Debt and Destruction
1987, was also a turning point. In the 1980's, economies like Germany had responded to the crisis of the late 1970's, and early 1980's, by effectively retooling, and investing in real productive-capital. It meant that Germany was able to maintain its position as the world's largest exporter until just a few years ago, when it was overtaken by China. China, and other emerging Asian economies had also used the opportunity to invest in real productive capacity. Whilst, obviously, the US and UK also invested in new technologies, their economies were more notably characterised, in the 1980's, by the process that became known as de-industrialisation. Whole swathes of traditional industries from coal mining, to steel production, ship building, and even some of those new industries that had developed after WWII, such as car production, were decimated, and in some cases entirely destroyed.
The conservative social-democratic governments, particularly in the US and UK, rather like the shareholders in companies, came to believe that, rather than expanding the economy based upon production, and the expansion of revenues, it was possible to expand the economy instead by an expansion of paper wealth, i.e. by an inflation of the price of assets. The means of achieving this is through borrowing, whilst the inflation of those asset prices itself becomes the basis of further borrowing, as those assets form the collateral against which further borrowing is undertaken. Its known as a Ponzi Scheme, and always ends in a crash, because current prosperity is a delusion based upon this borrowing, whilst the borrowing itself is continually increased solely on the basis of an artificial inflation of the assets that comprise the collateral against which the borrowing is undertaken, rather than a corresponding rise in new value creation. Its why, as set out earlier, in the period 1950 to 1980, US GDP rose by twice the rise in the Dow Jones, but in the period 1980 to 2000, the Dow Jones rose by more than five times the rise in US GDP! Once it's no longer possible to inflate the price of the assets, the whole house of cards collapses, as happened, for example, with the Tulipmania, or the South Sea Bubble, or John Law's Mississippi Scheme, or the Railwaymania in 1847. 
The collapse of Lehman Brothers and other US Banks in 2008, followed on from the collapse of the US housing market that had been blown up via such a process in the preceding years, whereby the subprime mortgage market had been inflated by selling mortgages to people who had no chance of being able to repay them, but based solely on the idea that the price of the houses they were buying would continue to go up in a straight line, so that lenders would always be able to recover their loans, by selling the underlying assets. But, this same process was true in relation to the UK property market, the Irish property market, and the Spanish, Portuguese and Greek property markets, for example. Moreover, whilst the property market illustrates the problem, it is only a microcosm of the application of this approach by these conservative governments on a wider scale. 
For example, in the 1990's, companies took contribution holidays from paying into pension schemes, because, although yields were falling, and higher share and bond prices meant that contributions bought fewer of them, they argued that they could finance future pension liabilities by cashing in on the large paper capital gains they had obtained from the rising prices of those shares and bonds. Of course, the fallacy of that argument was shown as soon as those share and bond prices crashed, as they did in 2000 and 2008. It meant that the company pension funds were seen to have huge black holes, in their ability to pay out the pensions workers had contributed towards.
It has meant the state has had to step in to cover the capital deficiency, which was caused by companies taking pension holidays, and using liquidation of capital gains, rather than yields to cover current liabilities. Governments took a similar approach in their arguments to finance the building of large projects using PFI, and they similarly saw higher house prices as the means by which people could cover the cost of their social care in old age, and so on. But, the idea that these asset prices, including house prices could ever only go up, should have been known to be nonsense, simply by looking at even recent history. In 1990, after having been inflated, UK house prices collapsed by 40%, in a matter of months. In Japan, in the early 90's, after its inflated asset markets collapsed, with the Nikkei Falling from around 39,000 to just 9,000, it also saw property prices fall by more than 50%, and in prime Tokyo locations by as much as a staggering 99%!
The fundamental contradiction can be summed up like this. Asset prices are the product of two things; the revenue produced by those assets, for example, rent on land, or interest on bonds, or dividends on shares; and the rate of interest. In order to keep asset prices inflated, and rising, low and falling interest rates are required. But, the rate of interest is itself a function of the economic cycle, and particularly of the long wave cycle. When economic activity rises sharply, the demand for money-capital begins to rise more quickly than the supply of money-capital, so interest rates rise. As interest rates rise, the capitalised value of assets falls. In order to prevent interest rates rising, therefore, its necessary to restrain economic growth, and so the demand for money-capital. Hence the application of measures of austerity after 2010. But, in restraining economic growth, and real capital accumulation, that also restrains the growth of profits, and it is from profits that the revenues – dividends, interest, rent – are derived, which are that second determinant of asset prices. It is also the source from which taxes are derived, and so, by constraining growth, it also constrains the potential growth in tax revenues, which the state requires to pay down its debts. That is why austerity could never work as a solution for Greece, and why all of the austerity imposed on the UK, still saw its debt, and debt to GDP ratio continue to rise after 2010.
In, the period prior to the 2008 financial crash, politicians also attempted to restrain the conditions which lead to rising interest rates. In the 1960's and 1970's, the continual growth in the demand for labour-power saw wages rise, and that rise in wages resulted in a reduction in the rate of surplus value, and thereby a squeeze on profits. At the same time, the rise in wages, and the growth in the workforce together brings about a continual rise in demand for wage goods that firms are driven, by competition, to try to meet so as to increase their market share, and their mass of profit, even as their rate of profit from doing so falls. It means they have to borrow more to finance their expansion, pushing up interest rates, and thereby reducing asset prices. A look at the Dow Jones, in the period after 1965 up to the mid 1980's, shows that it fell in inflation adjusted terms, and this is typical for all asset prices during that period.
In the early 2000's, as the demand for labour rose sharply, states attempted to prevent a similar rise in wages, and a similar reduction in the rate of surplus value. Faced with soaring costs of skilled labour, for plumbers, joiners, electricians and so on, for example, Britain encouraged 2 million EU migrants, the eponymous Polish plumbers, to come into the UK labour market. In March 2008, as UK petrol tanker drivers engaged in a short strike, for a 14% pay rise, Labour Chancellor of the Exchequer, Alistair Darling, appeared on Sunday morning TV to appeal for workers not to push for inflation busting pay rises, as I discussed at the time.
But, the fact was, as discussed in that post, and several others at the time such as Tory Voodoo Economics, Why So Many Merchants of Doom, The Bums On Pews Indicator, and More News Contradicts Doom and Gloom, the global economy had continued to grow, despite the credit crunch that had begun in 2007, and which had led to the collapse of Northern Rock.
The view that 2008 represented an economic crisis of capitalism is wrong, as indicated in those posts. It was a financial crisis centred in the financial markets, that had been astronomically inflated in the previous 25 years, as each time the bubble began to burst it was inflated again by central bank intervention, and by intervention by the state to divert potential money capital into financial speculation.
Fictitious Capital Eats Real Capital - Part 2
2007-2008 ECONOMIC BOOM AND A SEVERE FINANCIAL WARNING
Fictitious Capital Eats Real Capital - Part 2
2007-2008 ECONOMIC BOOM AND A SEVERE FINANCIAL WARNING
«as those assets form the collateral against which further borrowing is undertaken. Its known as a Ponzi Scheme»
ReplyDeleteAh this is rather optimistic because the recent asset price booms, especially in the UK as to residential property, have not been quite Ponzi schemes, because they have been redistributive.
That is their main effect has been not the distribution of imaginary gains to pyramid-members, but the redistribution of very real revenues from poorer to richer people. There is a Ponzi element, but it is not the main one.
When rents go from £400/month to £800/month, that's very real revenue that get redistributed from the renter to the landlord, and similarly when a house price goes from £200,000 to £400,000 the buyer loses £200,000 and the incumbent seller cashes in that £200,000.
The reason is that unlike for tulips etc. people don't have an option as to whether being the greater fool or not: they cannot say "rents/prices are a bubble, I am better off by not buying and being homeless".
The same in large part applies to shares, inasmuch as people have to accumulate financial assets for their pension, given the destruction of state pensions (which are effectively "invested" in GDP bonds). The "buy and hold" propagandists have a point.
In large part the asset bubble has not been a debt fueled Ponzi scheme, where the debt can be "invalidated" and that results in a debt-deflation crash.
The situation is something quite different, because that debt has in effect the status of currency, and the bubble is an effect a policy of high inflation.
This is not immediately obvious because:
* "Economists" define as "inflation" only wage increases.
* "Economists" define as "money" only that issued by the central bank and with no usage restrictions.
A better way of looking at the recent decades is that:
* There are two types of money:
** "Winner" money that can only be used to buy specially approved "commodities" like real estate and shares (via both collateral rules and rules on who can access central bank funding). But asset sellers can convert it to "loser" money to buy "loser" commodities like labour and wage goods.
** "Loser" money that can be used for anything, but is used mainly to pay wages and buy wage-goods.
* There have been:
** A tight control of the issuance of "loser" money, plus a large increase in the supply of commodities like labour or wage-goods.
* A fantastic rate of inflation in "winner" money.
The trick has been that the rate of exchange between "loser" and "winner" money has been kept at par despite the enormous rate of inflation of "winner" money.
Put another way, the sell-side (either for real estate or shares) have been playing fantasy-finance with a never ending supply of Monopoly style tokens, but those tokens can be exchanged for sterling at par. Nice job if you can get it...
I disagree, but don't have time to reply to all this at the moment. I will try to respond in the next few days.
ReplyDeleteBTW, there is also a question of terminology: “as those assets form the collateral against which further borrowing is undertaken” is or should be known as the "debt-collateral spiral, for "Ponzi phase" I like H Minsky's definition, where the people buy assets (with debt typically) solely because of the prospect of capital gains (in the case of assets bought with debt the capital gains are needed to repay both principal and interest).
ReplyDeleteThe debt-collateral spiral of course can enable and often enables a Ponzi phase, but they are distinct concepts, in my view.
Hi Blissex,
ReplyDeleteSorry I still haven't had time to respond, but I've been, and still am very busy with a host of things, including a book review I have promised to do for the Weekly Worker that I haven't started of yet!
I don't like skimping on responses. I will definitely respond properly, but it may be later this week.
I am replying to all of your comments here, in 4 separate replies. That includes your comment posted to my separate blog post on Why Labour Should Be The Champion of Business.
ReplyDeleteThe asset price booms have been no more redistributive than with any other Ponzi Scheme. A Ponzi Scheme, like a Pyramid Scheme, is redistributive to those who run it, and those that are in at the start of it. It works by providing superficially high returns to those in at the start, by paying them inflated returns on the basis of utilising the payments into the scheme of those that come later. These high returns, act to encourage new punters into the scheme, which provides the basis for paying out the high returns, and dependent upon the nature of the scheme, it also pushes up the unit value of shares/units in the scheme, so that in addition to high returns, it also promises significant capital gains, which again encourages further, bigger fools to enter the scheme. Provided those who obtain these high returns, and the capital gains that are produced, get out of the scheme before it collapses, then they have had a very real redistribution of income and wealth in their favour, at the expense of those who came later.
The asset price booms, including in relation to property have been no different to that.
“When rents go from £400/month to £800/month, that's very real revenue that get redistributed from the renter to the landlord, and similarly when a house price goes from £200,000 to £400,000 the buyer loses £200,000 and the incumbent seller cashes in that £200,000.”
The increase in rent has been a consequence of rising property prices. It does not represent “real revenue” , because real revenue implies that additional value has been created by labour. That is certainly not the case here. It does, however, mean that existing revenues obtained by one group of people, become transferred to revenues received by some other group of people. Its no different, no more a real revenue, than is the increased revenue that the existing members of a Ponzi Scheme obtain, as a consequence of more people being encouraged to join the scheme. In fact, the increase in rents is interesting, because in large part, it has only been possible, because the state has subsidised those rents via Housing Benefits, that now amount, in the UK to over £9 billion. That is money transferred to landlords by the state, which it deducts in taxes from profits. If, that Housing Benefit was not paid, either wages would have to rise substantially, which would have the same effect, by reducing profits, to cover the higher wages, or else tenants would not be able to pay the rents, so defaults would rocket, demand for private rental property would fall, and that would put a large dent in the property market, a large part of which has been driven by the increase in buy to let landlordism. It is, therefore, only redistributive in the sense that it transfers revenue in one form (profits) into revenues in another form (rents). That is why it is contradictory to the needs of real capital, because it also hinders capital accumulation.
In the case, of the house price that rises from £200,000 to £400,000, let's look at that more closely. If the seller, as is usually the case, seeks to move up to a better house, say a house that was previously £400,000, it would now cost them £800,000. So, rather than pocketing a £200,000 capital gain, the effect on them is to cause them an actual £200,000 capital loss, because they now have to add an additional £400,000 to be able to buy their better house, whereas previously they only needed to add, £200,000. This, in fact, is why it has become increasingly impossible for existing home owners to move up the property ladder. Even if we assume that they only wish to move to another house of the same standard as the one they have sold, they will find that it too will now cost them £400,000, so that their paper capital gain, has been shown to be purely imaginary.
Cont'd
Only if they were to do what you have suggested no one will tend to do, in your other comment,
ReplyDelete“they cannot say "rents/prices are a bubble, I am better off by not buying and being homeless"
would they be able to realise the capital gain. But, as you say, no one will tend to do that. They might as I have done, sell, and then rent, or they might sell, and downsize to a cheaper house, so as to realise a part of that capital gain. But, this puts them in absolutely no different situation than anyone who was a part of a Ponzi Scheme, or Pyramid scheme, who took the revenues paid to them at the beginning, and sold out before all of the supply of bigger fools ran out, and the scheme/asset prices collapsed. In fact, it puts them in a worse position, in many ways, because, as you say someone who has bought a house, still has to have somewhere to live, whereas someone who had bought tulip bulbs, or units in a Ponzi Scheme, does not have to replace them, when they sell. In the case of a Ponzi Scheme, its only those who come in last who lose out, whereas those who came in first, and sold out, are okay. In the case of property, or shares and bonds, everyone left holding those assets when they crash at best sees their illusory capital gains disappear, and in most cases will see those capital gains turn into capital losses.
The only people who can sell out in relation to property, with no need to buy are the landlords, or those who own multiple properties. But, as soon as they begin selling, as recent data suggests they are beginning to do, as changes in stamp duty, and in mortgage tax relief make such ventures unprofitable, the effect is precisely to cause a rush for the door, which acts as the catalyst for a collapse in the market.
“The same in large part applies to shares, inasmuch as people have to accumulate financial assets for their pension, given the destruction of state pensions (which are effectively "invested" in GDP bonds). The "buy and hold" propagandists have a point.”
I totally disagree. If you buy shares or bonds, or other financial derivatives at the moment, and asset prices crash, you will have overpaid for the revenue those assets return to you, and you will suffer a significant capital loss, as asset prices crash. Put your money in the bank, provided its protected by the savings deposit guarantee, and when asset prices crash, that money will buy you five or ten times the amount of assets it would currently, with a corresponding rise in the yield you obtain from it! If you had bought shares at the top of the market in 1929, it would have taken until the 1950's, before those shares would have recovered their original value, and most people cannot afford to buy and hold over that long a time horizon. It took more than 15 years, even for NASDAQ listed shares to recover their 2000 nominal levels!
The asset price bubble has most definitely been debt fuelled, and that debt not only can, but has been invalidated over the last thirty years on several occasions, which is what led to central banks intervening to reflate those asset prices. The owner of a share, essentially is a creditor of a company, as with a bond holder. When share prices or bond prices crash, it is effectively an invalidation of the debt the company owes to the share or bondholder. It means the company can buy back its debt, at a fraction of what the share/bondholder thought they would be paid back. The same applies to the large amount of sovereign bonds. They have been most certainly invalidated in relation, for example, to Greece. That is why, in the Greek rescue, the aim of the ECB was to enable, the private holders of Greek bonds, to sell out of them. In the US sub-prime crisis in 2008, householders began to invalidate their mortgage debt as they found themselves in negative equity, by simply walking away from their houses, leaving the banks to pick up the debt.
Cont'd
There is only one type of money as currency, whether it takes the form of notes and coins, or credit money. It is only that, as Marx says in A Contribution to the Critique of Political Economy, once put into circulation it can go anywhere. What you are describing is only what I have described elsewhere, which is that the purpose of money printing, including the increase in credit money from the late 1980's onwards, was not to save the real economy, but was to reflate asset prices, as the main form of wealth of the top 0.01%. Exactly like a Ponzi Scheme, it did that, by ensuring that encouragement was given for capital gains in those asset markets, so that money was taken from general circulation, and driven towards speculation in assets. The reality of that will be seen as asset prices begin to crash, and all of that money swills out into the real economy, as firms are driven to accumulate as the demand for wage goods rises, and competition forces each of them to try to capture their share of this rising demand.
ReplyDeleteAs with property, and rents, as asset prices rose, yields fell, and in order to bolster yields, increasing amounts of profit had to be diverted into dividends that would otherwise have gone to capital accumulation. It was a massive conversion of potential capital into revenue.
As far as the debt-collateral spiral and Ponzi Phase is concerned, it seems to me they are the same thing. In a Ponzi Scheme, those running the scheme essentially are debtors to those who come later into the scheme. They “borrow” money from these later bigger fools, in order to pay it out to the earlier contributors to the scheme. Its that borrowing that provides the high returns to the existing members, and fuels the inflation of the prices of their units in the scheme. Its the high “asset value” of those units, which in turn then becomes the basis for encouraging further contributors to the scheme. As I've argued previously, that is precisely what happened with the asset price bubbles. In the 1980's'90's, the rate and mass of profit rose, and that enabled the mass of dividends, interest and rents to rise. The rate of interest – as opposed to mass of interest – fell, because the mass of realised profit, rose faster than the demand for money-capital for accumulation. A rising mass of dividends, with falling interest rates, fuelled rising share prices; a rising mass of rents and a falling rate of interest fuelled higher land prices/property prices. At a certain point, even as profit is diverted into dividends and rents, the yield on these assets begins to fall, and the motivation of speculators becomes not the search for yield, but the search for capital gains. A pure speculative bubble.
Cont'd
“Well, in my view cash-flows from it can largely finance the asset prices, "validating the price": unlike tulip bulbs southern english property produces significant cash flow, and unlike tulips staying out of the market is difficult (fewer people choose homelessness or living in job-poor areas than people choose to not buy or rent tulip bulbs).”
ReplyDeleteAs I've set out earlier, it only produces cash flow for landlords, and a large part of that is only possible because of the £9 billion a year of Housing Benefit subsidy paid by the state to landlords. An increasing amount of the motivation even for landlords in London, is not revenue or cash flow, but capital gain, as witnessed by the large amount of empty new apartment blocks in London. The only differences amount to differences in relation to who is doing the borrowing to finance the increase in the price of the assets.
“Put another way, a £2,000/month rent for a 1 bedroom flat can still be "validated" by putting 2-4-8 (depending on the percentage of income they are willing to spend on housing costs) people in it.”
That is simply a feature in determining how big the bubble can inflate before it bursts. I would suggest that the real point as far as that goes occurred some time ago, and is being masked by the payment of that £9 billion of subsidy. It was hidden by the mortgage tax relief that buy to let landlords have enjoyed – as against private buyers – which is being removed. Moreover, it depends upon mortgage rates, and interest rates being low, so that a) the price of land remains high, and b) the actual mortgage costs for landlords in buying remain low.
The fact is that the fall in yields is an indication that revenues can no longer validate asset prices. As Haldane points out capital has been eaten precisely by the process of increasing the share of profits taken as dividends, to try to protect yields, but the consequence of that is that profit does not go to capital accumulation, required to further increase the mass of profits and revenues. Revenues can no longer increase enough to validate asset prices, because the supply of money capital from profits available for accumulation, is falling relative to the demand for money capital, as a) rising economic activity leads to an increased pace of capital accumulation b) years of neglect of infrastructure is having to be addressed for the needs of the efficiency of capital, and by pressure on populist governments to reverse the effects of a decade of austerity.
Asset prices are a function not just of revenues, but of the rate of interest. As global interest rates are rising, and will continue to rise whatever central banks do in relation to money printing – which under current conditions would now result in even faster rising commodity price inflation – that causes asset prices, whether it is land/property, shares, bonds or their derivatives, to fall. That is quite separate from the fact that it raises the costs of buying financial assets on margin, and that it raises the cost of buy to let mortgages making that asset class even less sustainable, so causing landlords to sell up rather than face operating losses, whilst they see declining prices for their property, and also causing higher mortgages for private buyers, so that the cost of buying for them rises sharply.
All of those factors are now in play in causing asset prices to fall, although it is masked by the usual shift of huge speculative flows from one asset class to another, i.e. from bonds to shares, and back again. It is why we are seeing sharp rises in the VIX index of volatility, and indeed we saw the sharpest rise ever in the index that measures the changes in the VIX index itself, showing that the system is increasingly unstable. It is the sign that the asset price bubbles are close to bursting.
Ah interesting will think about it a bit too. For now my impression is that I understand your arguments, but that you miss the "necessity" side of my argument, plus there is some unfortunate terminology mixup.
ReplyDeleteOn the necessity issue, let me make a further point, I forgot to to add, but which I discussed several years ago, in a post dealing with demand and supply for housing. You are quite right that its possible for accommodation to be more fully utilised, so that 2-4-8 people, etc. occupy a residence, so that rising costs are shared out to extend the extent to which the price bubble can be inflated.
ReplyDeleteHowever, another aspect of that, which I dealt with in this discussion of supply and demand, is that in order to inflate these asset prices, the Tories in the 1980's, and after were very successful in persuading individuals that they had to have their own accommodation, just as they persuaded them they had to have their own car, and so on, turning the individual rather than the household into separate cost centres, which acted to also thereby boost consumer spending - easily seen in relation to each individual having their own car, but also the case where each individual has their own accommodation, with the need for additional furnishings, services and so on, much of which also tends to be bought utilising credit. I have a whole section on this in my book Marx and Engels Theories of Crisis.
Part of this was also encouraged, by the increase in the number of people going to University, where they were encouraged to go to a remote University, thereby also requiring separate accommodation, which they continued after graduating. Both my kids went to the local University and lived at home, thereby taking on no debt, and actually accumulated savings during the time they were at University. And, this is my further point, here. Both of my sons, now well into their 30's, continue to live at home, rather than go into huge debt to buy massively overpriced properties, or pay out exorbitant rents.
Capital has done a very good marketing job, in convincing young people that they absolutely must leave the parental home, and have their own accommodation, something that was never a feature of life for individuals until the mid to late 1980's. If that ended, and young people realised that it is massively financially beneficial for them to remain in the family home, rather than feel they need to have their own accommodation, and used such time at home, to build up cash, not only would existing property prices crash - especially as many EU citizens go back home - but, it would mean that the cash is king dictum would again be proved correct, as their cash hoard, would then enable them to a)buy a house for cash, as I did when I bought my first house, and b) that as house prices crash, their cash hoard would go five or ten times further than it does currently.
As I've set out in my book, there is actually 50% more housing per head of population today than there was in the 1970's, when property prices were only a small fraction of what they are today, which is an indication that those prices are purely due to a speculative bubble. That bubble, as with any other Ponzi Scheme has been fuelled by the idea that individuals have to get on to the bandwagon before the exorbitant prices become even more exorbitant. When individuals realise that is not true, or are forced by prices and rents to do what earlier generations did, and simply stay at home and save, the bubble will collapse. But, even without that, the higher interest rates in the rest of the economy, driven by increasing economic activity, and a squeeze on profits, will burst it in the very near future anyway.