Growth and Stock and Commodity Prices

Bourgeois financial pundits are considering what happens if the global economy grows next year, as COVID ceases to be an issue, and as governments end lock downs. There are two basic ideas that dominate their thinking. Firstly, if economies expand rapidly, then this must mean that profits expand, and so stock markets should rally. Secondly, if economies expand rapidly, demand for commodities will rise, and rising demand will mean rising prices for commodities. Both of these conclusions are false. 

Its quite true that, if economies expand rapidly, this will probably mean that profits grow. But, its only probably true that they will grow. If economies grow too rapidly, then large amounts of labour will be taken on to an extent that labour supplies become squeezed. At the very least, a point may be reached where no additional labour supplies are available to be exploited, so that the amount of absolute surplus value cannot increase. And, as labour supplies become tight, the continued increase in demand for labour will cause wages to rise, so that the amount of relative surplus value actually falls, meaning that surplus value in total would fall. This is the situation Marx describes in Capital III, Chapter 15, as representing a crisis of overproduction of capital. 

A further possibility is that, if economies grow rapidly, the expansion of production causes the demand for raw materials to rise sharply, and the price of these materials then increases. As Marx sets out, in Capital III, Chapter 6, a sharp rise in the price of materials, or other parts of constant capital may not be passed on into the final prices of commodities, because to do so would cause prices to rise to a level, where demand for the final output would fall so much that, again, there would be overproduction, this time of commodities. Firms might have to absorb some of the increase in their costs, out of their surplus value, in order to maintain demand at levels that allows them to continue producing at the minimum efficient levels. 

So, a sharp rise in economic activity could result in the actual mass of profits falling. Bourgeois economics does not see this possibility, because it views profits not as being created by labour, but by capital, or entrepreneurship. If capital produces profits, then the more capital, the more profit there should be. But, even assuming that there is more profit, does this mean that stock markets must rally? No. Firstly, suppose that in these conditions, the mass of profits rises by 10%, but that in order to produce this 10% increase in profits, 20% more capital must be advanced. Its then obvious that, although the mass of profit has risen, the rate of profit has fallen. If we assumed that all capital is provided by shareholders, then these shareholders have to lend more capital, to produce any given amount of profits. The return to these shareholders would then have fallen, and to compensate for that situation, the price of shares would have to fall, so that the yield on them was raised. 

Instead of stock markets rallying, they would fall, so that these lower prices restored former yields. If, share prices fell, to restore yields, then this would also cause bond prices to fall. Falling stock and bond prices, would also cause land prices to fall, for the same reason. Movements between these asset classes would restore risk adjusted yields between them, but the overall result would be that these prices fell. 

Now, let's look at the other aspect, here, commodity prices. The orthodox economist says, if demand rises, then commodity prices rise. That is because they see prices as being only market prices determined exclusively by interactions of demand and supply. If demand rises, the orthodox economist says, prices must rise, because, although the increased demand brings forth increased supply, the orthodox economist makes the assumption of diminishing returns, so that in order to produce this increased output firms have to endure proportionately greater cost. They must use less fertile land, and so on. This is the opposite to the position taken by some “Marxist” economists who argue that prices are simply a function of values, and who, thereby, discount the role of demand in determining prices. 

But, values are themselves a function of the level of output. The reason that capitalist production undercut handicraft production was that, by producing on a large scale, it was able to reduce the value of its output by utilising division of labour, as well as the introduction of machines. This is why the underlying assumption of orthodox economics of diminishing returns is wrong. However, the fact that it is wrong, as an underlying assumption, i.e. as a description of the conditions that exist for production over the longer-term, does not mean that it may not be true in the short-term, as Marx sets out in Capital III, Chapter 6, and in Theories of Surplus Value. 

If demand for raw materials increases rapidly at the start of a period of prosperity, supply can only be increased to meet it within bounds. Some new land may be rented to be cultivated, existing mines and quarries may be worked more intensively and extensively, but these tend to be the conditions where diminishing returns do materialise. The land surrounding existing farms that was less fertile tends to be the land first brought into additional cultivation; working mines to deeper levels means starting to operate in less fertile seams, or requires additional costs to be able to get to it, and so on. To expand, production significantly, and to access more fertile land, requires that entirely new areas of land be brought into production. This is what Marx describes in Theories of Surplus Value, Chapter 9, where he examines what is essentially the long wave. However, to bring such new lands into production requires a significant amount of time and investment. Marx estimates around ten years. 

Consequently, its quite true that, in the short-term, certainly at the commencement of a long wave expansion, a sharp rise in demand, resulting from the more rapid economic expansion, means that the average cost of production for many of these commodities rises. The market value and thereby the market price of these commodities increases, and indeed, for the reasons, Marx sets out in Capital III, Chapter 6, such sharp rises in prices can themselves lead to crises. We saw such sharp rises in prices for primary products in the period after 1999, when the new long wave uptrend began. As Marx sets out in Theories of Surplus Value, Chapter 9, its only when all of the new production brought into existence by this increase in economic activity, comes on to the market, that first market prices fall, as a result of supply shortages being ended, and then market values/prices of production fall, as this new production has a lower individual value than the old production, causing a further fall in market prices. That is what was seen in 2014, when all of the investment in primary production undertaken after 1999, resulted in large amounts of new production hitting global markets. 

The “Marxists” who ignore the question of demand, and who essentially accept the principle of Say's Law that supply creates its own demand, also fail to acknowledge the reverse of this that, just because producers produce commodities with a given value, that does not at all mean that consumers have to demand those commodities at prices reflecting those values, or indeed at any price at all. As Marx says, they might demand the quantity produced, but only at a lower price. Again, this is the basis of an overproduction of commodities. 

In the Money Morning newsletter, on Tuesday, Moneyweek Executive Editor, John Stepek wrote, 

“if investors really believe that reflation is the order of the day, then why is the oil price still sitting at $50 a barrel? Yes it’s recovered, but this time last year it was closer to $80 a barrel. Is this an extreme bet on reflation we’re witnessing? I don’t think so.” 

But, that assumes, as described above, that the price of oil is only a function of demand, not also of supply. It assumes that additional supply can only be had under conditions of diminishing returns, leading to higher prices. In fact, there is no reason whatsoever why rising demand for oil, as economies begin to rebound, following the ending of lock downs, should not see prices remain at current levels, or at best rise only modestly, because that depends upon the cost at which the oil can be got out of the ground, and those costs have been falling as a result of new technologies. Current low prices are a function of excess supply, but even when that excess is removed, there is no reason why prices should rise sharply. As I wrote some time ago, there is little likelihood that we will see $100 a barrel oil ever again, certainly not at 2000 prices. 

But, there are other factors involved in these prices. If we take commodity prices first, then these prices are not just a function of the value of the commodity, but also the value of money. More correctly, given that in a fiat money economy, money is itself replaced by money tokens and credit, it is a function of the value of these money tokens, which is itself a function of the quantity of them put into circulation, relative to the actual money they represent. The more this quantity is increased, the more the value of each token falls. In the past 30 years, the sharply falling value of those tokens was manifest in a hyperinflation of asset prices, as that liquidity was deliberately diverted into their purchase. 

Now, as a result of lock downs we have astronomical amounts of this liquidity being produced to finance unproductive consumption. It has been printed to pay out for furlough schemes and other such revenues for the self-employed, and so on. It is being used to finance bailouts of companies driven into near or actual bankruptcy, and so on. In other words, all of this liquidity is being diverted into pumping up monetary demand for commodities, at a time when lock downs have reduced supply of goods and services, which means that the money prices of many commodities will rise, i.e. inflation. But, as well as inflation, lock downs and the measures that have been introduced, also increase costs, so that prices are raised for that reason too. In Britain, Brexit means that costs are raised even more. That means not only rising inflation – which will be passed on into higher wages, thereby reducing relative surplus value and profits – but also that the cost of production rises, so that even with no change in the amount of profit produced, the rate of profit itself falls, as a consequence of this rise in the value composition of capital. 

Those factors, therefore, squeezing profits, and pressing down on the rate of profit, act to depress asset prices. But, there is a further aspect. As a result of furlough schemes, at a time when consumers were limited on what they could buy, a lot of very low paid workers found that their disposable income rose, resulting in savings rates rising. Data from the US shows that situation quickly reversing, as the furlough schemes end, and consumers again begin to start buying all those goods and services they were prevented from accessing. Latest US data show US deposit accounts, and current accounts being depleted rapidly, as unemployment has risen, furlough payments have ceased, and consumption is being caught up. 

What is happening with household savings is also happening to business savings, as they struggle to stay in business without sales income. When economies do expand, businesses will need to advance additional capital, with little in the way of cash balances to finance it. That means businesses will have to go into the capital markets in a big way to raise capital, and they will be doing so at the same time that governments are borrowing on a phenomenal scale to finance all of their spending to cover those costs of lock down. That means that interest rates will have to rise, and rising interest rates means rapidly falling asset prices. 

Next year is likely to produce developments that are far more complex than the superficial analysis of orthodox economics would indicate.