Wednesday, 26 July 2017

The Elastic of The UK Economy Is Ready To Snap

UK second quarter GDP rose 0.3%, on the first reading. That comes after just a 0.2% rise in the first quarter. I expect that the second quarter reading will be revised down, and that in the second half of the year, growth will slow further, or come to a standstill. The IMF the other day revised down its growth forecast for the UK to 1.7% for 2017. I think that is highly optimistic. The fact is that the UK economy has been living on borrowed time for several years. The growth has been built on froth, as an already huge level of private debt, has been recklessly expanded even further, simply to keep asset prices inflated, and consumer spending going. The use of credit has acted like elastic to stretch the ability of consumers to keep spending beyond their limits, now the elastic is about to snap.

In the mid 2000's, as the UK economy, along with the global economy grew rapidly, as the new long wave boom got underway, wages began to rise sharply, in a way they had not done for more than 20 years. In 2007, oil tanker drivers won pay rises of 14% with not much of a fight; the then Chancellor of the Exchequer, Alistair Darling, appeared on Sunday morning politics shows to implore workers to accept lower than inflation pay rises, so as not to push up inflation further. Plumbers and other craftsmen could not be found for love nor money, as the construction boom exposed the lack of investment in skills training, and the extent to which those previous skilled workers had been lost to the economy, following the damage to it by Thatcher, in the 1980's. It was why, the eponymous Polish plumbers were recruited to make up these shortfalls, something that is being seen again now, but in a different context, in relation to the shortage of nurses, and other healthcare workers.

For the previous 20 years, the stagnation phase of the global economy had meant that labour-power was in excess supply. In the 1970's, and early 80's, it was capital that faced repeated crises of overproduction, as rising wages squeezed profits, in the later 1980's, and through the 1990's, it was labour that faced repeated crises, as unemployment rose, technology raised productivity replacing labour, even where output expanded, causing wages to fall, and the rate of surplus value and of profit to rise. Falling wages from the late 1980's onwards, posed a problem for capital in realising profits on the vastly increased quantity of commodities that were being thrown on to the market as a result of this new revolution in technology.

As I set out in my book, part of the answer to this was that the value of labour-power was reduced as a result of this very same rise in productivity, and from the cheapening of wage goods now produced in China, so lower nominal wages did not result in a proportionate fall in living standards. Part of the answer was that the vast quantity of commodities produced in China, and sold in Britain, meant that part of the surplus value produced by Chinese workers in production, was realised by British workers, who now sold them as the number of retail and commercial jobs increased. And finally, the answer came from the vast expansion of private debt, as workers were encouraged to borrow on an unprecedented scale, as Thatcher's government removed financial regulations, and credit controls. This expansion of debt, often collateralised against the property that some workers after WWII had built up, meant that workers obtained the illusion of affluence, whilst all the time being impoverished, as their assets/capital was converted into revenue. That happened also with the pension funds they had built up over the previous half century, as pensions were increasingly paid out, not from the revenue generated by the fund, but from the illusory and ephemeral, paper capital gains that the funds experienced as part of the blowing up of a series of asset price bubbles.

In the early 2000's, the onset of the new boom meant that this period of falling wages, and rising private debt could be brought to a halt. But, the extent of the debt, and moreover, the extent to which asset price bubbles had been repeatedly inflated – The Greenspan Put – posed a problem for central banks and other policy makers.

The problem faced by Keynesian orthodoxy in the 1970's had been that, in order to halt recessions, increasing amounts of fiscal stimulus was required, and increasingly, employers who saw that any respite would only be temporary, began to use any uptick as an opportunity to raise their prices rather than add to their capital. They raised their prices, which meant that workers in a climate where labour supplies were already stretched, obtained higher wages, so that the result was an inflationary price-wage spiral. Monetarist orthodoxy now faced a similar problem.

Monetarist orthodoxy was that in order to stimulate economic activity additional liquidity had to be put into the economy, that would then reduce interest rates, and encourage additional borrowing, spending and investment. The problem is that this theoretical standpoint is bogus, for several reasons. Firstly, putting additional liquidity into the system, does not reduce interest rates, unless there was already a problem of inadequate liquidity, i.e. a credit crunch. All that additional liquidity does is to devalue the currency, and thereby create inflation. Secondly, even if interest rates did fall, then as Keynes pointed out, unless businesses see some potential for being able to sell any increased output, they will be unlikely to accumulate additional capital, just on the back of lower interest rates. The additional liquidity, he pointed out, would be like “pushing on a string”.

What capitalists are interested in is making additional profits, not simply theoretical profits, but actually realised money profits, as their commodities are sold. At a time when technological developments were making labour relatively surplus, and wages were falling, the rate of surplus value, the amount of profit that was theoretically being squeezed out of workers, in production, was rising, but the contradiction facing capital, was then how to realise this profit, how to turn it into actual money profits, when those very same workers formed a large part of the consumers for those same commodities.

When a supporter of Ricardo wrote describing such a situation that where workers wages were reduced so that profits were raised, this inevitably also led to a glut, Marx commented,

This is indeed the secret basis of glut.” (Theories of Surplus Value, Part III)

The third problem with the Monetarist solution was that having put additional liquidity into the system, the authorities then had no control over where it went. Some went simply into covering the increasing importation of those wage goods that were now produced in China and elsewhere, and sold in Britain, and the UK etc. It was one reason that the trade deficits in these countries expanded hugely. But, particularly during the 1990's, an increasing amount went into financial speculation, again egged on by the deregulation of financial markets undertaken in the UK and US in the late 1980's.

So, it is often said that the vast increase in liquidity has not resulted in a rise in inflation. But, it has. The inflation has been in asset prices. The Dow Jones Index rose by 1300% between 1980 and 2000. Similar rises can be seen in other stock markets. In 2008, the Dow Jones along with other stock markets crashed, falling to around 7500, but as yet more liquidity was pumped into the system, it rose from the ashes again. It now stand at over 21,000, nearly treble its level in 2008. It has risen by around 2100% since 1980, way in excess of the nominal growth of the US economy, during that period, or of the profits of US companies. And the same applies to the UK stock market.

That huge inflation of asset prices meant that in the 1990's, the paper value of pension funds rose massively. On the one hand, that meant that the contributions that workers and employers paid into those funds, bought fewer and fewer shares and bonds, and so undermining the capital base of the funds to generate revenues to cover future pension payments. On the other, the paper capital gains gave the illusion that the pension payments could simply be paid out of the capital gains rather than revenues. In other words, pension payments could be made by selling some of the shares and bonds in the fund, whose prices had risen significantly. It also meant that employers used this as an excuse not to make their own contributions into the funds, during that period, which boosted their profits, and is why pension funds today face huge black holes in their ability to meet their commitments.

So, increasingly, economies took on the form of a huge Ponzi Scheme, where no real new revenue was being created, at least not in proportion to the growth of asset prices, and revenue was being created by destroying capital, whilst the appearance of capital growth was being achieved simply by printing money, and encouraging borrowing, and speculation in financial assets and property, which in turn acted as collateral for yet further borrowing!

The problem was that when in 2007, the working of the real economy began to impinge on this dream world, as inflation began to rise, central banks attempted to raise interest rates, and that exposed the extent to which financial markets were simply floating in mid-air, supported by nothing substantial. The epitome of that was the subprime lending to the housing market, and the extent to which banks and building societies had lent money way in excess of realistic property values. Some banks collapsed across the globe, before central banks and states intervened to bail them out, and thereby prevent a collapse of those grossly inflated asset prices. Ironically, but also typically, it was Labour's bailing out of those banks and other assets that caused government borrowing to spike, but which has subsequently enabled the Tories to pursue its policy of austerity, based on the lie of Labour profligacy!

Central banks and states succeeded in bailing out the banks, and reflating asset prices, only at the cost of depressing real economic activity over the last 8 years. It has distorted the current long wave cycle, which is now likely to be extended as a result. But, now, again, the real economy is asserting itself. Global growth has continued to grind higher. Even allowing for the extent of hidden unemployment, and underemployment in the UK, US and other economies, we are approaching levels of full employment. The figures given in the last couple of days of the inability to recruit nurses etc. are an indication of the extent of the problem, but other reports have shown that there is a shortage of around 75,000 lorry drivers, shortages of construction workers also exist, and with Brexit looming, not only are EU workers less likely to come to Britain, but EU workers already here are likely to start to leave.

The Bank of England, in particular, is in a bind. Brexit has already caused the Pound to fall, and inflation thereby to rise. UK households are at levels of debt now again comparable to those ahead of the financial crash in 2008. A number of recent reports indicate the nature of the problem, and how capital has stretched the elastic over recent years in order to keep expanding.

A couple of years ago, fears in the US were expressed over the size of subprime loans in the car sector. In the last few years, that phenomenon has appeared in Britain too. Today, very few new cars are actually bought outright. The majority are leased. Some months ago, I investigated the possibility of such a lease myself, only to find that what it really is, is just a means of car companies and dealers turning themselves into finance companies selling credit, as well as cars. The salesmen tried to show me that I was virtually being given free money, until I went through the figures with him to show that his conclusions were based on a series of false assumptions, and bad maths, just to put the best interpretation on it, and an attempt to deceive potential buyers to put a more accurate interpretation on it.

The other example, in recent days, has been the disclosure that millions of people were sold homes under a similar deception. Millions of people have bought homes that were only leasehold without apparently understanding the difference between leasehold and freehold. This seems to open up the potential for billion pound claims against solicitors who conducted the conveyancing of these homes, similar to the PPI compensation claims that arose out of the similar misselling ahead of the 2008 financial crash. The fact that millions of people could buy homes that they didn't know were leasehold, or without understanding the difference between leasehold and freehold is itself a reflection of the economy that has been created on the back of easy credit.

When I bought my first house, I was 23, and my wife 20. We bought it outright for cash having saved relentlessly for three years to do so. That makes you a bit more attentive to how you spend your money, and to make sure you do all due diligence before making any purchase. But, over the last thirty years or so, a climate has been created whereby no one saves money, no one buys things from their earnings, and everything is bought without any great thought, simply by using the easily available credit. When it appears that the things you buy are paid for by money that magically appears from nowhere, it makes you less inclined to spend time checking out all the details, even though you could do it easily nowadays by spending 5 minutes googling “leasehold”, rather than checking up the latest antics on Love Island! You are even less likely to spend time doing due diligence on your purchases, when, as now with leasehold properties, the government comes along to offer to bail you out, at taxpayers expense.  The same is true with houses bought in floodplains and so on.

But, the situation with leasehold is only a variation in the very policies that governments themselves have pursued in recent years to try to keep the property market inflated. Builders sold properties leasehold, because in doing so, they could sell them cheaper than if they were freehold. Like a car dealer leasing new cars, the builder gets a chunk of money now, and further chunks of money in ground-rent for ever more. It was a way of builders being able to sell more houses at a time when the demand for houses was falling, as people were already loaded up with too much student debt, credit card debt, car loan debt, store card debt, pay day loan shark debt and so on. But, it is really no different in that sense than all of the shared equity, and rent to buy scams that the government has also promoted over the years to try to keep housing demand from collapsing, at a time when real wages were still falling.

The Bank of England needs to try to prop up the Pound by talking about raising interest rates, because as the Pound continues to fall, inflation will rise again, and with labour becoming scarce that will lead to rising wages and squeezed profits, which is hardly a recipe for stock markets to rise further. But, actually raising interest rates will itself crash stock and bond markets, and send the housing market into a sharp decline. They are at the end of the road, the elastic has been stretched to the point of snapping, and Brexit means that Britain will be ill prepared to deal with the consequences.

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