Tuesday, 6 February 2018

Financial Markets Crash

The prescience of my current series of posts on the bubbles in Bitcoin and financial assets could not have been better illustrated than by the dramatic falls yesterday in the price of Bitcoin, and of US Stock Markets.

In thirty years of watching financial markets closely, I have never seen anything like what happened yesterday. I started writing my posts on Bitcoin and the financial markets last week, before they began to crash. I'd predicted at the start of the year that Bitcoin would go to zero. At the time I started writing last week, it had already gone from its peak of nearly $20,000 to $15,000, and was starting to fall further. By the time, the first post in the series appeared on Sunday, it had fallen to around $9,000, on Friday, and with it, US stock markets had fallen sharply too. The Dow Jones Index had fallen on Friday by around 700 points. 

To be honest, I expected that US markets yesterday might have had some kind of dead cat bounce having fallen by that amount, which was the second biggest points drop in the history of the index. But, as the day progressed, it became obvious that something more fundamental was happening. Asian, and then European markets had followed on from the falls in the US, on Friday, and when the US markets opened yesterday, the DOW immediately dropped by around 375 points. Later in the day, that was largely reversed, leaving it down by only a hundred points or so. At teatime, I was watching US CNBC, where one of the panel of traders commented that the decisions that people make in such conditions are nearly always wrong, and that all those who had sold at the open when the DOW was down 375, would be thinking that they had made stupid decisions. My wife commented that it was fine for him to say that with the benefit of hindsight, to which I replied, yes, we'll see if he still holds to that position at the end of the day, when it closes down 400 points. 

I'd been watching some TV during the evening, and my son had just come into the living room. Between programmes, I flicked across to Bloomberg, which showed the DOW down by 700 points. I was just telling my son about the earlier discussion, when as I was speaking, the index literally dropped by a further 200 points, causing me to exclaim “Whoa.” We'd been discussing Bitcoin, and the extent to which the fall in Bitcoin and the falls in the financial markets were connected, and he had been asking about the decision of Lloyds Bank and others to stop customers using their credit cards to buy Bitcoin. As we were talking, every few seconds, as the market boards refreshed, the DOW dropped in 100 point chunks. Within a matter of minutes, it had gone from being down 700 points to down 1600 points, the biggest intraday points drop in its history by a long margin. 

Yet, as I pointed out to my son, as we watched this unfold, this 1600 drop, which represented a fall of 6%, was only a quarter of the percentage drop of 25% that happened in the 1987 crash. That in itself is an indication of just how inflated the actual index has become.

In the next hour or so, the DOW moved back to being down only around 700 points, with Jim Cramer, who I was waiting to give us his opinions on Stark Industries, telling us that it was simply an indication of the markets not working properly, of a potential fat finger, or flash crash, and anything other than that the level of financial markets has been astronomically inflated, on nothing more than hot air, and central bank support, for a prolonged period that has now run its course. It's amazing how its never the case that the markets are not functioning properly when they rise bigly, as Trump would put it, only when they fall sharply. Despite the pleading that it was all a little temporary technical difficulty, and a buying opportunity, the DOW resumed its fall, ending down nearly 1200 points. 

But, it's clear, as I pointed out in the first part of my series on these bubbles, that the financial pundits really do not have a clue what is actually going on, and they simply operate on the basis of a series of mantras that they repeat mechanically, and those mantras are now failing them. One of those mantras is that when share prices drop bond prices rise, because asset allocators when they sell shares, switch into bonds, and vice versa. But, as I pointed out, this inverse relation is only applicable on a very short timescale, if it applies at all. So, for example, over the last thirty years, both bond prices and share prices have risen significantly, even if on any one day or week, this relative switching from one to the other gives the superficial impression that when share prices rise, bond prices drop, and vice versa. However, there is no reason that owners of shares do have to buy bonds when they sell shares, or vice versa. They could simply hold on to cash, if they feel that both asset classes are overpriced; they could use the money to buy some other asset such as land or property; they could use the money to simply spend, though when it comes to the trillions of dollars that the big investment funds move, that would not be the case; and finally the money could be used not for such speculation in financial assets, but to actually invest in the true sense of the word, by accumulating real capital, building new factories, buying additional machines and materials, employing additional workers. 

The truth that lies behind the crash, as I have been setting out in my series on the bubbles, is that it is precisely this latter activity that has been going on. The reason the 2008 financial meltdown occurred was ultimately that financial asset prices, and other asset prices such as land and property had been massively inflated. The reason they had been inflated was that starting in the 1980's, the global rate of profit had risen sharply, so that the supply of money-capital, from those realised profits, exceeded the demand for money-capital, so that interest rates progressively fell. As the prices of revenue producing assets is determined by the capitalised value of their revenues, as interest rates fall, the capitalised values rise. Moreover, because the global capitalist class now owns its private wealth in the form of this fictitious capital rather than real capital, it became increasingly concerned not to see that paper wealth fall, and so from 1987 onwards, whenever those asset prices did begin to fall, central banks stepped in to print money, and to thereby underpin the financial markets, and governments stepped in to prop up property prices, which also formed a large part of the lending undertaken by commercial banks, in mortgages. 

So, even when the economic conditions began to change, so that the excess supply of money-capital over the demand for it, began to reverse, so that interest rates began to rise, central banks prevented the necessary fall in asset prices that should have accompanied it, via these policies of reducing official interest rates, and increasing liquidity, which went directly into an inflation of those asset prices, and by creating this one way bet, thereby also sucked additional money and money-capital out of general circulation, and into financial speculation. By the early 2000's, as the new long wave boom that began in 1999 started to take hold, it meant that companies were using a larger proportion of their own profits for capital accumulation, and so throwing less of those profits into the money markets, whilst they were also going into the capital markets to borrow, to top up their profits with additional capital to invest in additional production. It meant that interest rates necessarily began to rise, and also as this economic growth picked up, and more workers were employed, in specific sectors, where labour shortages existed, or in others where workers remained well organised, wages started to rise, which began to put a squeeze on the formerly rising profits, meaning also that businesses that covered their working-capital, for things like wages, from short-term borrowing, they had to borrow more to cover the higher wages. 

It was this economic strength in the early 2000's, which fed through into higher interest rates, which provided the spark for the crash of financial asset prices, and of land and property prices. In the period after 2008, central banks and governments have tried their best to prevent those conditions reasserting themselves. Despite all of the proclamations of concern over low levels of growth, and the possibility of deflation, they have been concerned to try to prevent higher levels of growth that would lead to rising wages, and subsequently higher interest rates that would crash those asset prices. The policies of austerity were designed precisely for that purpose. The only deflation they have really been concerned with is the potential deflation of the hyper-inflated asset prices, and property prices. The deflation of consumer goods prices was itself a consequence of QE, and the artificial inflation of asset prices, which sucked money out of general circulation, and into speculation. 

But they have failed, because the underlying strength of the global economy, in this phase of the long wave cycle, eventually made itself felt. As more workers across the globe were employed, first, even with no rise in wages, this increased number of workers results in an increased demand for wage goods. The most dramatic example of that was the sharp rise in the demand for food that resulted in global food shortages in the early 2000's, as the global workforce had doubled since the 1980's, and rose by a third just after 2000 alone. As Marx describes in Capital III, and in Theories of Surplus Value, contrary to what Ricardo claimed, capitals do not require higher commodity prices, and subsequent higher rates of profit to get them to accumulate capital. If the demand for their output rises, for example, because of a rising population, each capital is forced to increase its own output, even if the rate of profit is falling, because competition ensures that, if they don't, their competitors will steal market share from them, which will undermine their long-term profitability and viability. 

Even with the relatively low levels of growth since 2008, the growth of the global working-class has continued, with a consequent growth in the demand for wage goods, which in turn leads to the requirement to accumulate additional capital to meet that demand. For a lot of goods and services, if the big companies are not prepared to expand their production to meet that demand there are lots of smaller firms prepared to fill that gap. In fact, it is in respect of those smaller firms that the underlying economic reality, and rise in market rates of interest has been apparent, because, as potential money-capital was sucked into financial and property speculation, so these smaller firms found it very difficult to obtain bank financing for their expansion, leading them to resort to very expensive forms of borrowing such as credit cards, or increasingly peer to peer lending. 

In the US, even allowing for the number of people, as in the UK, employed part-time, or on zero hours contracts and so on, payroll numbers over the last few years have continued to rise by an average of around 200,000 per month, (whereas a rise of only 75,000 is required to absorb new workers) and unemployment has continued to fall to below a level, which previously would already have been considered to represent full employment. On Friday, the market sell-off accelerated after yet another robust US jobs number, and continued data showing that the US economy continues to grow at an increasing pace, along with more or less every other economy in the globe. The idea that the stock markets can fall when the economy is growing strongly, confounds the bourgeois pundits, but, in fact, that inverse relation has always been the case. So, two things, as always happens at this point of the long wave cycle, assert themselves. 

Firstly, as employment rises, so the demand for wage goods rises, which creates the requirement for businesses to accumulate capital to meet this additional demand, and this capital accumulation itself thereby increases the demand for labour-power even further. That means the demand for money-capital rises, as businesses throw more of their profits into the accumulation of capital, and relatively less into the money market. Secondly, as this capital accumulation proceeds, and more labour is employed, so the excess supply of labour-power is reduced, and wages start to rise. The latest data for the US, shows this rise in wages starting to show through. As wages rise, that increases the demand for wage goods even more, until demand for some of them starts to become sated, so that suppliers have to sell them at lower prices, whilst workers begin to use some of their wages instead to buy a wider range of goods and services, including some that previously would have been considered luxuries. That means again that more capital must be laid out to meet this additional demand, but now, the rise in wages, also means that the rate of surplus value starts to get squeezed, and the rate of profit along with it. So, the demand for money-capital for real capital accumulation increases, whilst the squeeze on the rate of surplus value and rate of profit, relatively reduces the amount of realised profits available to finance such accumulation, and so the rate of interest rises. 

This illustrates the utter confusion of the bourgeois economists and financial analysts who cannot understand this process. What is more ironic, is that, in trying to understand it, they are forced to reject some of the fundamental aspects of their own ideology. The proponents of the free market never tire of telling us that prices cannot be determined by central planners. They are right. But, when it comes to one of the most important prices, the price of capital, or rate of interest, the free market apologists would have us believe that the central planners in the central banks are in full control of it, that the rate of interest is solely a function of the price that the central bank sets for it, in its official interest rates, supported by its use of money printing to increase the supply of money. But, of course, the central bank cannot determine the rate of interest any more than it can determine the prices of any other commodities. Moreover, they display their confusion further by mistaking money tokens for money, and money for money-capital. 

Money only becomes money-capital where it is used to be metamorphosed into real capital, i.e. where it is used to buy commodities to be used productively to produce profits. It is only by producing profits that an additional fund, equal to the profits, is created, out of which the interest on the borrowed money-capital can be paid. If I have £100, which I use to buy food to consume, this money does not act for me as money-capital, but only as money. If I borrow the £100, at a 10% rate of interest, having consumed the food, I have neither provided myself with the means of repaying the £100, or of paying the interest. If I borrow the £100 and employ it as capital to produce an output with a value of £150, this £150, allows me to repay the £100 borrowed, plus the £10 of interest on it, whilst still retaining £40 of profit of enterprise for myself. 

In both cases, the lender of the money, sees what they lend as money-capital, because for them it is self-expanding value. They start with £100 of money-capital, and it turns into £110 of money-capital when it returns with interest. But, looked at from the perspective of the total social capital, it is only in the case of where the money-capital is borrowed, to be actually used as money-capital, that it results in the creation of new value, and of a surplus value out of which the interest can be paid. 

The supply of money-capital essentially comes from two sources. Firstly, it comes from the realised profits of companies. In established societies, this is the primary source of all new money-capital. Companies produce money profits, and these money profits are paid into bank deposits. The company will either use the money deposited in the bank to finance the reproduction of its consumed capital, and to accumulate additional capital, or else it would leave a portion of those funds in the bank, which then becomes available for use in the money markets by those firms that require additional money-capital to finance their expansion. Either the money-capital is utilised to directly finance accumulation, thereby reducing the demand for money-capital on the money market, or else it flows into the money-market increasing the supply of money-capital. 

The second source of money-capital is savings. So, individual capitalists receive revenues either as profits, or as interest, and landlords obtain rents. The capitalists and landlords will not use all of their revenues to fund consumption, and so this provides them with large amounts of savings, which are then made available as money-capital. Workers too, at a certain point might have small amounts of savings, which the banks are able to pool into larger sums available to be loaned out as money-capital. At any particular time, therefore, the supply of money-capital may rise or fall depending upon whether realised profits rise or fall, and dependent upon whether the recipients of profits, interest, rent or wages use a larger or smaller proportion of their income for consumption, or as savings. 

What does not provide additional money or money-capital, as the bourgeois economists believe, is money printing by the central bank. When the central bank “prints money”, in fact all it is printing is additional money tokens. The more of these tokens it prints, the more it devalues each token, relative to the actual money it purports to represent. So, it thereby causes an inflation of money prices. If the money actually goes into general circulation, to be borrowed to be used as money-capital to be metamorphosed into productive-capital, it simply results in an inflation of all those commodities that comprise the productive-capital. The nominal rise in the supply of money-capital, is thereby cancelled out by an equal nominal rise in the demand for money-capital, brought about by those higher money prices. The consequence is that the rate of interest remains the same. What has happened over the last 20 years is that this money printing has been diverted into financial speculation, so that the depreciation of the money tokens, was reflected in a hyperinflation of the financial assets that were bought with those money tokens. It resulted in a progressive fall in the yield on those financial assets, because the revenue they produced continually fell relative to the price of the asset, just as, although rents rose, in absolute terms, they rose proportionately less than the rise in the price of property, so that rental yields also progressively fell. 

But, the market rate of interest that productive capital must pay continues to be determined by the demand and supply for that money-capital. If potential money-capital is sucked into financial speculation rather than productive investment, it cannot act to inflate the prices of those commodities that constitute productive-capital, and so does not affect either the nominal demand nor supply for it, in that respect. If the demand for money-capital rises because businesses need it to expand, then that will cause the interest rate they must pay to borrow to rise. If potential money-capital is sucked away from such activity into financial speculation, that will reduce the supply available for productive investment causing interest rates to rise, unless it is matched by a reduction in the demand for it, as firms hold back from productive investment in order to engage in financial speculation. If the demand for potential money-capital rises sharply, because borrowers need it as currency, during a period of panic, that will also cause the rate of interest to rise. 

It is not a conundrum that financial markets are selling off as the global economy grows more strongly. It is an inevitable consequence of that stronger growth, which causes interest rates to rise. The stronger economic growth does not cause interest rates to rise because it causes inflation, as the bourgeois economists again wrongly believe. As economic growth strengthens, in conditions where vast reservoirs of liquidity have already been created, that will also result in inflation as that liquidity flows back into general circulation, but it is not the inflation that is the cause of higher interest rates. Logically, higher rates of inflation again only affect the nominal levels of demand and supply for money-capital. What causes the rate of interest to rise is rather the fact that the actual demand for money-capital rises as a result of the stronger growth, and that at a certain point, the rise in wages reduces the rate of surplus value and rate of profit, thereby reducing the supply of money-capital from realised profits. 

The financial pundits were highly delighted yesterday when their old mantra that bond prices rise when share prices fall seemed to be restored. But, as I said in the first post, that relation can indeed occur on a day to day, or even week to week basis. It doesn't change the underlying fact that as the demand for money-capital rises relative to the supply, interest rates will rise, and to the extent that bond prices are not completely rigged as a result of QE, that will also result in bond prices themselves falling. In the last few months, bond prices in the US, and in Europe have continued to fall, and yields rise. The big fund managers and other asset allocators constrained by some of the rules that govern the investment of their funds, are required to remain invested, even where it would be advisable to sell everything, and that explains why this relative pricing of bonds and shares occurs. But, the logical relation means that if bond prices fall, so that bond yields rise, that makes shares relatively less attractive, so that money would then flow out of shares and into bonds, which would then reduce share prices. The same applies to other assets such as property. 

The other thing that confuses the bourgeois economists and financial pundits is that the stock market can fall, not only when the economy is strengthening, but when the mass of profits of companies is increasing. And, indeed, in a period such as we have now, as the global economy strengthens, I would expect that the mass of profits would indeed rise. The point is does it rise in the same proportion as the rise in the demand for capital, for further expansion? A firm might double its profits from £1 million to £2 million, but if previously it only expanded by half a million pounds, it was able to throw the other half million into the money market. If now, as demand rises, it is forced by competition to expand its output by £2.5 million, its profits are no longer enough to finance it, and it must go into the money market to borrow money-capital, going from being a supplier of money-capital to a borrower, and thereby being a factor in the rise in interest rates, which then acts to reduce the capitalised value of revenue producing assets such as shares. 

And, in fact, as I set out some time ago in relation to movements in the price of oil, we have seen in the last few years that whole countries such as Saudi Arabia, Russia and so on which obtained huge rents from oil production, and which were available to be thrown into the Petrodollar markets, now become instead borrowers on global money markets, because the fall in the price of oil means that their rents no longer cover the government expenditure. Even countries like Norway, find that the money going into their sovereign wealth fund is drastically reduced, which means that the supply of money capital into global money markets is thereby reduced, causing global interest rates to rise. 

As I sat watching the Dow drop by 100 point chunks last night, and in answer to my son's question about how it related to Bitcoin, I said that it reminded me a bit of the situation in 2008, which led me to correctly predict the imminence of the financial meltdown. Then it was a sharp fall in Oil Futures, that alerted me to the fact that a liquidity shortage was forcing financial institutions to sell anything they could quickly realise to get cash. The continued drop in Bitcoin, suggests that some large players might be experiencing problems with liquidity. The reason the banks have stopped people buying Bitcoin with credit cards, and notably not with debit cards, is that they are concerned that as the price collapses, the buyers will not be able to cover the losses, and pay off their credit card debt, leaving the bank to pick up the tab. We are once again, as in 2008, seeing the range of derivatives that have been developed, being the first to suffer catastrophic losses. Two Credit Suisse Short ETF's, related to the VIX, dropped by over 80% in after hours trade last night, leading to speculation that Credit Suisse would have to liquidate the funds, and that it might impact Credit Suisse themselves. Credit Suisse's shares were down by 10% in the pre-market trade. 

I expected a dead cat bounce in markets again today, given the enormity of the falls yesterday, but as I write its not clear if that will happen. The last time I looked, the Dow Futures were suggesting it would open down by around 450 points. US Bond prices are also falling again, which further indicates that, as Marx said, there is no reason why a financial markets crash, which simply reduces the paper wealth of some speculators, should have any deleterious effect on the real economy, and if anything should have the opposite effect. The US economy, like the global economy is fundamentally strong, and economic growth is accelerating. It is that very fact that is posing a dilemma for central banks, as interest rates inevitably rise. Whether this latest sell-off is the start of the 80% drop in asset prices I believe will happen sooner or later, only time will tell. 

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