All of these speculative bubbles burst, without being directly connected to the real economy, or having any necessary significant impact upon it. They amount to some gamblers in the casino losing their shirts, and others enjoying the gains.
“As regards the fall in the purely nominal capital, State bonds, shares etc.—in so far as it does not lead to the bankruptcy of the state or of the share company, or to the complete stoppage of reproduction through undermining the credit of the industrial capitalists who hold such securities—it amounts only to the transfer of wealth from one hand to another and will, on the whole, act favourably upon reproduction, since the parvenus into whose hands these stocks or shares fall cheaply, are mostly more enterprising than their former owners.”
(Theories of Surplus Value 2, p 496)
An example, of that was seen in 1847. From 1843, a new long wave uptrend had started. The global economy, centred on Britain, was booming. Following the Opium War, Chinese markets had been opened up, and masses of production was being sold into it. Huge profits ensued. But, it was also a time of crop failures, notably the crop failures in Ireland. Britain had to import food from Europe, and paid for it with gold. At the same time, large amounts of railway construction was taking place across Britain, and, from the start, the huge size of the companies involved required them to take the form of socialised capital, of joint stock companies that borrowed money, by selling shares on the Stock Exchange. The shares themselves, as assets, then became traded, and as with every stock market bubble seen since, the prices of those shares were driven higher and higher, increasingly unrelated to any possible earnings the companies were likely to make. Speculators, instead simply gambled that the prices of the shares would rise and rise to the moon. Until they didn't.
And, this was also an example of what Marx stated above. Many of those who gambled on these shares, were themselves private capitalists, the owners of private industrial capital. They diverted some of their own profits into this gambling on the stock market, rather than in investing those profits back into their business, despite the huge profits that could be made from their own production. The lure of massive capital gains from financial gambling, even outweighed the huge profits they could make from real productive investment. Worse, as with many of the financial crashes of today, they bought shares by borrowing, what is called buying on margin. To buy the railway shares, when they were issued, payment was made in stages. Seeing the potential for massive capital gains, much in the same way that today the buyers of meme stocks are lured into such gambling, they bought as many shares as they could, borrowing to do so. That was facilitated by low interest rates, which were themselves a product of the huge money profits that were being made, which created a large supply of available money-capital.
“At the close of 1842 the pressure which English industry suffered almost uninterruptedly since 1837, began to lift. During the following two years foreign demand for English manufactured goods increased still more; 1845 and 1846 marked a period of greatest prosperity. In 1843 the Opium War had opened China to English commerce. The new market gave a new impetus to the further expansion of an expanding industry, particularly the cotton industry... But all the newly erected factory buildings, steam-engines, and spinning and weaving machines did not suffice to absorb the surplus-value pouring in from Lancashire. With the same zeal as was shown in expanding production, people engaged in building railways. The thirst for speculation of manufacturers and merchants at first found gratification in this field...
The enticingly high profits had led to far more extensive operations than justified by the available liquid resources. Yet there was credit-easy to obtain and cheap. The bank discount rate stood low: 1¾ to 2¾% in 1844, less than 3% until October 1845, rising to 5% for a while (February 1846), then dropping again to 3¼% in December 1846. The Bank of England had an unheard-of supply of gold in its vaults. All inland quotations were higher than ever before.”
But, in 1844, basing itself on the fallacious Ricardian theory of money and interest-rates, the Bank of England had pressed for and secured the passing of the Bank Act. It linked the supply of currency to the amount of gold in the country. So, when a large outflow of gold took place, to pay for the import of food, the Bank of England reduced the supply of currency. That meant that there was a credit crunch. Businesses that previously gave their customers commercial credit, now needed cash themselves, as their suppliers reduced the provision of credit. As commercial credit dried up, businesses had to rely on discounting bills of exchange, and so the discount rate rose sharply. The discount houses, obtained money to discount bills, by themselves borrowing from the larger merchant banks, and ultimately from the Bank of England, but as this borrowing increased, so interest rates spiked. So, now all of the easy money that had fuelled the stock market bubble disappeared. Higher interest rates meant that the capitalised value of assets crashed, the inability to borrow meant that those that had bought on margin, and were now facing calls for payment on the shares they had bought, could not borrow.
“The rapid and easy flow of payments was obstructed, first here and there, then generally. The banking discount rate, still 3 to 3½% in January 1847, rose to 7% in April, when the first panic broke out. The situation eased somewhat in the summer (6½%, 6%), but when the new crop failed as well panic broke out afresh and even more violently. The official minimum bank discount rose in October to 7 and in November to 10%; i.e., the overwhelming mass of bills of exchange was discountable only at outrageous rates of interest, or no longer discountable at all. The general cessation of payments caused the failure of several leading and very many medium-sized and small firms. The Bank itself was in danger due to the limitations imposed by the artful Bank Act of 1844.”
(ibid)
The real basis of this crisis, as a financial crisis, of the type described by Marx above, was the Bank Act itself. By failing to understand money, currency and interest rates, it created an artificial credit crunch, which took interest rates to over 10%. The proof of that was that, eventually, the government was led to suspend the Bank Act, and as soon as it did, that alone was enough to end the credit crunch, even without a significant increase in liquidity.
“The government yielded to the general clamour and suspended the Bank Act on October 25, thereby eliminating the absurd legal fetters imposed on the Bank. Now it could throw its supply of bank-notes into circulation without hindrance. The credit of these bank-notes being in practice guaranteed by the credit of the nation, and thus unimpaired, the money stringency was thus instantly and decisively relieved. Naturally, quite a number of hopelessly enmeshed large and small firms failed nevertheless, but the peak of the crisis was overcome, the banking discount dropped to 5% in December, and in the course of 1848 a new wave of business activity began which took the edge off the revolutionary movements on the continent in 1849, and which inaugurated in the fifties an unprecedented industrial prosperity, but then ended again — in the crash of 1857. — F. E.]”
(ibid)
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