New age, old rules and the difficulties of transition

That capital accumulates goes without saying, considering that the past twenty years have shown the most phenomenal example of this process. But the mechanisms that allow this controversial enrichment are shrouded in mystery. And yet it is interesting, and possibly important, to understand how some individuals and nations accumulate investments and, subsequently, if it can continue indefinitely. In these times, when the world’s “Cadillac has a wheel in the ditch and a wheel on the track”, future prospects depend on the system’s capacity or incapacity to perpetuate itself, without the usual phases – those followed in the past – of massive destruction and reconstruction, of Phoenix capitalism. The new paradigm of an electronic world-network of information is just beginning. Adapting to it will be hard, and hardest of all for the giga-corporations. The actual capitalistic concentration seems the worst possible response to a changing environment, where the adaptability of numbers offers the best chance of survival. Capitalism has socialised and globalised production, demonstrating that its private and national property rights are a mystification propped up by police and military might.

The source of surplus value, which provides for rent, interest and dividends, is a puzzling question. The market price of goods and services contains the cost of the means of production, the wages of labour and the surplus value of unpaid labour. Capital provides for means and wages, but the surplus value cannot be capital paying itself and seems to come from nowhere, the nowhere-land of credit and monetary creation. Capital makes an outlay and gets back more in return, an extra value produced by debts and printed money, or by appropriate foreign exchanges.

The unpaid labour of surplus value is paid for, but it still has to be invested to accumulate. This investment will go to increasing production, or it will acquire a share of existing production. The two predominate alternatively as growth and recessions succeed one another, leading to excessive productive capacities or stock market bubbles. And both overreactions highlight the persistent overabundance of investment capital. All those who feel they morally should and materially must be spendthrift and save for a rainy day, and the few who just earn more than they can spend, add up to a river of diverted consumer demand (1). And when it all goes wrong, the first group loses out to the second. Increasing investments have another inconvenience, in that they bridle consumption. The value added by labour, over and above the cost of the means of production, is disposable income for consumption. Investing this income increases demand for investments and reduces demand for consumption. Consumer supply regresses accordingly and stagnates, whereas investment grows as unspent incomes are invested year after year. But all value produced must ultimately be consumed, no matter how long and complex the different stages of production. Factories to make factories to make factories cannot be an infinite chain. At some point consumer supply begins to grow as fast as the preceding growth in investment. However, during the period of investment growth employment increases, hence the total wage grows before there is an increase in consumer supply and inflates prices. These devalued wages are then subjected to the growing consumer supply. Price competition forbids wage rises so demand is sustained by consumer credit.

Foreign trade has always been the best aid to the accumulation of capital. In certain circumstances it allows consumption to be exported and investments to be imported. The classic example is 19^th century England importing raw cotton and exporting thread and textiles, and more recently, China importing technology and raw materials and exporting clothes, toys, pads, etc. The trouble is that if some nations do this, others must do the contrary. Instead of accumulating capital they exchange it for consumption. In one part of the world there is employment but wages do not reflect labour’s productivity. In the other part general unemployment results in dependence on government distributions and jobs or on huckstering for survival. The developed world accumulated wealth by taking the planet’s raw materials in exchange for trinkets and guns, and China has taken the relay on an unprecedented scale. It did this by importing technology as well as raw materials. And though the exported consumption contained little added value, this was compensated by very large quantities. The Chinese have followed the path to riches inaugurated by the earliest trading nations, and the rest of the world is paying its consumption with investments. The older industrial nations – basically the Axis and Allied powers of WW2 – are receiving the treatment they mete out to their vassal states. The appearances are different because the starting points were not the same, but the transformation of consumption into investments uses the same ageless mechanism.

The end of the Cold War and the East-West divide gave capital the possibility to exert itself globally. It could at last apply the rules of private profit everywhere on the planet. This was presented as a huge consumer market but was in fact a huge underemployed, docile and literate work force and a huge investment market, and capital has always favoured the latter and neglected the former. When mass production is national, as Henry Ford is reputed to have remarked, workers must earn enough to buy what they produce. When mass production becomes transnational, though Henry’s logic still holds it need not be applied. The great wave of investments that swept over Asia was predictably attracted to the lowest production costs (wages, security and environment). And what seemed like a growth in investments turned out to be a geographical displacement. Several industrial branches all but disappeared from their historic homelands. Low-skilled jobs moved from West to East, exported investments boomed and consumption was cheaper. The developed nations have their Mezzo Journo, their Poor South or sometimes North, as sources of cheap manufacturing labour. Asia was perceived as a global equivalent, a vast sweatshop with countless agile hands making things for patent and copyright holders in the minority world. And the perception became reality as production was outsourced. The middle class became yuppies or déclassés and the working class left closed factories for employment in the services sector, partly as domestic aids for the nouveaux riches. Now mowing lawns and cutting hedges may be healthier than many industrial jobs, but cleaners are often in contact with toxic agents, pay is less regular as are the hours and workers’ syndicates are rare or inexistent. A new social category appeared, the working poor, poverty having been previously associated with unemployment. All was not rosy but the rich were getting richer and there was the repeated promise of “trickle down”. Meanwhile, capitalism’s internal contradictions were at work.

If a nation overexploits a part of its territory with low wages and unskilled jobs, it is undemocratic and undermines national unity but it makes goods cheaper for the other regions. It is the heritage of dominion and the arbitrary borders drawn during the 19^th and early 20^th centuries. This dominion can be extended in the context of colonial empires and subject nations, but its extension in a context of independent nation states is confronted with the problem of different systems of currency, value and exchange. The colonial powers were forced to relinquish their empires but they kept their financial control over the new born states, and the Cold War was a monetary division of the world as well as an ideological one, with impervious barriers to convertibility. In the West, the US dollar was supreme, with other currencies tagging along. In the East money was not exchangeable. This limited commercial exchanges between the antagonists to bartering commodities. The dollar’s power reached its summit in the 1990s. The Soviet Union had fallen apart financially and politically, and for a while greenback money was legal tender in much of the broken empire. And China was pegging the yuan to it (in dollar we trust) at a fixed rate of exchange. The new millennium brought war, the European Common Currency and the BRICS, but the Asian bonanza only abated when consumer credit reached its subprime limits in 2007.

The export of investments increased investment demand. Increased investments can be financed with cash or credit. But credit needs to be returned and renewed frequently, which blurs the rights of property, whereas the ownership of cash is clear cut. So cash was preferred and the wherewithal of consumption was restrained and reduced in favour of increased investments. Labour produced more without receiving more, as all productivity gains were capitalised. And when the value invested started to come back as consumption, consumer credit insured there was no slack in demand. However, if invested credit leaves a doubt as to ownership, consumer credit can easily snowball out of control. Invested value goes into the production and distribution process, and returns with a profit. It can then renew the credit and the production cycle, and pay interest. Consumed value is destroyed and must be produced again for consumption to continue. Consumer credit increases consumption – that is the amount of value destroyed – but there is no value returned to renew the credit and no profit to cover interest. These must come from future earnings. However, increased spending should mean rising incomes that cover the credit’s renewal and maintain the growth in consumer demand. But this was not the case, as investments continued to grow instead of wages, and became increasingly speculative.

The investor has an income of 10 for consumption and obtains a credit of 5 for an investment. At term he has his income of 10 and his returned investment of 5 plus a profit. He can repay his credit and its interest, renew it and his investment, and increase his income by whatever profit is left after paying interest.

The consumer has an income of 10 and obtains a credit of 5 for more consumption. At term he has his income of 10. He repays his credit and its interest. Then, either he renews it and has a reduced income because of interest, or he obtains a larger credit to cover the interest.

In the first case, increased investments are maintained and consumer demand increases. In the second case, increased consumption is not maintained by a renewed credit. To maintain it a second credit of 5 plus interest must be obtained. And so on, so that consumer credit increases just maintain the level of consumption.

Contrary to investments, growth in consumer demand cannot be driven by credit alone. Nevertheless it was attempted, began as a very lucrative boom and ended predictably as a bottomless pit.

In any particular country, the largest consumer group is the state and all its subordinates. States also saw their revenues stagnate, and they also had recourse to debt, with the same consequences of borrowing more and more to spend the same or less. At the end of the 1960s America’s trade balance turned negative. More stuff (cars, bikes, cameras, Arabian light, et cetera) was coming in than was going out. The oil crisis of 1973 tipped the scales even farther and threatened the dollar’s stability. So the Nixon administration pressured Saudi Arabia to accept payment in US Treasury bonds (2). This was later extended to trade deficits with Japan, Germany and finally China. It was a perfect plot: paying the budget deficit with the trade deficit. It was possible in the 1970s because of America’s dominant military role in the Middle East. It was later generalised because the dollar dominated global finance. And the retroactive effect of these swaps developed the dollar’s controlling powers. In a similar way, when the euro zone was created the South sold its sovereign debt to the North and used the proceeds to buy Northern consumer goods. The process came to a sudden halt on the verge of default in 2009, and the European Central Bank was compelled to ease quantitatively, to transform credit into cash and thereby maintain the value of those debts, the interest paid on their renewals and more generally the value of the euro. The easing by the Bank of England was in line with the ECB, as British banks held a lot of Southern euro-bonds. The easing by the US Federal Reserve, on a much grander scale, is also doing all it can to sustain the value of Treasury debts, to keep down interest rates and to perpetuate the dollar’s global stature. The idea behind the strategy supposes that the down turn in the economic cycle will soon rebound into economic growth again. The trouble with this is that there are several cycles, short, medium and long ones. Each has its own time scale but they regularly join in an upward or downward path. And when the long ones get together, the short and medium do not have much effect. If long term debts cannot be renewed, their short term substitutes may not be able to hold the distance.

Borrowing cycles and business cycles have a lot in common, in particular their short, medium and long periodicities. And the ups and downs of demand are closely linked to credit for investment or consumption, especially consumption and its commercial preludes when investments show a preference for cash. Credit is not money. It is a sort of insurance that money is forthcoming. It makes future incomes available to-day (cash represents unspent past incomes), but they remain virtual until they materialise at the credit’s term. Universal credit is possible because payments use banking services, card or cheque, and these payments debit one account and credit another, a scriptural process that does not concern any actual money. So that cash deposits and credit granted by the bank have the same function and validity. However, payments are also made between accounts in different banks. These transactions go through a clearing house and are summed up daily, at which point banks must settle their accounts. Some have more and some have less, and the balance is re-established with cash. This process, along with badly enforced ratios, is supposed to limit the quantity of credit. Were a bank to grant too much of it, the overflow into other banks would quickly put it in difficulty. But banks are naturally secretive and are tempted by collusion. If all banks expand their credit at the same rate, the interbank balance is not upset. Until, of course, worse credit piles up on bad credit, when extra credit no longer increases demand.

Originally credit was a commercial practice. It allowed someone to buy in order to sell. Then, as a few merchants concentrated on banking, they began changing money, taking deposits, opening branches in major commercial cities and, in periods of economic depression, granting credit to governments. In the past this could be a fatal step, as kings and princes had few scruples about defaulting on their debts, and their heirs even less. Nonetheless, banking in general thrived and so did credit. They expanded considerably with industrialisation, and invested consumption around the middle of the 20^th century, while constantly dabbling in government finances. Cash is a payment with past income, credit is a payment with future income. Granting credit increases demand, but the effect on demand of paying back credit depends on whether incomes have risen, stagnated or dropped. This in turn depends on the rate of inflation and the repartition of productivity gains. In the case of rising incomes, credit has a buoyant effect, which disappears when incomes are stable or falling. Spending more to-day and less tomorrow does not promote growth in demand. Average US household incomes grew in the 1990s, stopped growing in 2000 and have fallen since 2007. But the credit of the growth years went on expanding until its systemic breakdown in 2008. When incomes stop growing, consumer credit increases without increasing demand. Unless it multiplies even faster, which it did and collapsed exhausted.

Long term borrowing concerns cash not credit. Being virtual and depending on future incomes, credit is seldom extended beyond five years. For debts lasting ten, twenty, thirty, and even a hundred years, actual money changes hands. The bonds that represent these long debts are issued and sold by businesses and governments. For businesses it is an alternative to the issuing and selling of shares that does not modify the business’ ownership. For governments it is an alternative to raising taxes that puts the burden of paying on some future administration. The other difference is that businesses invest these debts and get them back with a profit, whereas governments consume them in war and peace, and only occasionally invest them in infrastructure. And though the process takes more time, long term debts for consumption finally pile up without increasing demand, in the same way as short term consumer credit. However, over decades growth in GDP and inflation modify income and value, and hence the capacity to repay and renew long debts. In the past excessive government borrowing has benefited from both growth and inflation. At present ballooning Treasury debts are assisted by neither.

Successive long Treasury debts of the past thirty years are reaching their terms, and the scarcity of cash makes their renewals difficult. Quantitative easing by Central Banks has injected liquidity by buying bonds held by commercial banks, and has kept interest rates low. But the cash was not lent back to the Treasuries. It went to more lucrative investments, notably the stock market. Unable to attract enough cash to renew their long term borrowing, Treasuries have resorted to short term credit instead. This means they have to renew their debts more frequently and the piling up mechanism accelerates. The world is engulfed in a debt spiral with no exit other than systemic failure. And the criss-cross of liabilities between countries insures that none will be spared.

Prognosis is always hazardous, but things could start unravelling next autumn. Happy 2014!?

1. J.K. Galbraith had this to say forty odd years ago: “Recurrently our problem is to offset by sufficient investment (or by public or private spending) all that we are disposed to save from high levels of income; for if we fail to offset savings, income and output will decline and unemployment will rise.” Economics, Peace & Laughter, page 177, Pelican 1976

Also Keynes commented by Alan Nasser:

http://www.counterpunch.org/2013/05/03/the-economics-of-over-ripe-capitalism/

2. A process described by Michael Hudson:

http://www.counterpunch.org/2003/04/21/an-interview-with-michael-hudson-author-of-super-imperialism/