Four Little Words

Frank Lee

The South Sea Bubble, a Scene in ‘Change Alley in 1720 (Edward MAtthew Ward, 1847)

The ruling global elites of our time are like the Bourbons before them: “Have Learnt nothing and forgotten nothing.” – Talleyrand

It was Sir John Templeton, the American-born British investor, banker, fund manager, and philanthropist, who sardonically observed that in business and finance the expression ‘this time it’s different’ represented the four most expensive words in the business lexicon. Today’s market fundamentalists seem fixated with the quasi-religious belief that (a) bubbles can go on inflating forever, or (b) I will take my profit just when the market tops out. But how many times have the investing herd had their collective snouts rubbed into the reality that there is no such thing as a free lunch? Unless of course you are on the inside. Whenever a market is oversold and seems to offer something for nothing, market participants behave like wildebeest herds on the plains of the Serengeti stampeding in precisely the wrong direction to the refrain of – ‘this time it’s different.’

Even Sir Isaac Newton, possibly the greatest mathematician/physicist who ever lived, was swept away in the euphoria of the South Sea Bubble[1]: In the spring of 1720, he owned shares in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he “could calculate the motions of the heavenly bodies, but not the madness of the people.”

Newton dumped his South Sea shares, pocketing a 100% profit totalling £7,000 – smart move. But just months later, again swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price – dumb move. He lost £20,000 (or more than $3 million in [2002-2003’s] money). For the rest of his life, he forbade anyone to speak the words ‘South Sea’ in his presence. Poor old Issy; alas, he should have known better. But it has ever been thus and will continue to be so.

Another salutary episode, this time from the 20th century, confirmed the emergence and path of bubble assets/markets to their inevitable dénouement. There had been feverish growth in US stock market in the run-up to 1929, and, as usual, all the talk was of economic miracles, new paradigms, and so forth. Typical were the words of President Coolidge in December 1928: “No Congress of the United States ever assembled on surveying the State of the Union, has met with a more pleasing prospect than that which appears at the present time…there is tranquillity and contentment…and the highest years of record prosperity.”

Speculators, traders and investors in New York’s financial district drove up the market to dizzying heights exhibiting the same frenzied, hivemind bubble-mania behaviour; an archetypal boom to bust chapter. Later in October 1929 the prominent Yale economist, Irving Fisher, opined that ‘Stock prices have reached what looks like a permanently high plateau.’ Hmmm, I seem to have heard this somewhere more recently.

Three weeks after this somewhat premature pronouncement the Dow Jones Industrial Average (the US stock market) was down by one third. By the summer of 1932 the Dow closed down nearly 90% lower than its 1929 pinnacle. Fisher and many others had made the mistake of thinking that the long bull-market of the 1920s (the roaring 20s) had assumed an unstoppable momentum and would go on rising forever. (An end to boom and bust if you will.) Throughout the 1920s the Dow Jones Industrial Average (DJIA) had risen inexorably; this was in part due to the new technologies and production methods which were allowing scope for considerable economies of scale and therefore increases in output so that a mass consumer society was to come into being. Moreover, modern management and marketing techniques could keep this consumer boom humming along in perpetuity, or so it was thought.

This situation of optimism and, as Keynes put it, rising animal spirits was conducive to the general propensity to invest in stocks and bonds. Everyone was playing the market; the party was in full swing even in this era of prohibition. Something of the flavour of the times is captured in the novels of F Scott Fitzgerald, The Great Gatsby or This side of Paradise.

Of course, the situation was never going to last; bubbles never do, no matter how big or irreversible they may seem at the time. It should also be noted that it is precisely when the bubble phenomenon and attendant growth levels reach their most febrile state that the correction becomes imminent. And so, it panned out.

The impact on the real economy of the stock market crash was that by 1933 unemployment had reached 25% of the American workforce and the economy had contracted by 30%. Worse still the catastrophe had spread to Europe – Germany being particularly affected with unemployment levels comparable to the United States. Now the writers of the age were John Steinbeck graphically illustrating the conditions of life in 1930s America in The Grapes of Wrath and Cannery Row. The UK also felt the chill winds of depression crossing the Atlantic as best expressed in the literature of Arthur Greenwood’s Love on the Dole, or Orwell’s The Road to Wigan Pier.

Thus the ‘jazz age’ ended and was superseded by a more egalitarian order: Franklin D. Roosevelt was elected US president in 1933 and immediately used active fiscal policy to create jobs and stimulate the economy as well as social reforms like relief for the unemployed and old age pensions. He did meet with partial success in that unemployment fell in the US up until 1938. However, there was a fresh recession and unemployment began to rise again. Eventually rearmament and the Second World War led the world out of the 30s depression.

As an interesting side-bar the structural changes in the US economy from 1941 was profound, albeit temporary.

Now tell me that socialism or a command economy would never work or even be entertained in the United States!

At the present time we are experiencing a double whammy of a financial and increasingly economic collapse. What gave rise to this was the biggest credit and property bubble in the history of capitalism. The boom from the early 90s until mid-2007 was essentially floated on a sea of debt. Mortgages were advanced to almost anyone who wanted them regardless of their ability to pay; individuals spent freely on credit cards without any thought for the morrow. Their debts could be rolled over or compensated by increasing asset prices (mainly property). So as consumers borrowed against the ongoing increase in their house prices, banks would lend them more. So, there was an upward spiral: the increasing level of credit led to an increase in property prices and the increase in property prices led to an increase in the availability and uptake of credit; the classic bubble scenario.

Worse still the mortgages held by the banks were repackaged (securitised) into new financial products, Mortgage Backed Securities (MBS) and Collateralised Debt Obligations (CDO) and often sold on to other financial institutions: Hedge Funds, Pension Funds, Insurance Companies and so forth. Okay so far, so good, the party roared on. However, the weak link in the chain was the American sub prime market. A group termed NINJAS – No Income, No Job, No Assets. This group predictably began to default, and the banks were found to be holding assets of very dubious value. This initial default was the detonator which burst the house price bubble in all of those countries which had experienced a property boom – the US, UK, Ireland, Spain and Australia.

The meltdown also started to affect countries who had not experienced a property boom but whose banks had foolishly purchased dreaded mortgage backed derivatives and collateralised Debt Obligations (MBSs and CDOs). Banks in Germany, Switzerland, the low countries, Iceland, and more especially Eastern Europe, began to feel the heat. Many banks (and even countries – Iceland) were now insolvent and had to be rescued by the governments or usurious loans from the International Monetary Fund (IMF).

Enter the credit crunch. Credit dried up even though property prices were falling. Since the US and UK economies had been essentially based upon the property market it was inevitable that the banking and property collapse would impinge very directly on the real economy. At the time of writing unemployment was rising very sharply, and deflation with falling (or static) prices and wages. Retailers were under the cosh with falling sales, and bankruptcies and boarded up shops are an increasingly common sight. We were already in a recession, if not the beginnings of a longer-term depression. Moreover, there are likely to be further eruptions to come in the murky world of Credit Default Swaps and Derivatives. These are totally unregulated and highly leveraged markets involving literally tens of trillions of dollars traded over the counter (OTC). The only question remaining is how long and how deep this financial/economic downturn was going to be. More important still perhaps were the possible political ramifications of this situation.

Such was the ignominious end to the fatuous claim of ‘no more boom and bust’. The shame was that it was all so predictable. And the shaming part was the extent that the government of the day colluded – in terms of bank deregulation and ease of credit creation – in and made possible this bubble creation by the financial and banking sector. This was a joint market/government failure.

Fast forward 10 years from the nadir of the 2008 bust and the portents are manifest and alarming. Global debt levels are unprecedented. In mid-2018 Global debt hit another high, climbing to $247 trillion in the first quarter of 2018, according to a report published Wednesday. Of that figure, the non-financial sector accounted for $186 trillion. The debt-to-GDP ratio has exceeded 318 percent, marking its first quarterly rise in two years.

As far as individual countries are counted, the US total debt is now 202% for private debt, (2017 figures), public debt has increased by 105%, so that total debt to debt-to-GDP is in the range of 300% plus or 3 times as large as GDP. China also has problems, mostly private debt, but total debt, when public is added to private is a cool $34 trillion. I suppose one consolation is that the debt is nominated in Yuan, but maybe that just clutching at straws. But China does hold large volumes of US dollar denominated assets, Treasuries, which it can dump any time.

Now if the two major global economies have big problems, one can only shudder for everyone else and think what might happen if both US and China hit the buffers at the same time!

In terms of vulnerability Europe and the EU seem prime candidates for the debt shock-waves emanating from both east and west. GDP growth in Euroland is stuttering between 1.5 and zero. These are almost depression figures. Interestingly enough the ‘big 4’ euro economies have experienced the following increases in most recent annual real output figures. As follows: UK 1.5%, France 0.9%, Germany 0.6% and Italy at 0.1%. For Euroland as a whole the figure stands at 1.2% (Source: Trading Economics). It is also worth noting that the UK Remainers might have a difficult time explaining why their dire predictions about the UK is somehow worse than the even more calamitous figures from mainland Europe? But, hey, let’s not let facts spoil the Remainer hysteria.

Another important indicator of what is to come is the P/E ratio. Price to earnings ratio – as reported in the financial press – is the prices of equities compared to their earnings. According to the Standard and Poor (S&P) composite index the average P/E ratio (market valuation) since 1871 has been 16.9, at the present time it is 28.5, that is to say well above the average. On only two occasions during the twentieth century has this figure been exceeded: 32.6 in 1929, and 44.2 in 2000. This means that the US stock-market is overvalued. Nothing can stay overvalued indefinitely, even if central banks and Treasury departments want it to. Their Herculean efforts notwithstanding, they have not and cannot invent a perpetual motion machine.

Additionally, there is the flattening of the long-term bond yield curve. Government bonds and notes are sold for different durations, from overnight to 50 years. In normal times the rate of interest on these securities varies with the length of their maturity. However, when investment in long-term bonds increasingly aligns with shorter term notes and bonds the long-term yield carve begins to flatten and even dip below short-term debt instruments. This is usually a sign of a coming recession, since investment in short term notes and bonds are exposed for shorter redemption dates in an unpredictable economic/financial environment. All of which makes jumpy investors wary about committing themselves to long-term bets.

One of the consequences of the 2008 debacle and the great bank bail out was what followed in terms of income inequality and austerity. The banks were partially bailed out (there are still a number of basically insolvent banks out there – Deutsche Bank being number One). But what followed was a secondary corresponding bail-out of national economies by the imposition of austerity. Social welfare programmes were cut, as were wages, pensions, health and education, transport, interest rates on small savers, with other miscellaneous parts of government expenditure. This resulted in an income re-distribution upwards.

In short, the rich 1% got richer whilst most other cohorts either got poorer or trod water. So much is common knowledge. But the effects of a small group appropriating an increasingly large portion of national income means that their savings increase at a faster rate than their expenditures. This results in low growth or no growth and stagnation. In economist’s jargon the rich have a greater marginal propensity to save rather than marginal propensity to consume expressed as MPS>MPC, and the lower deciles have a greater marginal propensity to consume than to save, MPC>MPS.

Huge agglomerations of capital are therefore being effectively idled since the rich can’t spend their fortunes quickly or exhaustively enough whereas the other deciles of more modest means cannot effectively consume because they don’t have sufficient incomes, or, worse still, they are sinking into debt peonage which adds an additional impediment to growth.

We can say with some certainty that these austerity policies are never going to work, and I suspect that the elites know this. There will be no catching up by the dispossessed; this rising tide is not going to float all boats, on the contrary it will sink many. Yet the great bullshit mega-show issuing from the university academic economics departments, the financial press, the global institutions – IMF, WTO, WB, OECD, BIS – Treasury departments, Central Banks and Finance Ministries of governments around the world must go on. TINA (There Is No Alternative) the great courtesan of economic theory and policy is back in town. In fact, she never left.

Remembering the axioms of my youth I recall one in particular. “You don’t need a weatherman to see which way the wind blows.”[4] The canaries in the coal-mine are Brexit, Trump, the Yellow Vests, the awakening of Europe, east and west, and the emergence neo-nationalist and populist movements[5] in the struggle against globalization and for national sovereignty and democracy. Neoliberalism is increasingly under siege and the deepening of this crisis it is not going to stop.

Other economic policies and possibilities have always existed and still do. But don’t count on any policy other than the one already foisted on us. The PTB are guided by a learned ignorance. In a more profound sense, the question is not an inability to learn by our ‘betters’ but a determination not to. The PTB will not and cannot learn, and like the Bourbons they have learned nothing and forgotten nothing.

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