Monday, 26 January 2015

Fictitious Capital - Part 7

The basis of fictitious capital is the fact that capital itself becomes a commodity in the form of loanable money-capital (though as Marx points out this includes the loan of other forms of capital; it is the money equivalent of that capital value, that is the basis, however, of the calculation of interest). This loanable money-capital thereby gives rise to a claim on future income, in the form of interest. But, interest is a deduction from surplus value created by real capital. Interest is not a self-expansion of value, although the fact that loanable money-capital is only loaned if it produces interest, gives that impression. This claim to a share of future income takes the shape of various forms of legal document – loan certificates, bonds, shares, etc. These certificates then appear as though they are capital, but they are only fictitious capital.

These certificates themselves can be traded, and their market price moves up and down in accordance with supply and demand from speculators. Because each of these forms of certificate provide for a given amount of interest, which may be fixed or variable, movements of the price of the certificates affects the yield obtained by the owner. For example, a £1,000 bond that pays a £50 p.a. coupon, has a yield of 5%, if the bond is traded at its face value. If demand for these bonds rises, pushing their price up to £2,000, it still only pays a £50 p.a. coupon, which means that the yield, the relation between the amount of interest and the price of the bond, falls to 2.5%.

Shares pay a variable amount of interest in the form of dividends, which is dependent upon the profits made by the company, and the decisions of the company management, of what portion of those profits to pay out to shareholders, rather than to retain for investment etc. However, the same principle applies. For any given amount of profits, set aside for dividends, the yield on each share will fall, as the price of the shares rise, and vice versa.

As described earlier, a whole range of derivative products can then be created and traded, based upon the buying and selling of these certificates. In turn these derivative products, can then be traded as commodities, and their price can move up or down, with similar effect. In addition, each of these different kinds of fictitious capital can be used as though they represented real wealth, and can thereby be used as collateral for the purpose of borrowing, or in the case of banks that hold this fictitious capital, can be used as bank capital as a basis for additional lending, which in turn creates further fictitious capital.

Because all of these different forms of fictitious capital can be traded in this way, their price can move up or down completely separated from any changes in the accumulation of real capital, or in the mass and rate of profit. In fact, stock markets frequently rise more during periods of long wave economic downturn than they do during periods of long wave boom. That is because, during the former periods, the rate of profit rises, whilst accumulation of productive-capital, and the issuing of additional bonds and shares to finance it proceeds only slowly.

More precisely, during the Winter phase of the long wave, or the period that Marx describes as the period of stagnation, the rate of profit rises, as wages are pushed down, causing the rate of surplus value and so profit to rise.  The value of constant capital, and the price of raw materials falls during this period, thereby also causing the organic composition of capital to fall, and the rate of profit to rise.  This was seen in the period from around 1987-1999, for example, and forms part of the basis for the new expansion of capital.

In the Spring phase of the cycle, the rate of profit continues to rise, and is accompanied by a strong rise in the mass of profit, as economic activity expands more quickly. Reserves of labour-power are employed, and new reserves are created, by expansion into new geographic areas, along with the continued creation of a relative reserve, as the benefits of the previous innovation cycle, cause productivity to rise.  This is the situation seen from around 1999 to 2012.

In the Summer phase of the cycle, growth continues to be strong, but existing supplies of labour-power begin to be used up, and the advantages of rising productivity to create an additional relative reserve begin to falter, as well as having a reduced effect on reducing unit production costs, to counter rising material prices.  Wages are then pushed up, reducing the rate of surplus value, and squeezing profit margins and the rate of profit.  Any sharp rise in material prices, can no longer be so easily absorbed, squeezing profits further.  It has the effect also of requiring that a greater proportion of profits are devoted to capital accumulation and less is available as loanable money-capital pushing interest rates higher.  It is the situation Marx describes in Chapter 6 and 15 of Capital III.  This situation could be seen, for example, in the Summer phase of the post war long wave cycle, from around 1961-74, and is also described by Glyn and Sutcliffe in "Workers and the Profits Squeeze".

In the Autumn phase, or crisis phase as Marx describes it, these conditions of rising wages, as the supply of labour-power begins to run out, reaches a peak.  Profits are squeezed by a combination of rising wages, stagnant  productivity and an inability to pass on rising costs, as higher levels of consumption lead to higher levels of price elasticity of demand.  Tight profit margins mean that any shock more easily leads to market prices falling below costs of production.  It causes capital to seek a solution to these crises of overproduction by, as Marx puts it, a resort to the Law of The Tendency For the Rate of Profit to Fall

“The methods by which it accomplishes this include the fall of the rate of profit, depreciation of existing capital, and development of the productive forces of labour at the expense of already created productive forces.”

(Capital III, Chapter 15)

That is, in order to overcome the constraint on accumulation imposed by higher wages, caused by a shortage of exploitable labour-power, it is incentivised to innovate and to introduce labour-saving technology, which raises the organic composition of capital, and thereby lowers the rate of profit.  It introduces other technologies that cheapen both fixed and circulating constant capital.  These measures weaken the position of labour.  It could be seen in the latter part of the period between 1974-87, and which resulted in the defeat of the miners in Britain, the introduction of new print technology, which undermined the print unions and so on.

This creates the conditions for the rate of surplus value and rate of profit to rise in the Winter phase of the cycle, as set out above, which in turn creates the basis for the new boom.

Speculators are concerned with the total return on the loanable money-capital they advance. A low yield may, therefore, be no discouragement, if the potential exists to make large, quick capital gains. Loanable money-capital may, therefore, be advanced for such speculation rather than to finance the accumulation of real productive-capital. Moreover, this may be the case even where the profits to be made from productive investment itself is high and rising. As Marx and Engels describe, in Capital III, after 1843, a powerful economic boom commenced, which saw large profits being made. The profits financed large scale investment in productive-capital, the opening of new factories, purchase of new machines and so on. Yet, at the same time, the stock market craze of the time, The Railway Mania, saw large scale speculation in railways shares, whose prices rose sharply. This led many businesses then to bleed their working-capital, and to use available money-capital from the large profits, to speculate in railway shares.

This speculation in fictitious capital does nothing to facilitate the accumulation of real productive-capital. On the contrary, for the reason presented above, it can act to limit such accumulation. If there are 1 million shares in issue on a stock market, with an average price of £1, and the total amount of profits available for distribution as dividends is £100,000, the average dividend yield will be 10%. If, additional loanable money-capital enters the market, so that the demand for these 1 million shares rises, the average price per share may rise to £2. But, the additional loanable capital that has entered the market, has not, thereby bought one additional machine or other piece of productive-capital. It has created no accumulation of real capital, and thereby no potential for additional profit.

We now have a situation where the amount of profits available for distribution as dividends is still £100,000, but the price of shares is now on average £2, so the average yield falls to 5%. The speculators will be undeterred that they have seen the yield halve, because the actual amount paid to them as dividends remains the same, £100,000, whilst they have made a capital gain of £1 million due to the rise in the share price! This same principle applies to bonds, and other forms of fictitious capital. It is why, as stock, bond and property markets were massively inflated from the late 1980's onwards, despite rising masses and rates of profit, yields continually declined as the prices rose faster than the mass of profit. It is one factor that made it impossible to finance pension schemes, and why annuity rates collapsed.

Yet, for the speculator, the fall in yield is not significant compared with the potential for quick capital gains. Even an historically high yield of 10%, is nothing compared to the kinds of gains of 20, 30 and even 70% in capital gains that have frequently been made in the period after the late 1980's. In the last three years, for example, the S&P 500 has trebled!  Between 1980 and 2000, the Dow Jones 30 Index rose by 1300%! For the professional managers who run companies, this is also true. It becomes rational to use available profits not to invest in the business, in real productive-capital, that might return 20-30% p.a. in profits, but has to be invested on a ten year time horizon, with all the risks entailed with that, but to invest in the shares of some other company, which might rise by 30% or more in the year, or indeed, to simply use the profits to buy back the companies own shares, which thereby causes their price to rise – as the supply is reduced – and ensures that future years' profits appear as a higher earnings per share. Indeed, with low interest rates, it becomes rational to borrow money not for the purpose of productive investment, but solely for the purpose of buying back stock. 

The inflation of this fictitious capital then can occur completely removed from the accumulation of real productive-capital and profits, and indeed can be a limitation upon it, because productive investment can be crowded out by speculation. But, for that reason, collapses in these financial markets, in the prices of this fictitious capital, should not be confused with economic crises, although the former can lead to the latter.

“The monetary crisis referred to in the text, being a phase of every crisis, must be clearly distinguished from that particular form of crisis, which also is called a monetary crisis, but which may be produced by itself as an independent phenomenon in such a way as to react only indirectly on industry and commerce. The pivot of these crises is to be found in moneyed capital, and their sphere of direct action is therefore the sphere of that capital, viz., banking, the stock exchange, and finance.” 

(Capital I, Chapter 3, note 1 p 137)

But, for the same reason, a collapse of this fictitious capital can be cathartic for real productive-capital, and facilitate its accumulation.

“As regards the fall in the purely nominal capital, State bonds, shares etc.—in so far as it does not lead to the bankruptcy of the state or of the share company, or to the complete stoppage of reproduction through undermining the credit of the industrial capitalists who hold such securities—it amounts only to the transfer of wealth from one hand to another and will, on the whole, act favourably upon reproduction, since the parvenus into whose hands these stocks or shares fall cheaply, are mostly more enterprising than their former owners.”

(Theories Of Surplus Value, Part 2, p 496)

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