Thursday, 9 October 2014

The Arrival Of The Gold Ship

Anyone who doubts that the stock, bond and property markets – and the same is true for markets in things such as art, diamonds, wine or any other commodity, where speculators believe prices may rise, and capital gains be made – are being driven by liquidity, should have had those doubts removed by the action, in markets, over the last week or so. With crises in Ukraine, the potential for a global Ebola pandemic, a vicious, medieval force taking over large areas of Iraq and Syria, and moving into Libya, and other parts of North Africa, the markets have ignored all of these threats, and simply focussed on interpreting the words of members of the Federal Reserve Open Market Committee, which sets US monetary policy. Whenever its looked like official interest rates might rise, at some point, markets have fallen sharply; a word here that could be interpreted as looser policy for longer; a piece of weak economic data that might mean central banks hold off monetary tightening for another few weeks, see markets rocket back up again, as they did yesterday.

But, there is nothing actually new in any of this. Before the Californian and Australian gold rushes, of the 19th century, gold production was more or less just adequate to ensure the replacement of worn out coins, and for the production of luxury articles. Silver was used to cover trade with Asia, which expanded in the 19th century, both from Europe and from the Pacific coast of the US. That silver was largely replaced, as these additional supplies of gold became available.

Some of the additional gold was also absorbed into the domestic currency circulation. Marx quotes the testimony of William Newmarch, and it is surprisingly similar to the kind of thing seen, today, in financial markets, that have come to rely on the latest injection of additional liquidity, from central banks.

“"1509. At the close of 1853, there was a considerable apprehension in the public mind, and in September of that year the Bank of England raised its discount on three occasions... In the early part of October there was a considerable degree of apprehension and alarm in the public mind. That apprehension and alarm was relieved to a very great extent before the end of November, and was almost wholly removed, in consequence of the arrival of nearly £5,000,000 of treasure from Australia... The same thing happened in the autumn of 1854, by the arrival in the months of October and November of nearly £6,000,000 of treasure. The same thing happened again in the autumn of 1855, which we know was a period of excitement and alarm, by the arrivals, in the three months of September, October and November, of nearly £8,000,000 of treasure; and then at the close of last year, 1856, we find exactly the same occurrence. In truth, I might appeal to the observation almost of any member of the Committee, whether the natural and complete solvent to which we have got into the habit of looking for any financial pressure, is not the arrival of a gold ship" [B. A. 1857].” (Capital III, Chapter 35, Note 14, p 566)

The situation was in part due to the 1844 Bank Act. The Act was a particularly bonkers piece of legislation, introduced by Robert Peel, on the urging of bankers, such as Lord Overstone, Governor of the Bank of England. It tied the amount of money in circulation to the amount of gold held in reserves, irrespective of the economy's requirements for currency. So, when a credit crunch arose, in 1847 and 1857, it was exacerbated by the act, which drove up interest rates. On both occasions, the act had to be suspended, which quickly resulted in the financial crisis, it had created, being resolved, as the necessary liquidity was put into the system.

“It should be noted in regard to the accumulation of notes in times of stringency, that it is a repetition of the hoarding of precious metal as used to take place in troubled times in the most primitive conditions of society. The Act of 1844 is interesting in its operation because it seeks to transform all precious metal existing in the country into a circulating medium; it seeks to equate a drain of gold with a contraction of the circulating medium and a return flow of gold with an expansion of the circulating medium. As a result, the experiment proved the contrary to be the case.” (Capital III, p 565)

On the one hand, for most of the period, after the act was passed, less notes were issued than were allowed. On the other when the crisis required additional liquidity, the maximum allowed was not enough.

In 2008, when a financial crisis, like those of 1847 and 1857, arose, leading to a credit crunch, and a consequent impact on real economic activity, the financial crisis was again brought to an end by increasing liquidity into the system, and also where fiscal stimulus was used, such as the US, or even just an avoidance of measures of fiscal austerity, economic activity itself sharply rebounded, in a typical “V” shape.

But, it is a sign of intellectual inertia that, having rejected Keynesian intervention, for more than thirty years, in favour of Monetarist intervention, as a means of stimulating economic activity, seeing that response, the state has continued to believe that this set of tools could continue to work. In the 1970's, a similar thing happened. Because of the conjuncture of the long wave cycle, at that point, Keynesian intervention could no longer work. The problem was no longer short term cyclical dislocations that could be addressed by stimulating aggregate demand, to fill the gap until investment spending resumed.

The problem was that existing lines of production had been expanded to a point where any additional investment of capital within them, threatened to reduce market prices to below costs of production, i.e. to make each unit of production unprofitable, as well as to push up wages, thereby reducing the rate of surplus value. In other words, the basic conditions that arise, near the top of a boom, that lead to crises of overproduction, as described by Marx in Capital III, Chapter 15. But, unlike the earlier phases of such a period of long wave boom, where new lines of production are developed, that can absorb such excess capital, and which have high rates of profit, and low elasticity of demand, the peak of the boom is characterised by an absence of such industries.

Under such conditions, Keynesian pumping up of aggregate demand, therefore, just led to firms raising prices rather than investing, and workers demanding higher wages to pay those higher prices, which then led to inflation, as monetary authorities accommodated those demands. But, it took some time, before the intellectual inertia was overcome, and the state authorities (including those ideological arms of the state in the universities and media etc) realised that the Keynesian drugs were no longer working.

But, its also clear that the monetary drugs don't work either. In the late 1980's and 90's, Friedmanite monetary stimulus worked to boost economic activity, because it came at a time when an unusual number of people had accumulated assets, after WWII. For the first time, large numbers of workers owned houses, some owned shares, or bonds, and other investments. All of this fictitious capital could be used by these workers, as collateral against which to borrow. And, monetary stimulus encouraged them to borrow to excess – this also has the advantage for capital, that, ultimately, this borrowing is a means of depriving those workers of those assets they had put up as collateral against it. The same thing happened to French peasants, after the French Revolution, who were encouraged to put up their, recently acquired, property as collateral against mortgages, which subsequently ruined them. It thereby undermines the degree of independence that workers might have had, and makes them more dependent on retaining employment.

Monetary stimulus worked, only by stealing demand from the future, because debts have to be repaid with interest, and, if consumers are repaying that debt and interest, that is money they are not using for the purchase of additional commodities. An increase in liquidity was the necessary measure to take to address the credit crunch of 2008, but it could not be a means of stimulating economic activity, because, by that time, workers had already become massively over leveraged, and the outbreak of the financial crisis was a manifestation of it. They had leveraged to higher and higher levels, which had pushed up the prices of property, shares and bonds, which gave a false picture then of just how indebted they had become, because the debt was set against grotesquely over priced assets. But, as has happened on every such occasion in the past, the debt remains to be repaid, whilst the price of the asset sooner or later crashes – usually by huge amounts. The debtors are ruined, and to the extent they have only recourse to bankruptcy, they take down those lenders that had lent too much, and had inadequate capital – which given the level of debts built up over the last 30 years, on the back of this fictitious capital, is pretty much every bank in the world.

Despite increasing amounts of liquidity being pumped into the economy, it has had no effect on stimulating economic activity, particularly where it has been overridden by measures of fiscal austerity. It has even required bigger and bigger quantities of liquidity to be introduced, just to prevent bubbles bursting, or to reflate them when they begin to deflate. After 2008, the continuation of liquidity injections has not been for the purpose of stimulating economic activity, but only to give the banks a longer breathing space, before they collapse, under a mountain of bad debt. Instead of stimulating economic activity, it merely acts to goose financial markets. That is why those markets are unconcerned with Ukraine, Ebola, ISIS or any other real world event, but hang on every syllable issued by Fed, B of E, and ECB officials.

The representatives of capital are intellectually bankrupt, which is why they went into such a panic and period of despond in 2008. They can only repeat the message to keep the monetary taps open, even though that is a call to repeat the measures that created the 2008 crisis in the first place. They are hanging on the hope that Mario Draghi will pick up the baton from Ben Bernanke and Mervyn King in that regard. They are like those described, by William Newmarch, at the beginning, who, rather than looking to real economic activity as the basis of wealth creation, look to simply the arrival of the next gold ship.

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