Saturday, 27 December 2014

Oil Prices. Good For The Economy, Terrible For Financial Markets - Part 3

As Marx sets out in Capital III, in looking at the way interest arises as a deduction from surplus value, even where a productive-capitalist uses their own money-capital, rather than borrowing loanable money-capital, they come to see the interest as something different from the profit derived from productive activity. Interest is seen as some inherent quality belonging to capital, whereas profit is increasingly seen as merely a specific form of wages paid to the entrepreneur for engaging in such activity. That is particularly the case, Marx says, where professional managers take the place of individual private capitalists.

If £1 million of money-capital is borrowed by an entrepreneur, to buy productive-capital, and the rate of interest is 10%, the entrepreneur, the productive-capitalist, will expect to pay £100,000 in interest for its use. (This is true whether the loan is in the form of a bank loan, a bond, or the issue of shares to shareholders, although in the last case, the manager may decide to defer the payment of dividends, for so long as shareholders will allow it) But, by the same token, a productive-capitalist who uses £1 million of their own money-capital, will make the same calculation. They will see £100,000 of their profit as arising not from their productive-activity, but simply as £100,000 of interest on the capital they have loaned to the business. This is no different to the situation of the capitalist farmer who owns the land they farm, and thereby pays to themselves the rent that otherwise would have gone to the landlord.

But, however much the productive-capitalists, in these situations, see themselves as in no different a situation to that of the productive-capitalist who relies on borrowing loanable money-capital, it is quite clear that, in practice, they are in a different situation. When surplus profits, which are the basis of rent, disappear, the landlord will still expect to be paid rent, even if this means the productive capitalist makes losses rather than profits. When the profit of the productive-capitalist falls or disappears, the money-capitalist will still expect to be paid the interest on the loan, as well as to have their capital sum repaid to them. The productive-capitalist who owns the land they work, can simply defer the rent they would have paid to themselves, and the productive-capitalist, who sets up in businesses using their own money-capital, can likewise defer the interest they would have paid to themselves. This is why small peasants or share-croppers, who own the land they work, or small private capitalists, can continue, for a long time, making little or no profits, and even eating into their own wages, and the wages of their workers.

The rent that must be paid to the landlord, or the interest to the money-capitalist, is not the equivalent of an amount of value provided by the owners of those commodities, a value, which would then contribute to the value of the end product. Land is not the product of labour, and so has no value. Loanable money-capital is not really capital, but only fictitious capital. What the money-capitalist sells as a commodity, is the use value of capital as self-expanding value. So, neither the rent nor the interest are the equivalents of additional value acquired by the productive-capitalist. As Marx points out, they are then just costs that must be incurred, and a deduction from their surplus value.

“Of course the land and capital borrowed by the industrial capitalists from the idle capitalists and for which they have to pay a portion of their surplus-value in the form of ground-rent, interest, etc., are profitable for them, for this constitutes one of the conditions of production of commodities in general and of that portion of the product which constitutes surplus-product or in which surplus-value is represented. This profit accrues from the use of the borrowed land and capital, not from the price paid for them. This price rather constitutes a deduction from it. Otherwise one would have to contend that the industrial capitalists would not get richer but poorer, if they were able to keep the other half of their surplus-value for themselves instead of having to give it away. This is the confusion which results from mixing up such phenomena of circulation as a reflux of money with the distribution of the product, which is merely promoted by these phenomena of circulation.”

(Capital II, Chapter 20, p 490)

Where a business has been established on the basis of borrowed capital, the lender will want to be paid their interest, and to ensure that their principal sum is repaid to them. A small oil company that has borrowed money to invest in exploration, and the development of wells in deep sea oil production, can only make its interest payments, and the repayments of principal, if oil prices are high enough to cover them from its profits. If the profits are not sufficient, the company must, sooner or later, become insolvent, because, after making those payments, to the bank or bond holders, it does not have sufficient circulating capital, to cover the payment of wages, and for the purchase of auxiliary materials, to cover the costs of maintenance and repair and so on.

The bank or bondholders, under those conditions, will seek to foreclose on the loan, and rescue as much of the situation as it can. It will seek to sell off the business, and its capital, to some other buyer, so as at least to obtain the return of its principal. But, under conditions where a number of such liquidations are occurring, and where the potential for making profits, from such capital, have been significantly reduced, as the price of oil has fallen, the money-capitalist will be forced to sell at prices often well below the original value of the capital. In fact, much of the capital-value will be irretrievable. The fixed capital itself may have some residual value, but the capital sunk into the costs of exploration, or the sinking of test wells, does not reside in any physical form. It has been completely sunk.

This is a similar situation to a bank that has loaned money for the purchase of a house. The house buyer may also have borrowed money to cover the installation of luxury fixtures and fittings, but in the event of forced sales, where an increasing number of borrowers are forced to sell, they have no possibility of recovering the value of either the house or the fixtures and fittings, and the bank will also have lost most of the money it loaned for their purchase. It is usually the case that the market price of such properties is even lower than the current cost of building an equivalent house. That is because the seller is forced to sell at whatever price they can obtain, whereas the builder of an equivalent house is not, in the same way, forced to build at such a reduced price. It is only when the effect of these forced sales, across the market, begins to take hold, and causes non-forced sellers to reduce their prices so as to compete, when others, seeing prices falling rapidly, decide to sell before they become forced sellers themselves, and so on, that market prices, in general, begin to crash, and have a consequent effect on land prices, and the prices of new production.

Very large oil companies – and the same applies for other primary produces – are, ironically, in a similar position to the individual private capitalist, in the sense that they can often finance their purchase of fixed capital, and their exploration costs from internally generated funds. To the extent they borrow, it is often on the back of their huge balance sheet, which enables them to issue bonds at very low interest rates, at the most advantageous times, including to use that borrowing to pay off older, more expensive loans, or to buy back shares.

This difference between those capitals that are dependent on borrowed money-capital, and those that operate on the basis of their own capital, is significant, under conditions where profits are falling and capital is being liquidated. In turn, this effect has consequences for future values, profits and the rate of profit, which I will look at next.

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