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Sunday, July 30, 2017
Perceptions of risk of a recession (Source: Legal & General Investment Management)
by Kumar David-July 29, 2017
by Kumar David-July 29, 2017
My ‘Dummies Guide to Solar & Wind Power’ two weeks ago elicited encouraging responses. Obviously, there is a market for simple pieces. Since I know even less about economics than electrical engineering maybe I can risk straying into the territory of this essay. It’s a dummies guide written by a dummy and the target is again the 100% layman. I want to provide a primer on finance capital, why it rose to prominence in the last two decades, what led to the 2008 debacle, why this was unavoidable (you will not hear about that from bourgeois ‘experts’), and how capitalism bailed out its banks and financial institution. I will touch on why ‘recovery’ from the Great or Global Financial Crisis is still absent despite limitless massaging since Q4-2008 and why a second recession is likely.
Everybody is in debt – amazing! Surely if some are in debt others must be creditors. What’s the secret? Sovereign debt is rampant; the US government is in hock to the tune of $17 trillion; US corporate and household debt (mainly mortgages and credit cards) add to another $30 trillion. Governments, corporations and households in Britain, France, Brazil, Russia, nearly all of Europe, most of Asia and all of Africa are saturated in debt. Aside from the oil rich Gulf, Singapore and New Zealand, I can’t recall any sovereign (government) not drowning in red ink. This is true of China if you include the 26 provinces, state enterprises and private companies; in China, it is domestic borrowing. In the West households are up to their neck and savings rates are low or negative. Some businesses are in debt; others cling to cash like limpets and refuse to invest.
If everyone is in debt, who the devil is the creditor? Whose money do these wretches borrow? The IMF, global funds and banks (except central banks) do not print money; they acquire it from elsewhere and lend. [After 2008 central banks went on a printing binge, Quantitative Easing (QE)]. You have heard of the richest 1% and 10% owning more than 60% and 90%, or whatever, of global, American or European wealth. Well that stuff is hired as bonds, deposits and investments to banks, mutual and hedge funds. It is this vast pool of loot that the rest of the world is in hock to. Global bank and fund assets amount to $ 150 trillion (world GDP is $68 trillion). Pension and social security funds and post office savings, that is ordinary people’s money, accounts for maybe a third (I am not sure) of the $150 trillion. The rest is the filthy lucre of the ugly rich. That’s where the stuff comes from and that’s why the elite, the banks and global bureaucrats fight to get interest paid and debt repaid.
The rise of finance capital to superpower status, divorced from the real economy of business, material investment and households, is recent. At the turn of the nineteenth century, finance capital facilitated global expansion (Ceylon’s tea plantation, Suez and Panama Canals). It was handmaiden to investment in an age of classical imperialism. It is different now; finance capital is the senior partner.
Behind this change lies stupendous capital accumulation that cannot be profitably invested in manufacturing, agriculture, services and traditional activities. Bernanke called it the savings glut because he doesn’t know his Marx. The old Moor would not have raised an eyebrow; excessive accumulation and the limits of surplus value generating reinvestment are intrinsic to the lifecycle of capitalism. The very growth of wealth produces gigantic slush funds. The 1991 recession and the dot-com bust of the late 1990s revealed that there was nowhere left to invest profitably. High savings generated by China’s industrial revolution and explosion of exports created another leviathan. This monster needed safe parking and found its way back as dollars stacked in American Treasuries, the Bank of England and Frankfurt. Such is the genesis of finance capital, which then flexed its muscles as a powerful new global player. It is crucial for getting a command of this essay that you appreciate that finance capital did not emerge sui generis; it was an overgrowth of capitalism’s life cycle.
It was then inescapable that finance capital would begin to play with itself; a naughty and dangerous pastime. Unless capital is employed for generation of surplus value it is merely a board game like Monopoly. Money going round and round creates no real value; otherwise the making of wealth would need only a printing press and a game board and Indrajit Coomaraswamy could turn us all into millionaires. Wealth creates wealth only in productive activity. That’s common sense, but it underpins the theory of capitalism’s collapse under the weight of its own internal contradictions.
Two features of modern finance capital: (i) Now banks (and finance houses) are intricately interconnected. One failure has a knock-on effect across the system. (ii) Highly complex financial products known as ‘derivatives’ have emerged, some to serve needs (futures contracts, hedges) and others to enable finance capital to play with itself (CDS-credit default swaps, CDO-collateralised debt obligations, risk tranches and subprime mortgages); risky, opaque and at times verging on fraud. Proven risk analysis has given way to complex algorithms invented by ‘bright’ mathematicians newly minted by elite universities. (Rather like some of my pie in the sky, computing besotted, ‘brilliant’ PhD students). George Soros and Warren Buffett described derivatives as weapons of mass destruction whose purpose is speculation to conjure up profit out of thin air. Denied profits in conventional economic activity by capitalism’s sclerosis, finance capital has no option but the casino.
A feature of modern finance capital is staggering leverage ratios. (Leverage is the ratio of bank deposits plus market borrowing to the equity base).
The ratio in Q3-2008 was invariably 20 to 30; in Iceland and Ireland nearly 50! If a liquidity run was fortuitously set off, banks lacked the asset depth to weather it, and liquidity problem transformed into a solvency issue. (Solvency: Is a bank’s balance sheet strong enough for it to survive a short-term liquidity challenge?)
The 2008 tsunami and after
Mistakes may have been made, Fed governors Greenspan and Bernanke, Bank of England’s Mervyn King and ECB and BoJ governors may have made slips, but there is no way they could have prevented the 2008 catastrophe. Can the cleverest seismologist foil a gigantic earthquake? That is my punchline in this essay. The size and structure of the forces that had evolved within capitalism by the first decade of the twenty-first century were too big to subdue by higher or lower interest rates, more or less money injection, bank legislation or central bank intervention. To prevent the crisis would have required a lobotomy of the logic and laws of capitalism itself.
The 2008 story is well known; an incident here (BNP Paribas in August 2007), a difficulty there (bankruptcy of subprime borrowers in 2007-08), a convulsion in New York (Lehman Brothers bankruptcy, September 2008), then insolvency of Royal Bank of Scotland and Halifax Bank. This was a runaway train, the saga of the collapse of finance capital.
How the state intervened to bail out banks and tottering industries is also a known story. The state and central banks – that is the public, future debt burdens, taxes, earnings, and current pension and savings funds – were pressed into service. In the name of QE some $5 trillion has been injected into banks world-wide. Interest rates have been slashed to hover effectively at zero to encourage investors. The public purse has been ravished to resuscitate morbid capitalism.
Still not risen from the dead
Jesus Christ did it in three days; capitalism has not been able to repeat it in a decade. The Resurrection is the cardinal event of the Christian faith; in contrast, a second recession in the wake of continuing inability to rise again from the fall of 2008, will prophesy the demise of capitalism in the decade of the 2020s.
But why is capitalism unable to rise again; because nothing has changed in the fundamentals. What has been done is banks have been strengthened by new regulations on reserves, certain activities have been outlawed and ‘stress tests’ to ensure ability to withstand shocks have been implemented. Yes, banks are stronger and more secure. But this is all shooting at the wrong target, or at least shooting the aide-de-camp instead of the champ.
The principal contradiction lies in investment, profit, accumulation and competition as per the established model. Despite central banks gorging the economy with money and pushing monetary stimulus as far as it can go, there is no climate of investment. Interest are near-zero, hence the 10-year US Treasury Bond yield has been declining like a ski-slope; still no robust recovery. To put it in market jargon "there is absence of confidence, there is fear that investment will be stranded". Risk and uncertainty terrify post-2008 investors. The exceptions are social media and IT. All US economic indicators pop up and down like a jack-in-the-box. Global capitalism is in the doldrums of investment blight despite a structural surplus of capital.
What 2008 has displayed is a classic contradiction in the real economy manifesting itself as crisis and crash in the financial economy; a rash as symptom of internal pathology. I don’t see a way out on a simple all-capitalist road. But social democratic medications may alleviate it since fascism and austerity are ruled by the balance of social and political forces.