Saturday, 22 August 2015

Markets Crash

Over the last few weeks, global markets have been dropping, some times, as in the case of China, those drops have amounted to crashes. China has fallen by more than 30%, and is frequently seeing daily drops of around 6%. US and European markets have also been dropping.  Individual shares within stock market indices have been in correction territory (10% below their highs) for some time. It is only the peculiar nature of the way the indices are composed that has hidden that fact, because some very large companies have made it look like financial markets were still rising. Now, those markets are falling more significantly too. The Dow Jones fell throughout last week, and on Friday, the Dow Jones, fell by more than 530 points, the S&P 500 by more than 60 points, and the NASDAQ by more than 177 points. All were down more than 3%. The Russell 2000 Index, the Dow 30 and the NASDAQ are already in correction territory.

Market pundits and speculators see this as yet another reason to hope that the Federal Reserve, and, along with them, the Bank of England, will hold off from raising official interest rates. They hope that will be the case so that yet more easy money will once more reflate already massively over inflated financial and property market prices. But, as I have written previously, this reflects a fundamental lack of understanding about the nature of money, capital and interest rates on the part of bourgeois economists, a misunderstanding unfortunately shared by some Marxist economists.

That misunderstanding essentially comes down to this. Because they confuse money (currency) with money-capital (the money form of capital) they believe that interest rates can be lowered, simply by printing more money, and throwing it into circulation. They see interest rates as a price for money, rather than for money-capital, and so believe that this price can be lowered by increasing the supply of money. But, Marx and others explained why this belief is false, more than 150 years ago.

Interest rates, as Marx sets out in Capital III, Chapter 21 are not a price for money, but for capital as a commodity. That is they are the price that has to be paid for the use value of capital, the use value of being self-expanding value. Bankers and bourgeois economists got into a terrible muddle over this, confusing capital itself (as self-expanding value) with the commodities, which comprise the constant capital, and consequently confused the value, and the market price of these commodities, determined by demand and supply for the value of capital, and the demand and supply for capital.

But, Marx points out that capital, as capital, has no value, because it is not the product of labour. It has a use value, that of being self expanding value, and it is this use value, which is bought and sold in the market place, and it is the interaction of this demand and supply that determines interest rates. But, if interest rates are the price of capital, then its clear that these interest rates cannot be reduced simply by printing more money, because more money does not amount to more capital. Money here is just a means of measuring value, in the same way that a metre rule is a means of measuring length. If I measure the same length with a yard rule instead, it does not change the actual length of what is being measured, only the units in which it is being measured. If I print more money tokens, then all I have done is to reduce the unit of measurement, and in doing so have simply measured the demand and supply for capital by these smaller units, both change in the same proportion, and so the relation between the two does not change.

Marx set this out in Theories of Surplus Value, where he quotes David Hume and Joseph Massie to that effect . Locke had put forward the idea that interest rates were determined solely by the quantity of money put into circulation, and this view was also shared by William Petty.

Marx writes,

“Hume attacks Locke, Massie attacks both Petty and Locke, both of whom still held the view that the level of interest depends on the quantity of money, and that in fact the real object of the loan is money (not capital).

Massie laid down more categorically than did Hume, that interest is merely a part of profit. Hume is mainly concerned to show that the value of money makes no difference to the rate of interest, since, given the proportion between interest and money-capital—6 per cent for example, that is, £6, rises or falls in value at the same time as the value of the £100 (and. therefore, of one pound sterling) rises or falls, but the proportion 6 is not affected by this.”

And this is the reason that whatever central bankers may do, they cannot change the average rate of interest, even though they may be able to influence the price of various financial assets, and thereby some interest rates. But, where they reduce some interest rates, by such means, in one place, the consequence is necessarily to increase them elsewhere, so that this average is maintained. The only way that the supply of capital can be increased, so as to reduce interest rates is to create more of it.

In other words, capital must create a greater mass of profit, either by raising the rate of profit, or else by increasing the amount of productive-capital employed. Secondly, that profit once realised, as money-capital, must be used to meet the demand for additional productive-capital, rather than being used as revenue. In other words, as Andy Haldane said recently, capital must stop “eating itself”.

Instead of using realised profits simply to be paid out as dividends to shareholders, which are then used unproductively for either consumption or speculation, or else used to buy back shares, or to buy the shares of other companies, which has the same effect of simply inflating the prices of fictitious capital, the realised profits must be used to buy additional productive-capital. It doesn't matter whether the firm that makes the profits uses them for its own productive-investment, or whether it throws the realised money-capital into the money market so that other productive-capitalists then borrow it to buy productive-capital. What is important is that it is used to buy productive-capital, rather than to finance unproductive consumption and speculation, i.e. it is used as capital, not as revenue.

The other way that the supply of capital can be increased, is that, again as Haldane and Clinton pointed out recently, a greater proportion of existing realised profits should be used to buy productive-capital rather than being used as revenue to finance unproductive consumption and speculation. Finally, existing reserves of potential money-capital, can be mobilised for that purpose. Marx describes, for example, the way the savings of thousands of small farmers were brought together in banks, which could then be used as potential money-capital, used to buy productive-capital.

The reason that share prices have fallen, reflects this reality. Because, interest rates are determined by the demand and supply of capital, anything that affects either that demand or supply affects interest rates, whereas as Marx, Hume and Massie set out above, simply printing more money can have no such effect. Share prices, like bond prices and property prices are inversely related to the yield on these assets. If the price of a share or bond is £100, and it pays £10 in dividends or interest, the yield is 10%, but if the price rises to £200, the yield is only 5%. Conversely, if a share pays a dividend of £10 – and this is limited by how much profit the firm makes – whilst the average rate of interest rises to 20%, then the price of the share must fall to £50.

When the owners of money-capital become less willing to lend it, this amounts to a reduction in the supply of capital, which means that, if the demand for capital remains the same, interest rates must rise, and the consequence of such a rise in interest rates is a fall in the prices of fictitious capital. Over the last 30 years, asset prices have risen far, far faster than profits, which is why yields on these assets have continually fallen, even though the amount paid out in dividends, rents and so on has continually risen – the process of capital eating itself. Speculators ignored the fact that they were obtaining almost nothing in terms of yield on their shares, bonds and property, because the absolute amount of revenue continued to rise, but more importantly, they came to prize more highly what appeared to be far greater, and central bank guaranteed, capital gains.

That can only continue for so long as their remain “bigger fools” prepared to pay even more ludicrous prices for shares, bonds and property. That process is either at the end of the road, or very close to it, as the near zero yields on many of these assets demonstrates. The reason it is at an end is clear. The most obvious method for increasing the supply of capital, is to produce more profits, that can be realised as money-capital, which can then be used as a supply of additional capital. But, the more of these profits that are simply used for financial engineering, to pay out as dividends, or other returns to shareholders, or to finance share buybacks and so on, the less is actually used as money-capital. Consequently, the lower the level of actual investment in productive-capital, and consequently, the lower the potential to produce additional profits, and so increase the supply of capital.

Interest rates were able to fall continually from the 1980's, despite this, only because the annual rate of profit rose so spectacularly during that period, and from the late 90's, as economic activity throughout the globe increased, this much higher annual rate of profit, was reflected in a much higher mass of realised profits. But, for the reasons described previously, the conditions which led to that rise in the annual rate of profit have started to go into reverse – most notably a slowdown in the growth of productivity, which reduces the value of constant capital, increases the rate of surplus value, and increases the rate of turnover of capital. Competition meanwhile drives productive-capital to need to invest, so as to reduce costs, and maintain market share.

Some individual large capitalists even begin to see the potential to make a larger return on their capital by using it directly, as productive-capital, and thereby to make profits, than to use that money-capital simply to buy fictitious capital, so as to obtain a low rate of interest. That becomes all the more the case, when instead of bond, share and property prices going up more or less in a straight line, they begin to move in the opposite direction.

I have also set out the way that some providers of huge amounts of potential money-capital, for example, gulf oil states, and other suppliers of raw materials, who obtained huge rents, have overnight become borrowers themselves. So, the supply of money-capital begins to fall at the same time that the demand for capital rises, with the inevitable consequence that the prices of fictitious capital begins to fall. Moreover, because the prices of that fictitious capital has been inflated by the actions of central banks, which have printed money, which they have used to buy into these assets, this bubble does not just deflate, it bursts, as it did in 2008.

But, as I have pointed out in my first book, unlike 2008, central banks have already reduced official rates to zero, they have printed money in unprecedented amounts, and there is nothing more in that vein they can now do. They have missed the opportunity, over the last 6 years, to have normalised monetary policy, prior to this new financial crisis erupting. Moreover, in 2008, China was still able to act as a powerful stabilising force, using its vast reserves to stimulate its economy, and provide liquidity into the global economy. But, because central banks, including that in China, over the last 6 years, have simply attended to the needs of fictitious capital, whilst governments in various places have undermined productive-capital, by policies of austerity, the global economy has not strengthened sufficiently to take up the slack, and now the massive overproduction of capital in China, threatens to break out not just into a financial crisis, but into an economic crisis too.

We have arrived at a position where the yield to be obtained on financial assets is near zero, whilst the previous certainty of continual rapid capital gains on those assets has also ended. For any sensible owner of potential money-capital, therefore, the risks far outweigh the potential returns from such speculation. The potential supply of money-capital is then going to be severely curtailed, whilst the demand for money-capital is rising. If an economic crisis arises, then as Marx points out, individual firms demand money-capital almost at any price, simply to stay afloat, which sends interest rates soaring, and conversely, financial asset prices plummeting.

In the last week, yields on US Treasuries, and UK Gilts have actually fallen. But, this is rather like the phenomenon of people in a sinking boat scrabbling to find the last remaining air pockets. The currencies of all emerging markets have fallen relative to the dollar in the last year. Some have fallen by up to 90%. That pushes up their inflation rates, which puts further pressure on their own interest rates, to defend the currency and contain the inflation. The rise in UK and US bond prices, is merely a reflection of people bailing out of these emerging markets, and piling into the only remaining safe havens they can find. But, that is only a delay in the inevitable.

As 2008 showed, when the owners of money-capital decide the risks have become too great, they do not simply switch from one asset class to another, they do not just demand a higher rate of interest on their money-capital, from one type of financial asset, but from all. They sell out of everything. Central banks cannot change that simply by printing money, as the experience on the Shanghai Composite Index has demonstrated in recent weeks.

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