Disproportions, credit and crisis

For four months between October 2008 and February 2009 capitalism collapsed. As credit froze with Lehmans failure on September 15^th 2008 trade, output, orders and investment halted, in January 2009 US unemployment increased by 740,000 in a month, over five million US jobs have disappeared through the course of the recession the highest since the 1950s. Industrial giants like GM[1] and Chrysler have joined Bear Stearns, Lehman Brothers and AIG in the bankruptcy courts....writes Bill Jefferies...

What had been a mild slow down through the course of 2008, in the pattern of the mild recessions of the early 1990s and noughties was transformed by the post-Lehamans credit drought into one of the deepest recessions on record. The financial slump was by some measures more severe than that of 1929. The TED  spread the difference in the cost of borrowing from private banks or the US treasury rose over 20 fold, from around 20 points in January 2007 to 467 points in October 2008.[2] It was the UKs deepest financial crisis since World War One. Globalisation ensured that it was instantly replicated around the world so that by June 2009 over $1.4 trillion had been written off by the world's banks and financial companies.

Business cycle

The business cycle peaked towards the end of 2006 and by the end of 2007 the boom that the Economist magazine described as the strongest period of growth in world capitalist history came to end. In December 2007 the US entered what was for the first 9 months of 2008 a mild recession. The Eurozone and UK began to slow and the Chinese authorities worried by rampant inflation on the back of an unprecedented hike in raw materials prices, reduced lending, raised interest rates and increased the proportion of capital required by banks in a desperate attempt to slow their economy.

This general slow down explains both the cause and effect of the Lehamn Brothers collapse on on September 15^th 2008. The sub-prime crisis had already exposed the system of securitised mortgages as being hopelessly complex, the real value of assets concealed through the combination of sound and unsound loans. Through the course of 2008 the US authorities in particular undertook a series of ad hoc steps to stem the crisis, culminating (or so they thought) in the nationalisation of the of Fannie Mae and Freddie Mac, the two largest semi-state mortgage providers. But Secretary Paulson worried about “moral hazard”, the idea that bankers should take the hit when their bets go wrong, said enough was enough. There would be no more bail outs. No more saving the bankers from themselves. Dumb plan.

Over the weekend of September 15^th Lehman Brothers a major investment bank went bust, weighed down by billions of dodgy mortgage securities. Lehman's crash froze between $400-$600bn assets the marked feared that this massive amount of assets could be lost at a stroke. Securitisation spread what had traditionally been very local risks across all asset classes and regions - it created a systemic crisis. Complex financial holding companies meant different arms of these entities were subject to different accounting rules and regulatory oversight, worse as the regulation of securitized loans had reduced system-wide capital levels the system was less able to resist the effects of any crash. In other words no one knew what anything was worth and couldn't afford it when they found out. As a result lending simply came to a halt. A mild down turn was transformed into a very deep recession. Consumers could no longer borrow so demand evaporated. Firms slashed capital spending. Demand for raw materials evaporated overnight. The emerging markets which had splurged on developmental products and whimsical consumer purchases – in the summer of 2008 oil barons paid £450million for Manchester City - slashed spending plans. Unsold stocks of inventories mounted and firms slashed production and employment as orders collapsed in a desperate attempt to maintain profit rates.[3]

Meanwhile the world’s governments desperately sought to limit the melt down of the financial sector, by May the US government alone had pledged $12.8 trillion to patch up the banks. This pattern was repeated across the major imperialist economies. By June 2009 measures of financial stress had fallen by over 90% as the state has stepped into replace private lending, but the real economy was nowhere so easy to fix.

Two schools of crisis

 Stagnation school

The scale of the crisis poses questions about the previous boom, these are answered quite differently by the essentially two school of Marxists who have attempted to explain the crisis. One school, the stagnation theorists, don't even accept there ever was a boom. Chris Harman, Robert Brenner and Richard Brenner[4], three of its notable representatives claim that world output actually stagnated between 2002-2007 even when compared with the 1980s.

Their explanation for the crisis amounts to a crisis of realisation based on falling profit rates. According to them there was a disproportion or gap between the amount of savings available for investment and the amount of investments. The reason investment was too low relative to savings was as a result of falling or low profit rates. This gap between savings and investment meant that there was inadequate aggregate demand to realise production, leading to a series of bubbles and an explosion of consumer debt as the US Federal Reserve artificially held down interest rates to stimulate consumer demand. The present recession was a result of the “over-accumulation” of capital, but this over accumulation of capital is virtually perpetual, continuing for around forty years from the late 1960s onwards. The stagnationists anticipate that the crisis will either morph into a fully-fledged “Great Depression” or in their best-case scenario result in 10 years of stagnation such as experienced by Japan in the 1990s, except embracing the entire world economy, how that's different from the Great Depression is unclear. 

Expansion school

On the other hand there is what could be called the expansion school, articulated most clearly in this journal, but also supported by theorists like Jim Kincaid and the economics journalist Paul Mason.

This school asserts that the restoration of capitalism in the former centrally planned economies of China, Russia, the CIS and Eastern Europe combined with the defeats of the working class in the imperialist heartlands of the US and UK and the opening up of large semi-colonies like Brazil and India, resulted in a secular three decade rise in the rate of profit from the mid-1980s onwards until around 2007.

The pace of this rise in profits, particularly after the turn of the millennium most notably in China and the oil exporters, resulted in massive surplus profits, which were part of a general recovery in profit rates worldwide. These surplus profits brought down interest rates worldwide, but particularly in the major old imperialist powers like the US and UK[5] as the emerging markets began to export massive quantities of capital to the developed economies. 

During the 1990s, the average absolute current account imbalance for a G20 economy was 2.3% of GDP. In the three-year period from 2006-08, the average imbalance had risen to 5.4% of GDP. Saudi Arabia moved from being broadly in balance around the turn of the century to running a surplus worth more than 30% of GDP in 2008. China’s surplus rose from 1½% of GDP in 2000 to 10% of GDP in 2008.

There was a gap between savings and investment, but not as a result of falling profits, but rather because profits rose so fast that the could not be absorbed into their domestic economies quickly enough, China’s rate of fixed asset investment was already an historically unprecedented 40%+, these surplus profits were therefore exported at very low rates of interest to the US and UK.[6] Of all the possible markets, only the US $11 trillion mortgage market was large enough to absorb this amount of capital. By 2009 China's foreign exchange reserves had topped $2.5 trillion essentially accumulated in just five years.

As the scale of world production advanced faster than raw materials could be produced their price surged not least as the glut of supply that had resulted from the collapse of the planned economies in the 1990s was exhausted. This provided a further source of excess profits in the oil and more generally raw materials exporters. But placed serious limits on the boom, as rising prices hit US incomes, China's exports which had subsidised the reduction in the value of US wages started to rise in price and in China itself the cost of basic raw materials began to erode the value of even its gigantic fixed asset investments.

The striking conclusion is that it was the surplus profits of the newly restored emerging capitalist nations, the oil exporters and raw materials producers that provided the money to keep US interest rates low and which therefore, enabled the US housing bubble to happen. In other words rising US consumer indebtedness was not a result of falling profits or slowing production, but the exact opposite.

These profits provided the source of credit for the housing boom and for the consumption binge experienced in Western economies, which went not to realise output in them, but fund imports from the emerging markets. Paradoxically the rise in the domestic consumption in the US and UK did not spur their growth but reduced it as this consumption was spent on foreign production, indeed the rise and fall of mortgage equity withdrawal as a proportion of GDP very closely matches the rise and fall of the US and UK balance of payments deficit. The instability of these disproportions and their enormous scale when combined with the utterly obscure method of securitising financial assets produced a financial crisis of such monumental proportions that it threatened to destroy world capitalism, even while underlying profit rates remained relatively high.

The train was going so fast it came off the tracks. It wasn't stuck at a red light... so it came off the tracks. 

The proof

The proof of who was right and what we can expect lies in the growth of production and critically in movements of rates of profit.[7] Demonstrating the growth of world capitalism is a simple matter. While it is contested by the stagnation theorists who point to relatively low rates of growth since the turn of the millennium in the UK and USA, these theorists ignore or down play the growth of capitalism outside of its traditional heartlands, as we have seen the growth of these “emerging markets” came at the expense of the old imperialist powers but more than compensated for it. 

Output

Steel production is an absolutely fundamental measure of the health of world capitalism. Between 1980-89 it actually fell. Between 1990-2007 it trebled. Every other series of production, electricity, cars, food, concrete, aluminium etc. shows similar huge increases in the physical quantity of capitalist output. This is hardly surprising, there was as enormous one off increase in the world market as the former centrally planned economies were transformed into capitalist ones[8], this was rapidly followed by the ICT revolution which transformed the horizontal and vertical integration of production leading to very rapid increases in manufacturing productivity expressed in the deflation of manufactured commodities in the decade from the mid 1990s onwards.

The period of the alleged stagnation of capitalism was one in which the world market expanded to cover a further third of the world’s surface and the size of the working class doubled, but not only has capitalist production increased but whole cities, railway systems, docks, ports, steel smelters, hydro electric plants and road networks were handed over to world capitalism for free. In Marxist terms the world organic composition of capital fell very rapidly and world rate of profit increased as a result.[9]

Profit rates 

There is no consensus on what these are or how they should be worked out. The stagnation theorists rest their assertion for falling or stagnant profit rates on the work of Robert Brenner. Robert Brenner has constructed a series for a rate of profit, based on movements in US non-financial profits relative to the amount of fixed asset investment and inventories. But as Marxists we know that the rate of profit is not simply limited to non-financial profits, but includes financial profits, executive remuneration and foreign profits. Financial profits rose markedly through the first period of globalisation peaking in 2002 when they briefly reached 50% of US profits, before declining to around 25% of US profits[10] through the second phase of globalisation.[11] 

Executive remuneration has doubled as a proportion of GDP through the period of globalisation. And foreign profits now account for over 30% of US profits. Brenner’s calculation excludes increasingly significant additional sources of profits – also coincidentally those sources of profit which have risen most with globalisation. The significance of this can be demonstrated very clearly by dividing different measures of profit by domestic fixed capital consumption, to develop a measure of the rate of profit which is similar to that used by Robert Brenner. This graph shows three different masses of US profit, total corporate profits, domestic profits and non-financial profits divided by domestic fixed capital consumption.

Source: BEA table 6.16 and table 5.1 (line 15 domestic business fixed capital consumption)

From the mid-1980s onwards what we might call the non-financial rate of profit does indeed describe the path described by Robert Brenner, not really changing from the early 1980s onwards. But the lines based on domestic and total profits both rise significantly, with total profits - which include foreign earnings - rising in 2006 to a level not seen since the 1960s boom. Robert Brenner's calculations may have been fine for a non-globalised world. But that's exactly why they are so problematic today.

But his equation not only presents a seriously distorted picture of contemporary capitalism it further suffers by excluding the largest part of capital investments – spending on wages and raw materials. Inventories only refer to capitalists unused stocks not the amount of product consumed in production. Raw materials by some estimates constitute around 40% of the cost of a manufactured commodity, it is no accident that 10 of the last 11 recessions have been preceded by an oil/raw materials spike. The collapse in raw materials prices was an important pre-condition for the recovery of capitalist profits in the 1990s, just as the surge in their price from 2006 onwards meant that the credit crunch transformed a slow down into a major recession.  While failing to include wages in his calculation means that the secular downward trend in wages as a proportion of national income, which began in the early 1980s and was another key component of the recovery of profit rates with globalisation is not included.

According to our own calculations profit rates rose to levels not seen since the peak of the 1960s boom, an analysis which has been confirmed by the US Marxists Fred Moseley. And which is confirmed again by internal calculations made by the US bank Goldman Sachs. In a recent report from Goldman Sachs “The Savings Glut, the Return on Capital and the Rise in Risk Aversion[12]” they showed that in the period between 2002 and 2006 the US rate of return on capital doubled from 8% to 16% and more than trebled from its nadir the mid 1980s.

Even after the most precipitate drop in profit rates on record in the last quarter of 2008, rates of return remain double that of their 1980s low point. The assertion that profit rates stagnated up to 2006 is scarcely credible.

The Goldman Sachs series also shows the upward trend of profit rates, the bottom of every cycle is higher than the previous one, the top higher.[13] This pattern, which is relatively straightforward to establish from the publicly available US statistics, is repeated across the world according to Goldman Sachs data;

And for every major economy in the world. Goldman Sachs note that from 2002 onwards;

“There was an increase in the global rate of return on physical capital. Using a new cross-country database of returns to physical capital across the 10 largest economies in the world and covering more than 75% of global GDP, we show that the global return on physical capital rose through the 2000s, reaching a record high in 2006 and that, even in the midst of the credit crunch, it remains relatively high. The high return on capital argues against the view that the ‘savings glut’ swamped the available investment opportunities in productive assets.”

So the gap between investment and saving was not the result of falling rates of profit limiting opportunities for productive investments. Rather profits rose faster than they could be invested, while the cost of investment itself fell as productivity rose very rapidly, as the world organic composition of the capital, the global proportion of labour to capital fell and profits rose as a result or as Goldman Sachs put it;

“The increase in desired saving contributed to lower yields on all forms of debt financing, including government bonds, corporate bonds and securitized debt (consistent with the savings glut hypothesis).

It increased the effective labour supply of the global economy and boosted global growth, which (given a capital stock that is relatively fixed in the short run) resulted in an increase in the return on physical capital.” Page 3 

How long will the recession continue? 

The duration of the crisis will depend on how quickly and indeed whether the financial authorities are able to restore world credit, the signs are that they can notwithstanding the risk of further losses as the recession continues. The rate of inventory de-accumulation at the end of 2008 at least poses the possibility of a rapid recovery. It appears that Chinas recession is already over and the rate of internal fixed asset investment is lifting near Asia from the depths of collapse, certainly South Korea, Taiwan, Singapore and even Japan appear to growing in the second quarter of 2009.

A wider recovery depends on whether China and the oil exporters will continue to buy US and UK treasuries enabling them to keep down their interest rates and work off their debts. The signs are that they will, even while complaining about potential losses result from the scale of US assets they hold. This not least as the cost of financing the US balance of payments deficit has tumbled as the size of that deficit has fallen with the recession.  

No recovery for the workers

Even if a recovery has begun as appears likely in Asia at least and probably the UK, with unemployment continuing to rise and wages under increasing pressure it will feel like a recession for the working class. It will take time for the capitalist economy to recover from its near death experience. Past experiences of deep recessions which involved rapid inventory adjustments, 1960, 1974 and 1983, have seen V shaped recoveries as firms rebuild stocks as the economy recovers. But even a V shaped recovery does not mean the upward long wave will endure.

The levels of consumer debt based on mortgage equity withdrawal cannot return, the growth of the so-called emerging markets based on consumption in the West cannot continue. The growth model of the second phase of the long wave based on Eastern production and Western consumption from 2001-2007 is finished.

Can China and the oil and raw materials exporters now act as the major source of demand taking over the role of the US and UK consumer debtors? That is still far from clear even if the peak years of trade growth were in 2006/7 even while the rate of Mortgage Equity Withdrawal was already on the wane nonetheless it is the question which will determine the direction of the world economy over the next five years. 

Wed 10, June 2009 @ 17:01