Sunday, 18 January 2015

Oil Prices, Good For the Economy, Terrible For Financial Markets - Part 6

At the end of Part 5 it was indicated that the three tables show why the belief of bourgeois economists, that interest rates can be lowered, by central banks printing money, via QE, is misplaced. As Marx demonstrates in Capital I, Chapter 3, money is the universal equivalent form of value. Put in other terms, we might think of “The Metre” as the universal equivalent form of length. Rather than measuring the length of objects in terms of multiples of other objects, we have chosen one object, a metre standard, as the means of measuring all objects, and thereby making useful comparisons.

For example, we might measure the length of a swimming pool as being equal to the length of 10 tables, or 4 cars and so on. But, this is not a very useful way of measuring, and not only because the length of tables, and cars also differs. It is inconvenient for the same reason that it is inconvenient to measure the amount of value of a table, as equivalent to that of a certain number of chairs, or coats. That is it is easier to have one single unit of measure against which everything else can be equated. But, as Marx describes, in “A Contribution To The Critique of Political Economy”, this particular measure does not remain constant, in the way that a metre does. In so far as money exists in the physical form of a money commodity, such as gold, its value moves up and down, dependent upon changes in productivity that enable more or less gold to be produced in a given quantity of labour-time. But, when the money commodity is replaced, in circulation, by money tokens, be they tokens made of that same precious metal, tokens made of more base metal, or tokens made only of paper, or even consisting only of binary digits within a computer programme, the value of these tokens itself moves up or down in response to whether more of these tokens has been put into circulation than is warranted by the value of money they are intended to represent.

“The token of value, say a piece of paper, which functions as a coin, represents the quantity of gold indicated by the name of the coin, and is thus a token of gold. A definite quantity of gold as such does not express a value relation, nor does the token which takes its place. The gold token represents value in so far as a definite quantity of gold, because it is materialised labour-time, possesses a definite value. But the amount of value which the token represents depends in each case upon the value of the quantity of gold represented by it...

Worthless tokens become tokens of value only when they represent gold within the process of circulation, and they can represent it only to the amount of gold which would circulate as coin, an amount which depends on the value of gold if the exchange-value of the commodities and the velocity of their metamorphoses are given...

If the value of gold decreased or increased because the labour-time required for its production had fallen or risen then the number of pound notes in circulation would increase or decrease in inverse ratio to the change in the value of gold, provided the exchange-value of the same mass of commodities remained unchanged...

The number of pieces of paper is thus determined by the quantity of gold currency which they represent in circulation, and as they are tokens of value only in so far as they take the place of gold currency, their value is simply determined by their quantity. Whereas, therefore, the quantity of gold in circulation depends on the prices of commodities, the value of the paper in circulation, on the other hand, depends solely on its own quantity. 

Apart from their function they are useless scraps of paper. But this power of the State is mere illusion. It may throw any number of paper notes of any denomination into circulation but its control ceases with this mechanical act. As soon as the token of value or paper money enters the sphere of circulation it is subject to the inherent laws of this sphere...

Let us assume that £14 million is the amount of gold required for the circulation of commodities and that the State throws 210 million notes each called £1 into circulation: these 210 million would then stand for a total of gold worth £14 million. The effect would be the same as if the notes issued by the State were to represent a metal whose value was one-fifteenth that of gold or that each note was intended to represent one-fifteenth of the previous weight of gold. This would have changed nothing but the nomenclature of the standard of prices, which is of course purely conventional, quite irrespective of whether it was brought about directly by a change in the monetary standard or indirectly by an increase in the number of paper notes issued in accordance with a new lower standard. As the name pound sterling would now indicate one-fifteenth of the previous quantity of gold, all commodity-prices would be fifteen times higher and 210 million pound notes would now be indeed just as necessary as 14 million had previously been. The decrease in the quantity of gold which each individual token of value represented would be proportional to the increased aggregate value of these tokens. The rise of prices would be merely a reaction of the process of circulation, which forcibly placed the tokens of value on a par with the quantity of gold which they are supposed to replace in the sphere of circulation.”

(Marx – A Contribution To The Critique of Political Economy)

In other words, all this change in the quantity of money tokens – be they paper notes, cheques, or credit money – in circulation, effects is to change the value of those tokens, and thereby to bring about a change in nominal price levels – inflation. Its clear that, on this basis, none of the proportional relations can be changed. If I measure a swimming pool with a a metre rule, and find it to be 25 metres long, and measure a football pitch and find it to be 150 metres long, the football pitch is 6 times longer than the swimming pool. If I halve the length of my metre rule, the swimming pool will then be 50, and the football pitch 300, but the latter will still be six times the length of the former, irrespective of the change in the unit of measurement.

The rate of interest can only fall if the supply of loanable money-capital rises relative to its demand. It is that situation which is shown in the three tables. That can be seen by simply changing the relations so that the supply of loanable money-capital falls relative to the demand. Suppose, for example, that more money-capital is required for accumulation of productive-capital. A larger proportion of the surplus value is used for that purpose, leaving a smaller proportion to be paid out as dividends. If dividends amount to 5% of the total productive-capital, whereas previously they amount to 7.5%, this has two consequences.

Firstly, accumulation of productive-capital is greater, and so the production of surplus value is greater. Secondly, less loanable money-capital, is available for speculation in the purchase of shares, so the money-demand for shares does not rise so fast. The consequence is that the earnings per share rises faster, and the dividends per share rises more, whilst the price per share rises more slowly, so that dividend yields do not fall so much.

This is shown in the revised calculation of each table.

Table 1

Value Production
Constant Capital Variable Capital Surplus Value
4000.00 1000.00 1000.00
4200.00 1050.00 1050.00
4416.00 1104.00 1104.00
4649.52 1162.38 1162.38
4902.23 1225.56 1225.56
5175.97 1293.99 1293.99
5472.75 1368.19 1368.19
5794.79 1448.70 1448.70
6144.53 1536.13 1536.13
6524.65 1631.16 1631.16
6938.10 1734.52 1734.52
7388.11 1847.03 1847.03
7878.25 1969.56 1969.56
8412.42 2103.11 2103.11
8994.94 2248.74 2248.74
9630.54 2407.64 2407.64
10324.42 2581.11 2581.11
11082.31 2770.58 2770.58
11910.49 2977.62 2977.62
12815.89 3203.97 3203.97

Originally, the productive-capital, and the surplus value produced by it, increased by only 70%, and now it has trebled, as has the surplus value.

Table 2

Value Distribution

Rent Dividends Profit of Enterprise Accumulation
250.00 250.00 250.00 250.00
262.50 262.50 255.00 270.00
276.00 276.00 260.10 291.90
290.60 290.60 265.30 315.89
306.39 306.39 270.61 342.17
323.50 323.50 276.02 370.98
342.05 342.05 281.54 402.55
362.17 362.17 287.17 437.18
384.03 384.03 292.91 475.15
407.79 407.79 298.77 516.81
433.63 433.63 304.75 562.51
461.76 461.76 310.84 612.67
492.39 492.39 317.06 667.72
525.78 525.78 323.40 728.15
562.18 562.18 329.87 794.50
601.91 601.91 336.47 867.35
645.28 645.28 343.20 947.36
692.64 692.64 350.06 1035.23
744.41 744.41 357.06 1131.75
800.99 800.99 364.20 1237.78

This additional accumulation of capital, and consequent rise in the mass of produced surplus value, also causes the mass of rent, dividends, and accumulation to rise. Previously, rent rose to £420, and now rises to £800; dividends previously rose to £630, and now rises to £800, even though the percentage distribution of dividends has fallen from 7.5% of productive-capital to 5%; accumulation rose to £270, and now rises to £1240.

But, this also shows why the belief of market pundits that increases in economic activity, and rises in the mass of profits must lead to higher share prices, is wrong. It is often the other way around.

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 0.050
5000.00 5500.00 1.10 0.21 5.24 0.048
5000.00 6025.00 1.21 0.22 5.46 0.046
5000.00 6577.00 1.32 0.23 5.66 0.044
5000.00 7158.19 1.43 0.25 5.84 0.043
5000.00 7770.97 1.55 0.26 6.01 0.042
5000.00 8417.96 1.68 0.27 6.15 0.041
5000.00 9102.06 1.82 0.29 6.28 0.040
5000.00 9826.41 1.97 0.31 6.40 0.039
5000.00 10594.47 2.12 0.33 6.50 0.038
5000.00 11410.05 2.28 0.35 6.58 0.038
5000.00 12277.32 2.46 0.37 6.65 0.038
5000.00 13200.83 2.64 0.39 6.70 0.037
5000.00 14185.61 2.84 0.42 6.75 0.037
5000.00 15237.17 3.05 0.45 6.78 0.037
5000.00 16361.53 3.27 0.48 6.80 0.037
5000.00 17565.35 3.51 0.52 6.81 0.037
5000.00 18855.90 3.77 0.55 6.81 0.037
5000.00 20241.19 4.05 0.60 6.80 0.037
5000.00 21730.00 4.35 0.64 6.78 0.037

Previously, the price of shares quadrupled. Now the share price only slightly more than quadruples, despite the fact that the mass of surplus value increased by four times the rise in the original example. The extent of that is shown by the fact that originally the earnings per share increased by 70%, whereas now they have risen by more than 300%. Previously, that was reflected in the p/e ratio moving from 5 to 12, whereas now it rises only from 5 to 6.78. Similarly, the dividend yield previously more than halved from 7.5% to 3.1%, whereas now it has fallen by only a bit more than a fifth from 5% to 3.7%. This is solely the effect of a relative reduction in the supply of loanable money-capital going to fund speculation, and a rise in the money-capital used for accumulation of productive-capital. It does not take into account, the effect of issuing additional shares to raise money-capital, which would reduce share prices further, as well as reducing earnings per share, and dividend yields.

If this is considered in the context of bonds, the relation to market rates of interest can be seen even more easily. Suppose the original loanable money-capital advanced by the recipients of rent and dividends was used not to buy 5000 shares with a face value of £5,000, but to buy 5,000 bonds with a face value of £5,000. These bonds have a coupon rate of interest of 5%, which means that they pay out £250 per year. But, the recipients of rent and dividends, now use their revenue from these sources to speculate in these bonds, and as the mass of this revenue available for such speculation continues to rise each year, so the price of this fixed number of bonds rises. As the price of the bonds rises, but the coupon remains constant, so the yield falls.

That is the situation that existed for 30 years from around 1982, which created a secular down trend in yields. The sharp falls in the oil price, and in other primary products, means that this situation is significantly changed, so that the driving force for higher bond, equity and property prices is removed, and along with it the driver of lower yields and interest rates. This change in material conditions is a consequence of the shift in conjuncture of the long wave cycle from the Spring to Summer phase, as the huge investments in primary product production, now come to fruition, causing global prices for these products to fall, before plateauing. But, that same conjunctural shift is also associated with another shift, which requires that a greater proportion of surplus value is used for the accumulation of productive-capital, rather than continuing to simply flow in greater quantities into the money market.

On the one hand, falling rents causes less loanable money-capital to flow into money markets, reducing the supply. On the other, there is a need to advance additional productive-capital, as productivity begins to slow, and the need to invest in fixed capital, and in research and development increases. That means the demand for loanable money-capital rises. At the same time, this increase in the productive-capital that must be advanced, relative to the surplus value produced, causes the annual rate of profit to begin to fall, so that the mass of surplus value itself grows more slowly, in turn reducing the amount that can be distributed as rents, and dividends. The consequence is that yields, and interest rates begin to rise sharply. But, the only way that is possible, is if bond and share prices fall even more sharply. This is the background to the sell-off in financial markets over the last few weeks. The rise in sovereign bond prices in the US, UK and EU should be seen in the context only of a temporary movement into safe havens out of equities.

There are other danger signs for those financial markets that have  materialised in the last week or so. The sharp rise in junk bond yields has been referred to previously. The justification for that can be seen in the number of small and medium sized oil producers that are now in serious trouble. In the last week alone, 18% of Canadian oil rigs have been shut down. But prices continue to drop, because even as these less profitable rigs are taken out, additional supply continues to come on stream. OPEC is determined to keep pumping because it does not intend to lose market share, as it has in the past. Russia is producing more oil.

It was previously noted that the Schiller CAPE index for the S&P 500 is at 28, a level only previously seen prior to major stock market crashes such as 2000, 1987, and 1929. A further indicator now shows that the market is extremely overstretched. That is the measure of margin debt to GDP, which again is at levels only seen prior to these major crashes. Margin debt, is borrowing undertaken by speculators to finance their trades, rather than putting up their own money. This is fine so long as the trade is successful, and the borrowing can be paid back, but any significant drop in prices, or sustained fall, means that speculators are unable to repay the banks from whom they have borrowed. This very high level of margin debt is just another reflection that speculators have come to believe that share prices, just like bond prices and property prices could only ever go in one way. Serious crashes again always occur when such confidence is at the record high levels.

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