Wednesday, 22 October 2014

Another 2008 Is Inevitable - Part 5 of 5

What makes another 2008 inevitable, therefore, is that when this process began to unfold, six years ago, it was possible for central banks to rescue commercial banks by printing money to end the credit crunch, official interest rates were slashed, and the bad debts of banks, in the form of grossly inflated asset prices, were once again reflated, allowing the banks to continue a process of extend and pretend, in relation to their loans. But, its clear that the potential to repeat that exercise is greatly limited, whilst the mass of debt, and build up of fictitious capital, is much greater. For one thing, official interest rates are already at their zero bound. For another, the efficacy of money printing has been increasingly diminished as a means of reflating asset prices. The scale of money printing after 2008 has been much greater than during the 1980's and 90's, yet, compared to the 1,300% increase in the DOW, during that earlier period, it has only risen by 70%, in the last 14 years.

As stated earlier, in the Eurozone, the LTRO has been singularly unsuccessful, in increasing bank lending, into the economy, and the desirability, let alone justification, of Italian and Spanish bond yields lower than those in the UK or US, is highly questionable. The UK has ceased its QE programme, and the US is ending its programme this month. Already, the consequence of that has been to increase volatility. The VIX volatility index has risen from around 12 to 27, a level which in the past has again meant that the potential for a stock market crash is greatly increased. Over the last three weeks, stocks have moved up and down violently, responding to comments by Federal Reserve spokesmen about when US interest rates are likely to rise.  As I pointed out, recently, this is similar to the situation, in the 19th century, when UK markets continually looked forward to the arrival of treasure ships, from Australia, that brought back gold, which was then used to increase the currency circulation. 

Meanwhile, as stated at the beginning, although we have record low official interest rates, which presses down on savers, we have record high interest rates paid by an increasing number of people reliant upon pay day lenders. There is a limit to which people can simply cover their debts, by borrowing more from more usurious lenders, under conditions where we have real wages being reduced by more and for longer than at any time in more than 130 years . Even in Germany's much more successful economy, as Paul Mason reports in the article referred to previously,

“As a result, says Professer Fratzscher, the lowest paid 60 per cent of the workforce has actually seen their wages decrease over the last 15 years.”

In the US, property prices having fallen by up to 60%, have spiked in the last year or so, but it seems only as a result of buying by speculators, rather than home buyers. Each spike causes a reaction in the shape of a fall in demand, and whenever interest rates rise it causes demand to fall, and prices to fall back. Meanwhile, the kind of sub-prime lending, and derivatives, that was seen ahead of 2008, in housing, has now been seen in relation to car loans.

In the UK, having thrown everything it could at the property market, short of actually giving people wodges of money in their hand, to put down as deposits, no questions asked, property selling prices, in most of Britain, have continued to weaken, and the number of properties on estate agents books has continued to rise, and remain there for longer. Even London property prices appear to have started to fall. Prices seem to have reached such a level, given the continued fall in wages, that potential buyers cannot now afford even the monthly mortgage payments, let alone raise the required minimum deposit. As interest rates rise, and as the UK economy follows Europe into a new downturn the potential for a significant drop in UK house prices is on the cards.

For the last thirty years, as the secular decline in interest rates underpinned a rise in asset prices, fuelled by liquidity induced speculation, a psychology understandably developed of  “buy on the dips”. A secular rise in stock and bond markets, as well as of house prices, induces the myth that these prices can only move in one direction over the longer term. But, of course, even over the shorter term, buying at the wrong time can seriously affect your wealth. If you held stock in 1929 ahead of the Wall Street Crash, it would have taken until the 1950's, until your portfolio recovered its previous value. In 1947, with lots of people seeking houses after the war, my parents bought a terraced house for £1,000.  Had they waited another two years, they could have bought a brand new semi-detached house for just £250.  As late as 1974, their house had only just reached the same price they paid for it in 1947!

I suspect many people who have bought houses in the last 15 years will find themselves in a similar position, of being burdened with a high level of mortgage debt for another 20 years, but with the market price of their property reduced to a quarter its current level. The fact is that a reversal of the conditions which led to secular bull markets, can also lead to equally prolonged bear markets for shares, bonds and property. Rather than buying the dips, during such a period, it becomes a safer bet to sell the rallies, i.e. each time prices rise, take the opportunity to sell any shares, bonds, or property you still have. There is no reason that US, UK and other stock, bond and property markets, should not follow the experience of Japan since the 1990's, of a sharp sell-off, taking them back to the levels prior to the inflating of the bubbles, followed by only modest increases over the next period.

The other factor, which makes another 2008 inevitable and worse, is the question of who owns the debt, and who has the liquidity? Usually, the “smart money”, the very rich and the true money-capitalists, exits financial markets at the point that everyone else (what has been termed by others as the lumpen investoriat) is piling into them, because that is a sign of the top of the market. The smart money sells their shares, bonds, property, gold and so on to the ordinary punter at the top of the market, and lets the latter suffer the losses, as markets fall. Where they have not been able to do that, for example, in Greece etc., in 2010, they use their political influence to get the state, at a national or international level, to bail them out. So, for example, the ECB and other institutions, bought up peripheral European bonds, and the ECB is proposing to do the same thing again on a larger scale, also buying worthless mortgages and mortgage backed securities from banks, if it has to undertake some form of QE.

But, the current conditions are peculiar. After 2008, and following the Stock Market Crash of 2000, many retail investors have fought shy of throwing their money into the markets, even as over the last five years, those markets have almost doubled. Retail investors have singularly failed to join in the market euphoria, which has, therefore been driven almost entirely by institutional investors. Although, many analyses show that the super rich have benefited considerably from this process, because they own the majority of privately owned assets, even these individuals have not been enthusiastic buyers of the market. In fact, their reluctance to commit large sums to the market is illustrated by the continued high level of bond prices, and more exceptionally by the example of BNY Mellon, which found demand, from large investors, to place money on deposit, in its vaults, so great that rather than paying interest on those deposits, it charged them for doing so! A similar example is to be seen with German Bunds, which on several occasions over the last few months have paid a negative rate of interest.

What we have is banks, that have been stuffed full of liquidity, when what they really needed was capital, using that liquidity, not to lend into the market, but attempting to repair their balance sheets and profitability, by investing into the safest financial assets – government bonds, currently backed by central banks. That pushes up bond prices, and pushes down bond yields. So every time, there is some kind of scare that leads to a suspicion that stock markets might fall, money floods into these bonds, as has been seen over the last few weeks.

However, although the banks have all of this liquidity, it is liquidity that has been provided to them in the form of cheap loans from central banks. That means central banks have vast amounts of fictitious capital on their own balance sheet, as the other side of these loans, as well as in the form of all the bonds they have themselves accrued as part of QE. The banks have liquidity, but they also have huge debts to repay to the central bank, that are currently only sustainable because of the low interest rates the central banks are charging them, and because their own balance sheets are flattered by the high valuations of assets in their possession. The banks are exposed to two related mortal dangers – a rise in official interest rates, which increases the cost of servicing their loans from the central bank, and a sharp drop in asset prices, which would decimate their balance sheets.

The banks do have high levels of deposits, despite near zero interest rates on deposits, made possible because the banks have no need to compensate savers, and encourage them to deposit money, when they can borrow for next to nothing from the central bank. The high level of deposits arises, because large corporations have lots of cash on their balance sheets, that has built up over the last thirty years, as a result of the rising rate and mass of profit. On a global basis, that is manifest in the glut of savings, from such corporations, as well as the savings from surplus economies like China.  In addition, even in the developed economies, sections of the population themselves have large amounts of savings, which they are desperate to preserve rather than risk in speculative activity buying over priced shares, bonds, or property.

For those institutions that do need to obtain some level of income, whilst maintaining a level of security of investments, like pension funds, this means that they have been increasingly forced to search for yield in increasingly risky assets, such as junk bonds. Demand for such bonds has risen considerably, pushing their prices higher, and their yields lower. The problem with these bonds, and the same thing applies to things such as property, or gold, is that they are not liquid. The market for shares not only runs into trillions of dollars, but every day there are billions of transactions, as large numbers of people buy and sell. If you want to sell even a large block of shares, its always possible to find buyers.

But, ask anyone trying to sell a house, in most of Britain today, and the picture is quite different. In many places, houses are up for sale in excess of a year, and for as long as two years before a buyer can be found. The consequence is that, when the number of sellers increases, even by a relatively small proportion, the lack of immediate buyers causes prices to fall sharply. That same fall itself causes others to panic and seek to sell themselves, at lower prices. There is a rush to an increasingly small door, all at the same time, that starts a firesale in which prices collapse. 

In such a period, as 2008 demonstrated, this has a contagious effect on all other assets, especially as those unable to sell, but who need liquidity, are forced to sell even those things that are not particularly over priced. When asset prices collapse, cash is king. During the 1930's when property prices collapsed, in parts of New York, mansions sold at 10% of their previous prices. Those who had sold their shares ahead of the collapse, were able to use the cash to buy up such properties. The legendary investor, Sir John Templeton, is noted for the fact that in the 1930's, when stock markets had collapsed, he bought 100 shares in every company listed on the NYSE, that was below $1 per share. That amounted to 104 companies. Within a matter of years, each of those 10,000 plus shares was worth many times the $1 he had paid for them.

In fact, as set out earlier, it is frequently in such periods of economic stagnation, particularly after a stock market crash, like 1929 or 1987, that share prices do rise sharply, because, during such periods, the rate of profit rises, but the investment of the realised profits in productive-capital remains sluggish. The consequence is that the surplus of loanable money-capital over its demand pushes interest rates lower. The money gets invested into fictitious capital, into shares and bonds, rather than into productive-capital, and so the process described earlier arises, of an increasing quantity of money chasing a limited supply of shares, pushing the share prices higher. That was what happened in the 1980's and 1990's, as the period of long wave downturn ran from around 1974 to 1999. Particularly, after 1987, the rate of profit rose, but economic activity and investment in productive-capital remained relatively sluggish. The excess of money-capital pushed down interest rates, and exacerbated by policies of money printing, following the crash of 1987, it fuelled the resultant bubbles in stock, bond and property prices.

The Spring phase of the long wave, that ran from around 1999 to 2012, has seen a continuation of the rising rate of profit, but coupled with the sharp rise in global economic activity, referred to at the start, it also saw a huge rise in the mass of surplus value, which exceeded even the increased demand for money-capital to finance additional productive-capital, which is why global interest rates continued to fall. As Marx describes, these two periods, when the rate of profit is rising (the period that Marx calls stagnation, and which is the Winter phase of the long wave, and the period that Marx terms prosperity, which is the Spring phase of the long wave) are the two periods when interest rates are falling. In the period that Marx terms the crisis stage, which is equal to the Autumn phase of the long wave (from 1974 – 1987, for example), interest rates are high, and may spike, because firms require money-capital at almost any cost to stay afloat. In the Summer phase (1962-74, for example), which corresponds to the period of boom in Marx's description, the demand for money-capital rises relative to its supply, pushing interest rates up to their normal level.

We are now in such a period, when the annual rate of profit is declining (not of course uniformly everywhere, or in a straight line), which is the basis of steadily rising global interest rates. Rising interest rates means falling share, bond and property prices. Any attempt to reduce interest rates by printing money will fail, and result only in rising inflation, and a sharp sell off in bonds, causing market rates to rise even more. 

However, today, although a large number of people are exposed, because they bought over priced houses during the last 15 years, the real threat, when those prices collapse, is not for their buyers, but for the banks who own all of the fictitious capital, in the form of mortgages for that property. That is why every attempt has been made to delay that collapse in prices. At the same time, large numbers of people frightened by the experience of 2000 and 2008, have refrained from also buying over priced shares and bonds, preferring to at least keep their money safe, as simple deposits, even if it means accepting near zero levels of interest. Those who have these large quantities of liquidity are well placed to pick up these assets when their prices collapse, and this time the losers will be the banks and financial institutions, along with the super rich, left holding increasingly worthless paper.

That is why the state has done all it can to defer that financial panic, even if the cost has been to damage the real economy. But, they have merely, in the process, exacerbated the contradictions, and made a bigger collapse all the more inevitable. It is not a question of if another 2008 occurs, but only of when.

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