Month: May 2016

Marx stressed the role of banks in collecting together money lying idle in the economy and converting it into active capital available to be lent out – loanable capital is one term he uses, interest-bearing capital is another.  He notes that this process involves a centralisation of available money capital.

The business of banking consists … in concentrating money capital for loan in large masses in the bank’s hands, so that, instead of the individual lender of money, it is the bankers as representatives of all lenders of money who confront the industrial and commercial capitalists.  The bankers become the general managers of money capital… they concentrate the borrowers vis-à-vis all the lenders. (Capital Vol. 3, Penguin, p. 528)

Marx adds that the cash reserves of industry and commerce are amalgamated with money saved, ‘by workers (by means of savings banks) as well as landlords and other unproductive classes‘ (p. 618).

A global surplus of money capital, relative to the level of demand by borrowers, was one of the main underlying causes of the financial crisis of 2007 and its lingering aftermath.  World  long-term interest rates have been falling over the past two decade, and in the advanced economies are currently even lower than the previous record set 5000 years ago in Babylon.

Such low rates are, in themselves, a strong indicator of a relative surplus of loanable capital. Of course loose monetary policy by central banks has also made a contribution to the fall in interest rates.  But central banks would certainly not have wanted the zero interest rates of the current period.  To stimulate their economies they have been forced to give additional impetus to a trend which was already happening as a result of market forces – a greater supply of money capital relative to the demand for loans.

The post-2000 build-up of excess money capital in the system had three main sources.

1] the corporate sector

After the short downturn of 2000-1, profitability in the corporate sector in the major economies recovered rapidly but investment lagged – and this remains the case in 2016. In identifying situations of excess money capital it is essential to consider not just the rate, but also the mass of profit.  In 2015, the influential Toronto-based research organization, the McKinsey Global Institute [MGI], published convincing evidence that the build-up of cash reserves in the corporate sector was only the latest phase of a trend which started in the 1990s.

In a comprehensive study, MGI analysed the accounts of 28,250 companies which had more than $200 million ( or equivalent) in annual revenue. The study covered private as well as listed public companies in 42 countries and 18 industrial sectors.

In the United States, Western Europe, Japan, and South Korea, the corporate sector’s share of national income had increased by 1.5 to 2 times since 1980. Corporate profits, before tax and interest payments, had risen from 7.9 per cent of world GDP in 1980 to almost 10 per cent  in 2013. Thus an enormous rise in the mass of profits extracted.

The mass of profits after payment of taxes and interest had risen even faster – from 4.4 per cent  of world GDP in 1980 to 7.6 per cent in 2013.

MGI estimates that the real growth rate for the total pool of global corporate profits was an average of 5 per cent a year from 1980 through to the present. It forecasts that this may now begin to slow, though only to a still respectable average real growth of 1 per cent a year.  But for the 1980-2013 period it concludes that, ‘the world’s biggest corporations have been riding a three-decade wave of profit growth, market expansion and declining costs’ (p. 3).

The MGI study also showed that investment lagged increasingly behind this profits surge. After the East Asian crisis of 1997, investment dropped by 10 per cent in South Korea and the South- East Asian economies affected.  In the US and Europe a similar fall took place after the dotcom crisis of 2000.  Profits recovered rapidly from the downturn of 2000. But investment in the productive sector did not revive to the same extent and has remained subdued right through to the present time.

The mass of uninvested cash built-up rapidly.  Much of it was handed out to shareholders in dividends and share buy-backs, and in pay increases to executives.  But despite this, in the major economies, the corporate sector quickly accumulated large reserves of unused money capital.  Here the MGI data is astonishing:

Since 1980 corporate cash holdings have ballooned to 10 per cent of GDP in the US, 22 per cent in Western Europe, 34 per cent in South Korea and 47 per cent in Japan. (p. 3).

These cash piles have mostly been lodged in banks or invested in the short-term money markets – often after having been passed through a tax haven to evade corporate taxation.

In Marxist commentary there has been a widely accepted belief that the level of the profit rate is virtually the only determinant of the level of investment that needs consideration. But in fact the relationship between profits and investment is quite variable over time. For example James Crotty in an important paper has shown that in the US, in the early 1980s when profit rates were low, the pressures of competition and rationalisation dictated that if companies were to survive and flourish they had to invest heavily.  This was what happened (Crotty calls it coerced investment), and where necessary, companies borrowed the extra capital required.  Thus, a combination of low profits and high investment.

But the reverse is also possible, and this has been the case over the past 15 years.From the 1990s onwards, as investment lagged and profits rose (though with periodic setbacks), the corporate sector in the major economies became a net financial lender to other  sectors of the economy.

2] The foreign currency reserves of governments

In the world economy after 2000 there was a rapid build-up of trade imbalances. The US was the major country which ran a trade deficit. This by 2006 had grown to equal no less than 6 per cent of US GDP.  The surplus countries included Germany, Japan, the oil-producers, and a number of low-wage manufacturing countries led by China.  In the Asian economies especially, resistance to a rising exchange rate became a major policy objective.  China itself had not been devastated by a crash in its exchange rate, as had South Korea and the other economies directly hit by the crisis of 1997.  But the message of 1997 was assimilated by China as well as other countries in Asia: build large stocks of international currency reserves; don’t let a trade surplus cause a rise in the exchange rate of your currency. Thus to stop their currencies rising against the dollar, the central banks of the Asian surplus countries used the surplus dollars earned by their exports to buy financial assets in the US. Treasury bonds were a favorite purchase, but also bonds issued by the quasi-government agencies (such as Fanny Mae and Freddie Mac) supplying mortgages in the vast US housing market.

Chinese international currency reserves which were tiny in 2000, had risen by 2014 to the equivalent of over $4 trillion (compare US GDP in that year – about $15 trillion). The combined reserves of the surplus countries, including China, rose from $2 trillion in 2002 to $12 trillion by 2014.  These large official reserves made a major contribution to the oversupply of money capital in the world’s credit markets.

3] the personal sector

A third channel for money capital accumulation is the personal sector.  Here the picture is complex.  There has been a huge rise in the overall levels of household debt in the world economy. Mortgage debt especially, but also hire purchase, credit card, and student loans. As is often noted, in the high-income economies, led by the US, it is borrowing by households which has been crucial in maintaining the level of consumer demand, given that for more than two decade, average real wages have scarcely increased.  Apart from government borrowing, the rise in household debt has been the major source of demand for loanable capital.

But there have been two ways in which the personal sector has added to the pool of loanable capital, rather than helped in its absorption by increases in borrowing.

(1) In China, although investment levels in the post-2000 period have soared to very high levels, the rate of saving by Chinese households has risen even higher. China is exceptional, but average household savings are relatively high in many other countries in the global South.  The much higher growth rate of the Southern economies in recent years has increased their relative weight in the world economy, and therefore the size of their contribution to the oversupply of loanable capital.

(2) There has been an enormous surge in the level of personal income and wealth secured by those in a position to capture large amounts of the rising surplus-value extracted directly or indirectly from the productive sector. Average levels of dividend payments have continued to rise in the high-income economies.  Extensive share buybacks have allowed shareholders to sell some of their shares at elevated prices.  There has been an enormous, and much discussed, increase in the salaries, and stock options which executives pay themselves.  In this period there has been a continuing acceleration in the numbers and average wealth of the rich. and the trend is as evident in the emerging as in the high-income economies.  According to the latest Credit Suisse Global Wealth Report the number of dollar millionaires worldwide grew from less than 13 million at the turn of the century to over 36 million in 2014. There are now over 1,800 billionaires.

Obviously the rich spend much of this extra money on luxury consumption.  But large quantities of their wealth are kept in liquid form and are saved rather than spent.  Growing amounts are passed over to the financial sector to be lent out or invested. A recent Oxfam Report quotes estimates that at least 8 percent of individual financial wealth is tax laundered through offshore tax havens, that’s a total of $7.6 trillion (compare world GDP in 2015 of just $78 trillion).

Corporate cash piles, plus official reserves of international currencies, plus personal wealth held in liquid money form – these are three of the major channels through which exceptional quantities of loanable capital have been accumulated in the period since around 2000.

A Marxist account of the current crisis has to trace the impact of this tide of money on the financial system, as it struggles to balance the seduction of possible large profits against the dangers and strains posed by ultra-low interest rates and an insufficient supply of creditworthy borrowers and safe financial investments in the global economy.

One of the major developments in the world economy over the past 15 years has been the extraordinary fall in average real interest rates. (after allowing for inflation.) As the graph below shows, the world average fell from 4 per cent in the 1990s, to 2 per cent in the period just before the financial crisis of 2007. There was then a further steep fall to the near zero real rates of the present time – the lowest in recorded history.  Interest rates have generally been lower in the high-income than in the emerging economies, but in both regions real rates have plummeted.

Part of the explanation is that in most of the major economies, governments have been encouraging their central banks to implement low interest rate policies. For example programs of quantitative easing [QE] have involved the large-scale purchase by central banks of bonds in the financial markets. This is often called printing money, but the term is misleading. It is not that governments have been financing their expenditure by getting the central banks to print money. More accurately, what is increased by QE is not the money supply, but the level of reserves in the banks. As Mian and Sufi explain in their outstanding book House of Debt, p. 154,

an increase in bank reserves leads to an increase in currency in circulation only if banks increase lend in response to the increase in reserves … bank lending plummeted during the Great Recession (2008-10) just as bank reserves skyrocketed.

QE and similar policies are part of the falling interest rate story. But other forces have been at work in lowering rates. These are set in the financial markets by the balance between the demand for money to borrow and the supply of money available to lend. The major central banks intervene powerfully in these markets. Despite the huge deregulation of finance – one of the central objectives of the post-1980 neoliberal agenda – until the early 2000s, the central banks in the big countries seemed still to have the power to determine short-term interest rates in their domestic economies, and also to exercise considerable influence on long-term rates.

But the fundamental reason for the fall in long-term real interest rates since 2000 is a global surplus of money capital. There has been a larger supply of money capital available to be lent out, than the demand for credit by borrowers. During the recent period in which central banks have been trying to lower the interest rate, they have been only adding a further impetus to processes that were happening anyway.

The strongest evidence in support of the surplus money capital thesis is that when, in 2004, the US central bank, the Fed, tried to raise long-term interest rates, it found itself unable to do so.

Alan Greenspan was Fed Chairman from 1987 to 2006. In his memoirs The Age of Turbulence (2007) he recounts his traumatic encounter with the limitations of central bank power in the epoch of deregulated neoliberal finance. After a three year policy of low interest rates to lift the economy from the downturn caused by the dot.com crisis of 2000, starting in Feb 2004, the Fed implemented a series of increases in short-term interest rates.

Normally the financial markets would respond in ways which caused long-term interest rates to rise as well. The Fed had decided that a increase in long-term rates, and notably the mortgage rate, was urgently required to cool out fast-rising prices in many sectors of the US housing market. (They sensed trouble ahead … though nothing remotely on the scale of the 2007 crash.) But in June 2004 Greenspan and his colleagues were shaken by the refusal of long-term rates to rise:

We had increased the [short-term] Federal funds rate, and not only had yields on ten-year Treasury bonds failed to rise, they’d actually declined … this was extremely unusual … market pressures seemingly coming out of nowhere drove long-term rates down instead of up … What were these market forces? They were surely global, because the declines in long-term interest rates during that period were at least as pronounced in major foreign financial markets as they were in the United States  (p.378).

Greenspan recognized that there were now forces at play in the world economy which were acting to lower interest rates. However, he was still taken aback by the inability of the world’s most powerful central bank to effect even the smallest rise  in long-term interest rates in the US economy. He continues:

Even though globalisation had reduced long-term interest rates, we had no reason to expect, in the summer of 2004, that Fed tightening would not carry long-term rates up with it… The unprecedented response to the Fed money tightening suggested that in addition to globalisation profoundly important forces had developed whose full significance was only now emerging. I was stumped. I called this historically unprecedented state of affairs a conundrum.

Looking back to this moment of revelation, Greenspan, in his memoirs, meditates on the deeper forces which have been influencing the global supply and demand for credit. He touches on a number of themes which need to be addressed in any Marxist account of the crisis. Because inflation had fallen worldwide since the early 1990s, lenders were willing to accept a lower rate of interest. This fall in price inflation owed much to the fact that more than a billion low-wage workers had joined the world industrial labour force after the integration of China, Russia and other centrally planned economies into the international production and trading system.

So – that’s one factor, says Greenspan. But connected with this, he says, is:

a worldwide increase in the supply of loanable capital, relative to the investment of those savings in productive activity. Excess potential savings flooded global financial markets, driving interest rates lower… during the past five years developing country growth has been twice that of developed countries. Their savings rates, led by China, rose from 24 per cent in 2002 to 32per cent in 2006 as consumption lagged and investment fell far short of the rise in savings (pp. 285-7).

The Fed found that it had no alternative but to go with the flow of market processes – to accept that monetary policy was now more limited in its capacity to control interest rates. Thus we find Greenspan writing that:

this decade’s decline in long-term interest rates, both nominal and real, is mainly a result of geopolitical forces, rather than the normal play of market forces … I very much doubt that either policy actions or central bank anti-inflationary credibility played a leading role in the fall of long-term interest rates in the past one to two decades… I doubt that we had the resources to counter the downward pressures on real long term interest rates which were becoming increasingly global. Certainly Japan did not. (pp.387-391).

In 2016 the major central banks are struggling to counter the global forces that are lowering interest rates, and also causing growth to falter. And they find themselves compelled to try and achieve this …by pushing interest rates even lower! Yet the prevalence of zero (and negative) interest rates in many sectors of world credit markets poses serious dangers for the system. Profitability in the banking sector is badly hit. Cheap borrowing provides the fuel for speculative booms in financial markets. General levels of debt tend to increase because the cost of servicing debt is low. Debt overstretch makes the weaker sectors in the world economy vulnerable to small increases in interest rates, or to whatever undermines their capacity to service debt – hazards such as a fall in the rate of growth, an increase in unemployment, or a decline in profitability.