Financial dead-ends

Investments are basically bonds and shares. Money is lent at interest, or part of a company is bought and receives an equivalent share of the profits. In the first case the debt is redeemed at its term and the rate of interest is set down for the duration of the loan. In the second case the shares have no term, though they may be redeemed by a buyback, and profits tend to fluctuate up and down. However, both bonds and shares can be sold on the stock market at a profit or a loss. The stock of bonds and shares is continually increasing with new emissions of both. But most transactions on the market concern bonds and shares already in circulation. These constant exchanges push up prices if demand exceeds supply, and bring them down when supply exceeds demand. Logically the prices should be linked to the return on investment. But that cannot hold when interest rates are below the rate of inflation, and when many shares do not receive dividends. In those circumstances, which are the present ones, the only profit to be had from bonds and shares is to speculate on their rising or falling prices. Buying to sell and selling to buy can be very lucrative when the future forecast is correct. It can be costly if the forecast is wrong.

Investments on the stock market are mostly speculation on price changes. But there are some investments in new and existing companies that actually increase or modify the production of goods and services. They may also affect employment by an increase or a decrease. There is a surge of new companies when a new technology goes into mass production. It happens to some extent all the time, and occasionally something revolutionary comes along. Movable-type printing really shook Europe out of the Middle Ages. A similar jolt was given by coal-fired steam engines and coal-gas lighting. Then along came the internal combustion engine and the ubiquitous electric motor. And, of course, the most recent world changers have been the computer and its internet attendant. These particularly symbolic examples were accompanied by countless other innovations, either as part of the central element, or as fallout from it, and by a vast number of new companies and new branches of old companies. These major transformative technologies begin by adding to all existing ones and provoke strong growth in production and employment. Then they start replacing parts of the existing structure. And they inevitably make some preceding technologies partly or completely obsolete. This phasing-out of redundant productions puts a brake on growth and restores a more habitual rhythm. The expansion stage needs a lot of investments. New companies multiply at an amazing rate, and when the excitement dies down many simply disappear. Big companies eat small ones, and having spread out for a while capital returns to its usual path of concentration. How many car-makers were around in the 1950s, how many search engines in the 1990s, not to mention all the other domains of today’s quasi monopolies?

Renewable energy - solar and wind-driven electricity generation - is producing growth in investments as it adds itself to the existing energy production. But if renewables really do replace fossil fuels, then growth on one side will be accompanied by obsolescence on the other, and the result in terms of investments and employment will probably be negative. For the time being oil, gas and coal still rule production as sources of energy and of synthetic materials, and their global consumption is still growing. And as climatic disruption bites harder and harder and emergency situations multiply, the vulnerability of wind and solar energy and of electricity in general will become apparent, as opposed to fossil fuels that can be stocked in large quantities and transported by land, sea and air. When the electricity grid goes down from fire, flooding, wind or snow, fossil fuel motors are still running and are able to get things going again, whereas batteries have nowhere to charge up. Fossil fuels and electricity are complementary, but it is hard to imagine that one can replace the other.

The Digital Age has reached maturity and has started to produce obsolescence in all domains. At the same time extreme weather conditions are the cause of increasing destruction, be it crops, forests, buildings or infrastructure. The investment opportunities in production are shrinking, and rebuilding what has been burnt, swept away or blown down is all cost and no gain. If or when (some signs suggest it has already started) the chances of getting a return on productive investments becomes less and less likely, there must be a growing glut of money speculating on bonds and shares, and a growing demand pushing up prices. This process is completely sterile. It creates no wealth for society. Instead it drains wealth and periodically destroys it. More and more money goes into the market exchanging the same paper over and over again, to their more or less distant terms for bonds and to eternity for shares. When more money is put on the market prices go up. And when money is taken off the market prices go down. However, the market cannot draw in all existing money, so the uncertainty is about the level at which it has drawn in all it can. At that point prices stop rising and everyone wants to get their money out. This provokes panic selling and brings prices crashing down. In those cases the first out are the winners and the last in the losers. At present the cash pumps of central banks are getting close to the bottom of the barrel. The first to run dry will set off a chain reaction that promises to be spectacular.

Capital accumulation and credit

All goods and services are exchanged on the market for more than they have cost. More money is obtained from the market than has been paid in. This surplus must come from somewhere. Though it did puzzle him, Marx set aside the money question and imagined two departments – one for investments and the other for consumption – exchanging their productions. This model worked quite well and could accommodate growth, but it did not explain who was paying the surplus value when it was brought to market. Later, Rosa Luxemburg concluded that it was paid with colonial plunder. Then the post-colonial period would show that there is an exchange of consumption for investments, essentially raw materials. This follows the basic rule of capitalism, which is to accumulate wealth instead of consuming it.

Employers only pay their employees for a part of the value their labour has added to production. The rest is kept by the employer who must transform it into a capital investment. Companies that produce investments can exchange their surplus value among themselves, investment for investment. Whereas those that produce consumption must transform it into investments abroad, guns and cars for minerals and oil. Or they can grant consumer credit. Undamaged by WW2, America’s industry was the first to partly convert from supplying war time consumption to supplying peace time consumption. For a decade or so, American companies held the market for consumer goods. But by the mid-1960s, Europe and Japan were back to producing their own. This constriction of the world market (the post-colonial market was not yet in place) meant a necessary expansion of America’s interior market. It was made possible by a massive development of consumer credit. And this was such a success that it was copied by other industrial nations, except those under “communist” rule who would come to it at the end of the century.

Buying now and paying later means consuming more today and less tomorrow. This consecutive fall in demand can be compensated by another credit being granted, with always more new credit being consumed than old credit being paid back, and so on exponentially. Consumer credit allows the surplus value of consumption to be exchanged for money and accumulated as capital. In the decades following WW2 growth was also stimulated by real wage rises from a distribution of productivity gains. Since the 1970s wages have stagnated and growth in consumer demand has depended increasingly on consumer credit. However, invested credit returns its value, often with a bonus, whereas consumer credit is consumed. The credit that allows the exchange of the surplus value of investments accumulates capital. The credit that allows the exchange of the surplus value of consumption also accumulates capital, but it piles debts on debts. And an increasing portion of the credit granted merely renews past credits, while an ever smaller share goes to increasing demand. When everyone has all the credit they can or want to have, that is when subprime lending gets out of hand.

No more middle of the road, left or right

Imagine there is a run on cash because the value of the paper stuff, bonds, shares, mortgages and their derivatives, seems increasingly uncertain. The variety of banks, insurers and funds that hold most of this paper must sell it to supply the growing demand for cash. All this selling brings down the price of paper assets and, hence, the value of reserves held by banks, insurers and funds. This spiral could get nasty, but the central bank intervenes by buying all the paper on offer, thereby stopping the fall in prices and then pushing them up again. After a while things are back to normal, with asset prices higher than ever, until the next cash chase.

This briefly describes the events of 2008-2009, and after with quantitative easing. What is not mentioned is the destination of all that cash, and the possibility of central banks repeating the same scenario in the not too distant future. A large part of the new money created by central banks went back to paper assets as their values began to rise again. Central banks created money to buy paper, and those selling used the proceeds to buy paper. Each new monetary unit produced a demand of two units. Prices rose steadily to peaks last July, only surpassed in the last few days. Central banks saved global finance from catastrophe by inflating an even larger bubble. So that when the next run on cash sets in, central banks will have to create money at an even faster rate than they have these last ten years. This may have already begun, as the New York Federal Reserve has increased its operations on the repurchase agreements market (repo) from 35 to 45 to 75 and finally to 120 billion dollars per day. Meanwhile the US Federal Reserve is reducing short term interest rates and is resorting to QE all over again. All this signals a liquidity shortage that could worsen with Xmas shopping.

The world spends more than it earns, which means a lot of borrowing. This has been going on for ages, with debts piling on debts. It has been estimated that more than three years of income are owed worldwide (1), and this sum is multiplied by derivatives (2). The 2008 crisis was triggered by mass defaults on mortgages that had been packed up with other debts and sold on. So that no one knew where they were and which package was good or bad. Today’s defaulters are car-buyers, and the sums involved are small compared to house-buyers ten years ago. Governments have also considerably increased their debts. But governments cannot default, at least not on their home debt, whereas some have defaulted on their foreign debts. The other big borrowers have been corporations, allured by low interest rates. A lot of this corporate debt has been used to buy back shares, as financial “engineering” to push up dividends for the remaining shares. But it has also kept alive all those “unicorns” that spend more than they earn. All that government and corporate debt will never be repaid and will have to be renewed at term, in some near or not so distant future when lending conditions could be far less advantageous. At present, rates of interest on Treasury bonds are close to or below the rate of inflation. This is still better than holding cash, except that cash can be transferred abroad and lent at much higher interest rates.

Central banks have poured cash into the financial system to keep it functioning. This has produced an upward transfer of wealth to the very rich, but has not cured the illness. It is life-assistance to a moribund patient and seems to be able to continue indefinitely. A small minority is bloated with wealth, while the rest must work countless hours just to afford a roof and transportation. The eight-hour day, obtained by long and bitter struggles, is just a memory for many workers, while so many more around the world have never experienced it. Central banks are sustaining government budget deficits by buying up Treasury bonds and keeping interest rates low. Banks are then lending this cash to companies that are buying back shares to boost their market prices. But none of this is adding anything to the average household income. It just makes the rich richer, the not so rich poor and the poor even poorer, though a lot of that wealth is just paper and could be scrapped overnight. Such an impoverishment of the middle-class had not occurred for close on a century, since World War 1 and the ensuing upheavals. When the middle-class is déclassé, its members follow one of two paths. They may join the working class and share their knowhow and assurance, or they may follow a leader who promises to restore their former status. Some try one and then the other. When the middle-class realises it has no future, it can follow a revolutionary path or a reactionary one. It can be a servant to the poor or a slave to the rich. Those two possibilities will not stay open very much longer, as events accelerate in one direction or the other.

1. https://www.axios.com/global-debt-increase-q1-2019-92ef0a63-b86e-471d-84c8-588a719f3fc2.html

2. https://www.investopedia.com/ask/answers/052715/how-big-derivatives-market.asp