Covid and fictitious capital

During the year of the COVID, output, investment and employment in nearly all the economies of the world plummeted, as lockdowns, social isolation and collapsing international trade contracted output and spending.  And yet the opposite was the case for the stock and bond markets of the major economies.  The US stock market indexes (along with others) ended 2020 at all-time highs.  After the initial shock of the COVID pandemic and the ensuing lockdowns, when the US stock market indexes plunged by 40%, markets then made a dramatic recovery, eventually surpassing pre-pandemic levels.

It is clear why this happened.  It was the injection of credit money into economies. The Federal Reserve and other major banks injected huge quantities of cash/credit into the banking system and even directly into corporations through the purchase of government bonds from the banks and corporate bonds; as well as through direct government-backed COVID loans to businesses.  Interest rates on this credit fell towards zero and, with so-called ‘safe assets’ like government bonds, interest rates even went negative.  Bond purchasers were paying governments interest in order to buy their paper!

Much of this credit largesse was not used to keep staff in pay and employment or to sustain corporate operations.  Instead, the loans have been used as very cheap or near zero-cost borrowing to speculate in financial assets.  What is called ‘margin debt’ measures how much of stock market purchases have been made by borrowing.  The latest margin debt level is up 7.7% month-over-month and is at a record high.

Marx called financial assets, stocks and bonds, ‘fictitious capital’.  Engels first composed this term in his early economic work, the Umrisse; and Marx developed it further in Capital Volume 3 (Chapters 25 and 29), where he defined it as the accumulated claims or legal titles, to future earnings in capitalist production; in other words, claims on ‘real’ capital, ie capital actually invested in physical means of production and workers; or money capital, cash funds being held. A company raises funds for investment etc by issuing stocks and/or bonds. The owners of the shares or bonds then have a claim on the future earnings of the company. There is a ‘secondary’ market for these claims, ie buying and selling these existing shares or bonds; a market for the circulation of these property rights.

Stocks and bonds do not function as real capital; they are merely a claim on future profits, so “the capital-value of such paper is…wholly illusory… The paper serves as title of ownership which represents this capital.” As Marx put it: “While the stocks of railways, mines, navigation companies, and the like, represent actual capital, namely, the capital invested and functioning in such enterprises, or the amount of money advanced by the stockholders for the purpose of being used as capital in such enterprises…; this capital does not exist twice, once as the capital-value of titles of ownership (stocks) on the one hand and on the other hand as the actual capital invested, or to be invested, in those enterprises.” The capital “exists only in the latter form“, while the stock or share “is merely a title of ownership to a corresponding portion of the surplus-value to be realised by it”.

Investors (speculators) in financial markets buy and sell these financial assets, driving prices up and down.  If cash (liquidity) is flush, share and bond prices can rocket, while banks and financial institutions invent ever new financial ‘instruments’ to invest in.  As Marx put it: “With the development of interest-bearing capital and the credit system, all capital seems to double itself, and sometimes treble itself, by the various modes in which the same capital, or perhaps even the same claim on a debt, appears in different forms in different hands. The greater portion of this ‘money-capital’ is purely fictitious.”

The central banks become key drivers of any financial asset boom  Again, as Marx put it some 150 years ago, “Inasmuch as the Bank issues notes that are not backed by the metal reserve in its vaults, it creates tokens of value that are not only means of circulation, but also forms additional – even if fictitious – capital for it to the nominal value of these fiduciary notes, and this extra capital yields it an extra profit.”  The creation or ‘printing’ of money by central banks provides the liquidity for speculation in the stock and bond markets – as we have seen in the year of the COVID.

Marx reckoned that what drives stock market prices is the difference between interest rates and the overall rate of profit. As profitability fel in 2020, what kept stock market prices rising was the very low level of long-term interest rates, deliberately engendered by central banks like the Federal Reserve around the world.  ‘Quantitative easing’ (buying financial assets with credit injections), has doubled and tripled in this year of the COVID.  So the gap between returns on investing in the stock market and the cost of borrowing has been maintained.

But here is the rub.  The share price of a company must eventually bear some relation to the profits made or the profits likely to be made over a period of time. Investors measure the value of a company by the share price divided by annual profits. If you add up all the shares issued by a company and multiply it by the share price, you get the ‘market capitalisation’ of the company — in other words what the market thinks the company is worth.  This ‘market cap’ can be ten, 20, 30 or even more times annual earnings.  If a company’s market cap is 20 times earnings and you bought its shares, you assume that you would have to wait to reap 20 years of profits in dividends to match the price of your investment.

You can see from this (CAPE Shiller) graph below that, as long term interest rates have fallen, the market cap price of corporate shares relative to profits (earnings) has risen.  Currently, it is at levels only surpassed in 1929 and during the dot.com boom of 2000.

If profits drive the share prices of companies, then we would expect that, when the rate of profit in capitalism rises or falls, so would stock prices. To measure that, we can get a sort of average price of all the company shares on a stock market by using a basket of share prices from a range of companies and index it. That gives us a stock market index.

So does the stock market price index move up and down with the rate of profit under capitalism? The answer is that it does, over the longer term — namely over the length of the profit cycle, but that can be as long as 15-20 years.  In the shorter term, the stock market cycle does not necessarily coincide with the profit cycle.  Indeed, financial markets can reach extreme price levels relative to the underlying profits being engendered in an economy.

The most popular way of gauging how far the stock market is out of line with the real economy and profits in productive investment is by measuring the market capitalisation of companies against the accumulated real assets that companies have. This measure is called Tobin’s Q named after the leftist economist, James Tobin. It takes the ‘market capitalisation’ of the companies in the stock market (say, of the top 500 companies in what is called the S&P-500 index) and divides that by the replacement value of tangible assets accumulated by those companies. The replacement value is the price that companies would have to pay to replace all the tangible (and ‘intangible’?) assets that they own (plant, equipment, software etc).

For the last 100 years or so, the average mean Q Ratio is about 0.78. The Q ratio high was at a peak of the tech bubble in 2000 reaching 2.17 — or 174% above the historic average. The lows were in the slumps of 1921, 1932 and 1982 at around 0.28, or 62% below average.  But in this year of the COVID, Tobin’s Q has reached 233% above the mean – a new record.

Another useful measure of the value of the stock market relative to the real economy is the Buffett index.  Named after famed billionaire financial investor who uses this index as his guide, it measures the money value of all stocks and shares against the current national output in the real economy (GDP).  Again, this shows that in the year of the COVID, the stock market has reached record high relative to the ‘real economy’.

Indeed, financial speculators remain in total ‘euphoria’ as they continue to expect central banks to plough yet more loans and cash into the banks and institutions, along with a likely subsidence of the COVID pandemic in 2021 as vaccinations are distributed.  The belief is that corporate earnings will recover sharply to justify the current record highs in stock prices.

Citi Research has a “Euphoria/Panic” index that combines a bunch of market mood indicators. Since 1987, the market has typically topped out when this index approached the Euphoria line. The two exceptions were in the turn-of-the-century technology boom, when it spent about three years in the euphoric zone, and right now.

This ‘euphoria’ index complements the views of the world’s most powerful investment bank, Goldman Sachs. Their experts forecast another 15% rise in the US stock market in 2021.

But as Marx explained, eventually investment in financial assets will have to come into line with earnings in the real economy.  In the year of the COVID, profits in most corporations plunged by 25-30%.

Goldmans and other investor speculators seem convinced that profits will bounce back this year, to make sure that the price of fictitious capital does not turn out to be fictitious. But that seems unlikely.  COVID-19 is not yet over and the vaccination distribution will take well into this year to reach levels of necessary so-called ‘herd immunity’, and that assumes the vaccines can also deal with the new COVID variants.

Moreover, the stock market boom of 2020 was really confined to just a few companies. In the year of the COVID, the S&P 500 index rose 18.4%, but the portfolio of FAAAM (Facebook, Alphabet, Amazon, Apple, Microsoft) plus Netflix rose 55%. The contribution of that latter group to the S&P 500’s growth was 14.35%. So the rest of the S&P companies gained only 4.05%.

Most companies lost money in 2020.  And there is a swathe of businesses, mostly outside the top 500, but not entirely, which are in deep trouble.  Earnings are low or negative and even with the cost of borrowing near zero, these ‘zombie’ companies are not earning enough to cover even the interest on existing and new loans.  These ‘financially challenged’ zombies constitute about 20% of companies in most economies.

Even before the pandemic, the zombie companies were contributing to a significant slowdown in corporate investment levels. With so many companies in trouble, there is little prospect of a huge jump back in investment and earnings this year.

Central banks will go on providing yet more ‘liquidity’ for banks and corporations to speculate in financial markets. So fictitious capital will continue to expand – after all, as Engels first said, speculating in financial markets is a major counteracting factor to falling profitability in the ‘real economy’.

But all good things must come to an end.  Probably in the second half of 2021, governments will attempt to rein in their fiscal spending and central banks will slow the pace of their largesse.  Then the extreme levels of stock and bond prices relative to earnings and tangible capital are likely to reverse, like a yo-yo does when the string is pulled back to the reality of being fixed to a holder (real capital).

21 thoughts on “Covid and fictitious capital

  1. Michael. Thank you. Comprehensive analysis. But……as I’ve suggested we are through the looking glass Capitalism driven by the pursuit of operational profit is dead (you’ve rightly and consistently argued that the driver for cpitalism is profit). The state in the US and elsewhere is using its power, validated by Covid, to intervene in the economy to displace that factor and I believe it’s permanent. Owners of fictitious capital know that capital is a social relationship and it’s about exploitation not value creation so they are indifferent whether corporations make a profit of not so long as the market cap of companies they invest in go up. They are now feeding off the state, not the profit-making corporation, and will continue to buy shares so long as the state allows them to crystalise capital gains (extra fictitious capital). This will persist as long as they believe the state will allow them to do that indefinitely. Biden and the restored US political establishment are haunted by Trumpism (as the British establishment is by Corbyism) in the way Marx argued 19th century governments were haunted by communism. Any withdrawal of government support for the economy on the scale we’re seeing will bring about a crash that would inevitably lead to a renaissance of Trump or a SuperTrump both in the US and elsewhere. What will precipitate an end to this policy? Well it won’t be before the next US election. This will effectively institutionalise what looks like a short-term aberration (investors, corporations and workers will not only become accustomed to this arrangement, they will depend upon it). The political implications? We differ on this too. My analysis is based on the argument that — in advanced economies where service industries are dominant — value is an intangible and is only subjectively perceptible (this approach makes it easier to comprehend what’s happening. The idea of tangible value acts in your system as a anchor that must in due course bring capital prices to their real level). The shift from tangible good manufacturing to intangible service creation is a revolutionary change in the mode of production that has long invalidated capitalism’s purpose: it’s already dead. The state has now taken over the corpse and through its Covid policies is making it look like it’s still alive — and so long as the owners of fictitious capital are making fictitious profits why should they want to notice). The only thing that’s needed is to recognise that it’s happened. We now have on a global basis a form of unequal and authoritarian (aren’t we being told in detail how to behave?) communism. The radical argument is that this needs to be reformed (since the state’s in almost total control in the US, this can be done) to an equal and liberal form. Extraordinary times mate.

  2. The Buffet indicator can be interpreted as Marx’s rising organic composition of capital. The rising price-earnings ratio is the inverse of Marx’s tendential fall of the rate of profit. The rising Q is a bit more problematic. It should cause a boom in investments, but it does not. One possible explanation sometimes offered is invisible capital, that not all investments appear in the balance sheets. (Haskel, Westlake: Capitalism without Capital)

  3. Dear Dr Roberts,

    I’ve been educating myself in economics by this blog for a while now, and picking up on reading suggestions when you talk about them, or when they otherwise pop up in discussions.

    The ASSA 2021 discussion drew my attention to the work of Paul Cockshott, so I’ve just finished his latest book, written for a general audience: “How the World Works: The Story of Human Labor from Prehistory to the Modern Day”.

    I wonder whether you’ve read that book, and more generally I’m curious as to how your views and Cockshott’s align. To a layperson like me, he came across as a cogent, scientifically-inclined economist who cares for data rather than abstractions, much like you, and much like what the Marxian tradition seems to be as opposed to the mainstream.

    Your thoughts on the book, if you have read it, would be very much appreciated.

  4. Many stocks, especially the FAAAMs, do not produce dividends. Money is only made when they are sold at a price below the buy price. Which is when a ‘sale’ panic comes in.

  5. Thanks for a timely article. I note the FT has an article today investigating Bespoke’s Ludicrous Index which covers corporations with over 500million in sales. Corporations join this index when their market cap exceeds 10× sales. The index is approaching dotcom levels. Thomas the price-earnings ratio which is a multiple is not the inverted tendential falling rate of profit. You can have a simultaneous rise in the P/E multiple and a rising rate of profit. Which is why I compare the the P/E ratio to the inverted rate of profit using the same profit stream. When the P/E multiple (the fictitious ratio) rises above the rate of profit multiple (the real ratio) markets enter into bubble territory. I find it the most accurate predictor because it is 3 dimensional whereas Q is only 2. As soon as Q4 profits are released I intend to up date these graphs but earlier ones can be found on my website theplanningmotive.com

  6. In 2020, German savings banks and banks requested around EUR 265 billion in additional loans from the Bundesbank. As a result, the total of these refinancing loans rose from 75 to 340 billion euros, as reported by the FAZ.
    However, only a small part of the additional quarter trillion went into the economy. The liquidity aid from the federal government that companies in Germany made use of during the corona crisis has so far only amounted to 80 billion euros.
    What do savings banks and banks need so much additional money for?
    The most likely answer is: “… that the German banks are looking ahead to supply themselves with liquidity for the remainder of this year because they fear high loan defaults …” (FAZ).
    In the first half of 2020, German bank loans to domestic companies amounted to a record amount of over 1,600 billion euros. The banks have now put around 16% of this loan amount on the high edge for an impending liquidity shortage.
    Wal Buchenberg, Hannover

  7. What’s the difference between the container ship owned by Maersk, and the corporate debt or loans, financing the construction and deployment of that container ship? Is one “real” because it’s a physical object, and the other “fictitious” because it’s a social relation? Of course not, in fact the container ship itself in order to be capital is part and parcel of that precise same social relation that necessitates the use of credit and debt.

    Is there “fictitious capital”? Sure there is: Bernie Madoff’s schemes were “fictitious capital,” but the profusion of corporate debt instruments, and equity “floats” are only fictitious capital to the extent that ALL capital is “fictitious,” i.e the assets behind the credit instruments cannot be reproduced profitably enough.

    I’ve been hearing about “fictitious capital” for 50 years, so far back that Lyndon LaRouche, one of the greater floggers of this notion was still considered a Marxist. And for 50 years, fictitious capital was supposed to mark the persistent decay of capital as a mode of production, the detachment or decoupling of “growth” from underlying profitability, and on and on it went, and still goes.

    Turns out of course that capital has sustained itself, weathered severe contractions, and continued to exhibit a cyclical, if decelerating, growth pattern despite the so called “death agony” now I guess “zombie corporations” of the system.

    Of course fictitious capital is just one way of explaining the persistence of capital while providing a rationale for predicting its imminent, not immanent, collapse. FC belongs in the same category of pseudo-explanations as the various iterations of Hubbert’s Peak Oil theory, the euro vs. the dollar theory, Japan then replacing the US as the linch-pin of capital (and China now), and the superior productivity of labor in the (pick one) Soviet Union, China, or any country of choice.

    Credit instruments originate in 1) the uneven reproduction times of capital 2) as revenue instruments, for apportioning the total available profit, or surplus value, among the “hostile brothers” of capitalism.

    We would all be better off to throw the various theories, explanations, and uses of fictitious capital into the scrap heap, where they belong, next to the retired jet liners, surplus locomotives, that capitalism self-devalues as an essential process of its persistence.

    At a certain point, for Marx, critical economics is supposed to “dissolve itself” into class struggle. And when it doesn’t do that? It, the critical economics, becomes a rationale, a description, the effort of 1000 hands to grasp a single straw.

    1. You have a problem. How do you explain the divergence between the market value of industrial assets and the price of the claims on them. If the price of the claims, primarily shares, bonds and mortgages coincided with the value of the underlying asset, then fictitious capital would be unknown. But precisely because there is a marked divergence either above or in a recession below the market value of assets or if you like the current cost it is necessary to distinguish the one from the other. In addition it is necessary to demarcated tier 1 from tier 2 fictitious capital with the former a direct claim on the stream of surplus value and the latter, leverage, which is a claim on the price movement of the direct claims found in tier 1, in short a bet on a bet.

      1. Real capital increases by sucking in living surplus labor.
        Fictitious capital only increases through buying and selling: the seller gains what the buyer loses.
        The fictitious character of this capital becomes visible when all owners try at the same time to turn their capital into money.

      2. “Real capital increases by sucking in living surplus labor.
        Fictitious capital only increases through buying and selling: the seller gains what the buyer loses.
        The fictitious character of this capital becomes visible when all owners try at the same time to turn their capital into money.”

        One, expropriating surplus labor, doesn’t occur without the other, buying and selling.

        All capitalists are always trying at the same time to turn their capital into money. The failure to realize that transformation is part of the conflict intrinsic to capital, to “real” capital, not fictitious capital.

        The failure to realize the value of the milk produced does not mean the milk is fictitious; nor does it make the loans to producers fictitious capital. The credit instruments are inseparable from the physical assets, just as use value is inseparable from exchange value in commodity production.

        The credit guarantees backing international trade are not fictitious, although they can be trade separately from the commodities, and the exchange of commodities, being guaranteed.

        Swindles, cons, etc. are fictitious capital, as there is no value underlying the exchange; that is not the case with credit and debt instruments, as was proven so painfully in the collapse of the asset values underpinning the credit markets in 2008, 2009.

  8. Price only accidentally ever coincides with value, so what’s the big deal? Price is the phenomenal expression of value, and the price of a container ship, its revaluation so to speak fluctuates depending on market conditions. So a container ship at $10 million represents “fictitious capital” but at $6 million it’s non-fiction?

    Most of what is referred to as fictitious capital isn’t capital at all– it’s not being put to use to exchange itself with the means of production, but is used to distribute the available profit– futures, options, swaps, etc.

    Exactly what is fictitious about IBM share price at $140 a share, but is non-fictitious at $40 a share?

    Better yet, what’s fictitious about an secondary offering where the receipts are used to fund expansion vs a secondary expansion that is used to retire debt?

    What is fictitious about corporate cash, cash type instruments, and short term financial instruments, used to park reserves on hand, when awaiting the right market conditions to finance an acquisition?

    The entire argument is specious. The fact that there is a massive deviation between price of physical assets and the amounts of credit secured by those assets is no more indicative of a fictitious nature of the system of capitalist appropriation than the price of oil at $140/barrel is “fictitious” compared to oil priced at $50 barrel; nor does it mean the mass of loans secured by oil revenues, based on an anticipated price represents fictitious capital.

    Is your objection that the stock valuation deviates from “book value”? That’s absurd. S&P 500 stock valuations are usually 3X as great as book values, ranging from 5X in 2000 to 1.8X in 2009. Was there less fictitious capital in 2009? Good luck explaining that one with the mounds of non-performing debt in 2009.

    1. Stock market capitalisation for the US is given as 160 percent, sometimes only 100 percent. The value of the capital stock is a multiple of GDP. So the value of all shares is not larger than the value of the capital stock. This does not indicate any overvaluation of fictitious capital with respect to the capital stock.

    2. You’re being venomous but I tend to agree with the thrust of your argument.

      One technical point: there is no agreed definition of capital in conventional economics. it’s just assumed to exist and, whatever it is, is represented in economic models as k.

      The argument that it’s a social relationship expressing property right claims over what it controls makes sense.

      What capital is as far as the S&P is concerned is something else.

      I was employed in a service firm with practically no tangible assets and it valued itself by projecting a cash flow to the future, discounting it by the stipulated discount rate and then adding in a terminal value. I tended to regard this as imaginary capital because the cash flow projection was imagined by me.

      Anyway, I prefer to distinguish between tangible balance sheet assets used in production (like a machine) and intangible assets including IP, copyright etc plus financial assets (which can’t be used directly in producing goods and services because they are electronically-stored digits).

      On average, more than 90 per cent of the assets of LSE listed companies are non-physical and therefore can’t be directly used in production. This proportion is rising.

      So maybe a better distinction is between tangible and intangible capital?

      1. After 50 years of being tormented by fictitious capital I can forgive anti-capital his venom, but the passing of time does not make him right. I am writing a quick post to clear this all up and will list the link as soon as it is posted on this blog. All I can say to anti-capital, if you were right, New York, London, Singapore and Shanghai would have remained provincial towns.

  9. Where I work that doesn’t even register as a mild irritant much less venom, but I guess there are other more genteel atmospheres, so my apologies. All I can answer to comrade ucanbepolitical is that if he is right, New York, London, Singapore and Shanghai would be fictitious cities.

  10. As a factor that everyone is forgetting, if there is a bubble burst as expected, the value of the currencies will also suffer enormous instabilities, as the production of companies without cash will also suffer a calamity.
    In order to have a more correct idea of the future, one has to take into account the nominal value of the bonds.

  11. This is a very good article. I think there might me a big stock market crash and economical recession in these coming 4 years. States just can not continue their monetary policy which only causes more speculation but no economic growth. Negative interest rates are unsustainable. This has to end some where. Poor countries will be the most affected from this because they are heavily debted to these foreign industrial giants. Their currencies will lose value during this crisis and render them completely unable to pay their debts. At least this is empirically what happened in Turkey meanwhile the 2020 recession.

  12. I wish more folks were aware of the disconnect between the market value (capitalization) and real book value of our favorite publicly traded companies. Tesla market cap is near $800B. Last I read, their Sept. 2020 report had their listed assets at $45B, $28B funded by liabilities (debt) leaving $17B in equity or Paid-In capital.

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