In the face of deteriorating global economic conditions the financial and economic powers-that-be seem fixated on policies which are both ineffective and inappropriate.
Anyone who entertains the notion that central banks around the world actually know what they are doing, and have the magic box of tricks to get the world economy back on track, really ought to take another look at where we have arrived, and where we are going.
Recently the Chairman of the Bank of England (BoE) and former Goldman Sachs employee, Mark Carney, announced new a monetary stimulus package designed to get the UK economy moving again. It consisted of the following measures:
- Interest rates at a record low of 0.25%, a level not seen in the BoE’s 322-year history with more to come.
- An extra £60bn of newly created money to buy government bonds, drive down gilt yields and force investors into riskier assets
- A new £100bn scheme to encourage banks to lend cheaply to UK companies
- A pledge to buy £10bn of corporate debt issued by UK companies who make a genuine contribution to the UK economy.
All of which adds up to another helping of QE and even lower interest rates of 0.25% with negative rates on the cards. Is this second round of monetary easing going to be any more successful than the first? Or is monetary policy alone going to result in escape velocity and usher in growth? Judging on past performance the prognosis is not encouraging. Last time around QE – i.e. BoE purchases of privately hold UK bonds (Gilts) – injected £375 billion into the economy which was supposed to lead recipients to engage in productive investment into the (real) value-added productive economy. Alas, most of this BoE largesse did not enter the real economy.
Banks (who were the main investors) instead used it to repair their badly damaged balance sheets resulting from the 2008 crash; invested it abroad into more favourable profit climes; deposited it straight back into the BoE in the form of excess reserves (this is what also happened with the US central bank, The Federal Reserve) on which they were paid interest. Other non-financial companies invested their newly acquired liquidity in share buybacks and mergers and acquisition activities. The great paradox of QE was that it resulted in a contraction of money supply – measured as M4 – see chart below – and therefore there was no generalised inflation outside of the above-mentioned asset classes.
The only investment, if we can call it that, which occurred was the speculative purchasing of shares (stocks), property and bonds which pumped up the price of these assets making money for those persons and institutions who happened to own these assets. But as Marx pointed out these price appreciations weren’t real value; it was just asset-price inflation, or, as he put it, fictitious capital, which could disappear (as it did) overnight.
For speculators, however, this was a bonanza. You push up the three asset-classes, bonds-stocks-property, with aggressive leveraged buying from free monies lent to you by munificent central bankers like Mr Carney and Fed boss Janet Yellen. When the market tops out, you sell-off and take your profits. That’s the first leg. When the market crashes (markets undershoot on the downside as much as they overshoot on the up side) then you get to buy bargains at fire damage sale prices. Neat trick eh? The speculators win when prices climb and then win when prices plummet. In the trade it is called ‘pump and dump’.
The crux of the matter is that businesses are stubbornly refusing to invest in productive capacity and no amount of monetary easing will induce them do so. You can take a horse to water but …. Seems we are up to our neck in Keynes’ liquidity trap.
This of course raises the question as to why this was the case. Investment decisions are of course related to the rate of interest; and as the text books say high rates of interest will tend to have a negative influence on investment and vice-versa. But of equal and possibly more importance is the return on such investments. The theory of diminishing returns on investment projects goes way back to Quesnay and the French physiocrats, to the British political economists David Ricardo and Thomas Malthus, and in more recent years to Marx, Schumpeter and Keynes. In short, the theory postulates that each successive input (costs) will result in the long run of a fall of output (profits) until a point is reached where output turns negative relative to input and the enterprise is no longer viable. Keynes called this the decline in the Marginal Efficiency of Capital, and along with Schumpeter attributed this to the disappearance of viable investment projects and Animal Spirits.
As JMK explained:
…the crisis is not primarily caused by a rise in the rate of interest, but a sudden collapse in the marginal efficiency of capital.’
For Marx, the explanation of falling profitability was the growth in what he termed the ‘organic composition of capital’ which we would probably call the capital-labour ratio. Given the labour theory of value which he inherited (with modifications) from Adam Smith and David Ricardo, human labour was said to be the source of value – or what we would call value-added – and since it would be increasingly replaced by capital then the rate of profit would fall. Thus, in all these instances investment would tail off as profitability declined.
Additionally, in a recent book – Killing The Host – the American economist, Michael Hudson, argues that the financialisation of mature economies in the west has led to a type of parasitism of rent-seeking activities by financial institutions which are sucking the life out of the productive, value-creating economy.
The rise of the Finance, Insurance and Real Estate (F.I.R.E) sector – banks, credit agencies, investment companies, brokers and dealers of commodities and securities, security and commodity exchanges, insurance agents, buyers, sellers, lessors, lessees and so forth – has now reached such a level that it has become larger, more ubiquitous, and profitable than productive industry. Prior to the ascent of financialised capital and the deregulation and privatisation mania, the role of finance was usually restricted to greasing the wheels of the productive (value-creating) economy. Commercial banks took the publics’ deposits and funnelled it as credit into manufacturing and commercial enterprises. In this regulated environment, commercial banks and other financial institutions were legally circumscribed in the level of credit they could extend.
Then, in 1986, came the Big Bang: finance was now off the leash. Instead of producing real value as embodied in goods and services, selling of ownership titles was to become the chosen field of investment.
A good example of this has been share buy-backs. Most of the rise in global stock market valuations has been due to companies borrowing at very low interest rates and buying back and retiring their own shares. This means that those shares remaining in circulation go up in price since the book value of the company remains the same while its volume floating shares (this is called market capitalisation) have contracted. On paper the firm has become more profitable since its share valuations have increased. This means an upward revaluation for the shareholders and the CEOs who now hold their hands out for a bonus. Money lending in general consisting of asset-backed securities, student loans, mortgages, car-loans, credit cards, all serve to increase the flow of rent to the financial sector which are simply overhead costs on the real economy.
Moreover, notice that no new value has been created. The whole thing was just an exercise in moving pieces of paper around.
What is worse this process has not only slowed down the flow of investment monies into the productive sector, it has now reversed the flow from the productive into the financial sector. As for growth, nothing grew except the shareholder bonanza and the CEO’s bonus. The one-time symbiosis between the productive and financial sectors has thus transmuted into a parasitic relationship. Other methods used to generate positive cash-flows include predatory take-overs and lobbying for corporate tax cuts.
In this way, it is entirely possible to generate profits during a period of economic downturn and investment slump.
Mr Hudson also gives a good explanation of what in economics is called ‘economic rent’. Economic rent (also known as price gouging) is the practise of charging higher price for an item due to a market structure – monopoly/oligopoly – which enables this pricing policy.
The utility/energy industries in the UK – a blatant cartel – have been doing this since they were privatised during the Thatcher era. Privatisation has been little more than a legal licence to print money. Privatisation and deregulation simply means the commodification of what were once public goods. Mature economies in the west now seem to be returning to the pre-industrial age of rentier capitalism.
Although the origin of the word ‘rentier’ is obscure, it was used by the classical economists including David Ricardo, John Stuart Mill and Karl Marx to identify a particular socio-economic group – usurers – whom they regarded as both anachronistic and parasitic. Mill argued that it was both morally reprehensible that these people should earn monies not by dint of their labour but in their sleep, as their assets earned interest/rent. Just as the present-day Duke of Westminster, Gerald Grosvenor, earns rents from his properties in Mayfair. The Sunday Times Rich List 2016, estimates the Duke was worth £9.35 billion. In (“Theories of Surplus Value” 1862-1863) Marx noted that capitalism was inherently built upon practices of usury and thus inevitably lead to the separation of society into two classes: one composed of those who produce value – capitalists/industrialists, and the other, which feeds upon the first one – the rentier.
Whatever the merits of these theories it is a brute fact that investment/growth/profitability have all been in long term decline. Attempts to shore up business growth has involved the issuing of increasing inputs of debt, a sort of monetary narcotic. But still the ongoing secular stagnation trend continues. Global corporate profitability was around averaged around 30-33% in the early 1960s and has now fallen to less than 20%. In an attempt to overcome this stagnation debt (private and public) 246% of global GDP in 2000 to 286% in 2014. A trend that shows no signs of abating. All this must lead to the inexorable conclusion that since debt is growing faster than output then diminishing returns have set in. Thus:
By 2005, US$5 of new debt was necessary to create an additional US$1 of growth; a five-fold increase from the 1950s.’ S. Das – The Age of Stagnation – p.2
Where all of this is heading doesn’t look particularly appetising; but what is becoming patently obvious is that the Finance Ministers, Central Banks, Financial Elites, Financial journalists, and opinion formers around the world either (a) don’t know what they are dealing with (b) think they know what they are dealing, but don’t, and therefore propose totally inappropriate ‘solutions’ (c) the masters of the universe sitting in their air-conditioned offices and trading floors, who know perfectly well what is happening – but they don’t particularly care; they’ll just take the money and run.
One such, Chuck Prince, Chairman of Citigroup a multinational US investment bank epitomised the morality of the masters of the Universe. During the orgy of speculation- which he was aware would end in tears – he opined that, ‘… if the music is playing you have to keep on dancing.’ When the music stopped, however, and the unsuccessful gambles with the company’s money had led to the collapse of the Bank, Prince resigned with a golden parachute of US$38 billion. Citigroup had later to be rescued by a US government bailout.
When the music plays you have to keep on dancing – a valediction for our times perhaps.