Thursday, 30 July 2015

The Attack on Fictitious Capital Continues

I wrote recently about the attack on fictitious capitalThe Attack On Fictitious Capital Begins. Fictitious capital is things like shares, bonds and property. In other words, it is assets that appear to be like capital, as self-expanding value, but really are not. The dividends on a share, or the yield on a bond, or the rent on property, is only a share in the surplus value produced by real productive-capital. All of the pieces of paper which represent this fictitious capital, a share certificate, a bond, a mortgage or a rental agreement, are merely paper duplicates of the real capital, which make it appear that this capital exists twice or more. But, these bits of paper themselves get traded, and have a life of their own, with their prices move completely independently of the real capital. That is why we've seen the Shanghai Stock Market rise by 130%, and then collapse by 30%, for example. But, the money that gets sucked into speculation in the various forms of this fictitious capital, is also potential money-capital that could have been used to finance the accumulation of real capital. To the extent that it acts as a diversion from that, it undermines the real capitalist economy.

That is why, a conflict has broken out between the representatives of this fictitious capital, who want, at all costs, to maintain, and if possible further inflate, the prices of this fictitious capital, which is what the various acts of Quantitative Easing, by central banks, has done, and the representatives of the productive-capital, particularly of the big industrial capital, which takes the form of socialised capital, such as joint stock companies, as opposed to the remnants of private capital, in the shape of the smaller individual and family owned businesses. Fictitious capital, and this private capital is represented by conservatism, whereas the socialised capital is represented by social democracy.

In recent weeks, however, even some of the representatives of fictitious capital, including some of the big money lending capitalists, and their strategists, have recognised that there is a problem, because the more the prices of fictitious capital, in its various forms, rises, the lower the yield on those assets. That has been dismissed over the last 20 years or so, because, the owners of this fictitious capital have been able to console themselves with the fact that, the yield on their assets may have been shrinking to zero, but they have been making huge capital gains on the assets. You would not worry that you obtained little dividends on your Chinese shares, for example, if the value of your shares, themselves had more than doubled in a year!

The problem, is, as Andy Haldane and others have noted, is that if profits go into this speculation, or are used to pay out dividends, rather than to invest in real capital, then the potential for profits to continue to grow is diminished. At some point, appearance and reality will be brought forcibly into alignment, and that prices of the fictitious capital will crash. The representatives of that fictitious capital want to avoid that situation. From my own perspective, I think that such a crash is now inevitable, and will be beneficial, as I set out in my first book, because it will create the conditions for profits once more to be used for accumulation rather than speculation and other forms of unproductive consumption.

Another example of the situation described by Haldance and Clinton, of this shrinking yield, is property. Go back to the mid 1990's, after the house price crash of 1990, and ahead of the new bubble that started forming around 1997, and rental yields, for landlords were around 15%. On top of that, after 1997 landlords obtained more or less annual capital gains on their property. But, as property prices rose, whilst the potential for tenants to pay higher rents declined, because wages were stagnant or falling, and now even Housing Benefit is being cut, the ratio of the rent to the price that landlords had to pay for properties continually fell, in the same way that dividend yields fell on shares, and bond yields fell.

Today, rather than 15% yields on rental properties, landlords are lucky to make 5-6%, and then there are the risks of being able to rent the property, management costs, and the potential of damage caused to property by tenants. In London, where property prices have gone through the roof, rental yields are more like just 2%. But, just as with bonds and shares, the owners of this rental property have been more concerned that they were able to make large capital gains, as property prices rose, rather than that they made decent rental yields on their investment. That has been particularly notable with all of those Asian property syndicates from Singapore, Malaysia, Hong Kong and mainland China, that have bought into property developments in London and elsewhere that have no chance of ever being let out to tenants at current rents, but whose owners are only concerned with making these capital gains. Some of them may be learning the lesson of such speculation from what has happened to property prices in their own region, as well as with speculation on the Shanghai Stock Market.

But, as I also wrote recently, we have seen periods like this before in history, where large numbers of people are encouraged to take on board large amounts of debt, to purchase such fictitious capital, particularly property, only to find that it results in their ruination and expropriation. As I wrote there, George Osborne's Budget gives an indication of how this process could now be unfolding once more. On the one hand, in the next few weeks, official interest rates will be rising, which will both spark a series of rises in mortgage rates, but in any case will lead to falls in property prices. The Buy-To-Let landlords, who are different to many of the old style landlords, who owned the property they rented outright, have been encouraged, rather like the speculators on the Shanghai Stock market, who speculated on margin, to buy their rental properties with mortgages. In fact, the government gave them incentives to do so, by allowing them to write off their mortgage interest against their rent, for tax purposes.

There is a story going around at the moment, that Osborne went to his local tax office, and was shown the redacted details of one such landlord, who made £150,000 in rent during the year, but paid no tax, because they had been able to set off all of the mortgage interest on a number of properties, along with other costs. Whether that is true or not, in his Budget, Osborne withdrew part of the tax relief for such interest on buy to let mortgages, and has made clear the rest is going too. That is two ways the Buy-To-Let landlords will get hit. Firstly, their interest payments on their mortgages will rise, squeezing the yield on their properties further, and secondly the tax relief they currently enjoy will be removed, squeezing that yield even further.

I reported some time ago that some of the biggest buy-to-let landlords, with portfolios extending up to around £100 million had begun to sell out, as they saw the top of the market. With these further measures, it appears that more buy-to-let landlords are following suit. Its reported that 9% are already in the process of selling up, with another 23% considering doing so.

Yet, as a discussion at indicates, the pain for the buy-to-letters may be only just beginning. As well as removing this tax relief, Osborne is looking at the need to raise a lot more money in capital gains. The BTL's are another obvious source for this. Currently, there is a disincentive for them to sell properties, because when they do, they are hit for CGT on the full capital gain on any property. But, with properties rising in price, the obvious thing for them to do, is to realise the capital gain, by re-mortgaging the property on the basis of its current price. But, they then use the realised sum to buy another rental property, again on a mortgage.

Whilst, property prices were rising, every year, by large amounts, and while mortgage rates remained low, and the government was providing tax incentives, this was a one way bet. However, as the discussion at Houseprice Crash indicates that same process could now cause the BTL's a very serious problem. The government is thought to be proposing to levy CGT not just when such a property is sold, but also if a landlord realises the capital gain by re-mortgaging. However, because they have used the proceeds to buy additional properties, they could now find that they do not have sufficient funds to cover the CGT.

The following indicates the problem. Suppose a landlord bought a £50,000 house, in 2000, with a 10% deposit. If the price of the house is now £211,000, there is £161,000 of capital gain on which to pay CGT. Taking the annual allowance into consideration, he has to pay CGT on roughly £150,000 of gains, which is £42,000.

If they re-mortgaged and used the proceeds to buy another property so that his loan to value remains 90%, he only has £20,000 of equity in the house. That’s not enough to cover the CGT bill. In fact, unless they kept the new mortgage to less than 80% of the property price, they would be unable to cover the CGT.  But, he can’t sell his other properties to cover the expense because the same problem exists. When they sell this other property, that becomes due to CGT on this gain too. Unless the BTL's have been storing up a money hoard to cover such eventualities they are screwed, and almost by definition they will not have been creating such hoards, because the whole basis of the model is to use any realised equity, to leverage up further to acquire additional property.

Any BTL's operating at the margin, and there must be many, as rental yields have been squeezed close to zero, will have a problem. The mindset created over the last 20 years of relying solely on capital appreciation, which has applied across all of the various classes of fictitious capital, will have drawn them in, believing that they were getting richer, only to find as with so many more people, that they have only mired themselves in a morass of debt, from which they cannot now escape. The more the capital gain on their properties, the greater the morass, from which they must try to become disentangled, because the more CGT they will be liable to pay, so the more properties they would need to sell to pay the tax, but the more properties they sell, the more their capital gain, and the more tax they become liable to pay.

That is like the situation I described recently, that in order to cover their debts on shares bought on margin, speculators in China have to sell anything and everything to raise the cash, so the prices of everything drops, creating a vicious downward spiral. Its the same thing that happened in 2008, and has happened in every other such situation. In China, the state has been trying to hold the line, by introducing all of the usual measures to ban short selling, to stop large shareholders from selling at all, and so on. But, its not working. In Britain, the government has done something similar in the past few years to try to keep property prices from collapsing. It introduced various scams of shared ownership, Help To Buy, and so on, but that isn't working either. It has only postponed the actual collapse of property prices, and thereby made the collapse when it comes all that more pronounced.

The problem is indicated in an article on Bloomberg. I have argued previously that we are in a long wave boom cycle, similar to that which began in 1949, and lasted until 1974. This boom began in 1999. The features of this cycle are almost identical to those of the previous one, including the fact that gold, measured against other commodities, peaked in 1961 (the nominal peak in 1980 was only a measure against a depreciated dollar) 12 years into the cycle, just as it peaked this time 12 years into the cycle in 2011. The price movements of other primary products, such as copper have followed the same pattern too, as has the pattern of productivity. I believe that profits will also follow a similar pattern, and we are seeing a similar pattern for wages too.

In the article, the example of 1966 is cited in respect of inflation. On a purely chronological basis, 2015 is the equivalent of 1965.  As it states, at the start of that year, core inflation stood at 1.3%, about the same as for the US today. Unemployment was falling below 5%, slightly lower than today. But, by the end of that year, core inflation had risen to 3.1%. It continued to rise, despite repeated interest rate rises. By 1971, the core rate was over 5%, and it only fell because of the depressive effect of the oil price shock and recession in 1971/2. Core inflation continued to rise to over 10% by 1975, and headline inflation rose much higher, and didn't get back to below 2% until 1995.

As I pointed out the other day, it takes two years for a tightening of monetary policy to begin to have an effect on prices. The Federal Reserve and other central banks are way behind the curve in terms of taking action to deal with the inflation that is in the pipeline. What is different today, compared to 1966, is that, we have an unprecedented amount of liquidity that has been pumped into global markets, as well as changes in the global financial system, that have created not only the power of private banks to create money, but the creation of a huge shadow banking system, with the same capacity. Alan Greenspan in an interview yesterday on CNBC himself commented that he believed that there was a huge bond bubble, and warned that liquidity in such markets could disappear in minutes, when panic causes large numbers of people to want to sell, when there are no buyers, so that in the midst of a sea of liquidity, there arises a credit crunch.

As productivity growth slows, and the long period of cheap commodities from China comes to an end, consumer price inflation is bound to rise. Already, even as labour markets only begin to tighten, the largest capitals are raising wages to retain and recruit labour, and because they know that this pressures other capitals to raise wages, a process which benefits the larger capitals, as consumption rises, and with it the mass of profit. As commodity prices rise, as Marx describes, the value of labour-power rises in consequence, so wages must rise. That is facilitated by the sea of liquidity swilling around markets. A price-wage spiral is then set in place, which is likely to increase faster than anyone currently envisages. Whether central banks tighten monetary policy or not, interest rates will rise, as money-lenders seek to protect themselves against inflation.

A September rise in US official rates looks inevitable, and indeed well overdue. If the Fed raises, the UK will have to follow. That will be the start of the collapse of property prices, and of the prices of all other forms of fictitious capital.

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