Deleveraging and the economic recovery

The latest jobs figures for June out of the US startled all the mainstream economists.  They were expecting a steady rise in employment to be confirmed by the data, suggesting  that the US economy was continuing to recover from the Great Recession.  Then both politicians and economists could claim that things were getting back to normal with reasonable economic growth and a fall in unemployment.  June’s data and the downward revisions for April and May revealed no such thing.  Not only did employment rise by a paltry 18,000 in June, but the unemployment rate rose from 9.1% to 9.2%.  And yet the economists employed by the US administration had been forecasting only one year ago that the unemployment rate would be below 8% by now.   Moreover, the number of long-term unemployed has now reached a record high since the slump of 2008 and if you add in the numbers not able to get work or so discouraged from looking, there are now over 21m Americans of working age wanting a job and unable to get one.

The unemployment rate has crept steadily higher since March, lifting from 8.8% to 9.2% as of June. That is a level last seen in 1983, coming out of the double dip 1980-2 recession. For 45-54 year olds, who are supposedly in their peak earning years and need to be saving for retirement, the 7.3% unemployment rate exceeds that of any prior recession in the post World War II era.   On average, the unemployed are finding work only after nearly 40 weeks of search, and there are still 6.3m US citizens that have been unemployed for 27 weeks or longer.

And yet, as I have outlined in previous posts (see Profits lead the way, 28 April 2011 and Profit and investment in an economic recovery, 29 December 2010)), there is an economic recovery taking place if you look at the profits of US businesses.  Total US profits have now returned to their pre-crisis level and profitability (profits measured against the stock of assets and cost of the workforce) has also recovered from a trough in the recession.  The reason for the failure of rising profitability to be translated into more jobs and falling unemployment is that the owners of businesses are unwilling to spend their  cash piles on investing in new equipment and more workers.

There are two reasons for this.  The first is that many companies, particularly the smaller ones that provide the bulk of new jobs in the US (because the larger companies continually shrink their workforces) still have considerable debt burdens that they need to reduce.  The second reason is that American households are also loaded up with debt, mainly mortgage debt, that they can no longer service in the slump.  Millions of Americans are failing to make their mortgage payments and are being slowly forced into giving up their homes through repossessions by the banks.  Both small firms and households are thus deleveraging, i.e. reducing their debt.  And they are going to go on doing this before they are willing to employ more workers or spend more on consumer goods.  Thus, even though nonfarm nonfinancial corporations accomplished a $478bn increase in pretax profit flows since the recession officially ended, spending flows on business fixed investment are up only $30bn through the first quarter of 2011.

Because the level of debt that was built up by American households and corporations was so large before the credit bubble burst, it is going to take a long time to clear to a level that begins to be acceptable.  There has been a lot of research of how long deleveraging takes after a credit crisis.   Carmen Reinhart and Kenneth Rogoff (see This time is different, / produced a heavy historical study of previous crises going back over centuries and found that after a debt crisis, deleveraging can take years.  McKinsey Institute published a very illuminating study putting a figure on it: deleveraging usually took four to seven years after a crisis breaks (see Debt and deleveraging,…/debt_and_deleveraging_full_report.pdf).

In a way, these studies are really saying that what Marx called ‘fictitious capital’ builds up in a capitalist economy when capitalists switch their profits from productive investment in industry and technology into unproductive speculative investments in real estate, stock markets and other financial assets.  They do this because profitability starts falling in the productive sectors (where real values are created) and they go in search of better profits in unproductive ones (which either appropriate value from productive sectors through interest rates, rents or engender fictitious values through rising stock and housing prices).  But there are limits to this trick, eventually culminating in financial busts in the stock market (2000) or property (2007).

Because these investments are unproductive in creating new value, eventually they come into conflict with reality.  Stock investors find their share prices stop rising because the companies they are investing cannot justify their share price with sufficient profits.  Or householders stop taking out more or bigger mortgages because their incomes just do not cover the house price, however generous the interest rate or the mortgage terms.  Then much of the capital invested in the stock market or house mortgages turns out to be fictitious.

We can see how fictitious capital can distort the real level of profitability by measuring profits not just against tangible fixed assets in the corporate sector but also against the level of debt held by those companies.  This is something that I calculated for the US economy in a previous post (see The cycle of profitability and the next recession, 18 December 2010).   The red line shows profitability relative to tangible assets and the green line shows profitability relative to tangible assets plus debt.  It shows a rising gap between the profit rate on tangible assets and that on assets plus debt from about 1982 onwards.  Indeed, in the last few years since the Great Recession, when the overall profit rate recovered, the profit rate adjusted for rising debt continued to fall.  So fictitious capital was hiding the true situation and continued to do so after the Great Recession.

To ‘cleanse’ the economy of this debt is going to take a long time because it rose so much.  McKinsey reckons that deleveraging has hardly begun.  I would say it cannot be cleared without another significant slump in capitalism in order to get rid of the dead and imaginary capital.  In the meantime, we are likely to see very weak economic activity in the US and the other major capitalist economies, which have similar levels of debt to the US.  Real growth will be less than 2% a year on average.  Eventually profitability will start to slip back again (see my post, Returning to the long view, 15 June 2011 anticipating that already).  In a few years time, the slump will return.

7 Responses to “Deleveraging and the economic recovery”

  1. Peggy Dobbins Says:

    Thanks for clear summary. I wish you few progressive economists would make the leap to clarifying real profits are a function of “equitable exchanges of different forms of labor time, the Productivity of which develops Unevenly inevitably”. And that “world average labor time we workers add to products of same kind MINUS that that other workers put in what we have to pay for is the Common wealth, monetized and privatized, we still see money changers steal. But we can learn and see some bills guaranteeing n hours of work for a livable wage to all who apply. Start the cure at the bottom

  2. hartal Says:

    How much of the recent spike in profitability is due to factors such as rationalization of existing investments (that is, downsizing and thereby raising labor productivity), eating up seed capital so to speak, financial industry profits from the carry trade enabled by Fed policy, and profits from foreign operations bolstered by a weakening dollar.
    Those seem to be the reasons for rising profitability, yet that would mean that profitability on new or marginal investments has not risen. Capital will not achieve a real boost in profitability without a reduction in capital costs first and foremost through centralization and a rise in the rate of exploitation. That will make debts manageable and stimulate new accumulation, but the centralization that it will take to reduce to reduce capital costs and create the unemployment necessary for raising the rate of exploitation may well prove to be socially intolerable. History is about to be thrown wide open.

  3. Ron Cohen Says:

    lets assume that the rate of profits does not change, and the amount of debt does not change, but the size of tangible assets goes down. in that case, the ratio between assets & profits will go up, and the ratio between assets & profits + debt will go down. i think that this is what your diagram shows. of course debt and profits can’t be static, but in general what your diagram shows is that while assets went down profits went up – this is due to two factors: the increasing rate of exploitation in the US, and profits coming else where. it does not show the distortion by fictitious capital, but the continuous migration of capital from the US.

  4. michael roberts Says:

    I’m not sure I follow your argument. The rate of profit (R) on the two measures is defined as 1) profit (P) divided by tangible assets (A) and then 2) profit (P) divided by tangible assets (A) plus debt (D). So 1) is R=P/A and 2) is R=P/A+D. The debt is in the denominator in 2) not added to the numerator. That is total profit (P) in both 1) and 2).

    So in 1) if A falls but R is unchanged, then P must have also fallen. In 2) if A falls and both R and D are unchanged, then P must fall again. I dont see how P rises in either case.

    If you mean that the rate of profit rose during 1982-97 because of an increase in the rate of exploitation and not from falling assets, then that is partly true. In my book, I show that a rising rate of exploitation was an important factor, but also a cheapening of constant capital (slowing asset accumulation) leading to a fall in the organic composition of capital was also important. These are the counteracting tendencies to Marx’s law of the tendency of the rate of profit to fall.

  5. little keithy Says:

    On fictitious profits. There was a useful survey by Forbes in, I think, May 2009 of the top 500 US companies. It showed that every dollar of profit in 2007 was worth 17 cents in 2007 ie a fall of 83 per cent. Particularly hit were banks and the financial sector that had gone from huge profits to losses (bourgeois categories but still useful).
    The other point it showed was the sclerotic nature of the largest capitals. The three car companies, Fords, GM and Chevrolet were in the top eight of companies by revenue but on rate of return were in the 490s. Suggestive of the the way in which even the largest fixed capitals pull in profits via the average rate of profit but are condemned by their own contradictions on productivity.
    The distinction between values and profits (especially rents and interest) is worth pursuing in understanding crises.
    The question on debts is how far will the current policy on maintaining debt value (value used in the loose sense not Marxist sense) through austerity undermines value in the Marxist sense.

  6. Mike B) Says:

    I’m wondering about that most mysterious of all commodities, money. Is it not the case that the USD has fallen in price (by half since the onset of the GFC) because of the large amount of cash sloshing around in the world due to speculative pricing vis a vis assets. Driving up the price of assets e.g. real estate, made them seem to have more value than they did. IOW, the bubble of price was blown around assets whose values remained constant if not in actual decline through wear, tear and time. Now, the lowered price of the USD on world markets makes the newly created values/commodities more correctly reflect themselves as wealth as the older assets e.g. housing deflate. Result is that profits are increasing on sales of newly produced commodities. Meanwhile, the over priced asset of 2006 labour power is declining as well. Peggy’s point is a good one. Labour power is now so productive that it’s putting itself out of jobs. The key here is time. Employed workers, as a class, are putting in more and more time and producing for capitalists for less in real wages because their labour power, like all other commodities is being cheapened in the process of capitalist production. Shorter work time would go a long ways to solving this problem. Still, as you rightly point out, debt exists because what we all saw as wealth was nothing but a speculative price bubble: fictitious capital. What the big bond holders e.g. French banks are trying to do is to is have the working class ‘pay’ back their inflated bonds at the new, uninflated price of the USD. This is what ‘austerity’ is all about, IMO.

  7. phw Says:

    Hi Michael, thank you for the great post. I have one question. You wrote: “We can see how fictitious capital can distort the real level of profitability by measuring profits not just against tangible fixed assets in the corporate sector but also against the level of debt held by those companies”. I was wondering in what sense you used the word “distort”. As for the traditional measure of profit rate vs. the extended one that includes financial assets, I thought your point (which I agree with) was that the latter reveals the profitability of capital better than the former does. Maybe my misunderstanding?

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