UK budget: slashing public services and welfare

November 25, 2015

The main headline news from the UK’s annual government spending review is that the British Conservative chancellor George Osborne has done a U-turn on his previous plan to cut what are called tax credits that supplement the pay of the poorest working families.  The planned cuts in these ‘credits’ were part of the aim to cut another £12bn off the already huge cuts in welfare spending that the Conservatives have made.  This backtracking by Osborne is a victory for the campaigning of the left-wing Corbyn-McDonnell Labour opposition leadership.  If the so-called moderates were still the leaders of Labour, there would have been no fight at all.

This U-turn means that the government will exceed its own self-imposed ‘cap’ on welfare spending for the next three years.  But, as shadow chancellor John McDonnell has pointed out, cuts in income to the poorest working (not unemployed) families are still in the pipeline.  That’s because the Conservative government plans to introduce what it calls ‘universal credits’ to cover all sorts of benefits in two years and phase out tax credits.  The new credits will pay out much less.  Working families will lose so that the government can meet its ludicrous target of ‘balancing the books’ on the government budget by 2019.


The irony is that, despite all the measures of austerity imposed by the Conservatives since they came into office in 2010, they still cannot get the government deficit down in cash terms and are way behind their original targets for annual deficits as a share of GDP.


That’s because of two things.  The government has reduced taxes so much for the rich and for corporations that the tax returns have just not met targets.  And the UK economy has grown much more slowly since 2010 than forecast, so tax revenues have grown more slowly.  This has forced the government to keep on cutting government spending to try and get the annual deficit down and stop the public debt to GDP ratio from rising.

Forced to maintain spending on health and education (although as share of GDP they will fall), the government is imposing huge cuts in other public services: transport -37%, agriculture -15%, justice -17%, culture -22%.  In this spending review, the government also announced an increase in ‘defence’ spending and a little more on health, although it wants £25bn in ‘savings’ from the health service over the next four years – ludicrous as the population rises and gets older.

The Chancellor boasted that by the end of this parliament in 2020, government spending will be only 36% of GDP, making it the lowest ratio among advanced economies, excepting Switzerland and Australia.  This is a marker for how anti-state spending this government is and how pro big business it is.

The Chancellor has been lucky in that interest rates remain very low, keeping the cost of servicing public debt low. But it is also fudging projections for future tax revenues, claiming that the UK economy can grow at about 2.4% a year for the next four years. He is hoping to reach his 2020 budget target by cutting spending less than previously planned now in order to impose larger spending cuts and tax increases later. And there are new taxes: increased local government tax, a tax on buying homes for renting out, a levy on employers to pay for apprenticeships and the introduction of loans for grants for nurses and other students.  Nurses will now have to pay for their qualifications training and then get low pay and long hours.

But if global interest rates rise with the start of Fed hikes and a global recession returns and stops the UK economy in its tracks, then even these revised budget projections will turn to dust.

Marxians, Marxists, profitability, investment and growth

November 24, 2015

I continue my campaign, along with a small band of like minds, arguing that the ups and downs of real economic growth are driven by changes in business investment.  And, in a capitalist economy, that investment is driven by the level and movement in the profitability of capital and in the mass of profits generated by the workforce and appropriated by the owners of that capital.  To me, this seems a simple and realistic analysis: profit rules.  But this thesis is dismissed, ignored and rejected by mainstream, post-Keynesian and other ‘Marxian’ economists,

Mainstream economists reckon economic growth comes from a growing workforce and rising productivity per worker.  That is true by definition, but what drives each component?  According to mainstream economics, it is exogenous population growth plus the consumption and savings decisions of millions of individuals that materialise through the ‘hidden hand’ of the ‘market’ into aggregate supply and demand for goods and services.  The consumer rules, growth follows.

According to the Austrian school, economic growth does come from investment.  But it is the direct result of savings.  The supply of savings will create investment and consumer demand through the workings of the market.  Savings rule, growth follows.

According to the Keynesians, of various hues, it is consumer and investment demand that creates incomes and then savings.  Demand creates supply through the workings of the market (but sometimes with the help of government).  With the mainstream Keynesians, consumption by households rules; for the so-called post Keynesians, investment rules.  For both, demand rules, growth follows. But for neither does profit nor profitability play a causal and central role in changing investment or consumption; on the contrary, the reverse is the case.  As Keynes put it: “Nothing obviously, can restore employment which does not first restore business profits. Yet nothing, in my judgement, can restore business profits that does not first restore the volume of investment.”  (Collected Writings Vol 13, p343).

In a recent discussion on the nature of Marx’s Capital and its relevance today, Prof Riccardo Bellofiore made a distinction between Marxians and Marxists.  ‘Marxian’ economists are people who have taken Marxist theory forward to deal with new developments in capitalism, while ‘Marxists’ are stuck in the past of Marxist dogma and 19th century capitalism.  It seems to me, however, that ‘Marxian’ economists tend to bend to the mainstream or Keynesian view that, while profit is obviously key to the nature of exploitation under capitalism, it plays no role in explaining the pace of economic growth or the regular and recurrent slumps in that output under capitalism. For an explanation of that, we must look to instability in the banking and financial system, the growth of credit (or debt), rising inequality squeezing labour’s purchasing power (‘underconsumption’), or monopoly ‘stagnation’ (a glut of profit).  But don’t look to changes in the profitability of capital or the movement of profit and value created in the production and productive sectors of the economy.  That’s old fashioned.

Well, I must be an old-fashioned ‘Marxist’ (well, at least, I am old).  I am continuing the battle against ‘revisionism’ of ‘Marxians’ to promote Marx’s law of value and his law of profitability as an interconnected explanation of the causes of economic growth and crises under capitalism.  So sometimes, it is relieving to get some support from mainstream economics.

First, Matthew Klein in the FT has a piece that points out that the conventional view of the relatively poorer rate of investment in Europe compared to the US is due to the weakness of its banks and their refusal to lend is wrong. There is no supporting evidence for this ‘credit’ cause of slow growth.  In Europe, the collapse in credit is due to a lack of demand for borrowing not restrictions by banks.  As the graph of Eurozone bank lending and loan demand shows, “the … demand for credit collapses out of proportion of anything bankers expressed about their willingness to lend”.

EZ bank lending

Klein goes on, “it’s difficult to look at all this and argue the problem has been the supply of credit. Something else seems to be at work.”

Paul Krugman in a blog post praised Klein’s analysis. Krugman reckoned it confirmed his long held view that the cause of the stagnation in Japan during the 1990s was not bad banking but the Keynesian ‘liquidity trap’ i.e. too high interest rates and a desire to hoard cash, not spend: “there’s little support for the bad-banks-did-it story, even though everyone repeats it. But look back at my 1998 BPEA on Japan, which is more or less where I came in. …I argued (154-158) that the nonresponse of monetary aggregates was exactly what you should expect in a liquidity trap, and that there was little evidence (174-177) that banking problems were actually central to the economy’s weakness.”

Be that as it may, we could also remind ourselves what Krugman said back then about Japan. “It appears as if the slump could go on forever. A dynamic analysis makes it clear that it is a temporary phenomenon—in the model it only lasts one period, although the length of a “period” is unclear (it could be three years, or it could be 20). Even without any policy action, price adjustment or spontaneous structural change will eventually solve the problem. In the long run, Japan will work its way out of the trap, whatever the policy response”. So apparently, liquidity trap or not, Japan would recover.  When it did not, Krugman pushed to break the trap with quantitative easing which he reckoned would do the trick.  As we know, after several bouts of QE from Japan’s monetary authorities, Japan remains stagnant, with five technical recessions since QE was introduced.

What Krugman does not refer to in his post on Europe’s banks is that Klein adds a little note from David Watts from CreditSight.  Watts finds that if he runs growth in sales revenues and the level of utilisation of existing capacity for Eurozone non-financial companies against business investment, he finds there is a close correlation.  In other words, what drives business investment are the level of sales and profits.   Klein concludes: You don’t need any estimate of a “credit channel” (or “policy uncertainty” or “confidence”) to explain why companies boost or cut their capex. They spend when it’s profitable, and don’t when it isn’t.”

The simple answer is best.  Recently, the Bank for International Settlements (BIS) latched onto the same point—that the Great Recession and the subsequent weak and slow recovery in the major economies was a product of the collapse in business investment. As the BIS put it: “Business investment is not just a key determinant of long-term growth, but also a highly cyclical component of aggregate demand. It is therefore a major contributor to business cycle fluctuations. This has been in evidence over the past decade. The collapse in investment in 2008 accounted for a large part of the contraction in aggregate demand that led many advanced economies to experience their worst recession in decades. Across advanced economies, private non-residential investment fell by 10-25 percent.”  And the BIS went on: “the uncertainty about the economic outlook and expected profits play a key role in driving investment, while the effect of financing conditions is apparently small.”

So the bank dismisses the consensus idea that the cause of low growth and poor investment is the lack of cheap financing from banks or the lack of central bank injections of credit, just as Klein finds. Instead, the BIS looks for what it calls a “seemingly more plausible explanation for slow growth in capital formation,” namely, “a lack of profitable investment opportunities.”  Companies are finding that the returns from expanding their capital stock “won’t exceed the risk-adjusted cost of capital or the returns they may get from more liquid financial assets.” So they won’t commit the bulk of their profits into tangible productive investment. “Even if they are relatively confident about future demand conditions, firms may be reluctant to invest if they believe that the returns on additional capital will be low.”

And now to back the BIS analysis up and give us old-fashioned ‘Marxists’ some Xmas cheer (sorry too early), there is a new analysis by mainstream economists Kothari, Lewellen and Warner from three American business schools,  called The behavior of corporate investment.  The authors find a close causal correlation between the movement in US business investment and business profitability.AggregateInvestment

In the graph below, the authors show the return on total assets of US non-financial companies (measured as after-tax profits as a percentage of assets – red dotted line); and the rate of fixed investment against total assets (blue line).  What does it show?  That the US non-financial corporate rate of profit fell secularly from the 1950s, reaching a low in the mid-1980s and then consolidating or rising a little after that.

Quarterly fixed investment (Capx) and after-tax profits (NI) scaled by lagged total assets for nonfinancial corporations from 1952–2010. Data come from the Federal Reserve’s seasonally-adjusted Flow of Funds accounts. Shaded regions indicate NBER recessions.

Profitability and investment

Those who are regular readers of this blog will not be surprised at that finding.  But the graph also shows that business investment (as a share of assets) has declined in tandem with profitability.  Again, this confirms the work of ‘Marxist’ economists like Kliman, Jones and Tapia Granados, among others.

The three mainstream authors of the paper find that “investment growth is highly predictable, up to 1½ years in advance, using past profits and stock returns but has little connection to interest rates, credit spreads, or stock volatility. Indeed, profits and stock returns swamp the predictive power of other variables proposed in the literature.”  And that “Profits show a clear business-cycle pattern and a clear correlation with investment.” The data show that investment grows rapidly following high profits and stock returns—consistent with virtually any model of corporate investment—but can take up to a year and a half to fully adjust. This was exactly the conclusion that I have reached in my own study and jointly with G Carchedi (  See my graph below.

profits call the tune

The authors find that “investment growth is closely linked to recent profit growth and stock returns but only weakly related to changes in interest rates, stock volatility, and the default spread. We find no evidence that investment drops following a spike in aggregate uncertainty, contrary to the predictions of many models with irreversible investment. We also find no evidence that investment growth slows after a rise in short-term or long-term interest rates, contrary to the idea that Federal-Reserve-driven movements in interest rates have a first-order impact on corporate investment.”  So all the alternative explanations of crises offered by monetarists, Keynesians and post-Keynesians have no empirical backing.

The authors also measured the predictive causal correlation between changes in profits, GDP and investment and the Great Recession.  They found that “if investment maintained its historical connection to profit growth, investment was predicted to drop by 14.7%, roughly two-thirds the actual decline of 23.0%.”  This two-thirds figure is almost exactly what I found for the period 2000 to 2013. I found that the correlation between changes in the rate of profit and investment was 64%; second, the correlation between the mass of profit and investment was 76%; and third, the correlation between the rate of profit (lagged one year) and the mass of profit was also 76%.

US corporate profit and investment

Finally, the authors found that “at least three-quarters of the investment decline can be thought of as a historically typical drop given the behavior of profits and GDP at the end of 2008. Problems in the credit markets may have played a role, but the impact on corporate investment is arguably small relative to a decline in investment opportunities following the 2008 recession and financial crisis.”  

You can’t beat old fashioned ‘Marxist’ economics.



Will the world economy enter a new recession next year?

November 21, 2015

The US Federal Reserve bank is planning to raise its basic interest rate at its 15 December monetary policy meeting.  This will be the first Fed hike since 2006.  That fact alone shows how long and how deep has been the impact of the global financial crash of 2007-2008, the subsequent Great Recession of 2008-9 and the ensuing and seemingly unending long depression of below trend economic growth since.

For six years, the Fed has held its interest rate near zero to ‘save the banks’ from meltdown, to avoid debt depression like the 1930s and to revive the economy with cheap credit.

Ben Bernanke, the Fed chief at the time, continues to argue that this easy and ‘unconventional’ monetary policy did that trick.  Bernanke has recently published a book defending his strategy and does interviews for the same.

In this blog, I have analysed the success or otherwise of quantitative easing where it has been applied in the US, Japan and now in the Eurozone.  It has been a dismal failure in reviving the major economies.  It has been a great success in supporting a boom in the stock and bond markets and in financing new credit bubbles in emerging economies.

Fed QE

Apparently, a majority of Fed monetary policy makers reckon that, at last, the US economy is growing fast enough to ‘tighten’ labour markets and even raise the possibility of rising inflation perhaps eventually beyond the 2% target that Fed looks to.  But that conclusion is debatable at the very least.

It’s true that the unemployment rate has halved to 5% from its peak of 10% at the depth of the Great Recession, but it is still above the pre-crash lows. And inflation remains well below the Fed target.  Headline inflation which includes energy and food prices is near zero, and even excluding these items, ‘core’ inflation, although rising is still below the Fed target at 1.9%.  And if you look at the prices that average Americans pay for the goods and services they use, based on the personal consumption expenditure (PCE) index, then inflation is very low.


Moreover, real GDP growth remains pretty pathetic at around 2.2% a year on average, well below the average of 3.3% a year before the global financial crash.  The ‘trend gap’ shows no sign of being bridged. Indeed, what is happening is that the official economic bodies are lowering their estimates to potential GDP growth towards the actual level of growth so that the ‘output gap’ disappears.

US trend GDP

In other words, it is being admitted that the US economy is now set on a permanent path of lower long-term growth, based a low growth in population (despite one million net immigrants a year) and very low productivity growth (as business investment growth slows).

US productivity

The damage to the US economy from the Great Recession has left a permanent scar; what is called ‘hysteresis’.  In a new study, Professor Laurence Ball of Johns Hopkins University (, from a sample of 23 high-income countries, concludes that losses of potential output as a result of the Great Recession ranged from zero in Switzerland to more than 30 per cent in Greece, Hungary and Ireland. In aggregate, he concludes, potential output this year was thought to be 8.4 per cent below what its pre-crisis path would have predicted. This damage from the Great Recession is, he notes, much the same as if Germany’s economy had disappeared. This measures the permanent loss of resources and value caused by capitalist slumps.

Indeed, work by Keynesian economists Larry Summers, Olivier Blanchard (ex-IMF chief economist) and Eugenio Cerrutti found that a high proportion of recessions, or about two-thirds, are followed by lower output relative to the pre-recession trend even after the economy has recovered. In about one-half of those cases, the recession is followed not just by lower output, but by lower output growth relative to the pre-recession output trend. That is, as time passes following recessions, the gap between output and projected output on the basis of the prerecession trend increases. They suggest important hysteresis effects and even “superhysteresis” effects (the term used by Laurence Ball for the impact of a recession on the growth rate rather than just the level of output).

This can be looked at from various angles of economic theory: from the neoclassical Wicksellian view that the ‘natural rate’ of interest (or profit) is permanently lower; from the Keynesian one that the US economy is in ‘secular stagnation’ and/or a permanent ‘liquidity trap’; or from a Marxist one that the US (and major economies) is locked into a depression because of low profitability created by excessive accumulation of tangible capital and financial debt in the past.

The first two theories in some way suggest that the Fed should not hike rates in case they take the cost of borrowing either above the ‘natural rate’ or burst the credit bubble and push the economy into a deeper liquidity trap.  The Marxist view is that, just as zero interest rates and quantitative easing made little difference in restoring a low profitability, high debt economy, so raising rates will solve nothing either.

The Keynesian answer (at least among those Keynesians like Krugman, Summers, DeLong and Wren-Lewis) is: keep going with the easy money policy but add to it a round of government spending, financed by government borrowing.  You see, the main cause of the Great Recession was ‘lack of demand’ and the main cause of the subsequent weak recovery or depression was the application of ‘austerity’ (i.e. cuts in government spending in trying to balance the books as though an economy was like household finances).  Rising debt does not matter because one person’s debt is another’s asset.

Well, there are a number of questions there.  First, did governments in the major economies apply austerity?  Well, some did and some did not too fiercely despite the neo-classical rhetoric of many finance ministers.  Second, did more or less austerity correlate with slower or faster growth?  The Keynesians say it did.  They proclaim the power of the Keynesian multiplier, namely that one unit of extra government spending over taxes will deliver a multiple of one unit of real GDP, especially in times of slump.  They usually cite a ratio of 1.5 times.

The evidence for this is weak and a matter of intense debate, although only this week, Paul Krugman made another attempt to prove that austerity was the cause of global weakness.  I did a correlation between fiscal deficit expansion by various governments against an increase in real GDP and found little correlation, especially if Greece is removed.

Growth and austerity

And in the latest study of the impact of austerity on growth, Alberto Alesina and Francesco Giavassi found that “fiscal adjustments based upon cuts in spending are much less costly, in terms of output losses, than those based upon tax increases. ….spending-based adjustments generate very small recessions, with an impact on output growth not significantly different from zero.”  And “Our findings seem to hold for fiscal adjustments both before and after the financial crisis. We cannot reject the hypothesis that the effects of the fiscal adjustments, especially in Europe in 2009-13, were indistinguishable from previous ones”.  In other words, cutting government spending (austerity) had little effect on the real GDP growth rate and that applied to the post-crisis ‘austerity policies of European governments.

G Carchedi and I have considered the mechanism of government tax and spending policies on economic growth from the Marxist viewpoint.  We started from the premiss that economic growth in capitalist economies depends on an expansion of business investment and that depends ultimately on the profitability of those investments. So we looked at the multiplier effects of government spending, taxation and borrowing on growth through the prism of profitability – a Marxist multiplier, we called it.

Our Marxist multiplier analysis revealed that it was very unlikely that extra government spending, whether financed by taxes or borrowing, would boost profitability in the business sector and therefore raise capitalist investment and economic growth.

I have tested our premiss that it is the profitability of business capital that matters not government spending.  I found that there was a significant positive correlation between changes in profitability of capital and economic growth, unlike the lack of correlation between more government spending and growth, as the Keynesians claim, at least in a slump.

growth and profitability

That again tells me that if we want to know what is going to happen in the major capitalist economies we must look at the key indicators of business investment and the profitability of capital, not at inflation, employment or the level of ‘austerity’ as mainstream economists do.

So what are the prospects for global capitalism on those Marxist criteria and what is the likelihood of a new slump as the Fed prepares to hike?  I have discussed these questions ad nauseam on this blog in the past.  But let us consider the latest evidence.

At the recent meeting of the G20 in Turkey, apart from discussing the mess in the Middle East and the migration crisis in Europe, the ministers reaffirmed their pledge or expectation that the major economies will grow by an extra 2% by 2018.  What an ‘additional’ 2% of G20 GDP means is difficult to judge.  But anyway it is really a sick joke.

Far from accelerating, global growth is slowing down further.  In its twice-yearly outlook, the Organisation for Economic Cooperation and Development (OECD) cut its forecast for global economic growth to 2.9% in 2015 and 3.3% in 2016, down from 3.0% and 3.6%, respectively.

Presenting the outlook in Paris, OECD secretary general Angel Gurría said: “The slowdown in global trade and the continuing weakness in investment are deeply concerning. Robust trade and investment and stronger global growth should go hand in hand.”  Catherine Mann, OECD chief economist said: “Global trade, which was already growing relatively slowly over the past few years, appears to have stagnated and even declined since late 2014. This is deeply concerning. Robust trade and global growth go hand in hand….“The growth rates of global trade observed so far in 2015 have, in the past, been associated with global recession.”

We also have the preliminary real GDP figures for the most important capitalist economy in the world, the US. In third quarter of 2015 (June to September) US economic expansion slowed sharply. The economy grew at a 1.5 per cent pace annualised pace in the three months to September, down from 3.9 per cent in the second quarter.  The US economy has expanded in real terms over the last 12 months by just 2%, down from 2.7% in Q2 and business investment slowed to its lowest yoy rate for over two years; at an annual rate of 2.1% compared with 4.1% in Q2. And investment in new plant actually dropped 4% and investment in software and such rose at the slowest pace since 2013.

Meanwhile Japan’s economy contracted in the third quarter. Real GDP declined an annualized 0.8 percent, following a revised 0.7 drop in the second quarter. Again, the biggest worry was the weakness in business investment. This was the fifth ‘technical recession’ since Japanese PM Abe launched his ‘Abenomics’ and quantitative easing programmes. And in the Eurozone economic growth slowed to just 0.3% in Q3, from 0.4% in Q2.

And then we have the so-called emerging economies.  I have reported on their demise in several previous posts.  The policy of easy money and quantitative easing did not only lead to a stock and bond market boom in the major advanced economies, it also led to a similar boom in emerging economies as Asian, Latin American and ‘emerging’ European corporations borrowed heavily from cash-rich Western banks at cheap rates, mostly in dollars, to generate mainly a property and construction boom.  Emerging market corporations now have debts near 100% of GDP on average, matching those for corporations in the advanced capitalist economies.  But the commodity price boom upon which much of growth was based has collapsed.  Global demand for oil and basic metals has slumped and this has spilt over into the demand for Asian exports.  Export prices have slumped, currencies have dived and yet debts remain, mainly in dollars.  And now the Fed is set to hike the cost of borrowing dollars.

So does all this mean we are heading for a new global slump?  Well, I have raised the risk that a Fed rate hike could be the trigger for a new slump, just as it was in 1937 when it brought to an end to recovery from 1932 during the Great Depression of the 1930s.  Only the preparations and beginning of the world war ended that slump.

The strategists of capital are not stupid.  They have tried to estimate the likelihood of a new recession.  Goldman Sachs pointed out that the current economic expansion — beginning in July 2009 — was now 76 months old.  Using data since 1950, they calculate that the unconditional odds that a six-year-old expansion will avoid recession for another four years—and mature into a 10-year-old expansion—are about 60%.  So the odds of recession over the next year are only 10-15%.   And mainstream economic indicators for recessions using a range of economic variables suggest little likelihood of a slump in the US.

recession probable

But this sort of indicator is pretty useless and it is backward looking, so recessions are on you before the data indicate them.  And mainstream economics never forecast the Great Recession anyway.  Indeed, we know that all the leading international economic agencies, the leading economists and investment gurus were predicting faster growth in 2007-8 as the global financial crash unfolded.

Moreover, in my view, modern capitalist cycles of slump to slump have not been just six years or less, but generally 8-10 years: 1974-5, 1980-2, 1990-2, 2001, 2008-9.  If that were to hold again, then the next slump would not be due to start before next year at the earliest.  And if the Fed’s rate hikes are to have an impact, they won’t be felt on the cost of debt and investment for at least six months.

It is best to consider the Marxist indicators that I have referred to: profitability and profits and business investment.  There has been some debate in Marxist economic circles that profitability is not low or falling and that there is an excess not a dearth of profits in the major economies.  I have discussed these arguments that the capitalist world is ‘awash with cash’ in previous posts.  All I can add is that cash and profits are the not the same and profits and profitability are not either.  I have not measured US profitability for 2015 and final proper data for 2014 is only just becoming available, but 2014 showed a decline, with rate still below the peak of 2007 and the higher peak of 1997.

I have shown before in previous posts that global corporate profit growth has nearly ground to a halt and in the US on some measures, it has gone negative.

global corporate profits

The latest earnings results for the top 500 companies in the US confirm that both revenue and profits fell in the most recent quarter.

S&P earnings

And as I have shown before, where profits go, business investment is likely to follow, with a lag.

Watch this space.

Savings glut or investment dearth?

November 18, 2015

Martin Wolf, the Keynesian economic journalist in an article in the UK’s Financial Times, has highlighted a paper by two economists at the US Federal Reserve, Joseph Gruber and Steven Kamin that showed a widening gap between corporate savings (or profits) and corporate investment in most of the major economies (Gruber corporate profits and saving).

Corporate net lending

This gap, technically called ‘net lending’ by corporations, Wolf describes as a global ‘savings glut’.  The notion of a “savings glut” was first mooted by former Federal Reserve chief, Ben Bernanke, back in 2005.  He argued that economies like China, Japan and the oil producers had built up big surpluses on their trade accounts and these ‘excess savings’ flooded into the US to buy US government bonds, so keeping interest rates low.

Martin Wolf and other Keynesians have liked this notion because it suggests that what is wrong with the world economy is that there is too much saving going on, causing a ‘lack of demand’.  This is the proposition that Wolf recently pushed in his latest book.

In his book, Wolf concludes that the cause of the Great Recession “was a savings glut (or rather investment dearth); global imbalances; rising inequality and correspondingly weak growth of consumption; low real interest rates on safe assets; a search for yield; and fabrication of notionally safe, but relatively high-yielding, financial assets.”

And yet it was not falling consumption or rising savings that provoked the Great Recession, but falling investment (as even Wolf partially recognises in the quote).  Investment is by far the most important part of the dynamics of a capitalist economy.  As Wolf says: “companies generate a huge proportion of investment. In the six largest high-income economies (the US, Japan, Germany, France, the UK and Italy), corporations accounted for between half and just over two-thirds of gross investment in 2013 (the lowest share being in Italy and the highest in Japan).”

So is the gap between corporate savings and investment caused by a ‘glut of savings’?  Well, look at the graph provided by Wolf, taken from the OECD.

corporate gross savings

With the exception of Japan, since 1998, corporate savings to GDP have been broadly flat.   And for Japan, the ratio has been flat since 2004.  So the gap between savings and investment cannot have been caused by rising savings.  The second graph shows what has happened.

corporate gross investment

We can see that there has been a fall in the investment to GDP ratio in the major economies, with the exception of Japan, where it has been broadly flat.

So the conclusion is clear: there has NOT been a global corporate savings (or profits) ‘glut’ but a dearth of investment.  There is not too much profit but too little investment. The capitalist sector has reduced its investment relative to GDP since the late 1990s and particularly after the end of the Great Recession.  And when you read closely the Fed paper cited by Wolf, this is also the conclusion. Gruber and Kamin demonstrate that rates of corporate investment “had fallen below levels that would have been predicted by models estimated in earlier years”.

Joseph Gruber and Steven Kamin conclude their paper with a puzzle: “what is causing this paucity of investment opportunities, and what are its implications for future investment and growth?”  Wolf cites various reasons for weak corporate investment: the ageing of societies  thus slowing potential growth; globalisation motivating relocation of investment from the high-income countries; technological innovation reducing the need for capital; or management not being rewarded for investing but instead for maintaining the share price.

Many of these causes have been cited before and I have discussed them in previous posts.  But most interestingly, after citing the Federal Reserve paper, Wolf fails to mention the conclusion of the Fed authors on the cause of weak investment in the last 15 years.  I quote: “We interpret these results as suggesting that investment in the major advanced economies has indeed weakened relative to what standard determinants would suggest, but that this process started well in advance of the GFC itself. Finally, we find that the counterpart of declines in resources devoted to investment has been rises in payouts to investors in the form of dividends and equity buybacks (often to a greater extent than predicted by models estimated through earlier periods), and, to a lesser extent, heightened net accumulation of financial assets. The strength of investor payouts suggests that increased risk aversion and a precautionary demand for financial buffers has not been the primary reason firms have cut back investment. Rather, our results are consistent with views that, for any number of reasons, there has been a decline in what firms perceive to be the availability of profitable investment opportunities”.

So the cause of weak investment in productive assets and a switch to share buybacks and dividend payments and some cash hoarding was primarily due to a perceived lack of profitability in investing in productive assets.  This confirms the conclusions reached by other studies that I have cited in previous posts dealing with the fallacious argument that corporates are ‘awash with cash’.

I would suggest that we already have an answer to the question of why ‘profitable investment opportunities’ are scarce.  Overall profitability in the major capitalist economies peaked in the late 1990s and has not recovered to that level since.  I have discussed this in a recent paper on the world rate of profit (Revisiting a world rate of profit June 2015).  But here is a graph based on the work of Esteban Maito cited in that paper.  Global profitability peaked in the later 1990s and has not recovered.

world rate of profit Maito

As a result, companies have used their ‘savings’ to invest not in productive assets like factories, equipment or new technology that could boost productivity growth (which has slowed to a trickle), but instead paid out more dividends to shareholders, boosted top executive pay and bought back shares to boost their prices.  And much of this has been done by multinationals borrowing more at near zero rates, while shifting cash into offshore tax havens to avoid tax.

In my view, this clearly lends support to Marx’s law of the tendency of the rate of profit to fall as an explanation of weak investment in the major capitalist economies since 1998.  Marx’s law would suggest that any fall in the rate of profit should be accompanied by a rise in the organic composition of capital (the ratio of the value of capital equipment to the wages of the labour force) faster than any rise in the rate of surplus value (the profit extracted from the labour force).  In my recent paper, I show that in the current ‘depression’ period since 2000, the organic composition of capital rose 41%, well ahead of the rise in the rate of surplus value at 7%.  So the rate of profit has fallen 20%.  ‘Profitable investment opportunities’ have shrunk.

We are told by the likes of Ben Bernanke and echoed by Martin Wolf that today’s problem of ‘secular stagnation’ is being caused by a ‘global savings glut’ in surplus countries and even in G7 countries.  In other words, there was too much surplus (value) to ‘absorb’.  But this is a fallacy.  There was not a ‘savings glut’ but an ‘investment dearth’.  As profitability fell, investment declined and growth had to be boosted by an expansion of fictitious capital (credit or debt) to drive consumption and unproductive financial and property speculation.  The reason for the Great Recession and the subsequent weak recovery was not a lack of consumption (consumption as a share of GDP in the US has stayed up near 70%) but a collapse in investment.

Keynes, Marx and the effect of QE

November 11, 2015

One of the interesting sessions at last weekend’s Historical Materialism conference (apart from my session, of course) was one on the work of Suzanne de Brunhoff.  Brunhoff was a Marxist economist from the 1970s onwards who specialised in Marx’s theory of money and applying it to the conditions of modern capitalism.  She died this year.  There is no space to deal with her contributions here.  What I want to take up from the session was a presentation by Maria Ivanova of Goldsmiths University, London.  Ivanova made some key observations about Marx’s theory of money, but also of Keynes.  She pointed out that, in his Treatise on Money written in 1930 at the start of the Great Depression, Keynes argued that central banks would have to intervene with what we now call ‘unconventional monetary policies’ designed to lower the cost of borrowing and raise sufficient liquidity for investment. Just trying to get the official interest rate down would not be enough.

As a recent paper from the Levy Institute put it: “In the penultimate chapter of volume 2 of the Treatise, Keynes raises the question of the ability of the monetary authority to influence the price level…despite his doubts, Keynes nonetheless answers his own question in the affirmative, urging central bankers to adopt extraordinary, unorthodox measures in an attempt to counter the deepening recession.”  Keynes proposed: “My remedy in the event of the obstinate persistence of the slump would consist, therefore, in the purchase of securities by the central bank until the long-term market rate of interest has been brought down to the limiting point, which we shall have to admit a few paragraphs further on. It should not be beyond the power of a central bank (international complications apart) to bring down the long-term market-rate of interest to any figure at which it is itself prepared to buy long-term securities.”  So here we have it in 1930: it’s quantitative easing (QE) as advocated and implemented by the self-proclaimed saviour of the financial crisis, Ben Bernanke at the US Fed and later adopted by other central bankers.

In the Treatise, Keynes was convinced that such measures of buying government bonds and boosting fiat money quantity rather than just trying to lower the price of short term money would be effective “Thus I see small reason to doubt that the central bank can produce a large effect on the cost of raising new resources for long-term investment, if it is prepared to persist with its open market policy far enough.”  This would work because it would increase ‘liquidity’ in the banking system and it would also raise ‘confidence’ (that ‘fairy dust’ of modern economics) by convincing investors that the low cost of borrowing was here to stay.  The latter point presaged the theory of modern monetary economist, Michael Woodford, who was a big influence on Bernanke, who claimed back in 2010 that QE would work in the same way. As Keynes puts in the Treatise: “The remedy should come, I suggest, from a general recognition that the rate of investment need not be beyond our control, if we are prepared to use our banking systems to effect a proper adjustment of the market rate of interest. It might be sufficient merely to produce a general belief in the long continuance of a very low rate of short-term interest rate”.

Well, was Keynes (followed by quantity of money theorist Milton Friedman and the modern monetarists like Bernanke and Woodford) right?  Did QE restore investment and economic growth through increased ‘liquidity’ in the banking system and by raising ‘confidence and expectations’? Clearly not.  The Bank of Japan adopted such measures through the 1990s with little success in restoring investment and economic growth.  The QE adopted by the Fed, the BoE, the BoJ and, more recently, the ECB, may have put huge amounts of cash into the banks and inspired speculation into ‘higher-yielding’ assets like bonds and stocks, and even boosted the cash hoards on large non-financial firms, but it has not restored business investment and economic growth to pre-crash levels. 

As Brunhoff explained, Marx’s theory of money argues that there are three functions of money: as a means of payment or circulation; as a measure of value; and as a store of value.  A monetary economy provides the possibility of hoarding, taking money out of circulation to preserve its value.  In a slump or crash, capitalists try to hoard and avoid investment. If profitability stays low, then even a low rate of interest or mountains of ‘liquidity’ will not release that hoard, or the ‘liquidity trap’, as Keynes called it.  You can lead a horse to water, but you cannot make it drink. So no matter how much cash the central bank pumps in by buying government or even corporate securities, investment does not recover.  It’s like pushing on a string.  Such was the argument of Marx against the quantity on money theorists during the banking crisis of the 1840s.

But nothing changes.  It is ironic that at the same time the huddled groups of Marxists were debating these issues at the HM conference in London, the IMF was holding an extravaganza debate on the ‘success’ of unconventional  monetary policy at its much more august venue in Washington DC.  Over two days, all the illustrious from Ben Bernanke, Claudio Borio, Adair Turner and Paul Krugman were present to hear papers by top monetarist economists.

And what did they conclude?  Here is a flavour:  One economist from the LSE commenting on QE found that: “Yet, there is little evidence that the program led to an increase in credit.”  Some Fed economists considered the macroeconomic effect of QE.  They concluded that “our analysis suggests that the net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case.”  Then some European economists looked at the impact of the ECB’s QE.  They found that QE “significantly reduced bank risk and allowed banks to access market based financing again. The increase in bank health translated into an increased loan supply to the corporate sector, especially to low-quality borrowers. These firms use the cash inflow from new bank loans to build up cash reserves, but show no significant increase in real activity, that is, no increase in employment or investment”.

So it seems that Keynes’ original belief was wrong that QE could get a capitalist economy out of a slump by pumping banks and companies with cash or keeping bond rates permanently low.  Indeed, let us return to Keynes.  By 1936 after five more years of depression (similar to the time post the Great Recession now), Keynes became less convinced that ‘unconventional monetary policies’ would work.  In his famous General Theory of Employment, Interest and Money (GT), Keynes moved on.

As the Levy Institute paper notes: “What has not been borne out is the expected impact on the rate of investment. Businesses have indeed increased their borrowing, and the spread between corporate junk bonds has fallen to near-historic lows as companies seek to borrow at historically low interest rates. However, these funds are not being used to finance new investment. Similarly, banks have accumulated record levels of reserves in their deposit accounts at the Fed, earning the short-term interest rate, which is nearly zero. Thus, the policy has been successful in influencing the interest rate in the way Keynes predicted, but it has not had the impact on investment that he outlined in the Treatise.”

Why did the policy of QE fail, according to Keynes?  The problem was that “The state of confidence . . . is a matter to which practical men always pay the closest and most anxious attention… because of its important influence on the schedule of the marginal efficiency of capital. There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former” (p148–49). Thus, “there is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable. “

So low interest rates and extra liquidity cannot get things going again, if the profitability of investment (what Keynes calls the ‘marginal efficiency of capital’) remains too low. Keynes concluded in the GT: “I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest”.  And so Keynes moved on to advocating fiscal spending and state intervention to complement or pump-prime failing business investment.

Many Keynesians are still wedded to QE, however.  It is just that not enough QE has been done.  We need to consider negative interest rates and ‘helicopter money’, named after the idea that the central bank should just drop cash from helicopters to people below to spend – the modern version would be to credit every household bank account with a few thousand dollars.  The People’s QE, advocated by some advising the new left-wing leaders of the British Labour party, is a variant of this approach.  You might think these measures would work.  But if you got $1000 suddenly in your bank account, would you spend it or instead save it for a rainy day or pay down some outstanding debt?  It’s not clear that ‘helicopter money’ would do the trick in boosting ‘demand’ and thus growth.

As Stephen Cecchetti has pointed out, these ‘extreme’ QE measures are really forms of fiscal spending as the government must be prepared to bail out the central bank if the helicopter money is not spent and never seen again. Funding banks to invest in the productive sector has gained some traction with the new EU infrastructure fund or the proposed National Investment Bank by the British Labour leaders.

The Keynes of the GT was classic or ‘old Keynesianism’ that was dominant in the post-war period.  But with the failure of ‘old Keynesian’ macro-management in the 1970s (with stagflation), there was a morphing into ‘new Keynesianism’ and back to the efficacy of monetary policy, as in the Treatise. The ‘old Keynesian’ style fiscal spending is now mainly ignored or dismissed by mainstream economists as lacking credibility.  But some ‘old-style’ Keynesians continue to press for running budget deficits and borrowing more to do the trick.

There is no space to show why Keynes’s view in the GT for more government spending cannot deliver economic recovery in a long depression.  I have dealt with it in several previous posts.  Suffice it to say that Keynesianism ignores the barrier between fiscal spending and growth created by low profitability.  The Keynesian multiplier (more government spending accelerates economic growth) is not decisiveThe Marxist multiplier (higher profitability leads to higher growth) is.

Anyway, the days of QE have come to an end, at least in the US.  The US Federal Reserve, after the recent strong employment figures, is preparing to raise its policy rate for the first time in nearly ten years!  Some argue that the Fed’s QE programme has done its job by counteracting the slump and fiscal austerity sufficiently and now monetary policy can return to normal.  Other mainstream economists like Krugman, Summers, Stiglitz etc are worried that a Fed hike could push the economy back into recession.  As we enter 2016, we shall find out.


Too much profit, not too little?

November 8, 2015

Most years I attend the London conference of the Historical Materialism journal.  This brings together academics and others to present papers and discuss issues from a generally Marxist viewpoint.  This year I presented a paper on whether rising inequality causes crises under capitalism (Does inequality causes crises).  My session was well attended and the audience included many of the small band of Marxist economist s around at the moment.

The gist of what I said was this.  Rising inequality of income and wealth in the major economies has become a popular thesis among both mainstream and heterodox economists.  The thesis is founded on the arguments that wages as a share of GDP have been falling in the major economies. This creates a gap between demand and supply, or a tendency to underconsumption.  That gap was filled by an explosion of debt, particularly household debt.  It is also encouraged financial institutions to engage in riskier financial investments that exposed them to eventual disaster.  The credit boom fuelled a housing bubble but eventually that burst and the house of cards came tumbling down.  QED?

My paper attempted to refute this theory of crisis with the following simple points.

1) Private consumption has not been weak or did not collapse, causing a demand gap – on the contrary in most economies and particularly in the US, consumption to GDP during the so-called neo-liberal period rose to record highs.

2) The major international slumps of 1974-5 and 1980-2 cannot be laid at the door of rising inequality because it did not rise at the time.  Indeed, most Marxist economists at least agree that the 1970s slump was the result of a squeeze on profits not a squeeze on wages.  The rising inequality thesis cannot apply as a general theory of crises.

3) Actually, the share of labour income in national income when non-work income is included (net social benefits) did not fall in the neo-liberal period.  Labour income share kept pace with consumption share and debt was not needed to fill a ‘demand gap’.

4) A fall in consumption does not take place before slumps, so the house of cards did not collapse because of a fall in consumer demand.  It is a fall in investment that provokes a slump and during a slump, it is investment not consumption that falls the most.

Investment in slumps

5) There are many studies that show no connection between rising inequality and credit or banking and general crises under capitalism.

6)  There are better causal connections and correlations between profitability and investment and economic growth than between inequality, consumption and growth.  Profits call the tune.

For a fuller account of these arguments, see my HM paper.

There did not seem too much opposition to my thesis, although there were questions on my data.  The discussion at the session came from an accompanying paper by Jim Kincaid, formerly economics lecturer at Leeds and other universities.  Jim’s paper, which was apparently just an excerpt from an upcoming article in the HM journal, aimed to analyse why investment has been faltering in modern economies, particularly since the end of the Great Recession.  Above all, he wished to question or refute the theory that Marx’s law of the tendency of the rate of profit to fall is the underlying cause of crises, as advocated by myself, Carchedi, Kliman and several others.

Jim Kincaid said he supported the position of Dumenil and Levy that each major slump or ‘structural crisis’ in the history of modern capitalism has had a different cause.  The 19th century Great Depression was the result of falling profitability; but the Great Depression of the 1930s was not, and was caused by rising inequality and ‘crazy investment’.  The 1970s slump was the result of falling profitability but the Great Recession was again caused by rising inequality and ‘crazy financial investment’.  These arguments of D-L have been dealt with in this blog before and are also taken up in my paper on inequality presented.

Interestingly, Professor Riccardo Bellofiore, who also presented a different paper in the session on translating Marx’s concepts, commented in passing that he reckons Marx’s law of profitability has been dead in the water since the late 19th century depression because since then the ‘counteracting factors’ have overcome the law ‘permanently’.  This is a strange conclusion given all the recent evidence cited in this blog for a secular fall in profitability globally since Marx’s time. Next year, G Carchedi and I will publish a book, a collection of papers from scholars around the world that will confirm Marx’s law of profitability with empirical evidence.

But what was the essence of Kincaid’s critique of those ‘monocausal’ advocates of Marx’s law of falling profitability as the cause of crises under capitalism? To quote Kincaid’s abstract:  “I argue: (1) empirically, the thesis of falling rates of profit in the major economies is based on an uncritical use of not always reliable government data; (2) Harvey and other sceptics are correct to stress that central to the present crisis is the inability of the global system to absorb large quantities of surplus money capital derived from high rates of surplus-value extraction (profits included)”.

Kincaid argues that it was not a falling rate of profit, or too little profit that caused the Great Recession and subsequent weak recovery, but too much.  Capitalist firms have built up huge cash reserves from profits that they are not investing productively.  So the problem is one of how to ‘absorb’ these surpluses, not how to get enough profit.  This also shows, according to Kincaid, that the causal sequence for crises, namely falling profits to falling investment to falling income and employment is nonsense because we have rising profits and falling investment.

Thus we have from Kincaid a thesis of surplus absorption that echoes not only that of David Harvey he refers to but also the view of Paul Sweezy and Paul Baran of the Monthly Review ‘school’ that monopoly capitalism has sunk into stagnation because it cannot dispense with ever-increasing surpluses of profit.  The fallacies in this view have been dealt with by many authors.

But what about the issue of cash mountains in major non-financial companies?   Close readers of my blog will know that I have dealt with this issue in several previous posts.

Let me now reiterate some of the points made in those posts (the data have not been updated given the time, but will not have changed much).  It is true that cash reserves in US companies have reached record levels, at just under $2trn – see graph below.  (All figures come from the US Federal Reserve’s flow of funds data.)  The rise in cash looks dramatic.  But also note that this cash story did not really start until the mid-1990s. In the glorious days of the 1950s and 1960s when profitability was much higher, there was no cash build-up.

Liquid assets

But the graph is misleading.  It is just measuring  liquid assets (cash and those assets that can be quickly converted into cash).  Companies were also expanding all their financial assets (stocks, bonds, insurance etc).  When we compare the ratio of liquid assets to total financial assets, we see a different story.

Liquid assets to total

And according to Credit Suisse’s latest figures, US corporate cash to total assets (financial and tangible) has risen but still way below the 1950s and 1960s.

Follow the cash

US companies reduced their liquidity ratios in the Golden Age of the 1950s and 1960 to invest more or buy stocks.  That stopped in the neoliberal period but there was still no big rise in cash reserves compared to other financial holdings.  And that includes the apparent recent burst in cash.  The ratio of liquid assets to total financial assets is about the same as it was in the early 1980s.  That tells us that corporate profits may have been diverted from real investment into financial assets, but not particularly into cash.

Comparing corporate cash holdings to investment in the real economy, we find that there has been a rise in the ratio of cash to investment.  But that ratio is still below where it was at the beginning of the 1950s.

cash to investment

And remember within these aggregate averages lies the reality that just a few mega companies hold most of the cash while thousands of small and medium enterprises (SMEs) hold little cash and much more debt.  Indeed, a minority are re4ally ‘zombie’firms just raising enough profit to service their debt.

Why does that cash to investment ratio rise after the 1980s?  Well, it is not because of a fast rise in cash holdings but because the growth of investment in the real economy slowed in the neoliberal period.  The average growth in cash reserves from the 1980s to now has been 7.8% a year, which is actually slower than the growth rate of all financial assets at 8.6% a year.  But business investment has increased at only 5.3% a year in the same period, so the ratio of cash to investment has risen.

growth in assets

Interestingly, if we compare the growth rates since the start of the Great Recession in 2008, we find that corporate cash has risen at a much slower pace (because there ain’t so much cash around!) at 3.9% yoy.  That’s slightly faster than the rise in total financial assets at 3.3% yoy.  But investment has risen at just 1.5% a year.  So consequently, the ratio of investment to cash has slumped from an average of two-thirds since the 1980s to just 40% now.

It does seem that there has been build-up of cash relative to short-term debt, particularly in the credit boom of 2000s.  This suggests that corporations were borrowing more and needed to increase their cash buffers as a safety measure.

cash to ST debt

So companies are not really ‘awash with cash’ any more than they were 30 years ago.  What has happened is that US corporations have used more and more of their profits to invest in financial assets rather than in productive investment.  Their cash ratios are pretty much unchanged, suggesting that there is not a ‘wall of money’ out there waiting to be invested in the real economy.

In a recent paper in the Journal of Finance (2009), Why firms have so much cash, the authors found that there was “a dramatic increase from 1980 through 2006 in the average cash ratio for U.S. firms.”  But interestingly, cash hoarding was not taking place among firms who paid high dividends to their shareholders.  On the contrary.  The authors argue that the “main reasons for the increase in the cash ratio are that inventories have fallen, cash flow risk for firms has increased, capital expenditures have fallen, and R&D expenditures have increased.”  In order to compete, companies increasingly must invest in new and untried technology rather than just increase investment in existing equipment.  That’s riskier:  So companies must build up cash reserves as a sinking fund to cover likely losses on research and development. Rising cash is more a sign of perceived riskier investments than a sign of corporate health.

In a recent paper, Ben Broadbent from the Bank of England noted that UK companies were now setting very high hurdles for profitability before they would invest as they perceived that new investment was too risky.  Broadbent put it: “Prior to the crisis finance directors would approve new investments that looked likely to pay for themselves (not including depreciation) over a period of six years – equivalent to an expected net rate of return of around 9%. Now, it seems, the payback period has shortened to around four years, a required net rate of return of 14%.”  And remember that the current net rate of return on UK capital is well below that figure at about 11%.

Broadbent continued: “Even if the crisis originated in the banking system there is now a higher hurdle for risky investment –  a rise in the perceived probability of an extremely bad economic outcome….In reality, many investments  involve sunk costs. Big FDI projects, in-firm training, R&D, the adoption of new technologies, even simple managerial reorganisations – these are all things that can improve productivity but have risky returns and cannot be easily reversed after the event.”

So it seems that companies have become convinced that the returns on productive investment are too low relative to the risk of making a loss.  This is particularly the case for investment in new technology or research and development which requires considerable upfront funding for no certainty of eventual success.

And here is the rub.  Just at this time when Jim Kincaid raises the issue of huge cash reserves and suggests that the cause of crises is due the difficulty of ‘absorbing’ profits, US corporate earnings are falling and profit growth has ground to a halt.  Cash reserves are set to fall.  The latest tally by Thomson Reuters of earnings by the S&P 500 in the US finds that earnings are on course to fall 1.3 per cent on the back of revenues down 3.6 per cent. In Europe, Stoxx 600 companies are on course to report a drop of 8.2 per cent in revenues compared with a year ago and earnings falls of 4.3 per cent year on year.  And, as I have shown on numerous occasions, corporate profits in the major economies are now hardly growing at all.

US corp profits

Yes, large firms in the capitalist sector of the major economies have been hoarding more cash rather than investing over the last 20 years or so.  But they are not investing so much because profitability is perceived as being too low to justify investment in riskier hi-tech and R&D projects, and because there are better and safer returns to be had in buying shares, taking dividends or even just holding cash. Also many companies are still burdened by high debt even if the cost of servicing it remains low.

The point is that the mass of profits is not the same as profitability and in most major economies, profitability (as measured against the stock of capital invested) has not returned to levels seen before Great Recession.  And the high leveraging of debt by corporations before the crisis started is acting as a disincentive to invest and/or borrow more to invest, even for companies with sizeable amounts of cash.  Corporations have used their cash to pay down debt, buy back their shares and boost share prices, or increase dividends and continue to pay large bonuses (in the financial sector) rather than invest in productive equipment, structures or innovations.

I conclude that the cash reserves of major companies is not an indication that the cause of crises is due to inability to absorb ‘surplus profit’ but due to an unwillingness to invest when profitability remains low and debt is relatively high.  That is the cause of this Long Depression.  Marx’s law holds. Too much profit, or too little?  Too little.  Too much cash or too much debt?  Too much debt.

The natural rate of interest and economic recovery

November 5, 2015

There has been an eruption of an old debate among mainstream economics bloggers.  The debate is about, first, whether there is a ‘natural rate of interest’ that provides equality between investment and savings in an economy at full employment; and second, whether current interest rates in the major economies are above or below that ‘natural’ rate.

The concept of a ‘natural’ rate where desired investment in new structures, equipment and technology matches desired saving by households and firms in a ‘general equilibrium’ comes from the neoclassical economist of the late 19th century Knut Wicksell.  He argued that if investment exceeded savings in an economy, the natural rate would rise so that savings would then increase to match investment and vice versa.  If for some reason, the natural rate did not rise, then there would ‘overheating’ in the economy, in the form of inflation.  In the recession example, savings would be greater than investment and if the natural rate did not fall enough to reduce the desire to save, then there would be less than full employment.

Now you can see why this concept of a ‘natural rate’ might be important.  Maybe current market rates are too high compared to the natural rate so that we have a glut of saving (hoarding of money) and not enough investment – stagnation.  But maybe market rates are too low, below the natural rate, so that we have inflation being expressed in a bubble in property and financial assets.  This is the nature of the argument between the conservative neo-classical (Austrians) and the Keynesians.

As leading Keynesian Brad Delong put it: “Bill White, formerly of the Bank for International Settlements, has argued the Wicksellian natural rate must be high and monetary policy too loose because low rates have encouraged all sorts of yield-chasing behavior. But [W]e don’t see businesses dipping into their cash reserves to fund investment; a monetary hot potato; unexpected and rising inflation; and full or over-full employment. Instead, we see elevated unemployment and firms and households adding to their cash reserves. This is what Wicksell expected to see when the natural rate of interest was below the market rate: planned investment would then be lower than desired savings, households and businesses seeking to save would then transfer some of their cash out of transactions balances and treat them as unspendable savings (the “precautionary” or “speculative” demand for money), we would see too little money to buy all the goods and services that would be put on sale at full employment, and we would see no signs of inflation but a depressed economy.  That is the root of our problem: the natural nominal rate of interest … today is less than zero, and so the Federal Reserve cannot push the market nominal rate of interest down low enough.”

But is there a natural rate of interest?  Does this concept help us understand what is happening in an economy, especially in the major capitalist economies right now?  Well, Keynes dismissed the idea arguing that there was not one static natural rate but a series of rates depending on the level of investment, consumption and saving in an economy and the desire to hoard money (liquidity preference).  And there was no reason to assume that the capitalist economy would ‘correct’ any mismatch between investment and savings, particularly in a depression, by market interest rates adjusting back to the ‘natural rate’ in some automatic market process.  That’s because in a depression where investment returns are too low compared to the money rate of interest, capitalists will hoard their money rather than invest in a ‘liquidity trap’.

Marx too denied the concept of a natural rate of interest.  For him, the return on capital, whether exhibited in the interest earned on lending money, or dividends from holding shares, or rents from owning property, came from the surplus-value appropriated from the labour of the working class and appropriated by the productive sectors of capital.  Interest was a part of that surplus value.  The rate of interest would thus fluctuate between zero and the average rate of profit from capitalist production in an economy.  In boom times, it would move towards the average rate of profit and in slumps it would fall towards zero.  But the decisive driver of investment would be profitability, not the interest rate.  If profitability was low, then holders of money would increasingly hoard money or speculate in financial assets rather than invest in productive ones.  What matters is not whether the market rate of interest is above or below some ‘natural’ rate but whether it is so high that it is squeezing any profit for investment in productive assets.

Both Keynes and Marx looked not to a concept of a natural rate of interest’ but to the relation of interest rate for holding money to the profitability (or return) on productive capital.  Actually, so did Wicksell.  According to Wicksell, the natural rate is “never high or low in itself, but only in relation to the profit which people can make with the money in their hands, and this, of course, varies. In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low, and expected to remain low.”

More recently, the architect of modern ‘unconventional monetary policy as the solution to the ills of modern capitalism, Ben Bernanke, former chief of the US Fed, agreed.  Bernanke tells us that low interest rates are here to stay, but not because of lax monetary policy, but because the real rate of return on assets (both tangible and financial) are staying low.  They are low not because the Fed and other central banks have pumped too much money into the economy – although that used to be what Ben said he wanted to do.  No, the reason for low interest rates is the low rate of return on capital investment.  “The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.” 

Turning to Wicksell, Bernanke says the problem is that the equilibrium real rate is low because “investment opportunities are limited and relatively unprofitable.”… What this tells you is that monetary policy is restricted in its impact by what is going on in the ‘real’ economy, more specifically, the dominant capitalist sector.  “The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors.”

Ben’s argument that it is the underlying real rate of return on investment that decides things, not Federal Reserve monetary policy, is really to justify and defend his actions as Fed chair against criticism from the Austrian school and the neoliberal camp that he kept interest rates artificially too low; and from Keynesian camp that he did not intervene enough.  You see, the critics are wrong about Fed policy because the Fed has little say in the underlying growth or otherwise of the US capitalist economy.  That depends on its underlying profitability, or in Wicksell’s language, the ‘equilibrium ‘natural rate of return’. “The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States.”

Of course, there is no discussion of why profitability (or the natural rate of return) is low. Modern mainstream monetary theory has actually forgotten the points made by Wicksell, let alone Keynes or Marx.  The modern proponents actually seem to believe in some natural rate of interest and reckon that boosting the money supply or lowering interest rates to zero (or even negative) will boost consumption and investment.  The barrier of low profitability is ignored.

Previous Fed chair, Alan Greenspan actually reckoned that interest rates should be fixed so that speculation in financial assets could be encouraged and this would boost productive investment and consumption.  Well, his policy led to a credit-fuelled property and stock market boom and bust.  Top monetary economist, Michael Woodford also reckoned that Fed monetary policy could be manipulated so that it increased inflation expectations among households leading them to spend more.

And now the current Fed chair Janet Yellen has gone even further.  She backs Fed economic research that suggests very low interest rates could inspire increased consumption and investment so that demand creates its own supply.  This is the mirror opposite of Say’s law, rebutted by both Marx and Keynes, that supply can create its own demand.  So keep interest rates low or at zero.  But the evidence for this extreme monetarist Keynesianism is poor. And ironically, Yellen is set to hike Fed rates in December.

Both propositions (supply creates demand or demand creates supply) suggest that the capitalist economy can ‘correct’ itself through market processes, either because saving will lead directly to investment (Say) or investment can match saving through fixing interest rates at the ‘natural rate of interest’ (Wicksell).   Neither proposition makes sense or works in an economy where investment is set by profitability.  If the return on productive capital is too low, what happens to the rate of interest or savings will change nothing.

The next recession

October 30, 2015

Back last summer, there was growing concern that the world economy, already making the weakest recovery from the deepest slump in production and investment since 1945, was slowing down.

Indeed, it now seemed that the ugly thought of another recession, as economists call a contraction in production, incomes and spending, was a serious possibility within a few years or less.  The IMF raised the probability of recession in the so-called ‘emerging economies’ of Latin America, ex-China Asia and the rest of the world to near 50%.

recession probability

The slowdown in emerging economies has been led by the significant slowdown in China’s powerhouse economy, from double-digit real GDP growth just a few years ago to less than 7% now on the official figures (many ‘experts’ reckon real GDP growth is much lower than that). As China slowed, its inexorable demand for energy and other raw materials and other export goods from elsewhere dropped.  Other large emerging economies plummeted into recession (Brazil, Russia, South Africa). 

Indeed, as I have previously pointed out, before the crisis, world trade tended to grow around  twice as quickly as world GDP, but since 2012 trade growth has simply matched that of GDP.

World trade trend

 “The global economy is uncomfortably close to the edge,” said David Stockton, senior fellow at the right-wing mainstream Peterson Institute for International Economics.  “Economics isn’t rocket science, and even rockets frequently land in the wrong place or explode in mid-air,” wrote Willem Buiter, chief global economist at Citigroup, who has assigned a 55% chance of a moderate to severe global contraction next year.

This worry even led the US Federal Reserve to delay its planned and much anticipated hike in its base interest rate that affects the cost of borrowing dollars in the US and globally.  If the emerging economies were slumping, it would be the wrong time to dampen household spending and business investment.

However, the optimists among mainstream economics have dismissed these prognoses.  Emerging economies may be slowing down and some may have contracted outright, but the major advanced economies were doing okay and Europe was actually picking up a little from its depression of 2010-13.  So the global economic recession was not going to happen.

Well, now we are getting data for real economic growth for the third quarter of 2015 (June to September) from the major advanced economies – and it is not great news for the optimistic scenario.  The slowdown in economic activity experienced in China and in most emerging economies is now being repeated in the advanced economies.

The US economy is the largest in the world and up to now has been recovering relatively better than the other major economies within Europe and Japan.  In Q3, the US economy did expand but only at a 1.5% annualised pace, down from 3.9% in the second quarter. That meant that the US economy expanded in real terms over the last 12 months by just 2%, down from 2.7% in Q2.

US real GDP

This 2% growth rate has become the norm for the US since the end of Great Recession. There seems no prospect of a return to previous trend growth and that means there has been a permanent loss of value for the American people from the Great Recession.

US trend GDP

In Q3, US business investment slowed to its lowest yoy rate for over two years.  Business investment grew more slowly, up only at an annual rate of 2.1% compared with 4.1% in Q2. Investment in new plant actually dropped 4% while investment in software and such rose at the slowest pace since 2013.  And, as a share of GDP, investment remains below pre-crash levels.

US bus inv

Now, some have been arguing that business investment in things like plant, machinery and equipment is less necessary given the new ‘disruptive technologies’ of the internet of things, software, algorithms etc that do not require tangible structures.  So investment is taking place but it now costs way less and is not really captured in the data.

For example, McKinsey argues that the “the US economy has shifted toward intellectual property–based businesses. Medical-device, pharmaceutical, and technology companies increased their share of corporate profits to 32 percent in 2014, from 13 percent in 1989. Since a company’s rate of growth and returns on capital determine how much it needs to invest, these and other high-return enterprises can invest less capital and still achieve the same profit growth as companies with lower returns”.  McKinsey- US – Are share buybacks jeopardizing future growth

Or put it another way: “while capital spending has outpaced GDP growth by a small amount, investments in intellectual property— research and development—have increased much faster. In inflation-adjusted terms, investments in intellectual property have grown at more than double the rate of GDP growth, 5.4 percent year versus 2.4 percent. In 2014, these investments amounted to $690 billion.” So McKinsey concludes: “Certainly, some individual companies are probably spending too little on growth—just as others spend too much. But in aggregate, it’s hard to make a broad case for underinvestment”.

No doubt there is some truth in this.  But even if investment is increasingly in ‘intellectual property’ and not in factories and robots (really?), even in the former, there appears to have been a slowdown in the US.  Software investment is no longer outstripping investment in hardware.


US household spending did rise 3.2% in the quarter.  The tax intake for personal incomes fell, so disposable personal income increased 4.8% compared with 3.4% in Q2.  And with headline inflation near zero, real disposable personal income rose. That’s why household spending was up. But while it’s true that the US unemployment rate continues to fall, the pace of that improvement is waning.

Us job growth

The slowdown in US economic growth was also repeated in the UK, the only other major advanced economy that has experienced 2%-plus real GDP growth in the last year or so.  Real GDP rose just 0.5% in the third quarter of 2015, so that real GDP is now 2.3% higher than this time last year, down from a growth rate of 2.4% yoy in Q2.  Although UK real GDP is now 6.4% higher than its peak at the beginning of 2008 (before the Great Recession), nearly seven years ago, once the population increase (up 3m, partly from net immigration) is taken into account, real GDP per head has only just reached the 2008 level.

As in the US, UK growth was almost totally confined to ‘services’. Manufacturing and construction actually contracted. Within services, the main contribution came from property and finance, the ‘unproductive’ sectors of the economy.

Back in 2008, manufacturing was nearly 10% of GDP and real estate was 8.5%. Now manufacturing is 8.6% and real estate is 10.4%. Real estate has jumped over 20% since 2008 while manufacturing has contracted nearly 7%. Indeed, UK heavy industry like steel is being crushed by falling commodity prices, weak economic growth in Europe and the dumping of Chinese steel in world markets . That’s the nature of UK economic growth: unproductive and credit-fuelled.

As for the other G7 economies, the slowdown is even worse.  Canada is in a ‘technical recession’, two consecutive quarters of contraction in real GDP.

canada gdp

Japan is teetering on a recession.  And just today, the Bank of Japan (BoJ) lowered its forecast for real economic growth out to 2018. The BoJ now sees growth in the year to April 2016 at just 1.2%, down from 1.7%. For the year to March 2017, the BoJ now expects growth of 1.4% down from a 1.5% forecast in July. And for the year to March 2018, the BoJ forecasts growth of only 0.3%!

The other G7 economies are in the Eurozone.  Germany has sustained a very modest growth rate in the last few years of about 1.0-1.5%; France has growth even less each year; and Italy has been stagnant (although it appears to be finally making a mild recovery in the couple of quarters).  We shall know more when the Q3 GDP figures come out next week.  But Germany is likely to record slower growth as exports to Asia and China have taken a tumble.

Spain has been the fastest-growing of the Eurozone economies in the last year or so, having suffered badly in the Great Recession with a housing collapse and a massive increase in unemployment.  But the ‘boom’ since 2013 appears to be over.  Today, the figures released for Q3 2015 real GDP growth showed a slowdown to 0.8% on the quarter compared with 1% in the previous quarter.  The year on year rate was up to 3.4% though compared to 3.1% in Q2.  But that could be it.

So expansion in the major advanced economies is slowing alongside the sharp drop in GDP growth in the emerging economies.  Indeed, Taiwan, a key Asian industrial economy, has just announced that its real GDP in Q3 fell by 1% from a year earlier, the first contraction in six years.

Since World War II, recessions have occurred at regular intervals, between 6-10 years.  The current expansion is more than six years old, beginning in July 2009.  Mainstream economics has signally failed to predict them.  For example, in the spring of 2001, the US economy faced weak growth abroad and the fallout of the dot-com bubble, but only 15% of economists surveyed that summer believed a downturn had begun.  Yet the economy was in the midst of a recession that lasted nine months.  As for the Great Recession, the failure of nearly all mainstream economists and major international institutions like the IMF and the OECD to see this major slump coming is well recorded. (The causes of the Great Recession).

The next recession will pose big problems for the economic policy makers of the major countries.  Easy monetary policy (zero interest rates, quantitative easing) has been virtually exhausted (apart from being pretty ineffective anyway in boosting the ‘real economy’ rather than stock markets and banks).  Keynesian-style government spending has been rejected or curbed up to now because public sector debt levels have been so high and corporate profitability has been so low.

There are those like Ben Bernanke, former Fed chief or Andy Haldane, current chief economist at the Bank of England, who argue that central banks saved the major economies from a Great Depression and there is even more that can be done in printing money for direct handouts to households or having negative interest rates to avoid a new slump.

And the Keynesians like Paul Krugman, Larry Summers, Simon Wren-Lewis and a host of others continue to push for more government spending and budget deficits to ‘pump-prime’ the economy.  But this is more likely to reduce profitability and investment of the capitalist sector than save it.

The next recession cannot be avoided and it is not far away.

Canada: losing energy

October 20, 2015

So Justin, the son of the former Liberal PM of the 1970s, Pierre Trudeau, has triumphed in Canada’s general election.  The Liberal party came from behind to sweep into an outright majority victory, removing the incumbent Conservative government that had been in office for nearly ten years under Stephen Harper.

The third party, the New Democrats, similar to the British Labour party, which had been ahead in the polls at the start of the long 79-day election campaign, eventually fell back to a poor third.  The reason, it seems, is that the Liberals decided to adopt an anti-austerity programme, advocating budget deficits (not large though), improved minimum wages and an infrastructure investment plan, in opposition to the neo-liberal polices of the Conservatives.  The Liberals stole the NDP policies and romped to victory.

Justin Trudeau though faces a difficult task economically.  Canadian capitalism has been a relative success story, based on its close proximity to US imperialism and its capital investment and its resources of oil, gas and other minerals.  But that ‘luck’ also delivers big vulnerabilities: the economy is subject to the swings of boom and slump in the US and to changes in the world prices for oil and resources.

And world energy prices have plummeted in the last 18 months.  As a result, the Canadian dollar has plummeted from parity with the US dollar to some 30% weaker.  And the economy has slipped into a ‘technical recession’, where real GDP has contracted for two successive quarters.

Canada growth

Behind that lies a collapse in business investment, mainly in the energy sectors.  In June, there was a 4.6% fall.  As the IMF put it “Business nonresidential investment has slowed in recent years (following a strong rebound initially after the crisis). The slowdown has been widespread— including both the energy sector and broader spending on machinery and equipment”. cr1522

And as the Royal Bank of Canada puts it: “Business fixed investment fell at double-digit rates in both the first and second quarters of 2015 weighed down by massive cuts by energy companies. The persistence of low oil prices (WTI hit a cycle low in late August) will likely yield another hit to investment in the third and potentially fourth quarters. Despite large cuts introduced earlier in the year, the recent downdraft in energy prices and our revised assumption that the rebound in 2016 will be more muted than we previously thought, suggests that investment by the energy sector will continue to decline in 2016.”  fcst_sep2015

The only thing keeping the economy going is credit-fuelled, low interest borrowing, boosting consumption and a housing bubble.  The Bank of Canada has commented that the housing bubble will “increase the likelihood and potential severity of a correction later on”. Canada’s household debt-to-disposable income ratio stood at a record 164.6 in the second quarter of 2015, compared with 163.0 in the first quarter, according to the national statistics agency. It has risen from 142.52 per cent in the first quarter of 2008, the year of the financial crisis.  The Royal Bank of Canada’s affordability index for housing has reached 60% in Toronto, the highest it has been since the early 1990s.  Vancouver is ranked at more than 80%, the highest since 1982 when it exceeded 90%.   If interest rates start rising, this will drive up debt servicing for many.

Interest rates and business investment are low not just because of the collapse in energy prices.  Canadian business profitability has been weak and falling.  Productivity growth has been poor.

Canada biz

As the IMF put it in a recent report:  “Perceived low investment profitability has negatively affected the neutral rate. After a quick turnaround at the end of the recession, labor productivity and, especially, the investment specific shock (which drives investment profitability) have been underperforming until recently, reducing the demand for funds and, thus, preventing the natural rate from rising. In particular, news shocks to investment profitability turned particularly overly pessimistic by the end of 2011 even though labor productivity has been slowly improving.”  cr1523

Indeed, the trajectory for profitability for Canadian capital over the long term has been similar to that of the US: the profitability crisis of the 1970s, followed by a neo-liberal recovery and then a downward shift before the Great Recession.

Canada ROP

The recovery since the end of the Great Recession in mid-2009 looked promising as commodity prices, particularly energy, jumped.  But, like Brazil, with the collapse in the ‘commodity cycle’, Canada’s recovery petered out and began to reverse.  Now the new Liberal government is faced with weak or non-existent economic growth, businesses unable or unwilling to invest, and a risky housing bubble.  Meanwhile, the global economy continues to slow.

Debt, demand and depression

October 18, 2015

In the last few weeks, global stock and bond markets have been rallying after a period of sharp falls.  The reason is clear.

World index

The US Federal Reserve monetary policy chiefs have been talking down their plan of starting to hike interest rates this year.  At their last meeting in September, the statement said that the planned increase in the Fed’s interest rates, which sets the floor for the cost of borrowing to spend or invest, may be postponed because the weakening situation in the global economy, particularly in the so-called emerging economies.

The slowdown in global growth has been well-documented in this blog in several posts.  Now the expectation that the US Fed will not move ‘prematurely’ to drive up the cost of debt servicing in the rest of the world has helped to inspire a rally in the value of financial assets – for the moment.

But there has been no change in the underlying state of the global economy.  On the contrary, on the ‘supply-side’ global industrial production remains very weak – from the US to Europe, to Japan and to China.  ‘Domestic demand’ (ie spending by households and investment by companies) has been better, at least among households as the cost of credit cards and mortgages remains at all-time lows.

Global IP


The US economy has been the leader among the advanced capitalist economies for economic growth since the end of the Great Recession in 2009.  Even so, the US real GDP growth rate has averaged only 2.2% a year in six years, well below its trend average of 3.3% of the last 50 years, while growth per person is even lower.  And projections for the third quarter just gone don’t justify the current stock market confidence.  The Atlanta Federal Reserve produces the most accurate ‘high frequency’ forecast of US real GDP growth using a host of economic indicators.  Currently, it expects the annual real GDP growth to be less than 1%.

Atlanta fed

And while consumer demand has not slumped, what is showing signs of serious ‘wear and tear’ is profits.  I have signalled the slowdown in global corporate profits before.

global profits

And the latest US company earnings results for the third quarter of 2015 (June to September), with only about 10% released so far, suggest an absolute fall in company profits for the top 500 US companies.  The forecast is for a 4% contraction in earnings compared to last year in Q3 2015.

A fall in corporate earnings or profits in a slowing world economy is placing extra pressure on the ability to service debt built up, particularly by corporations in both the G7 and the emerging economies.  Both the IMF and the world’s central bankers are worried that the build-up of debt that started well before the Great Recession has only got bigger since in most economies.

An obscure international body of central bankers, the Group of Thirty, recently presented a report warning that  zero interest rates and money printing by major central banks were not working to revive economic growth and risked becoming semi-permanent measures. Instead, the flow of easy money has inflated asset prices like stocks and housing in many countries, even as they failed to stimulate economic growth. With growth estimates trending lower and easy money increasing company leverage, the spectre of a debt trap is now haunting advanced economies, the Group of Thirty said. It warned that the 40% decline in commodity prices could presage weaker growth and “debt deflation”.

The IMF in its latest report on global financial stability says the biggest risks to the global economy are now in emerging markets, where private companies have racked up considerable debt (up to $3 trillion) amid a fifth straight year of slowing growth.  This unprecedented lending spree has come to an end with the plunge in prices for oil, minerals and other commodities that economists attribute to China’s slowdown. The risk is that shocks from bankruptcies in the developing world’s private sector could be amplified in global financial markets.

And it’s not just emerging economies that have a fragility with debt.  Take the UK mining company, Glencore.  It has $30 billion in debt.  Charter Communications, after its acquisition of Time Warner Cable, will have as much as $67 billion in debt. And the combination of AB Inbev and SABMiller could create a brewer with over $100 billion in debt.  US corporate debt is up by about $1 trillion in the seven years since the financial crisis. But corporate equity is up as well.  Indeed, within the S&P 500 companies, the ratio of debt to equity has fallen from around 200% in 2009 to 100% today. So all is well?

Maybe not.  While equity (stock market prices) has kept up with debt, corporate profits haven’t. At the end of second quarter, 62% of all companies had twice as much debt as cash flow from their operations, according to JPMorgan Chase. That’s up from 31% in the first quarter of 2006.  The volume of corporate loans outstanding is now 14% higher than it was before the financial crisis. And, much like the situation in the run up to financial crisis, there’s been a boom in lending to risky borrowers. Last year, investors bought nearly $312 billion high yield bonds, often called junk bonds, up from $146 billion in 2006, which was the peak before the financial crisis.

According to McKinsey, at the end of 2007 the global stock of outstanding debt stood at $142 trillion. Then in 2008 the financial world fell apart. Less than seven years later, in mid-2014, there is an additional $57 trillion in global debt, and the data this year is going to show that we’ve hit another record high. Debt as a percentage of GDP is even higher now than it was in 2007: 286% vs. 269%. Total debt grew at a 5.3% annual rate from 2007–14. But corporate debt grew even faster at 5.9% annually.

Stock of debt

I have argued in many places that debt does matter under capitalism. Yes, credit is necessary to lubricate the wheels of capitalism and provide funds for investment where earnings cannot be raised in one production cycle.  But debt must be repaid eventually and at least be serviced without resorting to raising even more debt to pay for old.  And the ability to repay depends on profits.  If profits do not match the debt servicing, capitalist companies head for bankruptcy.  And the burden of debt weighs down on the ability or willingness of companies to invest.  That leads to slow growth.

Of course, we are continually told by Keynesian economists that the problem with capitalism and the very weak economic recovery since 2009 is a ‘lack of demand’.  Low profitability and the connection between profits and investment are ignored, while the claim that debt matters is dismissed.  Most Marxist economists also adopt this view.  For example, Chris Dillon, a Marxist economist blogger, seems to argue that ‘lack of demand’ is the chronic condition of capitalism that creates crises and stagnation in investment, in pretty much the same way as the Keynesians do.  And like the Keynesians, he reckons that “sensible aggregate demand policies might suffice to overcome realization crises”.  But unlike the Keynesians, for Dillon, capitalism cannot be reformed, because crises cannot be predicted and capitalist governments have no class interest in changing things.

The argument that what is wrong with capitalism is a lack of consumer demand is refuted by the evidence of the last ten years: consumption generally strong and investment generally weak.

Investment demand

A lack of investment demand is more to the point.  There is certainly not ‘over-investment’ relative to consumption, (the main cause of crises offered by Dillon).  There is serious under-investment, caused, in my view, by low profitability relative to existing capital (including debt).

The debate continues within mainstream economics between debt and demand as the kernel of the capitalist problem and on what caused the Great Recession and what is causing the weak recovery.  Kenneth Rogoff is the economic historian of financial crises and debt in modern economies.

Recently he has argued yet again that debt lies behind much of what has happened in the past seven years.  He remarks that “Some argue that we are living in a world of deficient demand, doomed to decades of secular stagnation. Maybe. But another possibility is that the global economy is in the later stages of a debt “super cycle”, crushed under a burden accumulated over years of lax regulation and financial excess.”  He rejects the modern version of Keynesian explanation, namely ‘secular stagnation’, promoted by the likes of Larry Summers and Brad de Long, caused by a chronic ‘lack of demand’ and thus the need to boost debt even more and raise government spending. “What if a diagnosis of secular stagnation is wrong? Then an ill-designed permanent rise in government spending might create the very disease it was intended to cure.” For Rogoff “most financial crises have their roots in a slowing economy that can no longer sustain excessive debt burdens.”

The Keynesians are not happy with Rogoff’s critique.  They make the point that if governments try to reduce debt and ‘balance the books’, they will cut back demand and so lower growth in a downward cycle that it will be difficult to get out of.  See this paper. So it seems that expanding credit can lead to a financial crisis but cutting it back can make things worse!

Perhaps, there is a middle way between not too little credit and not too much debt.   Thus argues former head of Britain’s Financial Services Authority, Adair Turner.  This was the agency that failed to spot the oncoming banking collapse in Britain in 2007.  But no matter, Turner, in a new book, Between Debt and the Devil, tells us most credit is not needed for economic growth—but instead it drives real estate booms and busts and leads to financial crisis and depression. Banks need far more capital, real estate lending must be restricted, and we need to tackle inequality and mitigate the relentless rise of real estate prices. But sometimes we also need to monetize government debt and finance fiscal deficits with central-bank money.  So government policy must straddle between the devil and the deep blue sea.

In a way, this is how top US mainstream economists Alan Blinder and Mark Zandi see it.  They state that “crises are an inherent part of our financial system”.  But, apparently, crises under capitalism are a necessary evil because “without them it is likely that the risk-taking necessary for strong long-term economic growth would be stymied.”  The problem is that “when the good times roll, investors find it difficult to avoid getting caught up in the euphoria, to take on too much risk, and to saddle themselves with too much debt.”

Yes, indeed, it is a conundrum.  But don’t worry about mass unemployment, bankruptcies and drops in living standards.  “The worldwide financial crisis and global recession of 2007-2009 were the worst since the 1930s. With luck (sic!), we will not see their likes again for many decades. But we will see a variety of financial crises and recessions, and we should be better prepared for them than we were in 2007.”  They argue that the ‘policy response’ by governments: cutting interest rates, printing money and a bit of government spending, eventually saved the day. Without that “we might have experienced Great Depression 2.0.”

The big problem for this comforting conclusion is that just as these economists congratulate themselves on avoiding another ‘Great Depression’ like the 1930s,  it seems that the world economy is heading towards a new slump, with debt still at record levels and government policies of monetary easing exhausted.


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