The Picture of Bubbles Bursting

The chart shown here is from data produced by the Federal Reserve Bank of St. Louis. It illustrates the proportion of US household and non-profit organisation net worth to household income. It is a useful measure of the extent of financial asset price bubbles, because that net worth is essentially the nominal value of people's houses, mutual funds and pension funds.

Now of course, as a measure of two things, one can rise or fall relative to the other, because one variable rises, or the other falls, or a combination of the two. Its certainly true that household income in the US has not moved very much in the last few years, even though wages are now starting to rise, as labour shortages begin to appear. But, the rise in net worth, relative to household income, cannot really be explained by any significant fall, in recent years, of household income. The spike in the relation, seen at the far right hand of the chart, can only be explained by a sharp rise in nominal net worth, i.e. a sharp rise in nominal prices for property, stocks and bonds. Put another way a series of bubbles.

A look at the rest of the chart illustrates the point, and also the significance. Almost identical spikes in the relation can be seen just ahead of 2008, and ahead of the Tech Wreck of 2000. An almost identical picture could probably be obtained for the UK, given the huge property bubble that has blown up, in recent years, and given that UK stock and bond markets have followed the US into bubble territory once more too.

As the chart shows, when the crash happens, it comes suddenly once this relationship has hit its peak. The chart already shows that the peak is already as pronounced as in 2008, and more pronounced than in 2000. It also indicates that the turn downwards has begun.

I have indicated over recent years, the basis of the crash that will ultimately arise, and which this chart indicates may be not too far away. I have also described it in my book Marx and Engels Theories of Crisis - Understanding The Coming Storm.

Back in 2013, I described the fact that a conjunctural shift had occurred in the long wave. It meant several factors were about to start to kick in. Firstly, the sharp rise in primary product prices that was typical of every Spring phase of the long wave, and which had again been seen after 1999, would come to an end. That meant that the prices of things like oil, copper, iron ore, steel, food and so on would drop sharply.

That happened on cue. The prices of all those things began to drop sharply in 2014. The basis of the fall in price is a reverse of why they rose in the previous phase. Firstly, high prices encouraged large scale investment in new production of all these primary products. That new production is much lower cost than the older existing production. It exploits newer, more productive land, and the investment from the start uses the latest equipment and techniques. Consequently, as this new production comes on stream, and accounts for an increasing proportion of total output, so it reduces the price of production of these various products.

Secondly, because it takes a long time for this new production to come on stream – around 10-12 years before a copper mine is producing at its optimal level – demand continues to outstrip supply for a long time keeping prices high, and thereby encouraging continued investment in new production. When that production does then all start to come on stream, it leads to a rapid rise in supply, which then outstrips demand, causing market gluts and drops in market prices. That has been seen in the fall in oil prices from a peak of $147 a barrel, and sustained prices over $100 a barrel, down to its trough a few weeks ago of $26 a barrel. But, it has been seen also in the sharp drops in the prices of copper, iron ore, steel, milk and so on.

Eventually, the oversupply tends to work its way out of the system. There has been an almost total cessation of new capital investment in many of these primary products, which means that as existing sources of supply are exhausted they are not replaced, so increases in supply slow down, and then more or less stop. That can be seen with oil production, particularly in the higher cost oil production, and in the steady decline in the US oil rig count. So, that element of the drop in prices comes to an end, but market prices stay relatively low compared to the past, because of the other element, the lower price of production of this new supply.

It was on that basis that at the end of 2014 I wrote that I expected that the price of oil could spike down as low as $25 a barrel – it actually dropped to $26 – but that during this year it would steadily rise within a range of $40 - $70 a barrel. Oil is now hovering around $50 a barrel. I also pointed out, at that time, that the drop in oil prices, whilst good for the economy, because they reduce the value of constant capital, and thereby raise the rate of profit, as well as reducing the value of labour-power, and thereby raising the rate of surplus value, was bad for financial markets.

Firstly, a lot of oil production finances huge rental incomes for states in the Gulf, Russia, Norway and so on, and those revenues tend to get recycled via the petro-dollar markets into financial markets, buying up a limited supply of shares, bonds and property, which blows up bubbles in all those financial assets. It represented a huge supply of loanable money-capital thrown into money markets, which pushed down global interest rates, and in turn pushed up financial asset prices via capitalisation. The sharp drop in those rental revenues, meant that this large supply of loanable money-capital would be reduced.

What is more, some of those economies, like Saudi Arabia, Russia, Venezuela, which depended on these revenues to finance their state spending suddenly found that although their low cost oil production was still very profitable at these low prices, the revenues were no longer adequate to cover their budgets. Instead of being net suppliers of money-capital into global money markets these countries became net borrowers.

The other point I made back in 2013, was that more than thirty years into a new cycle of productivity-raising innovations, that process would reach its peak. The process can be viewed in terms of intensive andextensive accumulation. It can be thought of like this. At the start of the cycle, say a firm has 10 machines. As one is worn out and due for replacement, it is replaced by a new machine that does the work perhaps of two of the older machines. The following year, when a further machine is worn out, therefore, it does not need to be replaced, as the new machine is already doing its work. It means the worker who operates this machine can then also be made redundant. The new machines thereby simply replace the old worn out machines, but do not add to the installed fixed capital, or necessarily bring about a rise in output. But, they do mean that this same level of output is now produced more efficiently, at lower cost, and with fewer workers. Labour is replaced, and wages fall, pushing up profits.

But, there comes a point whereby all of the older machines have been replaced, and the pace of development of even newer more efficient machines has slowed down, or the improvement they offer is not so great. At that point, it is not a matter of 1 new machine being introduced to replace two older machines, but of simply more of these newer machines, being installed alongside the existing installed base of more or less identical machines. Output and employment then rises, but productivity does not, or only rises slowly by comparison.

The consequence is that as employment rises, wages rise, and the rate of surplus value and profit declines. Each capital needs to borrow relatively more money-capital, so interest rates begin to be pushed higher. If we consider this in a global context, one reason that inflation was kept low, despite huge amounts of money printing, was that this huge rise in productivity caused the value of commodities to fall. China pumped masses of cheap commodities into western consumer markets, which kept the value of labour-power in those economies down. But, now productivity growth in China is slowing, for the reasons described above. In addition, Chinese wages and living standards have risen sharply, whilst the value of the Yuan has risen. The consequence is that the prices of commodities to be bought by global consumers are starting to rise.

Already the point has been made about the recovery in the oil price, and that has a fairly immediate effect on consumer prices, as it enters a wide range of consumer products, including petrol used not just in family cars, but in transporting every other commodity around the economy. From a fear of deflation a couple of months ago, Britain saw its monthly inflation figure spike up to 0.5%. Last month it fell back to 0.3%, but that is likely due to temporary factors, and a short term rise in the pound versus the dollar. But, continued rises in primary product prices, like oil, together with a likely sterling crisis as a vote for Brexit looks increasingly likely, will cause it to spike sharply. Meanwhile US inflation rose by 0.4% for last month alone, which would take annual inflation to over 5% if it continued at that rate. US core inflation is already above the 2% figure that the Federal Reserve claim is its target.

That higher inflation has several other consequences. Firstly, workers begin to demand higher wages to compensate for these higher prices, and they are better able to achieve that as the supply of labour-power begins to shrink, and the demand for labour-power increases. Firms also compete more intensely for new workers, and offer higher wages to attract them. That pushes down the rate of surplus value, and rate of profit, and causes firms to need to borrow more money-capital, pushing up interest rates. In addition, more workers in employment, and more workers earning higher wages, begin to consume more, and so firms have an incentive to match this increased demand for wage goods, by additional supply, which requires additional investment of capital, if only investment in more materials, and more workers to process them. Again that means an increased demand for money-capital, and an upward pressure on interest rates.

The period we are entering - the Summer phase of the long wave -
is equivalent to the period that ran from around 1961-1974.  It is
followed by the Autumn or crisis period (1974 -87).  As the chart
shows between the early 1960's to around 1985, financial asset
prices fall in real terms.  The underlying cause is that rising real
interest rates have a bigger impact in causing asset prices to fall
via capitalisation than increased revenues have in raising them.
It means that the prices of shares, bonds and property, enter a
 25-30 year secular decline, that mirrors their previous secular rise.

Secondly, the bond markets seeing more sustained inflation, begin to be concerned that the future value of their bonds, and the yields paid on them will be lower in real terms. They compensate by offering less for those bonds, and as bond prices fall yields rise, so that again interest rates are pushed up. Rising interest rates mean that via capitalisation financial asset prices fall. The chart at the start shows that those financial asset prices are at historically extended levels, and so as interest rates rise – something which central banks are powerless to prevent – those bubbles burst. This also tends to be a process that provides a feedback.  As history shows, in the kinds of conditions we are now entering, that feedback loop leads to those financial asset prices, such as stocks, bonds and property, falling in real terms for around 25 years.

In the previous period, the owners of fictitious capital have been obsessively concerned with obtaining capital gains. They have been encouraged in that activity by the fact that central banks have put a floor under stock, bond and property markets, buying into them whenever they showed signs of falling. So potential money-capital went into such speculation rather than productive investment. A look at the situation in the UK shows that the majority of bank lending went to finance property speculation rather than productive investment. But, if interest rates rise and bubbles begin to burst, without central banks being able to prevent it, the attraction of such speculation ceases, and the owners of that money-capital must again seek out yield on their money wealth. Real investment in productive activity again becomes a more attractive proposition.

Although, the cycle of technology acting to raise productivity is coming to a close, or has reached it, and although some of the new types of commodities developed in the last 20 years have become long in the tooth – witness the last few generations of iPhone – there remains many new type of commodity left to be developed. That is the case in relation to the continued growth in space technology, driverless technology and other forms of robotics, materials technology (graphene etc), as well as huge ranges of new commodities in the realm of gene and bio-technology, cybernetics, and health science. All of these are areas that have not been developed on the scale they should have been in recent years, as potential money-capital instead went into financial speculation.

But, all of these types of production are highly profitable, and have massive scope for the development of extensive markets, for many years into the future. The sooner the financial bubbles burst, and these new exciting areas of production are developed the better for all humanity.