The Problem For and Of The Banks

The problems in the banking sector, seen with the collapse of SVB and Signature, in the US, and Credit Suisse in Switzerland, are not over. The last week or so has seen continued selling of the shares of US regional banks, and further collapses, with larger banks, like J.P. Morgan, having to come in to bail them out or take them over. Further consolidation is inevitable and desirable, but also draws the larger banks closer into the vortex, as in 2008. As I set out recently, the problem is not with the profitability of the banks, as higher interest rates lead to wider spreads between their borrowing and lending rates, or, at least, they should. The problem is in relation to their capitalisation, and the value of assets on their books, and, unfortunately, for the banks, those valuations are also a function of interest rates. The next shoe to drop is property prices.

The problem the banks are facing is this. When interest rates rise, they should become more profitable, because the spread between what it costs them to borrow, and what they are able to charge on loans rises. If interest rates are at 3%, a bank might borrow at 2%, and lend at 4%, but if interest rates rise to 5%, it might borrow at 3.75%, and lend at 6.25%. On £1 million, it originally makes £20,000 profit, and now makes £25,000 profit.

The failure of SVB came as a result of customers taking part in an old fashioned bank run, except that, today, with internet, and electronic banking, customers can sit at home, and transfer money out of their accounts in an instant. To avoid a bank run, banks need to be able to show to customers that they don't need to get their money out, because the bank has sufficient capital to cover their withdrawals. That's why the US Federal Reserve stepped in, a few weeks ago, to assure bank customers that they would not lose money, in the case of a bank failure, because the federal deposit guarantee system would cover all of their deposits. That's a big commitment if all bank customers did panic, and start a bank run, on large numbers of banks.

For SVB, to cover withdrawals from customers, it needed to convert some of the assets held on its books. In particular, it needed to sell some of its government bonds, so as to get cash to hand to customers. The trouble is that, as interest rates have risen, the market price of those bonds has fallen. If the bonds could be held to maturity, they can be redeemed at their face value, of, say, $1,000, but the bank needed the money, now, not in two, five or ten years time, when the bonds were due to mature. Selling the bonds now, in the secondary markets, therefore, means that they can only fetch their current market price, which might be only $800. That left a big hole in the banks actual capital, which only becomes apparent when these assets have to be marked to market rather than to book. A similar problem happened in 2008.

Then, it was the value of property assets held on banks' books, at a time of a preceding property bubble, and impending bursting of that bubble. This time around, it has been a massive bond bubble that was inflated in the preceding period, as a result of an even greater amount of QE, and the bursting of that bubble that has provided the initial tinder for the conflagration. Another flicker of it came with the crisis in UK Pension funds, in the Autumn of last year, when the policies of Liz Truss caused UK interest rates to spike, leading to a sudden crash in bond prices, which left some pension funds with a huge drop in the value of their assets, assets which, with the model of the last 30 years, they have relied on to be able to sell to cover liabilities, on the basis of continually inflating asset prices, and capital gains.

Central banks have stepped in to try to prevent that crisis. Last year, at a time when the Bank of England was supposed to be starting QT, it, instead promised a further £65 billion of QE, to provide a breathing space for the pension funds to deal with their funding crisis. The removal of Truss's government, and subsequent rise in UK bond prices, ended the immediate problem. The ECB, fearing a new crisis for its peripheral economies, as with the 2010 Eurozone Debt Crisis, as interest rates rose, sharply, for economies in Greece, Portugal, Italy and Spain, also introduced a new programme of QE targeted at the bonds of those countries, to stop interest rates for them rising, sharply, as against those in Germany and other Northern European countries. In the US, the Federal Reserve has used its open ended backing for the FDIC's guarantee of deposits, along with encouraging the larger banks to bail-out the regional banks, whilst in Switzerland the Swiss National Bank, first tried bailing-out Credit Suisse, and then facilitated its take over by UBS.

But, that is not the whole problem, and so, in the last couple of weeks, we have seen US regional banks continue to come under pressure. The huge US banks are under continual scrutiny from the Federal Reserve. But, they also have larger resources, anyway. But, there is another difference, and that is that these huge national banks, tend to hold different kinds of assets, and liabilities. They are able to borrow more cheaply in money markets, and when they lend money, a greater proportion of it is to large corporations. This where the issue of R* and R** that I wrote about a while ago also comes in.

Why do interest rates rise? Real interest rates rise because the demand for money-capital rises relative to the supply of money-capital. In short, when the economy is expanding more rapidly, the demand from businesses for money-capital to finance the purchase of buildings, equipment, materials and labour-power rises at a faster rate than the increase in realised profits, which supplies the money-capital for that purpose. Those that obtain revenues, be they wages, rent, interest or profit of enterprise, in excess of what they require to finance their current consumption, or who have savings from previous such excess, can be incentivised to lend it by being offered a higher rate of interest for doing so.

Nominal interest rates can also rise as a consequence of inflation, which acts like depreciation. In other words, if I have £1,000 to lend, and the current rate of interest is 3%, but inflation is 10%, at the end of a year, when I get back the £1,000, it will only be actually worth £900, in today's terms. It will have been depreciated by 10%, just as with, say, a machine, whose value falls by 10% over the period of a one year lease. If I lease the machine, I would want to cover that £100 of depreciation, as well as the normal interest of £30, and so would want back £1,130. In the same way, if I lend £1,000, I will want back £1,130, to cover the depreciation of the capital, plus the normal interest. It will look as though the rate of interest was 13%.

So, if businesses, in a more rapidly growing economy, demand more money-capital, interest rates will rise. Consumers might also demand more money to finance the purchase of more expensive consumer durables, such as cars. Banks lending money for such purposes, then, can charge higher rates of interest for these loans, and, as described above, when this happens, the spread between what they pay to borrow, and what they charge to lend, grows wider, and so their profits expand. As their costs for things like bank buildings, equipment, and wages have not changed, these bigger profits mean a larger rate of profit. Indeed, for the bigger banks, the latest earnings season has seen these bigger profits, and rates of profit.

But, the picture is different for the smaller, regional banks. In the US, these regional banks are more akin to the Building Societies that existed in the UK up to the 1990's, and early 2000's, when most of them converted into banks. They rely more on deposits from savers, be they local businesses or households, rather than on financing from operations in the money markets – when they did do that, as with the UK's Northern Rock, prior to 2008, they were hammered when the costs of that short-term borrowing soared, due to the credit crunch – and to retain those savers, or attract more of them, they need to pay higher rates of interest on deposits. Here is where the problem for them resides.

The vast bulk of the loans these banks have made, not just in the US, but also in Britain and the EU, as well as across the globe, has not been to finance capital accumulation by businesses, nor consumption by households. Around 90% of it has been to finance the purchase of property, or other forms of speculation in property. So, whilst these banks could take advantage of wider spreads, as interest rates rise, on loans to businesses, they have an obvious problem charging higher rates to people who have borrowed money to buy a house.

A business seeing the demand for its products and services rise sharply, and the prices it can charge for them, can afford to pay more interest to borrow the necessary money to expand. But, someone who has borrowed money to buy a house, build houses and so on, sees no such ability. Indeed, as interest rates rise, and property prices fall, builders see their own profits drop. In the US, UK, and the EU, as well as in China and other parts of Asia, as interest rates rose, and mortgage rates rose, the demand for mortgages fell sharply, and property prices dropped. Yet, those interest rates are not yet covering the continued high levels of inflation.

In addition, as I have set out before, investment in large scale fixed capital tends to be lumpy. Take something like provision of broadband infrastructure. For a country, it requires a huge investment in fibre optic cables, switching gear and so on, all of which takes place in a relatively short-time. But, you don't build it only to cover current requirements. Once built, the traffic along it can increase every year for many years without any substantial additional investment. The same is true for a business that puts in place its own IT infrastructure, and so on. And, fixed capital can always be used more extensively and intensively, by introducing shift systems, and so on. So, output can increase significantly when demand rises, without any additional fixed capital investment, or borrowing to finance that investment.

What does increase is investment in circulating capital. In other words, businesses may be able to continue using their existing fixed capital, but will need to buy additional materials, and employ additional workers. However, the nature of this circulating capital is that, often, it can simply be financed by an expansion of commercial credit, which always expands in periods of economic expansion, and requires no additional borrowing. But, even where it can't be financed simply from an expansion of commercial credit, often firms can simply finance it out of their own profits, particularly where those profits are themselves expanding in real or nominal terms.

Consequently, a sluggish increase in bank lending to businesses need not reflect any considerable economic weakness. But, overall bank lending figures are even less a guide, given what has been said above, because with a large part of that lending going to finance property purchases and speculation, it simply reflects the fact that rising interest rates are hitting demand for mortgages and property. There is a big difference between that, and lending to finance either business investment, which creates additional employment and aggregate demand, or consumption, which increases consumer demand, and thus leads to business engaging in additional investment to meet it. The majority of house purchases are for existing properties, not new properties.

The appropriate response to the rise in interest rates in relation to property is a fall in property prices. That would mean that demand for mortgages, and for property would then recover, at these lower prices. It also means lower land prices, which, today, account for a disproportionate amount of the cost of building new properties. A fall in land prices would not only reduce the price of new houses, so encouraging additional demand, but it would boost builders rate of profit, stimulating additional supply, and employment, giving a further boost to the economy.

However, its clear why the banks that have built their model around continually inflating asset prices, and which have focussed 90% of their lending on property, do not see things that way. Higher mortgage rates, until such time as property and land prices adjust, means smaller demand for them, and so less profit for the banks. It might also mean that some existing borrowers cannot pay their mortgages and default. But, even without that, a large part of the capital on the banks' balance sheet is in the form of the property held as collateral against the mortgage. Just as with SVB, and rapidly falling bond prices, rapidly falling property prices would again hit their balance sheet requiring them to raise large amounts of capital from share or bond issues.

Banks that have built their model on lending to finance property purchase and speculation find they cannot raise their mortgage rates, because it would choke off demand for mortgages, and would also cause property prices to crash. That is not just the case for residential property, but also for commercial property, the demand for which has already been hit by the fact of people working from home, during lockdowns. If banks can't charge higher levels of interest for these mortgages and property loans, they also can't pay higher rates of interest to the savers they now need to retain and attract. It doesn't require customers to fear a bank run, to bring about a significant fall in deposits. Savers can get a higher rate of return on short-term money market funds than they can get on their savings in a bank.

So, this is the problem faced by the banks. They should be making bigger profits in this environment, on the basis of wider spreads, but for many of them, that isn't happening, because their model is based on lending for property purchase and speculation. Higher lending rates for that will crush demand for loans, and also bring about a crash in property prices, and so impact the balance sheets of the banks, as happened in 2008. To hold down those lending rates, they have to hold down deposit rates, and that makes them uncompetitive with money market rates, leading to a drain of funds, which undermines that capital base, requiring either additional capital raising or bail-outs, sharp drops in their share price, and take over by larger banks, which then get sucked into this maelstrom.

And, that creates problems for central banks. Central banks have created inflation as a result of excessive liquidity creation. To reduce that inflation they need to reduce that excess liquidity, which is what QT should do. However, QT, by preventing firms from raising prices, hits the profits of those firms, as they face higher wages, as a result of the demand for labour exceeding supply. It also means that, instead of buying bonds, central banks have to sell them, increasing the supply of them in the market, causing their prices to fall, and yields to rise.

That would also lead to a fall in share prices, and property prices. Given that the ruling class now owns all of its wealth in the form of these assets (fictitious capital), it is keen not to see that happen, as occurred in 1987, 2000, and 2008, and so its state, via the central bank does all it can to avoid it. Hence QE, and hence the variations of it, in the last year, even at a time when central banks were supposed to be engaging in QT, and were simultaneously raising their interest rates in an attempt to cause recessions, and so slow the pressure on rising wages.

But, the rising inflation means that even with the rise in central banks nominal interest rates, those rates are still significantly negative. So, consumers still have an incentive to spend their incomes rather than save them, especially as rates on deposits are only a fraction of central bank policy rates. Firms have an incentive to continue to expand to satisfy rising demand for their goods and services, especially as they can finance most of it from commercial credit, or else from their rising money profits.

So, the inflation in the system continues, even if it moderates slightly from earlier levels, and central banks then have a problem that if they raise their policy rates further, it simply causes bond prices to fall, and puts further pressure on those banks that cannot raise their mortgage rates accordingly, for fear of choking demand, and causing defaults and a sharp drop in property prices. They face the potential that what it costs them to borrow in capital markets becomes greater than what they can charge on their mortgages, and they can't even keep let alone attract additional deposits from savers, because they can't increase their deposit rates, whilst savers see the ability to get much higher yields on money market funds, and the purchase of short term Treasuries.

Central banks are being posed with the options of either giving an open ended commitment to bail-out these banks as they see their deposit base disappear, or else to engage in even more QE to push up bond prices and try to reduce yields, which would lead to a surge in inflation, once again, or to pivot and reduce their own policy rates, despite having failed to reduce inflation.

Another Huge Dose of QE

Last Friday morning, I wrote about the crash of SVB before most people had ever heard of it. By today, nearly everyone with money in a bank has heard of it. When I wrote about it on Friday morning, the bank had not yet gone bust, but its shares had collapsed, as it went to the capital markets to try to raise nearly $2 billion from new shares, to cover its capital losses from a forced sale of Treasury Bonds. Not surprisingly, few wanted to buy the new shares, and its depositors started a run in the bank, similar to that in Northern Rock, in 2007, except now, with electronic banking, you can try to shift your money at the press of a computer key. The bank became insolvent, and the authorities closed it down, leaving them with the question of what to do next.

In the hours following the closure of SVB, other similar small banks were forced to close their doors, such as Signature Bank in New York. But, dozens of small US regional banks have also seen their share prices crash, and the crisis-ridden European banks have also seen a continued sharp fall in their shares, in early Monday trading. The basic reason for the problem is what I explained more than a decade ago, and again summarised on Friday. The huge asset prices bubbles blown up as a result of central banks creating excess liquidity over the last 30 years, to protect and enhance the form of property of the ruling class – fictitious capital – means that the balance sheets of banks and finance houses are themselves a fiction, because the book value of the assets sitting on those balance sheets, massively overstate any real value of them, which is manifest whenever a crisis erupts, as in 2007/8.

In theory, the value of the Treasury Bonds on the books of SVB, provided it with adequate capital that could be used to cover any trading losses or deposit withdrawals by its customers. But, that ws only true provided those bonds could be sold at their book value, or at their nominal value if held to maturity. The problem is that, when the bank did face a requirement for cash to cover trading losses and deposit withdrawals from customers, it could not wait a year, 5 years, or 10 years for those bond to mature, so as to redeem them at par. It had to sell some of them immediately. But, as interest rates have risen the market value of those bonds has crashed, meaning that it would suffer a huge capital loss on the sale, of around $2 billion. Other banks, and not just small banks are in the same situation.

The problem also arises because the structure of banking and finance has changed over the last 30 years along with this action by central banks to create huge asset price inflation, via the injection of excess liquidity. Banks used to operate by having shareholders provide a large chunk of the bank's capital; they also used to rely on depositors to put money into the bank, which they used alongside that capital to make loans. The loans themselves also used to be to finance things like real capital accumulation by businesses. Where they made loans to consumers for things like buying a car, the car and so on, acted as something that could be used as collateral and sold to redeem the loan value. Even with mortgages, the loans were limited, usually to just 2.5 times the household income of the borrower, and then only after the borrower had shown they had been able to save a considerable amount, so as to provide at least a 10% deposit to buy a house.

But, in the 1980's, as a result of the deregulation brought about by Thatcher, in Britain, and Reagan, in the US, all that changed. Prior to the 1980's, the large majority of people, in Britain, lived at home with their parents, until they got married, usually in their mid 20's, before they would consider buying a house, or applying for a council house. A comparison of household composition over time illustrates that point.

In 1971, 79% of UK households were multi-occupancy, 70% were occupied by married couples. Only 19% were occupied by single people, with a further 2% occupied by lone parents. By 2011, those figures had changed drastically. Only 59% were multi-occupancy, the number of married couples had dropped to just 40% with a further 12% co-habiting, and another 7% other multi-occupants. By contrast, the number of homes occupied by one person had almost doubled to 33%, with 8% occupied by lone parents. Of the 19%, in 1971, that were single occupancy, the majority of those were old people who had lived in the house for a long time, and whose families had grown up and left, and spouses had died etc.

The fact that borrowers could only borrow 2.5 times their combined income, limited how much they could offer to pay for houses, and that put a limit on how fast house prices could rise. But, when Thatcher deregulated financial markets, in 1986, this limit on borrowing went. Now, the limit on how much you could offer for a house depended not on how much your income was, directly, but on how much you could afford to spend each month on a mortgage, and that depended on mortgage rates. In the 1980's, banks and building societies also introduced interest only mortgages, which further exacerbated that. As interest rates fell throughout the 1980's, and 90's, so the amount borrowers could afford each month on a morgage translated into larger and larger mortgages, which in turn meant they could offer larger and larger amounts for houses, directly pushing house prices higher.

It was also manifest in the fact that not only did banks and building societies, then, enable borrowers to borrow many, many more times their income, but they also gave mortgages for more than 100% of the market price of the house, on the basis that house prices would continue rising significantly each year, enabling them to get their money back, if they needed to foreclose. With everyone encouraged to borrow, whether to cover consumption, or to speculate – be it on a house, or to buy shares, PEP's, ISA's or private pensions – and no one saving, the banks and building societies increasingly financed their own lending, by borrowing themselves in capital markets. They loaned money long, at higher interest rates for mortgages and so on, but borrowed short, at lower interest rates, making a trading profit on the difference in rates.

But, that model collapsed overnight in 2007, when Northern Rock and other banks and finance houses found that overnight borrowing costs soared, as a credit crunch developed. The interest rates at which they could now borrow, were higher than the interest rates they were charging, and often locked into on the loans and mortgages they had provided, leaving them with trading losses, and a lack of liquidity. In reality, however, that lack of liquidity was a result of a lack of capital. But, that was just one aspect of the change that had occurred, because, now, 90% of bank lending went to finance this kind of property speculation that depended on ever rising house prices, with very little going to finance real capital accumulation by firms, particularly small firms, who found they could only borrow by much more expensive means, using personal credit cards, overdraughts, and so on.

Ironically, big companies that could borrow easily by issuing their own corporate bonds, did so, and enjoyed low rates of interest on those bonds, as asset prices rose, but used the proceeds, largely, not to finance real capital accumulation, but to finance the buy back of shares, inflating share prices, as part of the ever upward spiral of asset prices. And, although this fiction, based upon an ever expanding web of inter-connected debt instruments was exposed with the crash of 2008, unlike previous financial crashes, such as 1847, 1857, or 1929, this time, the state and central banks acted to simply reflate those asset prices, and so restore the paper wealth of the ruling-class, which owns its wealth, now, in that form, even at the cost of destroying the real economy, with austerity, the use of tax to buy up the worthless paper assets, and bail-out their owners, to inflate the currency by even larger amounts, so as to buy up and inflate the asset prices, and to hold back economic growth, whether by austerity, trade restrictions, or physical lockdowns, so as to hold down interest rate rises, which cause asset prices to fall.

In 2007, at its height, before the crash, the Dow Jones was at 14,000. Until recent falls it was at 37,000, and is still at around 33,000, or around 2.5 times its level at the bubble top. It fell to around 6,500. Even that was secured, only, by huge levels of support by the state asset purchase programme, and central bank intervention. But, compared to that, its now more than 5 times that level, almost entirely due to the actions of the central bank in inflating the currency supply, and the liquidity being diverted into speculation in assets.

And, all of the house of cards of derivatives that led to contagion in 2008, and during the Eurozone Debt Crisis of 2010, is still there. Back in 2013, I noted the reports that Germany's Deutsche Bank had exposure to around €55 trillion of derivatives, an amount equal to the entire global GDP. The position has not improved, but been papered over, and now we have other large European banks like Credit Suisse teetering on the edge. Its shares have been falling for months, and today, as bank shares continue to be hit, they have fallen another 12%, to just 2.20 Swiss Francs.

The response is again to rely on central banks not to raise interest rates further, and to engage in another bout of QE to bail out the banks and reflate asset prices, even though that is the cause of the problem, and also of the high levels of commodity price inflation also now afflicting the global economy. SVB Bank in Britain has been bought by HSBC for just £1, showing that the British government can drop its objections to Chinese interference when it wants to! States have generally said that depositors in SVB will be guaranteed 100% of their deposits, and not just what is guaranteed under various existing deposit guarantee schemes.

Depositors should be protected 100%, because, if you put your saving in a bank, you should expect that they are safe, and that the state is ensuring that by properly regulating the banks. Its not like speculating, in which you know the risk that you might lose some or all of your money. In addition, such guarantees are necessary to ensure the circulation of money, and so also of capital and commodities, required for the continued operation of the real economy. Businesses have money from sales going into bank accounts continuously, and similarly going out to make payments to suppliers, workers and so on. There is no reason why a financial crisis, resulting from speculation in assets should be allowed to affect that.

Or take someone selling a house. The money from the sale goes into their account, or into the account of the conveyancer. If that money in the account was not fully guaranteed, people would be unwilling to even engage in buying and selling their houses, if they feared at any time, the bank might collapse, and they would lose their money. This protection of deposits, and of the continued operation of the mechanism of liquidity circulation is the responsibility of the state, and quite separate from any speculative losses that individuals or institutions might suffer from the fall of various asset prices.

In the US, the Federal Reserve has now said that banks that require liquidity, and who face the same problem as SVB that if they sell bonds, they will suffer large capital losses, can now sell those bonds to the Fed at par. In other words, this is a new large dose of QE. The Fed is agreeing to buy Treasury bonds from banks at their face value, even though the current market value of those bonds might be only a fraction of it. The Fed will have to print more money tokens to be able to buy up those bonds, i.e. QE. This is at a time when it and other central banks were supposed to be stepping up QT!.

So far, this Bank Term Funding Programme is limited to $25 billion and lasts for a year. But, much more than that is likely to be required. The following chart shows that US Banks have securities the current losses on which, if they had to realise them, via sale, would amount to around $600 billion.

The speed with which that potential crisis has developed, is also indicated in the chart. But, SVB, and other small banks, plus what happened last year, with UK Pension Funds, shows just how quickly the crisis can erupt, as banks and other financial institutions have to sell assets whose prices have been grossly inflated, as a result of speculation driven by excess liquidity, and a global economy that has increasingly been driven not by the needs and laws of real capital, but purely by the requirement to keep asset prices inflated, so as to protect the form of wealth of the ruling class.

It indicates the extent to which that ruling class is now simply parasitic on the real economy, on the further development even of capital.

SVB Crash and Bank Capitalisation

Silicon Valley Bank (SVB), yesterday saw its share price crash by 60%, as it was forced to raise additional capital, by issuing $1.75 billion of new shares to shore up its balance sheet, following a capital loss of $1.8 billion from having to sell bonds with a value of $21 billion. The bonds, mostly US Treasuries, were yielding 1.79%, compared to the current yield on US 10 Year Treasuries of 3.9%. The crash spread panic across the US banking sector, with US bank shares dropping by around 6%, wiping $80 of their share prices. So much for banks being well capitalised following the lessons of the 2008 crash.

SVB has not gone bust, as with Lehman's in 2008, but it has had to raise capital to stay in business, i.e. it has had to sell a load of new shares to draw in additional capital, to plug the capital loss. This illustrates many of the things I have discussed over the last 15 years since the 2008 crash. Firstly, it shows the difference, highlighted by Marx, between profits and losses (resulting from surplus value), as against capital gains and losses (resulting from changes in prices). For a company that produces commodities, its profits (assuming prices equal exchange value) is a function of the surplus value produced by the labour it employs. If that labour produces more new value than the value of the labour-power (wages), it produces surplus value/profit. If it produces less new value than the value of the labour-power/wages, it results in a loss.

But, a firm might also benefit from having paid, say, £1 a kilo for the cotton it uses to produce yarn, whilst the price of cotton rises to £1.20 a kilo, by the time it sells the yarn, and which is reflected in the price it charges for the yarn. That would not change the amount of surplus value the firm's labour produced, but would appear as additional profit, when, in fact, it is merely a capital gain of £0.20 per kilo resulting from the change in the price of cotton. If the reverse happened it would result in a capital loss.  (See: The Tie-Up and Release of Capital)

For banks, their raw material is not cotton, but money itself. Their profit is made from the difference between the interest they pay to borrow money, and the interest they receive from lending money. Consequently, its often been argued that in conditions of rising interest rates such as those we have now, it benefits banks profits, because it widens the gap between the two. However, the other effect of rising interest rates, as I have set out in numerous posts, is to cause asset prices to fall. Because banks and financial institutions hold capital on their balance sheets in the form of financial assets, when interest rates rise, and these asset prices fall, they make capital losses.

If we take a government bond, as with those that SVB had to sell, a 10 Year US Treasury might have a face value of $1,000. The coupon interest rate on it, may be 2%, i.e. it pays $20 in interest each year to the holder. If held to maturity, the holder also gets back the $1,000 face value of the bond. However, bonds, like shares, are bought and sold in secondary markets. If interest rates are rising, the buyer of a new $1,000 10 Year US Treasury might get $30 in interest on it. That means the value of existing US 10 Year Treasuries fall. No one would want to pay $1,000 for these existing bonds, and get only $20 of interest a year, when they could buy a newly issued bond for $1,000, and get $30 in interest a year.

So, the market price of bonds falls. However, if the holder of those bonds holds them to maturity, whilst they will be losing out on $10 of interest a year, compared to the current rate of interest, they will avoid making a capital loss on the sale of the bond. Bond prices would have fallen to $666, from $1,000, creating a capital loss of $333, if they sold it in the market. This is the problem that SVB faced, and it was also the problem that British pension funds faced last Autumn following the sharp rise in interest rates, and fall in long-dated bonds, as a result of Truss and Kwarteng's Voodoo Economics.

SVB is not the only bank to have crashed in recent weeks, as interest rates have continued to rise, and asset prices fall. As I have set out previously, last year saw the biggest ever fall in bond prices in history, and when I say in history, I don't mean in the way the media usually mean, of in the last ten or twenty years experience of young journalists, but, literally, the biggest drop ever. Am I surprised? No, because I have been pointing out for the last 15 years that this was inevitable, and that despite all the assurances from central banks and governments that 2008 would not happen again, because banks balance sheets had been recapitalised and so on, it inevitably would. It would not happen in exactly the same way as in 2008, but it would happen, because the underlying causes of 2008 of massively inflated asset prices, be it shares, bonds, property or anything else that people can speculate in, had not been resolved. On the contrary, a look at the rise in global stock markets of around 150%, even from the peak of the 2007/8 bubble, the $18 trillion of bonds, globally, that had negative yields, the inflation of property prices once more, and so on, showed that it had grown much worse. All of that huge inflation of asset prices has been caused by the printing of excess money tokens and creation of credit.

As I stated more than a decade ago, the supposed recapitalisation of banks, particularly in Europe, following the Eurozone Debt Crisis of 2010, was a mirage. The capitalisation took the form of the assets on the banks balance sheets, and those levels of capital were flattered, precisely by the inflation of the prices of those assets. Again, that is precisely what has been shown now in relation to SVB, and undoubtedly many more will follow. These assets on bank balance sheets are valued at the prices the bank paid for them. As seen, if bonds are held to maturity, the holder can get back the face value of the bond. However, as a result of the idiocy of negative interest rates, some bonds were sold at prices higher than their face value. So, if you had paid $1,100 for a 10 Year US Treasury with a face value of $1,000, even holding it to maturity would still leave you with a $100 capital loss.

So, the capital adequacy of many banks is a fiction, and so are the so called “Stress Tests” carried out on them by central banks. Banks do not hold sterile assets if they can avoid it. In other words, they hold government or corporate bonds that pay interest. The investment banking side of banks and finance houses, of course, also hold shares in companies, and as with all such speculators over the last 30 years, their attention turned away from the revenue they could obtain from these assets (interest, dividends, rent) to the capital gains that could be obtained as asset prices continually rose due to the implementation of QE, and other methods of creating excess liquidity. But, now, as liquidity has sloshed out into the real economy, and inflation has risen, central banks have had to try to curtail that excess liquidity.

Their preferred method is to try to reduce inflation, by, again, hitting workers. The interest rate rises they have introduced have been designed to try to slow the real economy, causing workers to be unemployed, so that they do not demand higher wages to cover rising prices, and also to dampen demand so that firms do not expand, and demand additional capital causing market rates of interest to rise. It hasn't, and will not work, in current conditions, for the reasons I have set out in previous posts. The real means of reducing inflation would be to curtail liquidity by reversing QE, and implementing QT, but central banks will not do that aggressively, as it would lead to a squeeze on profits from higher wages.

So, they are stuck. They have to keep raising their policy rates, but, doing so hits asset prices far more than it slows the economy, or dampens inflation, as the current data on jobs, retail sales, and inflation shows. As asset prices fall, the true extent of under capitalisation of banks and financial institutions is again revealed, and especially, when, as with SVB, they are forced to sell those assets at market prices, which are now much lower than the book value of those assets on the balance sheet. That is also what happened in 2008. It is also what happened on an even bigger scale in Japan in 1990, when asset prices crashed, and with property prices crashing 90%.

SVB has been highlighted, because it is in Silicon Valley with a lot of high net worth customers. It has also suffered, as a creditor to a number of tech start ups, from the fact that following the ending of the tech boom created by enforced lock downs, the share prices of many of those companies has crashed, and the large expansions they undertook have been cut back. If you had invested in a bond fund that you saw producing a yield of just 1.79%, whilst you see the possibility of getting 4%, by simply buying a US Treasury, you will want to take your money out of the fund, and buy the Treasuries. That creates pressure from redemptions on the fund, an so, when banks and other financial institutions, then, have to sell the bonds in those funds, to meet the redemptions of customers, they have to sell them at current market prices, and not the face value. That is what happened to SVB, but it will no be alone.

And, nor is it just in relation to bonds. As interest rates have risen so also share prices have fallen, though by nowhere near enough to remove the froth in that asset class. 90% of the lending of banks has gone not to finance capital investment by businesses, but to finance property purchases and speculation. Recent UK data shows that sellers have been reducing asking prices for houses by an average £14,000 in recent months, as the effects of rising interest and mortgage rates take effect. Yet, you still see the adverts for all of the equity release scams. This time the lenders on these scams are likely to be the ones burned. They lend money to the unwary against the value of their house, on the basis that when they die, the lender gets their money back plus a large wodge of interest on it, from the proceeds of selling the house. The premise, as with the 125% mortgages provided by Northern Rock prior to 2007, is that house prices continue to soar. But, a sharp fall in house prices would leave them trying to get their money back from houses whose value might, then, be lower than the amount they loaned.

It might be said, as with 2008, that the problem is the complexity of financial systems, but that complexity arose to try to get around the underlying problem. Mortgage backed securities arose to get around the problem that some mortgages were a bad credit risk, but by bundling them with other mortgages the risk was spread. It allowed the paper chase to continue, but the real problem was the fact that money had been lent to buy properties whose prices were way too high, and caused buyers to go into unsustainable levels of debt compared to their earnings. It is the fact that asset prices have been astronomically inflated, and that the balance sheets of banks and financial institutions are a fiction based upon those inflated prices that is the real problem, and as higher interest rates now cause those asset prices to fall, that underlying problem is again exposed.

Following the Eurozone Debt Crisis, and crash of a number of EU banks, I pointed out that the actions of the ECB in simply increasing liquidity, pumped into those banks was a sticking plaster over the real problem, which was their lack of adequate capital. The ECB produced one scheme of QE after another under different names, and continued to do so up until this year. Europe has a further problem, which is that it has too many banks, which need to be rationalised into a smaller number of bigger banks, with better capitalisation.

Following the sharp drop in US bank shares yesterday, the price of bank shares in Asia also fell sharply overnight, and as trading began in Europe this morning drops of around 6% were seen there too in bank shares. The shares of some of those banks whose precarious condition I have set out before, such as Deutsche Bank, fell even more. As with 2008, and as with the crisis faced with UK pension funds last year, the interconnected nature of banks and financial institutions means the danger of contagion is ever present. It hasn't just been bank shares that fell, but stock markets overall have fallen by around 2% in the last 24 hours. It shows the insane nature of this casino as against the real economy, and yet it is the casino that central banks and states have nurtured in the last 30 years, at the expense of the real economy. That is because the ruling class owns its wealth in these fictitious assets, rather than in the form of real capital.

As the gamblers in the casino again lose their shirts, workers should not be too worried about it, but must instead insist that the madness there not be allowed to affect the real economy. We need to ensure that the banking system, as a transmission mechanism for currency and means of payment, continues to function smoothly, which is why it should be separated from the lending and speculation sides of banking and finance. We should refuse to allow the state to impose austerity or other means of compensating the speculators for their capital losses, as happened in 2008. If banks collapse, their workers should be allowed to simply take them over, and run them as cooperatives, and we should bring hem all together in one large financial cooperative designed to meet the needs of workers rather than speculators.

Jobs, Wages, Sales, Inflation, Profits, Interest Rates and Asset Prices

The data continue to confound the ruling class speculators and their ideologists and media propagandists, as well as frustrating the catastrophists, who had foretold of a post pandemic slump, as the latest instalment of their permanent crisis theory, in which the next recession is always at hand.

The US non-farm payrolls, for last month, as previously noted, soared by more than half a million. But, week after week, the number of US initial jobless claims, also continues to come in at less than 200,000, and often below the estimates too. Indeed, the trend for jobless claims has been steadily downward, rather than upwards, dashing the hopes of the speculators, and those like Larry Summers, who hope that the rate hikes introduced by the Federal Reserve would cause firms to slow down, and start sacking workers, so that pressure on wages and interest rates would abate, so that asset prices could be inflated again.

US wages are also rising at over 5%, which with the increased number of workers, increased number of hours, and all of the liquidity sitting in bank accounts, left over from lockdowns, means that the US consumer is still spending too. The figures for US Retail sales (ex autos), published last week, showed it rising by 2.3%, month on month, in January, and that is the largest increase since March 2021. Retail sales are now back above the trend from before lockdowns.

 

As all of this liquidity continues to flow out into the real economy, its clear that employment is a leading indicator in current conditions, whereas the sentiment indicators, have become increasingly divorced from the real economy. The sentiment indicators, suggesting declining activity, have been repeatedly shown wrong, because those that contribute to them are simply reflecting impressions taken from a doom laden media that has been forecasting recession and slow down for months.

And, the latest US producer prices data, also, shows that with employment rising, wages rising, sales rising, and economic activity increasing, it continues to pass through into the demands for inputs, and now, second or third round effects on producer prices begin to feed through, even before we get the main effects of rising primary product prices, as China comes out of lockdowns, and its economy gets into full swing. US Producer Prices rose by 0.7%, month on month in January, the most in seven months, and nearly double the estimate of 0.4%. Producer prices mostly affects goods inflation, which has been declining in recent months, whilst services inflation continues to increase.

This spike in producer prices suggests that, what has been said before about waves of inflation, is playing out, as the ground is being set for a new wave of goods price inflation, in coming months.

Meanwhile, for consumer price inflation, the data showed that it remains far higher and stubborn than had been predicted. Estimates were for it to drop to 6.2% year on year, but if fell only from 6.5% to 6.4%, and month on month, it rose by 0.5%, compared to just 0.1% the previous month. And, core inflation appears to be even more sticky.

That is tricky for the Federal Reserve, which had been looking to step down the level at which it was hiking rates, having moved from 75, to 50 basis point hikes in recent months, and down to just 25 basis points in February, with speculators hoping it might have been the last, and even that it might cut rates later this year. That looks impossible, with even thought that it might have to go back to a 50 point hike at the next meeting, and certainly that it will continue hiking for longer, and reach a higher terminal level.

But, even that is still being underpriced. Stock markets have basically gone nowhere in recent weeks, despite the potential for continued higher rates. The speculators continue to hope that firms will lay off workers, wage pressures will be reduced, and so the pressure on profits will be reduced. But, there is no indication of that happening, and the reality is that material conditions have changed fundamentally. In the US, Biden has used the power of the state to impose terrible wage deals on rail workers, and has sought to do the same with dockworkers, but US workers, like workers across the globe have had enough, and sense firmer ground beneath their feet, as economies expand, and relative labour shortages have developed. As firms see sales continuing to grow, especially in service industry, they continue to need additional workers, and are having to pay up to get them.

Those rising wages impose on profits, but, so far, firms have been able to utilise the excess liquidity that central banks have created to simply raise prices. Rising prices of materials and energy has led to a tie-up of capital, which appears to be a slower growth of profits, because a portion of surplus value is used, now, to replace consumed constant capital, at these higher prices, rather than appearing as realised profit, or dividends/interest and so on. With prices rising faster than hourly wages, even as total wages rise, therefore, a part of this tie-up of capital is covered by an increase in the rate of surplus value. But, much as happened in the early 1960's, a comparable period to that we are now in, workers will begin to close that gap, and then go beyond it.

As noted a few weeks ago, Rolls Royce workers in Britain won a 16.9% pay rise, and London bus workers at Abiello, have won an 18% pay rise. The struggle of US dock and rail workers is not over, despite the attempts of Biden and the Democrats to suppress them, and across the US, large numbers of workers are unionising in areas they have previously been unorganised, and are demanding pay rises to compensate for the high levels of inflation. As US workers, like those in other countries win these pay rises, squeezing profits, firms will again, seek to compensate by raising prices, and the central bank will accommodate them by increasing liquidity further, causing inflation to rise in yet another wave.

Only if they temper the increase increase in liquidity, will they be able to prevent a price-wage spiral, but that will mean, as happened in the 1960's, and into the 1970's, that profits will be squeezed. That squeeze on profits, at a time when firms continue to have to accumulate capital as rising demand for wage goods, pushes the economy forward, means that the demand for money-capital rises relative to its supply, pushing interest rates higher. It means that asset prices have much further to fall, despite the current complacency. In fact, already, with 10% inflation, asset prices are already 10% lower, in real terms than their nominal prices suggest. As in the 1960's, and 70's, those asset prices will fall, both as a result of actual falls in nominal terms, via a series of crashes, and steep declines, and as a result of a prolonged fall in real terms, extending over a couple of decades.

How Liquidity Flows From Asset Markets Into The Real Economy - Part 10 of 17

Going back to land used for agricultural/primary production, the demand for this land depends upon the amount of such production to be undertaken, and that depends not only on the demand for such production, but the amount of that demand satisfied by other producers, i.e. the import of cheaper agricultural/primary products. If market prices fall, because cheap imported agricultural/primary products are available, then surplus profits/rent on domestic production will fall, and land prices will fall along with it. That is why landlords opposed the Repeal of The Corn Laws.

Land prices have risen astronomically, along with the prices of other assets, over the last 40 years, but the cause has not been increased surplus profit/rent, but falling interest rates, leading to higher capitalised values of those rents. But, that is not the only, or main, cause. As Marx points out, landowners do not have to rent out the land they own, or sell it, for agricultural/primary production purposes. They can sit on it, or rent it, or sell it for other purposes, where a higher rent or price can be obtained. So, when property prices soared, beginning in the 1980's, and then again in the late 90's, the surplus profit available to builders rose sharply, but this surplus profit, was then absorbed as rent/land prices appropriated by landlords. After WWII, in Britain, land accounted for about 10% of the cost of building a house, whereas, today, it accounts for around 70% of the cost.

If the average price of a new house is £300,000, then £210,000 of this is accounted for by the price of the land, and the other £90,000 by the cost of production, and profit. Assume the rate of profit is 100%, so that it is equal to £45,000, and represents an annual rate of profit of 30%, on advanced capital of £150,000. If land fell back to being just 10% of the cost, that would be only £10,000, reducing the cost of the house to £100,000, assuming £45,000 profit. But, for the builder, before they start building, and commit capital, they must also consider the price of the land, which appears to them as much a cost of their production, as the bricks and other materials, and labour-power they must employ. The actual capital they had to advance, to build the house was, then, originally, £360,000, including the price of the land, giving an annual rate of profit of 12.5%, which we will take as being the average annual rate of industrial profit.

So, now, to make this average rate of profit, on advanced capital of £160,000, the profit falls to just £20,000, so that the price of the house falls to just (45,000 + 10,000 + 20,000) = £75,000, or a quarter of its current price. Of course, at this much lower price, the demand for houses would increase substantially, because all of those millions of people who cannot, now, afford to buy, or even to raise a sufficient deposit, would be enabled to do so. All those who seek to solve the housing crisis on the basis of increasing supply, must, first, address this question of land prices, so that builders can produce many more houses at prices that would still enable them to make the average annual rate of profit on their advanced capital. And, to address the question of land prices it is necessary to burst the existing property bubble inflated on the back of artificially low bond yields, caused by inflated bond prices from QE, and to end the absurdity of large amounts of land that could be used for development, in the Green Belt, being sterilised from such use.

A builder will be prepared to buy land at these inflated prices, if they know that they can sell the houses they build on it at £300,000, because that is what existing houses of that type are selling for, and it is these sales of existing houses that determine the market price. Sales of new houses, account for only about a seventh of total house sales, each year. To reduce the price of new houses, its necessary to reduce the price of land, and to reduce the price of land its necessary to reverse the inflation of the price of existing houses, which arose on the back of excess liquidity directed into that sphere.

Back To Part 9

Forward To Part 11

How Liquidity Flows From Asset Markets Into The Real Economy - Part 9 of 17

Let us begin with agricultural/primary production on land. The rent charged consists of absolute rent and differential rent. Both arise on the basis of surplus profits on this production compared to the average annual industrial rate of profit. The former arises because, on average, all such production produces these surplus profits, i.e. market prices exceed price of production, the latter because certain lands produce even greater surplus profits than others. Having thus determined the amount of rent, the price of land is only the capitalised value of the rent. If the amount of rent rises, the price of the land rises, and vice versa, and, similarly, if interest rates fall, the price of the land rises, and vice versa.

There are a variety of reasons as to why rent might rise. The average industrial rate of profit may fall, so that surplus profit in agriculture/primary production rises relative to it. That would tend to cause industrial capital to seek to migrate to agricultural/primary production in search of these surplus profits, raising the demand for land, and enabling landlords to charge higher rents. Agricultural/primary product prices might rise, due to an increase in demand, causing surplus profit to rise, and an increased demand for land. Assuming interest rates remain constant, this would result in higher land prices.

Its worth restating what Marx says about these higher (or lower) land prices, in Capital and Theories of Surplus Value, as its also important when considering house and other property prices, as part of analysing these other types of asset. Marx notes that if rent on land that is being cultivated rises (and consequently the price of that land also rises), this does not only affect that cultivated land. It also determines the rent (price) of equivalent land not currently being cultivated. In other words, if there are two adjacent pieces of land A and B, each with the same level of fertility, and A is cultivated but B is not, then, if the price of A is £1,000, the price of B will also be £1,000, or put another way, if the owner of B were to let it, the rent would be the same as that on A. 

That is because the rent is determined by the amount of surplus profit. If agricultural productivity remains constant, but the demand for agricultural products increases, so that a sufficient demand for production requires land B to be brought into cultivation, the surplus profit on this land B will be the same as on land A, and so the actual rent charged for land B, will also be the same, the difference now being that although the rate of rent remains constant, the amount of rent obtained by the landlord will double, because twice the amount of land produces rent.

If you look at house prices, estate agents, when valuing a house, start from the prices that identical, or similar, houses have actually sold for. That is why, at a time like this, when mortgage rates are rising, as a result of rising interest rates, the amount that buyers are prepared to pay for a house falls sharply, because what they can pay, each month, is more or less fixed, and it now represents a much lower value of mortgage. So, the selling price of houses falls, but its not only the houses that are sold that falls, but also that of all similar houses, whether their owners seek to sell them or not.

That is why, as I have set out, elsewhere, the argument that its only when mortgage rates reach levels that cause forced selling that house prices fall, significantly, is wrong. If buyers can only offer 50% of current prices, so that the prices of sold houses drops significantly, this will also be reflected in the valuation of all other similar houses, and, when the owners of those houses come to re-mortgage, or negotiate new fixed rate mortgages for their houses, they will find that it is these new, much reduced valuations they will be presented with, often requiring them to significantly increase the amount they must contribute in cash themselves. In other words, if someone had a £100,000 mortgage on a £100,000 house, when it comes up for negotiation of a new mortgage, and the house is now valued at only £80,000, whilst the outstanding mortgage remains £100,000, they will be required to put in £20,000 of cash, themselves, with the bank giving them a mortgage of just £80,000.

Back To Part 8

Forward To Part 10

How Liquidity Flows From Asset Markets Into The Real Economy - Part 8 of 17

So, now, how is this process reversed, and liquidity released from the sphere of assets into the real economy? It cannot simply arise from a general fall in asset prices, which is, itself, the effect rather than the cause. Asset price bubbles stop inflating because the number of buyers stops exceeding the number of sellers, and, as is the nature of all bubbles, such a condition rapidly leads to a sharp increase in the number of sellers, and sharp decrease in the number of buyers, leading to the bubble bursting. But, even this cannot explain how this results in liquidity, tied up in assets, washing into the real economy.

Take the situation of house prices, and two buyers and sellers, A and B. Both have houses with a current price of £100,000. If each decide they prefer the others house (A prefers the use value provided by B's house and vice versa, so an exchange increases the welfare of both), they could exchange on this basis. This is like products of equal value exchanging for other products of equal value, in a condition of barter, as described by Marx in Theories of Surplus Value. Here, commodities are bought with commodities. But, no change, then, arises if the price of both houses is £200,000, or conversely, if the price is £50,000. It is the difference between money as measure of value/unit of account, and money as means of circulation. The price of the houses is an “ideal price”, but no money is required to effect the exchange, i.e. as means of circulation. Both parties could put whatever identical price tickets on the houses they liked.  

This also highlights the delusion of all those convinced that, because the price of their house has risen, they have somehow become wealthier. For so long as this additional “wealth” remains tied up in the house (whose use value remains exactly as it was before), it is only an increased paper or notional wealth, of no use to them whatsoever. They could use it as additional collateral, in order to borrow more, but the additional borrowing means a reduction in wealth, not an increase, not to mention an increase in costs, in the form of interest on the borrowing, thereby, not only reducing wealth (stock of assets), but also affluence (flow of revenue). If they realise the capital gain by selling the house, they are faced with the question of where to live, unlike the seller of shares or bonds, for instance. And, now, they find that the price of the house they seek to buy has also risen wiping out the paper capital gain.

The “ideal price” of commodities is determined by the amount of universal labour they represent, as measured by money/standard of prices. That price moves up or down dependent upon the amount of universal labour required for their production, on the one hand, and the value of money/standard of price, on the other. Market prices, however, depend also upon the relation of demand and supply, causing a fluctuation around this ideal price, or, under capitalism, the price of production. If market prices of commodities exceed this ideal price/price of production for any length of time, then producers of these commodities, will make surplus profits, inducing them to increase supply, so as to make more of that profit, and capture more of the increased demand, or else, new producers will enter this sphere, in search of these surplus profits. Supply will rise, and market prices will fall to the ideal price/price of production.

But assets are distinguished from commodities by the fact that their supply cannot be increased in this way, and increased supply is not induced by surplus profits. Assets may be bought and sold as commodities, but they are not like other commodities that are produced by labour, and which, therefore, have value. The most obvious example is land. Land is not produced by labour, and so has no value. Yet, land is bought and sold as a commodity and has a price. It is bought and sold as a commodity, because it is a use value, necessary in production, as a surface upon which buildings are erected, as instrument of labour for the production of agricultural products, as means of production, for agricultural products, and as the source of minerals. It has a price, despite having no value, precisely because this use value is in limited supply, and cannot be increased, so that its owners can charge a rent for it. The price of land is only the capitalised value of this rent. If land could be increased in supply, in the same way that ice-cream, or any other commodity, can be increased, its price would fall to zero.

Back To Part 7

Forward To Part 9

How Liquidity Flows From Asset Markets Into The Real Economy - Part 7 of 17

Marx was right that those who had only small amounts of interest-bearing capital/savings, saw the interest they receive disappear to nothing, but, largely excluded from the possibility of becoming productive capitalists, themselves, in the era of imperialism, it simply led to them being also drawn into the sphere of speculation, as buy-to-let landlords, day traders and so on, again drawing liquidity into the sphere of asset purchases, in the hope of capital gains.

I have set out how the period since, about, 1987, saw falling interest rates leading to rising asset prices, and capital gains, which then led to a period in which money was increasingly diverted from the real economy (both from personal consumption and from potential productive consumption) into speculation in financial and property assets, in search of these capital gains, and this became the prime driver, rather than the pursuit of yield on those assets. Indeed, as the use of capital for productive purposes was held back, so the growth of the mass of profit was held back too, other than from what arose from rising rates of profit, and release of capital from higher productivity, and that meant, with soaring asset prices, yields inevitably fell, ultimately reaching the surreal condition of around $18 trillion of global bonds with negative nominal yields!

1987 was also the point, following the worst stock market crash in history, when central banks also committed themselves to preventing such falls in asset prices, so as to protect the paper wealth of the ruling class, and, thereby, its power and influence in society. They committed to doing that, even at the expense of the real economy. Its manifestation was the conversion of Ayn Rand devotee, and supporter of gold and sound money, Alan Greenspan, in to the world's money printer in chief. Each time stock or bond markets sneezed after 1987, Greenspan was there to increase liquidity, cut rates, and push them back up again. As with any such addiction, each new sneeze required a greater hit of the drug to satisfy it.

The increases in liquidity created a hyper inflation of asset prices, none of it trickling down or stimulating the real economy, but, instead, having the exact opposite effect. The great increase in inequality that occurred after 1990 was not one deriving from differences in income, but almost entirely one deriving from differences in wealth. Those who already owned property, or shares, or mutual funds saw their paper wealth explode, whilst those who did not saw their potential to acquire those things, and most visibly property, disappear. 

If you look for inequality data, however, you will invariably be presented with data on income inequality rather than wealth inequality, and nearly all of the media coverage of inequality is based on income not wealth. There is a simple reason for that. The data on income inequality is essentially constrained within the limits of those who obtain their revenues from labour. It is a measure of a growing inequality of the wages of the lowest paid and highest paid workers (the latter usually being described as middle-class), rather than the fundamental division in society, which is the division between all of these workers, high or low paid, as against the owners of capital, now capital almost exclusively in the form of financial and property assets. It is the basis of social-democrats arguing for redistributive tax polices on wages, taking from better paid workers to give to worse paid workers, rather than dealing with the fundamental issue, which is the ownership and control of capital itself.

In particular it is the issue of control. Workers already do, collectively, own all of the large-scale socialised capital that dominates the economy, in the form of corporations and cooperatives, but they are denied even their bourgeois right, as property owners, to exercise control over it. Instead, current company law allows its non-owners, shareholders, to exercise that control, and they do so in a way that workers never would. The shareholders, via the executives they appoint, rather than looking to the long-term interests of the company, look to their own short-term personal interests, which is why they have used profits to pay increasing dividends, and buy back shares, rather than to invest in additional productive-capital, for example.

Liquidity remained trapped in the green,
 and out of the red.

And, they have done that, because paper capital gains became their prime motivation, not the accumulation of real capital to produce real profits from productive activity. There is nothing new in that, because such financial bubbles have been blown up throughout history, and all of them eventually burst, ending the period of madness, and restoring some semblance of sanity and rationality. What has been different since 1987, is that, each time such a bubble has burst, central banks have stepped in to inflate it again, and governments have simultaneously intervened to goose property markets, deregulate credit and financial markets, and to impose fiscal austerity and so on, to lower economic activity, so as to reduce wages, boost profit rates, and lower interest rates. Because the state has intervened for 30 years, and most markedly over the last 20 years, to do that and more or less guarantee those capital gains, it was inevitable that money circulating in the sphere of assets would stay there, and just move from one asset class to another, in search of capital gains, and that money would continue to be pumped into that sphere, draining it from the real economy.

Back To Part 6

Forward To Part 8