total surplus value produced in the economy rises. Otherwise, the amount of industrial profit (the profit after deduction of interest and rent) available for reinvestment must fall. If share prices rise by a greater percentage than the rise in surplus value, then either a smaller portion of that surplus value must be used for accumulation as new productive-capital, so that dividends are paid out with the same yield, or else a smaller proportion must be paid out as dividends, in which case the dividend yield falls, which would, other things being equal, lead to a fall in share prices. If we take the example above, if the mass of profit available to be distributed remains the same at £5,000, then a rise in share prices, causing the value of the fund to double, simply results in the yield being halved from 5% to 2.5%. Moreover, as explained earlier, the doubling of share prices means that only half the previous number of shares can be bought with contributions. So contributions buy fewer shares, and the yield on those shares also falls, providing less income for pensioners, which is why annuity rates have fallen, and why company pension funds have run up deficits, unable to generate sufficient income to cover obligations.

It is this, which is behind the pensions crisis, not the nonsense about people living longer. Higher share prices mean it is easier for the capitalists, who already own them, to hang on to them, and harder for workers to buy those shares from them, and to obtain an income from them.

Earlier, it was argued that during the last thirty years, the amount of surplus value was rising, and the rate of profit was rising along with it. Yet, a look at the growth in GDP of the US shows that it increased by only about a fifth of the rise in the Dow Jones and S&P indices. The rise in stock prices could not be explained by an equivalent growth in surplus value, bringing about a growth of real capital, in the US, therefore. But, it could be explained by a rise in the proportion paid out to existing shareholders, or to fund share buybacks and mergers and acquisitions relative to the investment in real productive-capital.

Another explanation could be the fact that, during this period, the greatest accumulation of capital, and rise in the rate of profit arises, not in old economies like the US or UK, but in China and other dynamic Asian economies. US, UK and other multinational companies, therefore, might have made large profits, across the globe, but used them to accumulate capital in China, and other developing Asian economies. The profits of these multinational companies, therefore, may have been rising rapidly on these foreign investments, thereby pushing up the share price of those companies.

And, indeed the evidence of de-industrialisation of economies, like the US and UK, and relocation of some mature industries to lower cost areas, lends weight to that argument. In a recent article on Germany, Paul Mason notes, quoting Marcus Fratzscher of the DIW Economics Institute in Berlin,

“And while German companies do invest, they’re creating more jobs abroad: 37,000 jobs were created by the top 30 companies abroad last year, compared to only 6,000 in Germany.”

That may be one explanation, and it also provides some explanation of the fact that, for example, in the US, there are some new industries such as in technology, where companies have made large masses and rates of profit, and have also amassed huge money hoards on their balance sheets, whilst other older companies, for example, GM and Ford, not only saw their rate and mass of profit fall, but entirely disappear, as they racked up increasing losses. But, the example of technology companies also provides another explanation. That is that shareholders have been prepared to forsake dividends in exchange for capital gain, in the form of higher stock prices.

Companies may make larger profits, for example, but not increase the dividend, or, as in the case of many technology companies, pay no dividend at all. Instead, they may reinvest most or all of the profits, so as to expand the size of the business, as happens, for example, with Amazon. Provided, the additional investment in productive-capital, thereby results in the production of increased masses of surplus value, the price of the shares may, therefore, rise. Although, shareholders then see no rise in their income, they see a rise in their apparent wealth, because the price of their shares has risen, be it in the form of individual share holdings, mutual fund holdings, or their pension fund. As apparent capital, these shares etc. can then be used as collateral to borrow against, for example, to obtain a mortgage. But, then the collateral provided to the bank increases its bank capital, facilitating its additional lending, whilst the house bought with the mortgage can itself be used as collateral for further borrowing by the house buyer, to the extent that its price rises.

In the same way, banks that hold shares or bonds, see their price rise, and as these assets form part of the bank's capital, they facilitate the bank increasing its own lending, by multiple times the increase in the bank capital.

Another explanation is that companies having made large profits, use those profits to simply buy back stock, or to buy shares in other companies rather than to invest in real productive-capital. That is exactly what happened in the 1840's, as Marx and Engels described, with capitalists using the resources from their companies to speculate in railway shares. If a company has a million shares, each worth £10, and produces a profit of £1 million, all of which it distributes as dividends, it pays out £1 per share, a dividend yield of 10%. However, if the company uses the profits to buy back 10% of the shares, the price of the shares, other things being equal, will rise by 10%. This has other benefits. The current earnings per share is £1, but next year, with only 900,000 shares in issue, a £1 million profit, will automatically appear as an earnings per share of £1.11 per share. Moreover, with very low rates of interest, it is often worthwhile, for large companies, that can borrow most advantageously, to borrow money in the money market, and then use this money to buy back stock.

In addition, such companies can buy the stock of other companies, either as a form of speculation, in the belief that they will make large capital gains, as share prices rise, or else as preparation for taking over those companies, at some point in the future. In all of these cases, the share prices are being driven higher, not because of an increased mass of surplus value, being utilised to accumulate additional productive-capital, that makes possible the future increase in surplus value, but solely because additional loanable money-capital is being used to buy a limited quantity of stock, and in some cases, thereby to reduce the amount of stock in circulation. It is inevitably the case that, if increasing amounts of demand chase a limited or reduced supply of stock, then the average price of that stock must rise.

Moreover, a further delusion arises here. Listen to the comments on CNBC or Bloomberg, at any time, ahead of earnings season, when companies announce their quarterly profits, and you will hear discussion about why stock prices can continue to move higher, because earnings continue to rise, or have beaten expectations. In fact, the latter is meaningless. If I lead the market to believe that my profits for the quarter, are going to be zero, but they come in as £1 million, then I have beaten the earnings expectation, but it matters very little, if the reality is that last year my profits were £2 million! On the basis of expectations my share price might be expected to rise, but on the basis of my profits, this year compared to last year, it should fall.

But, the idea of my share price rising because my earnings have actually risen is not so straightforward either. Suppose, my profit this year is 20% higher than it was last year, £1.2 million rather than £1 million. I may have exactly the same number of shares this year, as last year, so the earnings per share (EPS) rises 20%, meaning the dividend could rise by 20%. But, this profit figure can hide a multitude of sins. Suppose, the original profit of £1 million, is made up as follows – revenue £5 million, costs £4 million. In other words, the profit margin is equal to 25%. Now, suppose that in the second case it is made up – revenue £11.2 million, costs £10 million, or a profit margin of only 12%.

The earnings have still risen by 20%, but the reality is that the cost of producing those earnings has more than doubled. In terms of the company's share capital, nothing has changed. It still has 1 million shares, the earnings per share will have risen from £1 to £1.20, but the reality is that in terms of the company's real capital, its profitability has declined. If it only laid out the same £4 million of productive-capital as in the previous year, its profit would have been only £0.48 million, and the earnings per share £0.48, a fall of 62%. 

Suppose, for example, that the company reinvested its previous year's profit of £1 million, and turned over its advanced capital more quickly. Previously, it may have turned over £1 million of capital four times a year, so that it laid out £4 million in total. Giving an annual rate of profit of 100%. Now, it advances £2 million of capital, that it turns over five times a year, giving an annual rate of profit of only 60%. So, the idea that rising stock market prices are justified by rising company earnings is false, because at some point, this additional real capital, that must be laid out, in order to generate those higher earnings, creates a rising demand for money-capital, satisfied either by new shares being issued, or else by companies issuing corporate bonds, or else results in a reduced supply of money-capital to the money market, as profits are immediately reinvested. In either case, the consequence is then to reduce the earnings per share, and the dividend yield, which undermines the share price, or bond price, as interest rates rise.

Already, in the US, when share prices are measured by the CAPE, they are at levels around 26, which in the past have been associated with stock market crashes. That is despite the fact, that in the preceding period there has been a record high level of share buybacks along with very low levels of share issuance, thereby inflating the effective earnings per share, and dividend yield. In the UK and Europe, stocks look less expensive on the CAPE, but again this ignores any potential change in the rate of profit, which makes it necessary to issue additional share capital, or corporate bonds.

But, as Japan in the 1990's demonstrated, because of the extent to which this fictitious capital, in the form of shares and bonds, sits on bank balance sheets, any significant fall in share prices also reduces that bank capital, causing a sharp contraction of lending, and rise in interest rates. Often a fall in share prices causes money to migrate into bonds, pushing up bond prices, and reducing bond yields. But, in a climate of rising interest rates, as banks curtail lending, bond prices are also likely to fall, causing a general fall in asset prices, including house prices, as buyers find they can no longer meet monthly repayments of double or treble their current levels. That in turn rebounds back on bank capital, as all of this fictitious capital is overnight devalued, causing a further contraction in lending. At the moment, none of the bank stress tests in Europe, the UK or the US factor in the kind of systemic collapse, of these asset prices, on the scale that occurred in Japan, in the 1990's, and which began in 2008, across the globe.

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