Saturday, 10 January 2015

Oil Prices. Good For the Economy, Terrible For Financial Markets - Part 5

In Part 4, it was indicated how the high oil prices that developed during the Spring phase of the long wave, as rapid global economic growth caused oil demand to rise faster than oil supply, resulted in large surplus profits, and rents. Those rents were then used to buy up financial assets, thereby increasing the price of bonds, shares and property without necessarily contributing anything to the accumulation of real productive-capital, and so increasing the potential for the production of additional surplus value. The consequence must be that asset prices increase faster than the rise in surplus value, causing a squeeze on yields/interest rates.

The following three tables explain the theory behind this. Table 1, shows the production of surplus value. Table 2, shows the distribution of the surplus value, broken down into rent, dividends paid out to money-capitalists (for simplicity its assumed that all money-capital is provided via an initial purchase of 5000 shares with a nominal value of £1 each), an initial £250 of profit of enterprise which covers the unproductive-consumption of functioning capitalists, and rises by 2% per year, leaving a residual element available for accumulation. This amount of accumulation is shown itself in Table 1, and indicated by the increase in the constant and variable capital, each year. It is assumed that the organic composition of capital remains constant. Finally, Table 3 shows the effect of the rent and dividends being used to create additional demand for the existing shares.

Table 1.

Value Production
Constant Capital Variable Capital Surplus Value
4000.00 1000.00 1000.00
4100.00 1025.00 1025.00
4203.50 1050.88 1050.88
4310.68 1077.67 1077.67
4421.74 1105.44 1105.44
4536.89 1134.22 1134.22
4656.34 1164.08 1164.08
4780.33 1195.08 1195.08
4909.12 1227.28 1227.28
5042.97 1260.74 1260.74
5182.17 1295.54 1295.54
5327.04 1331.76 1331.76
5477.89 1369.47 1369.47
5635.08 1408.77 1408.77
5798.99 1449.75 1449.75
5970.02 1492.51 1492.51
6148.60 1537.15 1537.15
6335.19 1583.80 1583.80
6530.28 1632.57 1632.57
6734.40 1683.60 1683.60

The total capital rises from £5,000 to £8,400, and the surplus value p.a. rises from £1,000 to £1,680. This reflects the fact that not all surplus value is accumulated. As Marx says, in Capital II, although capitalism is characterised by expanded reproduction, central to it remains remains simple reproduction. Here, its assumed that all the rent, and all the dividends are consumed unproductively. As Engels points out, where this money is used to buy bonds, or shares it has the effect of increasing the demand for this fictitious capital, and thereby increasing the price. But, the money paid out still finds its way into the purchase of commodities.

Suppose A owns £1,000 of shares, which they bought at this price. B has £2,000 of money available to spend. They might use this money to buy commodities for their own consumption. On the other hand, along with others in a similar situation, they may decide to bid for A's shares. As a consequence of this bidding process, which reflects an increased monetary demand for those shares, their price rises from £1,000 to £2,000. A sells the shares to B, for £2,000, putting the proceeds in the bank. The result is that the fictitious capital, the “value” of shares has doubled. But, A now has £2,000 in money, instead of B. A can now use this money to buy commodities. Indeed, for simple reproduction to proceed the money must at some point be used to buy commodities for consumption, or else there will result an overproduction of commodities, the surplus value contained in the total commodity-capital, will not be realised.

Table 2.

Value Distribution

Rent Dividends Profit of Enterprise Accumulation
250.00 375.00 250.00 125.00
256.25 384.38 255.00 129.38
262.72 394.08 260.10 133.98
269.42 404.13 265.30 138.82
276.36 414.54 270.61 143.93
283.56 425.33 276.02 149.31
291.02 436.53 281.54 154.99
298.77 448.16 287.17 160.98
306.82 460.23 292.91 167.31
315.19 472.78 298.77 174.01
323.89 485.83 304.75 181.08
332.94 499.41 310.84 188.57
342.37 513.55 317.06 196.49
352.19 528.29 323.40 204.89
362.44 543.66 329.87 213.79
373.13 559.69 336.47 223.22
384.29 576.43 343.20 233.23
395.95 593.92 350.06 243.86
408.14 612.21 357.06 255.15
420.90 631.35 364.20 267.15

Table 2 shows that as the total capital rises, with accumulation, so the amount of rent increases. The rate of rent – the ratio of rent to capital employed, remains constant at 5%. Similarly, the rate of interest is held constant at 7.5%, so that dividends increase proportionate to the rise in the value of the productive-capital, advanced, as accumulation proceeds. As Marx sets out in Capital III, as private capitalists are increasingly separated from the social function of management, so they become essentially merely money-lending capitalists, receiving interest in the form of dividends on the money-capital they provide for the purchase of productive-capital. The profit of enterprise is then a special form of wages paid to the functioning capitalists, i.e. managers. As with any other form of wages, its assumed that it is consumed unproductively. This leaves an amount of surplus value that can be accumulated. This amount is shown as accumulated each year in Table 1, being apportioned in a 4:1 ratio between constant and variable capital.

Table 3.

Share Prices

Number of Shares Demand Price Earnings Per Share Price/Earnings Yield
5000.00 5000.00 1.00 0.20 5.00 0.075
5000.00 5625.00 1.13 0.21 5.49 0.068
5000.00 6265.63 1.25 0.21 5.96 0.063
5000.00 6922.42 1.38 0.22 6.42 0.058
5000.00 7595.97 1.52 0.22 6.87 0.055
5000.00 8286.86 1.66 0.23 7.31 0.051
5000.00 8995.75 1.80 0.23 7.73 0.049
5000.00 9723.30 1.94 0.24 8.14 0.046
5000.00 10470.23 2.09 0.25 8.53 0.044
5000.00 11237.28 2.25 0.25 8.91 0.042
5000.00 12025.24 2.41 0.26 9.28 0.040
5000.00 12834.96 2.57 0.27 9.64 0.039
5000.00 13667.31 2.73 0.27 9.98 0.038
5000.00 14523.23 2.90 0.28 10.31 0.036
5000.00 15403.71 3.08 0.29 10.63 0.035
5000.00 16309.80 3.26 0.30 10.93 0.034
5000.00 17242.62 3.45 0.31 11.22 0.033
5000.00 18203.34 3.64 0.32 11.49 0.033
5000.00 19193.21 3.84 0.33 11.76 0.032
5000.00 20213.57 4.04 0.34 12.01 0.031

Table 3, shows that with accumulation of productive-capital funded internally from produced surplus value, there is no need to issue additional shares to raise money-capital. The number of shares in issue, therefore, remains at 5,000. However, the demand for these shares rises each year, as additional rent and dividends are amassed, and enter the money market in search for these shares. Its assumed that the price of the shares rises proportionate to the rise in monetary demand for them.

On this basis, the share price rises from £1 to £4, which is clearly much greater than the rise in surplus value over the same period – a 400% rise as opposed to a 70% rise. This 70% rise in surplus value is reflected in the 70% rise in the earnings per share figure from £0.20 to £0.34. Given that the price of the shares rises proportionately more than the rise in earnings per share, this necessarily results in the more than doubling of the price/earnings ratio from 5 to 12.01. Similarly, although the dividend per share continuously rises, given a constant rate of interest and a rising mass of capital, the dividend yield more than halves, because the price per share rises faster than the dividends per share. 

On this basis, yields and interest rates in general are squeezed. The process here is set out in relation to increased rent and dividends in respect of oil, but the same process could be applied to other primary products, and indeed to any other commodity in conditions where the production of surplus value runs ahead of the accumulation of productive-capital. That situation is typical of the Spring phase of the long wave cycle, and as Marx points out this causes interest rates to be low during what he calls the prosperity phase.

“After the reproduction process has again reached that state of prosperity which precedes that of over-exertion, commercial credit becomes very much extended; this forms, indeed, the "sound" basis again for a ready flow of returns and extended production. In this state the rate of interest is still low, although it rises above its minimum. This is, in fact, the only time that it can be said a low rate of interest, and consequently a relative abundance of loanable capital, coincides with a real expansion of industrial capital. The ready flow and regularity of the returns, linked with extensive commercial credit, ensures the supply of loan capital in spite of the increased demand for it, and prevents the level of the rate of interest from rising.”

(Capital III, Chapter 30)

It is this situation that breeds speculation, and a search for yield, such as is seen in the purchase of junk bonds. Moreover, as the rapidly rising prices of shares and bonds, creates instant fortunes out of thin air, so the desire to speculate in the hope of such capital gains, as opposed to investment for dividend yield takes over, so that the demand for this fictitious capital becomes ever more driven by such speculation than any hope of yield. The fall in yields, therefore, becomes no deterrent to further speculation.

“It breeds over-production, speculation, crises, and surplus-capital alongside surplus-population.”

Capital III, Chapter 15

This was the condition seen in the financial crisis of 2008. Marx and Engels describe, an almost identical situation of high rates and volumes of profits, that result in a surfeit of loanable money-capital, causing interest rates to fall, even amid high levels of productive investment, in respect of the financial crisis of 1847.

“But all the newly erected factory buildings, steam-engines, and spinning and weaving machines did not suffice to absorb the surplus-value pouring in from Lancashire. With the same zeal as was shown in expanding production, people engaged in building railways. The thirst for speculation of manufacturers and merchants at first found gratification in this field, and as early as in the summer of 1844, stock was fully underwritten, i.e., so far as there was money to cover the initial payments. As for the rest, time would show! But when further payments were due — Question 1059, C. D. 1848/57, indicates that the capital invested in railways in 1846-47 amounted to £75 million — recourse had to be taken to credit, and in most cases the basic enterprises of the firm had also to bleed.”

(Capital III, Chapter 25)

The examples above also indicate why the bourgeois economists faith in the ability to reduce interest rates by printing money is misplaced.  An increased supply of money tokens, only acts to devalue the value of each token.  In so doing it merely acts to multiply all of the prices above by the same factor.  But, for that reason the dividend yield, and every other ratio of one price to another remains unchanged.  As Marx demonstrates, the rate of interest can only change as a consequence of changes in the demand for and supply of loanable money-capital.  I will explain this further in Part 6, and its consequence for financial markets, and what this has to do with the current sell off in global equity markets.

No comments: