When Will Asset Prices Crash? - Part 9

I now want to take the rules described in previous parts, and to apply them to the conditions we have now, and that are developing to answer the question posed of “When Will Asset Prices Crash?”, and, particularly, is it any time soon?

The rules outlined can be summarised as these.

• Asset prices are determined by the process of capitalisation.
  
  
• Revenues from assets are a function of profits.
  
  
• Profits are a function of, and also determinant of, the long wave cycle.
  
  
• Interest rates are a function of the long wave cycle, and the variation in the demand for and supply of money-capital at different phases of it.
  
  
• Effects can be reinforcing or negating, depending on the phase of the cycle – rising profits make possible rising revenues, which increases asset prices, via capitalisation, and may also increase the supply of money-capital, reducing interest rates, which increases asset prices via capitalisation, but rising profits may also be accompanied by an increased demand for money-capital, due to a squeezed rate of profit, which causes interest rates to rise, which causes asset prices to fall. It depends on the phase of the long wave cycle.
  
  
• Inflated asset prices may crash at the start of a stagnation phase, for example, if something causes interest rates to spike, (1929, 1987), but the fact of a secular fall in interest rates, means that such crashes are reversed, and asset prices proceed higher.
  
  
• The rate of profit is a function of the long wave cycle. The mass of profit may be rising rapidly (boom), whilst the rate of profit is being squeezed by rising wage share, and rising input prices. Gross output expands at a faster pace than net output, demand for money-capital to finance expansion, driven by competition for market share, rises faster than supply, causing interest rates to rise. The opposite occurs in the stagnation phase.

The fifth long wave began in 1999. Its characteristics have been described, and it met all of the criteria seen at the start of previous long wave cycles. Global economic activity and trade expanded rapidly; the social working-day expanded rapidly, as vast new workforces were recruited; that increased global absolute surplus value production; the capital accumulation continued to be primarily intensive rather than extensive so that productivity rose, and relative surplus value increased; the demand for primary products, including food, rose sharply, but existing sources of supply could not respond, causing market prices for these products to rise sharply. Large scale currency printing, which had been undertaken since 1987, and continued in response to asset price crashes, the aftermath of 9/11, and so on, enabled these input costs to be passed on into end product prices, leading to rising inflation, which also began to feed into rising wages.

That was apparent by 2007, and central banks were led to raise interest rates, which sparked the crash in asset prices, and spread into the Global Financial Meltdown of 2008. It was four or five years early, because of the effects of repeated bouts of liquidity injections, which had acted to artificially inflate asset prices, and, thereby, depress yields, so that even small absolute increases in interest rates were large proportional increases, having a proportionally large effect on asset prices. In responding, central banks simply repeated the old play book that had exacerbated the crisis. Its important to understand that it was not the liquidity injections that caused the asset price bubbles and crisis – which is the argument of the Austrians – because the bubbles and the crash would have happened anyway, as they always do at these points of the long wave cycle. That is a function of periods of intensive accumulation, during the stagnation phase, when the supply of money capital from realised profits rises faster than the demand for it, so that interest rates fall prompting asset price rises and capital gains, and speculation. The liquidity injections simply put this process on steroids.

After 2010, to avoid a repeat of the economic conditions that led to rising wages, and rising interest rates, states introduced measures of fiscal austerity to slow economic growth. Together with renewed liquidity injections and various direct measures from the state to promote the purchase of assets, this acted to again divert money and money-capital into the purchase of assets in search of capital gains, and away from the real economy, thereby, depressing economic activity, and creating disinflationary or deflationary conditions for commodity prices, which were then used as justification for even more liquidity injections which went straight into inflating asset prices further, and draining even more money out of the real economy.

In A Contribution To The Critique of Political Economy, Marx notes that, when states engage in the printing of money tokens, their control over them ends as soon as they put them into circulation. In other words, they have no control over where those tokens flow into, or how quickly they are passed from hand to hand. So, their effects on what parts of the economy might be stimulated by them, what immediate effects they might have on enabling prices in some spheres to rise, are outside their control. But, with QE, central banks have tried to get around that. By using the liquidity to directly purchase financial assets, they did control where the additional tokens went, and they did so for the specific purpose of causing an inflation of the prices of those assets. In the various other measures that similarly channelled liquidity into the hands of commercial banks, it was again directed towards that same purpose, and towards the financing of speculation in financial and property assets.

That has indeed, given central banks a great deal of control over that flow of liquidity, especially when combined with the policies of fiscal austerity to hold back economic growth. But, it is not absolute, and the laws of political economy continue to apply, even if these actions have dulled them, putting the long wave cycle into hibernation. But, hibernation is not death. What cannot be changed, in the end, are various material realities, such as people must eat to live, and must live to work, and people must work if economies are to function at all, or if profits are to be produced, upon which those asset prices themselves ultimately are determined. The real world always imposes itself eventually over the fictitious world of paper money prices.

For example, in the 1980's and 90's, as many workers found that they could not obtain permanent employment, they were encouraged to become self-employed. It was the period of the big expansion of “white van man”, in Britain, the Gilets Jaunes, in France, and similar phenomenon across the globe. Indeed, as this petty-bourgeoisie was, thereby, expanded, it provided a further socio-economic support base for those conservative parties that were increasingly moving in a reactionary direction, and pushed them further down that track. It was the material basis for Brexit in Britain, Trump in the US, Le Pen in France. But, if we take the “white van man”, it requires that, now, as a small capitalist, they must invest some capital in the purchase of a van. They must also invest some capital, and, if they are even modestly successful, an increasing amount of capital, in stock to be sold from the van. They may even be successful enough to take on additional workers, which again means investing additional capital to pay wages. The increase in asset prices, caused by low interest rates and QE, is not directly of any determining influence to such a person. They do not have sufficient capital to invest in such assets, as to be able to live off any capital gains from them. They might see the price of their house rise, and be deluded into thinking this makes them wealthier, or they might, if they have been successful, plough some money into the purchase of buy to let properties, both to obtain rent, and to obtain actual, realisable capital gains.

As Marx explains, the purchase of land is not a value creating activity. It can act to cause land prices to rise, if the demand increases, but this rise in land prices is not an indication of any additional value created. On the contrary, the higher land prices are, the more capital a farmer has to hand over for that purpose, leaving them with less to invest in actual production. The white van man, or the retired person with some savings, which no longer provide them with adequate income from the interest on it, creates no new value in buying a buy-to-let property, and the higher the price of such properties, then, likewise, means the less they have available to use as actual capital that could be used productively to create new value, and profits. However, any such property that is bought may often require improvements to it, even if only to bring it to minimum standards required to be able to let it. Any such work is value creating. It is the undertaking of new value creating labour. Even this, therefore, feeds into an expansion of the economy. The employment of labour may be required, which means the payment of wages, which they, also, then spend, creating demand for other goods and services, but, even if the landlord does the work themselves, they require materials, tools and so on, which must be purchased, so creating additional demand for these commodities within the economy.

The feature of the prosperity, boom and first part of the crisis phase of the long wave cycle is precisely that all of these subterranean processes lead to an expansion of economic activity, of increased employment of labour, in a multitude of different forms, and, as the amount of labour employed rises, it produces additional revenues, and these additional revenues, then, again, are either spent for consumption, or else they are advanced as capital, and the balance of the proportion of these revenues consumed, or advanced as capital, rises, as against that proportion saved, and subsequently loaned.

Usually, this translates into significant capital accumulation by the large-scale capital that dominates the economy, but all of the repeated liquidity injections after 1987, to reflate asset prices, had already put in place a dynamic, whereby the owners of fictitious-capital, and their representatives in company boardrooms, were more interested in realising capital gains than increased profits from real investment. It was only the huge volume of surplus value being produced that enabled both to continue apace, along with the fact that, in conditions of such strong rising demand, as economies across the globe expanded, the basic law set out by Marx, that competition for market share drives accumulation, forced each of them to do so.

By 2007, the inflation of asset prices had become so extreme that even the slightest increase in interest rates was enough to undermine them. That it broke out in the form of the sub-prime mortgage crisis in the US, was just the specifics of this crisis, and, even without it breaking out there, the crash of 2008 was inevitable. But, the only answer that states and central banks have had since 2010 is simply to print even more money tokens so as to buy ever greater quantities of financial assets, so as to prevent their prices crashing once more. As they have done so, without the revenues on those assets rising, the yields have fallen further and further to the ridiculous stage at which many of the world's bonds now have negative yields, meaning that lenders are paying borrowers to take money off their hands! They do so only because they believe that the price of the bonds will be higher tomorrow, so that the yield is irrelevant, compared to the potential capital gain, a condition they have come to believe is guaranteed, because central banks are always ready to ensure those prices continue to rise. But, what happens when that is no longer the case, when it is no longer possible, or when the owners of bonds, even believe its no longer the case?

The answer is obvious, the owners of those assets, seeing the potential not only of negative yields, but also capital losses, rather than speculative gains, will scramble for the exits. The prices of the assets then crash spectacularly, and that is what happened in 2007/8. There was rising inflation as liquidity injected to inflate asset prices fed into rising commodity prices, pushed higher as supply failed to keep pace with rising monetary demand. Wages also began to rise in sectors, particularly, where there were specific labour shortages. Seeing British truck drivers get a 14% pay rise, Chancellor Alistair Darling appeared on TV to plead with workers not to try to seek pay rises to cover the rising inflation. Rising money wages threatened to squeeze money profits, which meant the central bank printing more money to enable firms to raise prices to avoid that, which means even higher inflation.

Instead, the central banks, sought to kill off the inflationary spiral, by raising their policy rates. That was enough to spook all of those owners of financial and property assets. The immediate effect was on overnight bank rates such as Libor, which sparked a credit crunch, and was the reason that the crisis first emerged in the sub-prime mortgage market amongst those mortgage providers like Northern Rock, who had been providing 125% mortgages, financed by their own short-term borrowing in the money markets. This latter phenomenon was required, because, after years of yields being squeezed, and years of central banks reducing policy rates, the rates of interest paid to savers had fallen so low that savings deposits formed a very low proportion of banks liabilities, used to finance lending.

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