The rule of chaos.

Supply and demand can only grow together. And demand depends on solvency, on being able to pay. Increasing demand needs more paying power. And paying means disposing of some form of credit, for past or future earnings. Credit is the key to the whole process. Too little credit and growth is stunted, and new technologies are not developed. Too much credit causes market bubbles and inflation. But the point at which the credit is circulated is as important as the quantity of extra credit granted. The choice of who gets to spend more and under what conditions, is far from neutral. It is an act of absolute power and of complete responsibility.

Originally and for most of history, credit was granted to merchants and kings. In recent times this has become credit for investment and credit for consumption. The choice is between these two. Favouring one rather than the other has far reaching consequences, and it is an ideological decision based on the principles of profit and the private property of the means of production. And, though banks actually grant the credit and are perceived as the main culprits when there is a crunch, they are just cogs in the system, albeit major ones. What must not be revealed is that the machine as a whole is at fault. A machine first conceived by robber barons, pirate merchants and usurious bankers. A machine built and perfected to concentrate wealth in the hands of a few.

A logical approach seems to suggest that increasing credit should go to increasing investments. As increased investments must precede increased consumption. And, in fact, increasing credit has been used in this way in the past, and still is. What changes is the proportion of extra credit that is invested. There have been times when all increasing credit was invested. The bombing and fighting in Europe (and the Far East) during WW2 had destroyed bridges and railway stations, docks and factories, power lines and canals, and reduced cities to rubble. All this had to be rebuilt before consumption could in turn increase. It lasted more than ten years. And mass production of houses, cars, refrigerators, and other consumer goods only got going in the late 1950s. Over the same period, the US was turning around a major part of its industrial production from supplying a military market to satisfying a civilian one. Investments were the priority everywhere and credit was used to finance them.

So increasing credit increases demand for investments. But investments are no more than accumulated past added value. And added value is the value to be consumed, the national product, the disposable wealth. When investments grow they increase added value, and demand for consumption out runs supply. This results in inflation, thereby cancelling the increased demand. And, when the chain of increased investments reaches its final consumer stage, the devalued demand is insufficient. However, regular growth in investments and perseverance would settle the matter. As, at some point, growing demand would join growing supply. Unfortunately, investments do not grow regularly and other factors have their parts to play.

When an investment is financed with credit, the nominal owner is the borrower, but it is the lender who gets back the value invested (when it is restituted by the production process), plus interest. The nominal owner only owns the investment when the credit is paid back. By which time the investment is used up or out of date. While the profit made by the investment is reduced by the payment of interest. This form of financing investments gives power to the banks that grant the credit. An alternative is to replace credit by shares, but then the shareholders own the investment and the profit. Whereas the entrepreneurial ideal is to finance investment growth with profits, ensuring ownership of both.

The perpetual conflict over the division of added value directly affects the circulation of increasing credit. It determines the passage from investor credit to consumer credit. Increasing investments by the means of credit increases added value and consumer demand ahead of supply. But if the increased added value is invested, instead of swelling demand for consumption, then supply and demand remain balanced and there is no inflation. Instead of going to taxes and wages, the extra added value is considered to be profit and is invested. This allows investments to auto-finance themselves, as increased investments increase profits and increased profits increase investments. However, when consumer supply does finally increase, the demand is lacking. And any increase of consumer demand, by a redistribution of added value, would mean reducing profits and returning to financing investments with credit. The other solution to failing consumer demand is to grant credit to the consumers. Growing added value continues to be invested, while consumer demand can also grow, thanks to generous credit facilities.

The main input of increasing credit moves from investment to consumption, but the two forms of spending are quite different. The value of an investment is returned by the production process, so the credit can be repaid and borrowed again. Only the interest concerns added value and consumer demand. Whereas consumed value is not returned and the credit can only be repaid by reducing future consumption. Increasing consumer demand with increasing credit is a dead-end. As credit must pile up, new on old, and never be paid back, until all the added value that is usually consumed (wages and taxes) goes to paying the interest on debt. That is the ultimate point that cannot be passed, but the credit machine always breaks down before attaining such heights.

Investing added value (profit and rent) and granting credit for consumption can be synchronised to avoid inflation. But this apparent stability has its limits. As consumer credit cannot be paid back without reducing demand, growth depends on adding new credit to renewed past credit. This applies as much to individuals as it does to towns, cities and to the governments of nations. As an ever greater part of added value is being invested (in stocks and real estate), wages and taxes dwindle and so does their capacity to pay interest.

Growth in added value (national product) goes to investments, while the part that is consumed remains constant, and hence diminishes in proportion to the whole. And accumulated consumer credit claims an ever greater slice of wages and taxes for the payment of interest. These reductions, in relative and absolute terms of the fraction of added value actually being consumed, are possible because of the froth of derived consumer credit. Transactions continue, but payments are ever more tortuous and actual cash, here-and-now money, is multiplied ten fold, twenty fold or more, into pay-you-later money. Then, as the diminishing fraction of consumed added value approaches zero, the machine runs out of fuel and stalls. This leads to a free-for-all, where the richest and the roughest always win the highest stakes, and are ready to start things up again for another cycle.

Investing added value and consuming credit is not a viable proposition. Its apparent stability is short-lived and ends up in chaos. So what of investing credit and consuming added value? Is it fatally doomed to inflation and bank (or state) control of the means of production, to centralised planning and the end of entrepreneurial initiatives? Is there no alternative but chaos or total control? Can growth in demand follow another path? A path where money is a tool for social cohesion on a global scale, instead of an instrument for division and dominion. Can it be understood that money as such does not exist? That it is just a medium of exchange and is the ongoing creation of a general consensus. And yet banks (and states) are allowed to act as though it was theirs to manipulate in arcane ways. As long as money, the wherewithal of investment and consumption, is not a public matter, plutocracy will continue to rule a chaotic and desperate world. Socialism or barbarity is still the crucial choice.

The mother of all snowballs.

To understand the constant fluctuation of prices, it is wise to begin by looking at the way prices are determined. The value of a commodity is the sum of the values that went into its production. The different costs of production concern the matter to be transformed, the depreciation of buildings, machines and tools, the energy consumed and the work force. The market price should cover this value, plus taxes, land rent, interest and profit. Alternatively, it can be said that the market price of a commodity should cover the value invested plus the added value. The value invested comprises the tools, machines and buildings, the matter to be transformed and the energy consumed. (In fact, investments are no more than the accumulation of past added values. That the added values are from the past usually means their variations have a belated effect on prices.) The value added by labour comprises wages, taxes, interest, land rent and profit. These five elements of value are liable to variations, either up or down. However, some may rise while others fall, and the overall effect on prices can be nil.

What seems to have happened is that wages (outsourcing), taxes (rebates) and interest (Allan Greenspan) were consistently reduced. This left the lion’s share of value to rent and profit. It also allowed for a considerable reduction in market prices, during a ferocious competition that completely modified the distribution of production around the world. Then, once the downward trends of wages, taxes and interest had reached their limits, they could only move up again. This means that either rent and profit fall, with a subsequent depreciation of real estate and stocks, or the market prices of commodities rise, resulting in inflation, or both.

There is, however, another side to the variations of prices on the commodity market, the monetary side. Supply is the quantity and the price of the goods on offer. Demand is the quantity and the value of money (credit, etc.) in circulation. If the quantity or, less likely, the value of money increases, so does demand. (An increase in the speed of circulation, and hence of spending, also increases demand. But electronic speed has reached a limit that is hard to beat. And how far in advance can incomes be spent?) There used to be a time when

the quantity of money in circulation could increase without necessarily affecting consumer demand. Extra money would be put aside for a rainy day. But savings are no longer hidden under a mattress, or buried in a jam jar. They are converted into derivatives. All circulating money that does not become demand is exchanged for “almost-money”, and recirculated. Savings are merely spent by someone else, notably governments who balance their budget deficits by selling treasury bonds. Savings are not deducted from demand. The demand is simply resituated elsewhere, and its value is doubled by treasury and corporate emissions of “almost-money”. The money has been spent and is circulating, but the potential demand of the saver persists.

What seems to have happened is that the long term savings that had been paying off budget deficits were essentially pensions and life insurance set aside by the post-WW2 baby boom generation and, fatally, they are beginning to spend what they had saved. Past savings that had not been withdrawn from circulation are coming back on the market as an increased demand. Just when present savings are at an all time low. This in turn means that treasury bonds are in lesser demand. Just when budget deficits are in full expansion.

Demand for goods is sustained by spent savings. But demand for bonds is weakening at a time of predictable XL supply. The price of essential goods can increase but, as a consequence, the market value of bonds must drop and interest rates rise proportionally. This will affect already failing rent and profit, and already rising prices. At some point in the near future, sinking buying power will lead to a general claim for higher wages, countered by rising prices, etc. The start of an inflationary cycle that will deflate the going value of past debts in general and of treasury bonds in particular. A similar process took place in the 1950’s, wiping out the massive war-bond emissions and the reconstruction borrowing of the 1940’s. The comparison stops there, however, as the balance of power and wealth has completely changed since then.

A currency has two distinct values. One on its national market, and the other on the international market. The use of a currency is restricted to its national boundaries (except for the US dollar that is legal tender in a number of countries, and the particular multinational Euro zone). This means that foreign trade is ultimately an exchange of commodities, and woe to those nations with no or insufficient commodities to offer. They must sell their work abroad and send home the wages. As no nation is completely self-sufficient, the exchange of commodities is a necessity. This regularly leads to a trade deficit for some, and a trade surplus for the others. An unbalance that used to be settled by transfers of bullion. But very few of the new post-colonial nations had gold reserves (in the ground). So, for numerous other reasons, the gold standard was finally abandoned in 1973. To be replaced by a standard based on the US dollar. First by paper money (petro-dollars), provoking great movements of liquidities and wild fluctuations in the exchange rates between currencies, then by paper bonds.

What seems to have happened is that growing trade deficits have been settled with treasury bonds. The example was given by the Nixon administration (vid. Michael Hudson’s account, counterpunch.org/schaefer04232003.html). Then, progressively, the practice became universal. Up to the junk-bond crisis of 1997, when numerous nations of South America, Africa and Asia found themselves on the verge of bankruptcy. Since then, only the wealthier nations have been able to continue paying their trade deficits with treasury bonds, notably some members of the euro-group (France, Spain) and the USA.

Paying a trade deficit with a budget deficit is a convenient way of borrowing what is already owed, for a prolonged period. Except that the method relies on a strong foreign demand for treasury bonds, and this is no longer the case. In fact, the likelihood of a weak demand and a strong supply of treasury bonds on the international market will push up interest rates and bring down the market price of existing bonds. This will affect the exchange rates of currencies, and should make it easier for the depreciated ones to export a larger quantity of cheaper goods. But, coming at a time when demand is weakening, this could lead to protective commercial barriers. A depreciated currency will also make imports more expensive. Thereby reducing them and the trade deficit, while having an inflationary effect on prices. As for budget deficits, they will be ever harder to finance.

The question is, “Can the present situation snowball into something gigantic?” And the answer is that there seems no way to avoid it. As all the factors are linked together by a world market and a master currency, the US dollar. The only difficulty is to estimate how long the central banks can go on filling the breaches to hold back the flood, and to forsee when the salvaging process will be forced to the forefront of political debate. It is ultimately the nation’s wealth that has been squandered.