The heart of darkness.

Adam Smith was the first to argue convincingly that wealth depends on human activity’s ability to transform the material environment. A constant remodelling of nature that has given mastery over the whole planet to one particular animal species, human beings.

Work acts on matter to give it use value. Exchange value is something else. Exchange value is the consequence of scarcity and abundance and thereby determines the distribution of wealth. Scarcity increases value and obtains a greater share of the abundance produced. Use value is the result of human action, whereas exchange value measures relative rarity. Two distinct values that are inseparable, as exchangeability supposes usefulness and, whatever its exchange value, a commodity is always the result of human activity.

Work creates use value as scarcity creates exchange value. But, before Adam Smith, work was denied its role in the creation of wealth. Use value, and hence wealth, came from the land, the soil and what lay beneath, claimed the physiocrats. Exchange value, and hence wealth, was produced by trade and commerce, replied the mercantilists. In both cases, scarcity was the essential factor. Scarcity of land owned by just a few, scarcity of commodities in the hands of merchants. And, as the work force was plethoric and workers two a penny, their participation in the production of wealth seemed negligible, proportionate to the meagre share of wealth they received.

The harnessing of steam power gave a new significance to the concept of work. Human activity kept its low status, but the new-fangled machines were increasing output and wealth at an unprecedented rate. Adam Smith had been influenced by the humanism of 18^th century Scottish enlightenment and, writing at the threshold of the mechanical age (The Wealth of Nations, 1776), he still considered work to be a human activity. A century later, James Joule was defining a unit of work in terms of mechanical energy and heat produced. By then, “work” was done by machines and workers were required to serve them, expendable appendages to the production process.

Capitalism seems an old idea. Some see its origins coinciding with those of money and the first measure of exchange value. Whatever may be, capitalism’s raison d’être is a return on investment, a surplus value. This had been obtained by merchants and money lenders throughout history. But surplus value acquired its modern sense with the industrial revolution and mechanised production.

The average productivity of human activity at the beginning of the 18^th century had not changed much since Roman times. By the end of that century, however, the steam engine and the innumerable inventions that accompanied it were increasing productivity at a prodigious rate. With mechanical power, precision and speed, a few were doing the work of thousands. This did not alleviate the work load, nor was it a cornucopia. It simply generated enormous profits and gave a new dimension to the theory of capitalism. Capital investments were not just land, or commodities, or gold currency. They included all the means of production. Wealth resulted from the combination of real estate, credit, raw materials, state of the art machines and, incidentally, labour.

By all accounts, the 19^th century was a bleak period for the working class. Charles Dickens described a pathetic situation, with no apparent hope other than charity and some Scrooge like miraculous change of heart. Forced into exile, Victor Hugo grudgingly recognised that a popular uprising could challenge tyranny (Les Misérables). But neither conveyed the vicious cruelty of the times as well as did Karl Marx in the first volume of Das Kapital. His factual comments, mostly taken from official British and continental sources, depict a very gruesome picture. Lives were short and absolute squalor was the rule. Slums were little more than shanty towns with foul water, no sanitation, dubious food, venereal diseases, tuberculosis and moral decline. It was the latter that first raised concern. Slums were a breading ground for crime and for dangerous political ideas. Gambling, drugs and prostitution, illicit distilleries, thieves and bomb throwing nihilists were thriving in these urban sprawls of grinding poverty. Muted criticism grew to a chorus and, finally, to a public outcry. The underworld became the subject of novels (Joseph Conrad, Jack London), reforms were called for, but history is a material process. Moral campaigners merely climb on the band-wagon (1).

During the 18^th century, the developing agro-business began emptying the countryside of all non-essential inhabitants. A rural exodus, culminating in England with the General Enclosure Act of 1845 that brought a continual flow of labour to the urban centres. But, by the mid-1800’s, the flow had slowed down considerably. Even the Irish surge that followed the potato famine (1845/1851) was but a brief respite, as it also inaugurated cheap passages below deck on steamships to America. The labour force was dying young, often in childhood as employment would start at the age of ten or less, and health in general was worsening. Finally employers realised that the time of abundance was over. An expanding productive work force could no longer be maintained by replacements, it had to be taken care of. To paraphrase Marx, labour must earn enough to renew its strength individually and to produce new generations. The first step was to repeal the Corn Laws in 1846 and allow the import of cheap cereals, notably from America (2). Followed a minimum of education, a preoccupation for public health and the construction of low rent housing.

By the turn of the century, the proletarian condition had considerably improved on both sides of the Atlantic. Industrial expansion needed valid workers, as did the armies of empire. But this did not stop recurrent economic slumps causing mass redundancy and social unrest. And so, in 1914, the world plunged once again into war. As though making guns and ammunition, and killing and getting killed could resolve the lack of work, the poverty and hunger. After four years of slaughter (mostly working class dead and disabled, though upper class junior officers were badly hit too, Eton and Ypres) some academics turned their minds to the study of wealth. How was it produced, how did it circulate? Keynes even went as far as to read up on Marxist theory (the young John Maynard frequented the leftist Bloomsbury group). Meanwhile, Ford was paying his workers enough for them to be able to afford one of his model-Ts. This, probably for the first time, made the link between value produced and value consumed. Making things for the market can only be profitable, if there is a demand. So the consumer must have money in his pocket. Then recession struck again and nothing much came of it all. Though the support of state intervention by Keynes, while keeping well wide of socialism, is said to have influenced Roosevelt’s New Deal.

War followed war like a fatality, a human stain. But cyclical inevitability was finally being studied and reflected on. Trade and business, the production, exchange and final consumption of wealth, these grew, wilted, and grew again. Cyclical events were taking place and being measured. Juglar had noticed a 10-year cycle at the close of the 19^th century. Kondratieff had found a 60-years one using Russian and soviet statistics, and was sent off to die in the Gulag. Kuznets studied building cycles in Canada and brought to light a 20-year period. Finally Schumpeter pontified that business cycles were caused by the ups and downs of technological innovations. And what can be done about that? Other than have faith in the inventiveness of the future.

Events that repeat themselves at regular intervals must have reasons that explain the regularity of the repetition. Just as night and day are the consequences of the earth’s rotation. Business cycles are close to cosmic precision in their recurrences. Whereas the haphazard evolution of human technology is ongoing and dialectical, and tends to accelerate. As trial and error have no calendar and do not go round in circles, some other phenomenon must be at work. And the most obvious culprit has yet to be publicly unmasked.

In the complex mesh of production, trade and consumption, some periodic events do take place at fixed intervals. Salaries and rents come and go regularly, so do taxes and dividends, profits and interest. But not one of these intervals lasts more than a year. Only borrowing has fixed terms for repayments that go beyond the twelve month period, while covering that time scale as well. A loan can last hours, days, weeks, months, years, to almost a century (99-year Disneybonds). However, among all these possibilities there are preferences. And it so happens that, in the medium to long range, the most favoured intervals are 5, 10 and 30 years. Just the halves of the cycles studied by Juglar, Kuznets and Kondratieff.

Credit is the most obvious mechanism behind business cycles, behind the splendours and downfalls of the capitalist system, behind immense wealth and dire poverty. And yet no one points an accusing finger (Northern Rock and City Group are labelled black sheep but seem to be scapegoats). No one turns on the spot light. Even academics are wary of the subject. This suggests a closely guarded secret, a form of taboo, a potential lese-majesty. And, in fact, scrutinising credit means plunging to the very heart of power and wealth. A place where angels fear to tread, where only a fool sees the naked truth.

Credit is power. It makes the debtor beholden. And unlimited credit is unlimited power. The guns and the thugs are just for the wielding of power and to demonstrate its inherent brutality. Whereas the source of power is paying and holding, holding the puppet strings.

All right, now back off, there’s nothing to see.

But there must be, because the credit machine is fundamentally flawed and is constantly breaking down and crushing all human aspirations to freedom, health, knowledge and the pursuit of happiness. Though, sadly, these naïve ideals don’t count for much in a power hungry, money grabbing world. They just get a little lip-service from the candidates, when election time comes around. Don’t look at the strings, feel the emotion, the warmth, the charisma. I’m not a puppet, I’m human, and I suffer and care just like you.

Hey! You’ve been told to back off. This is your second and last warning.

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1. cf. Marx’s article on the American civil war and the abolition of slavery.

http://www.marxists.org/archive/marx/works/1861/10/25.htm

2. Where, for a variety of reasons, the non-essential rural native inhabitants were unable to make the move to the cities, and almost disappeared.

Banking on thin ice.

The banking system has two historic functions. The first is to make the circulation of money easier, safer and faster, by allowing depositors to pay by cheque, bank card, etc. The second is to create account money, by granting credit. The two functions are distinct, but both concern the payment of value and cannot avoid interacting.
Accounts are kept of all deposits. Small and large sums are credited and debited, moving among different accounts in the same bank or between banks. Once a day, all these movements are added up by a clearing-house, and each bank is given the state of its balance. (As the larger banks are doing business 24/24, 7/7, all around the world, the daily clearing process has lost its precision. On the other hand, computer technology makes it possible for banks to appraise their balances constantly.) For some banks, the sums credited are larger than the sums debited. For the others, the situation is reversed. Some banks have a surplus of money on their accounts. The others are in the red and must settle that debt before they can begin a new day’s business. Usually, the banks with the surplus lend it to the banks in the red.
The other function of banks is to grant credit to depositors. To do this they increase the value of deposits with virtual money. This is possible because only a small fraction of the total deposits actually moves around at the end of the day. As most of the value deposited never leaves the bank, it can be increased at will. However, as a security, banks are obliged to own collateral, such as gold, currency, bonds, stocks, real estate, etc. The value of which must be superior to a certain minimum fraction of the credit granted (currently 8%).
The interest paid on the credit granted by banks is their principal source of income. Wishing to maximise their incomes, banks face a double dilemma. Increasing the amount of credit granted means increasing the value of their collateral. But collateral is ever a fluctuating value. Stocks and real estate are particularly volatile. Their values frequently swell rapidly and deflate suddenly. And the more stable forms (gold and currency) pay neither rent nor dividends. The fluctuation of value on the market means that collateral can gain or loose value as of itself. So the problem banks face is the choice of collateral and the temptation to follow the rising market value of their collateral, by a corresponding rise in the amount of credit they grant.
The market values of the different forms of collateral rise and fall independently, each following its own particular cycle. But, every now and then, they move together in the same direction. At present, three forms of bank collateral, stocks, bonds and real estate, are valued at historic highs. The corresponding amounts of credit granted depend on these high values being maintained. It seems, however, that the three values mentioned above have peaked simultaneously. And that the desperate efforts at keeping them all up there together are doomed.
The weakest link is the rate of interest. It varies inversely to the market value of bonds. When interest rates rise, the value of bonds must drop accordingly (1). And, with inflation looming in the wake of mounting commodity prices, this two way movement seems inevitable in a very near future. And rising rates of interest will have a less immediate effect on the housing market and the value of real estate. They will also hit the stock market and credit in general, when the falling value of collateral reduces the amount of credit that can be granted (some have already called for a lowering of the necessary minimum fraction). A reduced supply that will put up the “price” of credit, cumulating with the increases due to inflation.
Rising prices and the interruption of cheap borrowing are the ordinary consequences of every credit bubble. But the cyclical coincidence of three forms of collateral, in their rise, peak and forthcoming slump, is a rare occurrence. It has facilitated an unprecedented swelling. But it also means that there are no secure forms of collateral to fall back on. As, apart from the three, currency is an obvious target for inflation. And gold is almost exclusively held by central banks and, anyway, there is nowhere nearly enough of it around.
The most likely scenario is stagnation accompanying inflation. Probably (inevitably?) for several years, as the gigantic paper structure of sub-prime junk that has filled so many balloons with hot air will not be absorbed painlessly overnight. This time the collapse will not be limited to Argentina, or the Asian “Dragons”. This time it concerns the whole Developed World. A financial turmoil of such magnitude that holding it off till after the November elections seems an impossible task. And yet, the presidential candidates have not voiced an inkling of what is brewing. No one seems to realise how thin the ice is. So how will they react when it all begins to crack?
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1. A bond labelled $100 pays $5 a year interest, that is 5%. If the rate of interest rises to 10%, then the $5 paid by the bond is 10% of only $50. The market value of the bond has been halved.