Canada: no change

Canada’s Liberal Party prime minister Justin Trudeau has managed to get re-elected for the third time in the snap general election he called.  The Liberals won or were leading in 158 seats out of a total of 338 seats, and the Conservatives trailed the Liberals, winning or leading in 122 seats, four more than their 2019 result.  But Trudeau will fall short of an outright majority in parliament and will need the support of the left-leaning New Democrats to get any legislation through (as before). 

Indeed, the result is more or less the same as in the last election two years ago.  Trudeau’s plan to get a majority based on the ‘success’ of the government’s handling of the COVID crisis backfired.  Many voters considered the election as a cynical move and a waste of time.  Indeed, it was the Conservatives who got the biggest vote (as in 2019) attracting 34 per cent support to the Liberals’ 32 per cent, but Liberal support is centred around urban and suburban areas where there are more seats.  And Canada has a first past the post system as in the UK.

Voter turnout has been slipping in the 21st century from a peak of 75%; in this election it was around 65% – much higher than the US, about the same as the UK but below other G7 economies Germany and Japan. A 65% turnout means that the ‘no vote’ party was the largest – and Trudeau’s Liberals attracted just one in five potential voters.

Canada: voter turnout (%)

As the smallest G7 nation in GDP and population, Canada has seen far fewer COVID cases and deaths than many other nations, and Trudeau recently reopened the border, but only to the vaccinated.  In the election Trudeau pointed out the dire situation in Alberta, run by a Conservative provincial government, which refused to adopt social distancing restrictions and now has a wave of cases and hospitalisations.  Interestingly, the anti-vacc extreme right-wing People’s Party failed to make a mark, polling only 5%.

Trudeau may be back in office, but like the other G7 economies, things are not rosy economically.  Canada’s 2021 economic outlook is similar to that of other developed countries. After the largest economic contraction since 1945 (a dip of 5.5% of GDP in 2020), Canada is still in recession, according to the latest figures, although forecasters (Oxford Economics) are still expecting a sharp recovery.

Even if the above forecast turns out to be correct (and that is uncertain), the long-term economic trends for the Canadian economy are not great.  A recent Macdonald-Laurier Institute report, wrote that Canadian “real GDP growth over the past decade has been as lethargic as the decade after the onset of the Great Depression in 1929” (Cross 2020). Thus, Canadian capitalism had already been experiencing problems for over a decade when the COVID-19 lockdown started. 

For an account of Canadian capitalism up to the 1990s, I recommend the work of Marxist economist, Murray Smith . For the recent period, Geoff McCormack of the Centre for Canadian Studies at Guangdong University for Foreign Studies has produced an excellent analysis of Canadian capitalism, which I draw upon here.  McCormack finds that in the 13-year period following the ‘Great Canadian Slump’ of 1990-92, the profit rate on Canadian capital rose from 13% to 28%. But after peaking in 2005, it began to fall, reaching 17% in 2019.

The downward trajectory of the profit rate during this 14-year period was accompanied by a stagnating mass of profit. Between the years 1993 and 2005, the mass of profit grew by 142%. After 2005 and until 2019, however, it stagnated, having grown by merely 1.5% over the entire period.

Canada did escape much of the impact from the global financial crisis of 2008-9 because of the long period of relatively strong profitability and capital accumulation preceding the crisis.  But by 2006, according to McCormack. profitability had begun to erode.  “Afterwards, “sneaking” stagnation became increasingly evident in rates of capital accumulation, capacity utilization, employment, as well as real wage and GDP growth.”

In the eight years following 2010, business investment in plant and machinery grew by an average of only 0.1%. Recovery after the Great Recession was driven a credit-fuelled boom in housing.  People got jobs but at low rates of pay, just as in other G7 economies.  In the years following the Great Recession, real wage growth slowed substantially, averaging just 0.4% per year.  As McCormack says, “given poor profitability, lacklustre capital accumulation, truncated capacity utilization, low employment and low real wage growth, it is unsurprising that real GDP growth, too, was weak.”

Canada increasingly relies on its production of oil and gas and other mineral resources. And so there is no drive to phase out fossil fuel production to save the planet. Trudeau put it in a speech to cheering Texas oilmen a couple of years ago: “No country would find 173 billion barrels of oil in the ground and leave them there.” So Canada, which is 0.5% of the planet’s population, plans to use up nearly a third of the planet’s remaining carbon budget. There’s oil in the ground and it must come out.

And even the growth in incomes in the last decade was not shared equally.  As in other OECD economies, the share of income going to the top 1% of ‘earners’ rocketed while the share going to the bottom 50% fell. Indeed, the top 1% has nearly as much income as the bottom 50%!

Canada: top 1% share (blue); bottom 50% (red) – World Inequality Database.

And wealth inequality in Canada is on a par with other G7 economies.

Source: World Bank

So the decade since 2009 has been characterized by sneaking stagnation, rooted in profitability problems that began after 2005. This has manifested itself in the stagnant accumulation of machinery and equipment, low industrial capacity utilization rates, low employment levels, as well as low real wage and GDP growth.  It is an expression of what I have called the Long Depression that all the major capitalist economies have sunk into since 2009 in the ten years leading up to the COVID slump.

And just as in other major G7 economies, corporate and household debt has jumped to record highs.  Despite very low interest rates, Canada’s corporate sector is weighed down by debt service costs. In 2020, 55% of corporate income went to paying interest and principal payments on loans, whereas it amounted to 43% in the US. The debt service ratio increased from 38% in 2006 to 57% in 2019 as economic stagnation wore on business balance sheets.

The Bank of Canada economists have classified 25% of Canada’s publicly traded companies as zombie firms ie. they persistently do not earn enough revenue to cover interest payments on their outstanding debts.

So Canadian capitalism bears all the hallmarks of the contradictions facing the rest of the G7 economies as they come out of the COVID slump.  PM Trudeau achieved nothing with his snap election and faces the same problems in getting Canada’s capitalist economy going as before.

Not so Evergrande

China’s Evergrande Group is the second largest property developer in China and it is teetering on the brink of bankruptcy.  Evergrande has hired ‘restructuring advisers’ and warned that its liquidity is under “tremendous pressure” from collapsing sales, facing protests by home buyers and retail investors.  Based in Shenzhen in southern China, Evergrande is saddled with almost Rmb2tn of total liabilities or over $300bn.

The share price of the parent, 3333 HK, is down 76% from where it started the year. In August, Xu Jiayin, Evergrande’s founder and one of China’s wealthiest men, stepped down as chairman of the property group. Trading in the company’s bonds has been suspended in Shanghai. Police descended on Evergrande’s office building in Shenzhen when individual investors in the company’s myriad “wealth-management” products gathered to demand repayment.

Evergrande’s demise is a reflection of the dangers of uncontrolled property speculation in the capitalist sector of China’s economy.  Evergrande relies heavily on customers paying for flats before the projects are completed. The Evergrande property model is essentially a Ponzi scheme, where the company collects cash from the pre-sale of an ever-growing number of apartments, plus hundreds of thousands of individual investors and uses the cash to fund further sales by accelerating construction in progress and funding down-payments. Like any Ponzi, this works as long as it’s accelerating. But when the market slows, those incoming streams of cash start to fall behind the growing arc of cash demands. Evergrande now has about 800 unfinished projects and there are about 1.2 million people waiting to move in.

Take one huge Evergrande project.  Prices for Evergrande’s Venice properties (situated on the coast 90km from Shanghai) have tripled since sales began in 2012 and 80% of the apartments have been sold in total, though about one-third are unoccupied. But this year sales have slowed. Data from the Qidong municipal housing bureau shows around 60% of the apartments that went on sale have been sold, despite a 15% price discount. Evergrande has now discounted all its apartments by as much as 30% and it has also sought to raise cash through spinning off its stakes in other companies.

What Evergrande reveals is the end game of the huge urbanisation drive that started off to house China’s people.  In a transformation of China’s cities, the urbanisation rate surpassed 60% last year compared with 50% in 2011.  But because this urbanisation was eventually conducted by the private sector for profit and based on owner-occupation (90% of Chinese own their homes mostly without mortgages), residential property construction has become a financial asset investment, just as it was and is in the major G7 economies.  This ‘financialisation’ began in the late 1990s, when the government pursued a policy of making state-owned companies offload their residential assets to their employees – a Thatcher-type selling to council tenants.  The idea was that the private sector would look after housing, not the state, from then on.

So instead of housing “being for living in” (Xi), it has become a sector “for speculation” (Xi).  Apartments in China have become the investment vehicle of choice for people.  Few buyers purchase an Evergrande apartment as their primary residence. And Evergrande has explicitly catered to the better-off Chinese, choosing locations that fall just outside of areas that restrict the number of units a person may buy and advertising the developments as second homes. All over China, even sales clerks and factory workers are sitting on empty Evergrande apartments and dreaming of selling them at a big mark-up to fund their children’s study abroad or their own retirement.

Property prices in coastal cities, where the best work and pay is, have doubled in the last ten years. In Shenzhen, the average apartment price has risen so much that some are finding it cheaper to live in Hong Kong, one of the most expensive property markets in the world. Since 2015, residential property prices have appreciated by more than 50% in China’s largest cities. Over the past decade, average residential land supply per new resident in the top ten cities is only 230 square feet—little more than the size of a typical hotel room—or less than 60% of the average per capita residential space in China.

Speculation has been rife as local governments try to raise funds by selling land to developers which then build estates through borrowing at low rates often from the unregulated shadow non-bank sector. “Property is the single most important source of financial risk and wealth inequality in China,” said Larry Hu, head of China economics at the foreign-owned Macquarie Securities Ltd. And he is right.

Much of the property speculation has been to build ever more commercial developments rather than housing. That’s because the main prerogative for local governments is to accrue revenue. If they can attract more businesses into their jurisdictions and if those businesses become profitable, then the local government can collect more corporate taxes. At the same time, residential land supply is deliberately kept scarce so governments can make money on residential land sales. In effect, residential land sales serve as a cross-subsidy on local governments’ pro-business land policy that sells commercial land cheaply.

The real estate sector now accounts for 13% of the economy from just 5% in 1995 and for about 28% of the nation’s total lending. Given that local governments have $10 trillion in debt, land sales are the most crucial and reliable source of income for debt repayment. So any drastic changes would seriously raise the risk of local government defaults.

The private property sector’s approach has relied on taking on large quantities of debt to accumulate more and more land — sometimes in speculative areas outside of major cities. In Evergrande’s case, it has enough land to house the entire population of Portugal and more debt than New Zealand.  In 2010, it had just Rmb31bn ($4.7bn) in debt and had $190bn of properties under development as of the end of 2020.

The group’s mounting credit woes have coincided with the change in government policy towards the “disorderly expansion of capital”; against big technology groups, the real estate industry and other sectors. The country’s housing ministry announced a three-year inspection campaign to tighten regulation of the property sector. Last year, the government implemented a strict policy aimed at reducing developers’ leverage, which China’s banking regulator has labelled the country’s biggest financial risk. The banks have been told to jack up mortgage rates. Local governments are being directed to accelerate the development of government subsidized rental housing and have been told to increase scrutiny on everything from financing of developers and newly-listed home prices to title transfers.

And in a classic case of ‘financialisation’, Evergrande financed its activities by issuing what are called ‘wealth management products’, in effect mortgage-backed bonds for foreign and Chinese retail investors to buy, paying high interest rates (7-9%).  Now the company is declaring its inability to meet these obligations. This uncontrolled expansion of debt by Evergrande and other property companies was ignored by China’s regulatory authorities, just as it was in the US leading up to the property and financial bust in the global financial crash in 2008.

What is going to happen, if and when Evergrande goes bust?  Will other property companies crash too?; are we heading for a huge financial crash in China and possibly globally, sparked by the end of China’s property boom?  Well, there are four other major Chinese property developers on the brink. The prices of the dollar bonds issued by these companies have collapsed on fears by international investors that those bonds cannot be refinanced when they mature, which would mean a default. So foreign investors in these bonds are taking a big ht.  And the ability of these property developers to issue new debt to raise new money to refinance has disappeared.

But in my view, there is not going to be a financial crash in China.  The government controls nearly everything, including the central bank, the big four state-owned commercial banks which are the largest banks in the world, the so-called ‘bad banks’, which absorb bad loans, big asset managers, most of the largest companies. The government can order the big four banks to exchange defaulted loans for equity stakes and forget them. It can tell the central bank, the People’s Bank of China, to do whatever it takes. It can tell state-owned asset managers and pension funds to buy shares and bonds to prop up prices and to fund companies. It can tell the state bad banks to buy bad debt from commercial banks.  So a financial crisis is ruled out because the state controls the banking system.

But if not a crash, what about the property bust and the high levels of debt incurred?  Won’t they reduce China’s ability to grow at the pace previously achieved and targeted for the next five years?  Western economists are clear on this: the debt is so large and China’s productive sectors are now so weak that even if China avoids a financial crash, the hit to household incomes and the profits of the capitalist sector are large enough to reduce investment and GDP growth.  China is heading for stagnation, if not a slump.

It’s true that China has built up a debt mountain in recent years, of which property debt is a significant part.  Total debt hit 317% of GDP in 2020. But most of this debt is in domestic currency and is owed by one state entity to another; from local government to state banks, from state banks to central government. When that is all netted off, the debt owed by households (54% of GDP) and corporations is not so high, while central government debt is low by global standards. Moreover, external dollar debt to GDP is very low (15%) and indeed the rest of the world owes China way more: 6% of global debt. China is a huge creditor to the world and has massive dollar and euro reserves, 50% larger than its dollar debt.

Chinese leaders want to curb the debt level. But as I have explained before, controlling the debt level can come in two ways; either through high growth from productive sector investment to keep the debt ratio under control; and/or by reducing credit binges in unproductive areas like speculative property.  The latter would mean a reduction in the profitability of the capitalist sector in China and this would lower the potential for productive investment by that sector.  So the loss of profits and household income from property busts would add to downward pressure on growth of output and incomes.

But that forecast is based on the view that the Chinese government should continue to rely ever more on its capitalist sector to deliver.  And yet China’s capitalist sector is in trouble in many ways just like in the G7 economies.  Profitability in the capitalist sector has been falling and is now at all-time lows; and much of its activities are increasingly in ‘unproductive’ sectors like consumer finance, property or social media. 

Again, as I have argued before, the basic contradiction of China’s economy is not between investment and consumption, or between growth and debt; it is between profitability and productivity. The growing size and influence of the capitalist sector in China is weakening the performance of the economy and widening inequalities.  In my view, the Chinese economy is now strong enough not to rely on foreign investment or on unproductive capitalist sectors for growth.  Increasing the role of planning and state-led investment, the main basis of China’s economic success over the 70 years of the People’s Republic, has never been more compelling.

China and common prosperity

Back in May the Chinese government set up a special zone to implement ‘common prosperity’ in Zhejiang province, which also happens to be the location of the headquarters of several prominent internet corporations– Alibaba among them.  And last month, China’s President Xi Jinping announced plans to spread “common prosperity”, heralding a tough crackdown on wealthy elites – including China’s burgeoning group of technology billionaires.  At its August meeting, the Central Finance and Economics Committee, chaired by Xi, confirmed that “Common Prosperity” was “an essential requirement of socialism” and should go together with high quality growth. 

Over the past fortnight, the tax administration pledged to crack down on tax dodgers and fined Zheng Shuang, one of the country’s most popular actresses, $46m for tax evasion. The Supreme Court declared the 72-hour work weeks common at many private-sector companies to be illegal. And the housing ministry said on Tuesday that it would cap annual residential rent increases at five per cent.  And a new layer of officials has been arrested for corruption.

Also, the government is moving to restrict domestic companies from listing on US stock exchanges, in a move threatening to restrict the growth of tech firms that had come to symbolise record Chinese economic growth rates and the emergence of rich company bosses.  The years of unbridled speculation by billionaire privately owned companies in league with various local and national officials to do what they want, including usurping state control of the retail banking system, are over.  

Billionaires in general, and the mega-wealthy beneficiaries of the tech industry in particular, are now scrambling to appease the party with charitable donations and messages of support.  Nasdaq-listed e-commerce website Pinduoduo saiid earlier this year it would donate its second-quarter profit and all future earnings to help with China’s agricultural development until the donations reached at least 10bn yuan ($1.5bn). The move prompted its shares to jump by 22%. Hong Kong-listed Tencent, reading the same signals from Beijing, set aside 50bn yuan for welfare programmes supporting low-income communities, bringing this year’s total philanthropic pledge to $15bn.

The announcement of the ‘common prosperity’ plans was preceded by the arrest of Hangzhou’s (Capital of Zhejiang) top official Communist Party Secretary Zhou Jiangyong by anti-corruption officials. It is rumoured his relatives had been making themselves rich with investments in local internet stocks. 

The crackdown on the tech giants and the attempts of the billionaires to gain control of China’s consumer retailing and banking sectors has quickly smashed the hopes of foreign investors too.  The Chinese tech sector explosive stock prices have been reversed.

The professed aim of Common Prosperity is to “regulate excessively high incomes” in order to ensure “common prosperity for all”.  And it is well known that China has a very high level of inequality of income.  Its gini index of income inequality is high by world standards although it has fallen back in recent years. 

China: gini inequality of income index (the higher the index, the greater inequality)

Source: World Bank

The gini inequality measure is used to measure overall inequality in incomes and wealth.  In wealth, gini values are much higher than the corresponding values for income inequality or any other standard welfare indicator.  China’s inequality of wealth is lower than in Brazil, Russia or India, but still higher than Japan or Italy.

Credit Suisse Wealth Report 2021

In my view, there are two reasons why Xi and his majority in the CP leadership have launched the ‘common prosperity’ project now.  The first is the experience of the COVID pandemic. As in the major capitalist economies, the pandemic has exposed huge inequalities to the general public in China, not just in income but also in rising wealth for the billionaires, who have reaped huge profits during COVID while the majority of Chinese, especially middle-income groups have suffered lockdowns, loss of income and rising living costs.  The share of personal wealth for China’s billionaires has doubled from 7% in 2019 to 15% of GDP now.

If this were allowed to continue, it would begin to open up schisms in the CP and the party’s support among the population.  Xi wants to avoid another Tiananmen Square protest in 1989 after a huge rise in inequality and inflation under Deng’s ‘social market’ reforms.  As Xi put it in a long speech in July to party members: “Realizing common prosperity is more than an economic goal. It is a major political issue that bears on our Party’s governance foundation. We cannot allow the gap between the rich and the poor to continue growing—for the poor to keep getting poorer while the rich continue growing richer. We cannot permit the wealth gap to become an unbridgeable gulf. Of course, common prosperity should be realized in a gradual way that gives full consideration to what is necessary and what is possible and adheres to the laws governing social and economic development. At the same time, however, we cannot afford to just sit around and wait. We must be proactive about narrowing the gaps between regions, between urban and rural areas, and between rich and poor people. We should promote all-around social progress and well-rounded personal development, and advocate social fairness and justice, so that our people enjoy the fruits of development in a fairer way. We should see that people have a stronger sense of fulfilment, happiness, and security and make them feel that common prosperity is not an empty slogan but a concrete fact that they can see and feel for themselves.” My emphases.

As Xi perceptively admitted in this speech about the demise of the Soviet Union: “The Soviet Union was the world’s first socialist country and once enjoyed spectacular success. Ultimately however, it collapsed, mainly because the Communist Party of the Soviet Union became detached from the people and turned into a group of privileged bureaucrats concerned only with protecting their own interests (my emphasis). Even in a modernized country, if a governing party turns its back on the people, it will imperil the fruits of modernization.”

The other reason for Xi’s policy move is that, despite the quick recovery in the Chinese economy from the global pandemic slump, COVID has not been eradicated in China or elsewhere and this has led to a slowing in growth.  In August, factory output went into reverse, slumping to an 18-month low, while the main survey of the services sector showed that sector took an even greater hit and contracted for the first time since last March.

Markit business activity indicator (composite) for China – now below 50 (contraction)

Rana Mitter, a historian and director of the University of Oxford China Centre, commented “Party officials fear that the tech giants and the people who run them are out of control and need to be reined in. And then we must add Xi’s determination to be nominated next year for a third term that changes to the constitution now allow.”  China’s capitalists imagined that they could act in the same way as those in the G7 economies by investing in property, fintech and consumer media and run up huge debts to do so.  But COVID forced the government to try and curb the rise corporate and real estate debt.  This has led to bankruptcy of several ‘shadow banking’ concerns and real estate companies. The giant property company Evergrande is struggling to repay $300bn debts and is now expected to go bust, unless the state bails it out. Evergrande claims to employ 200,000 people and indirectly generate 3.8 million jobs in China.

The government had to act to curb the unbridled expansion of unproductive and speculative investment.  The latest Financial Stability Report from the People’s Bank of China (central bank) states that between 2017-2019, “the overall macro leverage ratio has stabilized at around 250%, which has won room to increase countercyclical adjustments in response to the epidemic.” In other words, the government could afford the fund the support necessary to get through the COVID slump.  But the PBoC admitted that “under the impact of the epidemic in 2020, the nominal GDP growth rate will slow down, the macro hedging will be increased, and the macro leverage ratio will gradually rise. It is expected that it will gradually return to a basically stable track.”  So debt is set to rise as China goes into 2022.

The PBoC report claims that it has got all the shadow banking and other risky financial operations under control: “the financial order has been comprehensively cleaned up and rectified.  P2P online lending institutions in operation have all ceased operations, illegal fund-raising, cross-border gambling, and underground banks and other illegal financial activities have been effectively curbed, private equity funds, financial asset trading venues and other risk resolution have made positive progress, and the supervision of large financial technology companies has been strengthened.

But the report is also revealed that there is a section of CP leaders who do actually want to press on with opening up China’s state-controlled financial system to capital (including foreign capital) – and these views are strong within the Western educated bankers in the PBoC.  The PBoC report says that it wants to “continue to deepen reform and opening up, further promote the market-oriented reform of interest rates and exchange rates, steadily advance the reform of the capital market, and promote the high-quality development of the bond market.  On the premise of effectively preventing risks, continue to expand high-level financial opening.” Apparently, the PBoC officials reckon even more relaxation of the financial regulations will reduce risk! 

On the other hand, Xi and his supporters want to control the ‘wild east’ antics of the finance sectors in Shangahi and Shenhzen.  Xi is now proposing setting up a new stock exchange in Beijing to lure domestic companies into listing at home instead of overseas.  This is part of the strategy to reduce reliance on foreign investment.

According to China ‘experts’ in the West, this crackdown on finance, property and private tech is suicidal to China’s growth.  These experts reckon that China cannot sustain its previous growth miracle based on state ownership, planning and investment and instead must let the markets dominate economic policy and investment.  The World Bank has been a leader in promoting this strategy for China for decades.  The then-World Bank President Robert Zoellick told a press conference in Beijing. “As China’s leaders know, the country’s current growth model is unsustainable.” The so-called middle-income trap describes how economies tend to stall and stagnate at a certain level of development, once wages have risen and productivity growth becomes harder.  In early 2012, the World Bank and the Development Research Center, a think tank under China’s State Council, released a 473-page report that spelled out the reforms the country would need to undertake to avoid the “middle-income trap” and ascend to the ranks of high-income nations: ie let market forces rip.  

Investment banker, George Magnus, a supposed China expert, has long argued the old chestnut that “at higher income levels, economies become too complex for command-and-control management by individuals. Systems are increasingly what matters. Rules that are transparent, predictable and fairly applied enable market forces to take over the job of directing economic activity, raising efficiency and allowing innovation to flourish.”  Magnus, who devoted a chapter to the middle-income trap in his 2018 book Red Flags: Why Xi’s China is in Jeopardy, argues that in pursuing these policies and strategies, “China’s government will stifle incentives and innovation, and make it even more difficult to generate the productivity growth that all high-middle-income countries need to avoid the middle income trap.”

I have dealt with all these arguments in previous posts, so I won’t go into detail again.  But the reality is that China is already on the cusp of gaining high-income status, as defined by the World Bank.  Based on the World Bank’s current threshold and International Monetary Fund forecasts, the country should achieve that goal before 2025.  Indeed, as Arthur Kroeber, head of research at Gavekal Dragonomics in China, has put it“Is China fading? In a word, no. China’s economy is in good shape, and policymakers are exploiting this strength to tackle structural issues such as financial leverage, internet regulation and their desire to make technology the main driver of investment.” Kroeber echoes my view that: “On a two-year average basis, China is growing at about 5 per cent, while the US is well under 1 per cent. By the end of 2021 the US should be back around its pre-pandemic trend of 2.5 per cent annual growth. Over the next several years, China will probably keep growing at nearly twice the US rate.”

According to a recent report by Goldman Sachs, China’s digital economy is already large, accounting for almost 40% of GDP and fast growing, contributing more than 60% of GDP growth in recent years. “And there is ample room for China to further digitalize its traditional sectors”.  China’s IT share of GDP climbed from 2.1% in 2011Q1 to 3.8% in 2021Q1. Although China still lags the US, Europe, Japan and South Korea in its IT share of GDP, the gap has been narrowing over time. No wonder, the US and other capitalist powers are intensifying their efforts to contain China’s technological expansion.

In a report, the New York Fed admits that if China keeps up this pace of expansion, it “is well on track to high-income status… After all, per capita income growth has averaged 6.2 percent over the last five years, implying a doubling roughly every eleven years, and per capita income is already close to 30 percent of the U.S. level.”  But the NY Fed argues it won’t be able to as the working population is declining and there will be an insufficient rise in the productivity of labour to compensate.  I challenged that forecast in a previous post.

The reason that the NY Fed as well as many Keynesian and other critics of the Chinese ‘miracle’ are so sceptical is that they are seeped in a different economic model for growth.  They are convinced that China can only be ‘successful’ (like the economies of the G7!) if its economy depends on profitable investment by privately-owned companies in a ‘free market’.  And yet the evidence of the last 40 and even 70 years is that a state-led, planning economic model that is China’s has been way more successful than its ‘market economy’ peers such as India, Brazil or Russia.

As Xi said in his speech: “China is now the world’s second largest economy, the largest industrial nation, the largest trader of goods, and the largest holder of foreign exchange reserves. China’s GDP has exceeded RMB100 trillion yuan and stands at over US$10,000 in per capita terms. Permanent urban residents account for over 60% of the population, and the middle-income group has grown to over 400 million. Particularly noteworthy are our historic achievements of building a moderately prosperous society in all respects and eliminating absolute poverty—a problem which has plagued our nation for thousands of years.”

In contrast, the lessons of the global financial crash and the Great Recession of 2009, the ensuing long depression to 2019 and the economic impact of the pandemic slump are that introducing more capitalist production for profit will not sustain economic growth and certainly not deliver ‘common prosperity’. 

Indeed, it is the capitalist sector in China that is in trouble and threatens China’s future prosperity.  China’s capitalist sector is suffering (as it is in the major capitalist economies).  Profitability has fallen, reducing the ability or willingness of China’s capitalists to invest productively.  That is why speculation in unproductive investment has become ‘uncontrolled’ in China too.  Far from the need to reduce the role of the state, China’s future growth through a rise in productivity of labour as the total workforce shrinks in size will depend on state-led investment in technology, skilled labour and ‘common prosperity’.

Source: Penn World Tables 10.1 IRR series

Xi’s crackdown on the billionaires and his call for reduced inequality is yet another zig in the zig-zag policy direction of the Chinese bureaucratic elite: from the early years of rigid state planning to Deng’s ‘market’ reforms in the 1980s; to the privatisation of some state companies in 1990s; to the return to firmer state control of the ‘commanding heights’ of the economy after the global slump in 2009; then the loosening of speculative credit after that; and now a new crackdown on the capitalist sector to achieve ‘common prosperity”.

These zig zags are wasteful and inefficient. They happen because China’s leadership is not accountable to its working people; there are no organs of worker democracy.   There is no democratic planning. Only the 100 million CP members have a say in China’s economic future, and that is really only among the top.  The other reason for the zig zags is that China is surrounded by imperialism and its allies both economically and militarily.  Capitalism remains the dominant mode of production outside China, if not inside.  ‘Common prosperity’ cannot be achieved properly while the forces of capital remain inside and outside China.

Booms and bezzles

Major stock markets are hovering near all-time highs and commodity prices (food and materials) are rocketing.  At the other end of the scale, short-term interest rates are near or below zero, and even long-term government and corporate bonds are at record prices (record low yields). 

All this is driven by huge injections of money created by central banks to buy bonds and allow corporations and investment institutions to borrow at very low ‘margin’ rates to speculate in stocks, bonds, property and crypto-currencies; and also enable so-called ‘private equity’ firms and hedge funds to raise funds to buy up companies to ‘asset-strip’ and then sell on – merger and acquisition deals are at record levels.  A staggering $1.2 trillion in mergers and acquisitions transactions announced and pending or completed so far in 2021 have involved a private equity party.

This speculative fever inevitably breeds swindles, tricks and frauds. 

Liberal left economist JK Galbraith back in the 1950s, when referring to the ‘roaring twenties’ , called the results of speculation, ‘bezzle’.  Coming from the word ‘embezzlement’ Galbraith defined ‘bezzle’; as “a temporary gap between the perceived value of a portfolio of assets and its long-term economic value. “

Michael Pettis, the China-based Keynesian economist and co-author of the prize-winning book, Trade Wars and Class wars, latched onto Galbraith’s term to describe the current COVID pandemic financial boom.  Pettis links Galbraith’s definition of bezzle in these speculative financial booms to the work of Hyman Minsky, the semi-socialist post-Keynesian economist of the 1980s, who argued that financial markets can create (temporary) impressions of false wealth very similar to those of Ponzi schemes (where one investor is paid back with the money from a new investor). 

Minsky explained, “over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.” Pettis adds: “because the bezzle is, by definition, temporary (though it may last for a few years or even a decade or two), at some point the bezzle will be eliminated, and its elimination will reverse the earlier boost to the economy. When that happens, what appeared to be a virtuous cycle becomes a vicious cycle.”  But what is odd about Pettis’ account of ‘bezzle’ is that nowhere does he mention the work of Marx on credit and financial crashes – indeed everything Minsky and Galbraith have offered was developed by Marx before them.

On the question of speculation and criminality, Marx wrote in Capital, “The two characteristics immanent in the credit system are, on the one hand, to develop the incentive of capitalist production, from enrichment through exploitation of the labour of others, to the purest and most colossal form of gambling and swindling.”  On the question of the speculative boom turning into financial crash, again, Marx was ahead. “In every stock-jobbing swindle everyone knows that some time or other the crash must come, but everyone hopes that it may fall on the head of his neighbour, after he himself has caught the shower of gold (ie money – MR) and placed it in safety.”

Galbraith says that the speculator comes to believe that the money made from buying and selling stocks, bonds and derivatives is real and requires no reference to the creation of value by productive labour.  Again, Marx had already shown this: “All standards of measurement, all excuses more or less still justified under capitalist production, disappear.” Marx, however, provides a much clearer analysis than ‘bezzle’ by referring to what he called ‘fictitious capital’. 

Fictitious capitals are “titles of ownership…. to real capital.  They ..merely convey legal claims to a portion of the surplus-value to be produced by it. They “become paper duplicates of the real capital”.  The “gain and loss through fluctuations in the price of these titles of ownership, … become, by their very nature, more and more a matter of gamble, which appears to take the place of labour as the original method of acquiring capital wealth and also replaces naked force. This type of imaginary money wealth constitutes a very considerable part of the money wealth of private people.” Marx summed up the rise of the financial sector and its role in modern capitalism over 150 years ago as “a new financial aristocracy, a new variety of parasites in the shape of promoters, speculators and simply nominal directors; a whole system of swindling and cheating by means of corporation promotion, stock issuance, and stock speculation.”  Bezzle, if you like.

As Pettis puts it: “the bezzle represents recorded or perceived wealth that does not exist as real wealth (productive capacity), and as such it boosts collective recorded wealth above real economic wealth.”  Just insert fictitious capital for bezzle here.  Pettis argues that the credit (debt) created to speculate will eventually lead to higher levels of investment than can be economically justified and encourages more spending than households and businesses can really afford. In this way, a period of rapid growth can become a speculative boom.”  At a certain point, “the opposite happens: instead of artificially boosting growth when it is already high; amortization depresses growth through forced debt repayment and negative wealth effects just as it is already slowing.”  So credit can lead to over-investment not only in financial assets but also in productive sectors and the consequent slump can increase the loss in the value of productive capital. 

But what turns a bezzle boom into a debt disaster?  Pettis hints that it depends on the returns from productive investment.  Pettis then cites John Mills (sic) who wrote more than 150 years ago that “panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.” These are perceptive points about financial speculation and its eventual demise: from leverage of debt to deleveraging; from boom to crash, brought down by investment in ‘unproductive sectors’.  As Marx put it: “since property here exists in the form of stock, its movement and transfer become purely a result of gambling on the stock exchange, where the little fish are swallowed by the sharks and the lambs by the stock-exchange wolves.”

But what causes money to be increasingly invested ‘unproductively’?  Galbraith, Minsky, Mills and Pettis have no answer to this question.  As Galbraith admits: “Economies at times systematically create bezzle, unleashing substantial economic consequences that economists have rarely understood or discussed.”  It just happens – or as Minsky puts it: stability turns into instability. 

In contrast, Marx offers an answer based of the law of the tendency of the rate of profit to fall.  Falling average profitability leads eventually to a slowing in the growth of total profits from value-producing capital, which even a switch into speculative sectors cannot reverse indefinitely.  Eventually overall profits can fall absolutely.  Marx called this point an ‘absolute over-accumulation of capital’.  A slump in investment, production and financial asset prices then ensues. Credit is necessary in a capitalist economy to extend economic growth and productive investment, but it cannot sustain that expansion because that is dependent on the creation of real value, not fiction.  If new value does not grow to match more credit, credit will turn into unpayable debt.

Financial crashes occur in sectors or even across the board, but they are not always accompanied by a collapse in investment and production ie a slump.  But a slump in production always engenders a financial crash as credit drains away and debt defaults emerge.  This suggests that what is going on in the ‘real economy’ is what decides a financial crash, not vice versa. Indeed, that’s the evidence from the post-war slumps in the US, as G Carchedi has shown (see graph below): when profits in productive sectors fall, so do financial (fictitious) profits.

Capitalism is littered with bezzles in booms, but when the boom ends, those bezzles stop.

The rate and the mass of profit

Professor David Harvey is probably the best-known scholar of Marxist economics in the world.  Over the years, Professor Harvey and I have engaged in debate and discussion on Marx’s law of value and Marx’s law of the tendency of the rate of profit to fall.  Professor Harvey has always been sceptical of the relevance of Marx’s law of profitability in explaining regular and recurring crises of production and investment under capitalism.  He prefers alternative explanations.  In the past, I have debated with Professor Harvey on this in defence of the relevance, indeed the ultimate causal connection between crises in capitalism and Marx’s law.  You can read the substance of these debates here and also in the excellent book: The Great Financial Meltdown, systemic, conjunctural or policy created, edited by Turan Subasat.  See in particular, Part Two on Crisis and Profitability.

Now Professor Harvey kindly sent me in advance an article that has been published in the New Left ReviewThe article is entitled ‘Rate and Mass’. In this article Professor Harvey spells out again in detail his argument for considering the mass of profit over the rate of profit in the analysis of crises.  At one point, he says: “mainstream commentators are not alone in missing the import of mass. There is a long history of Marxist economists doing so, too—not least in work on the tendency for the rate of profit to fall.”  And later he comments that “Michael Roberts’ studies of the consequences of a falling rate of profit, (are) absent any concern for the importance of the rising mass”, referencing my book The Long Depression.

Well, in my book, go to p26 and you will find me saying: “The underlying contradiction between the accumulation of capital and the rate of profit (and then a falling mass of profit) is resolved by crisis.” And again, on p27 I say “on each occasion,… a fall in the mass of profit led or coincided with a slump”. Indeed, for several pages in that section of the book, I outline the role of the mass of profit in booms and slumps and quote other sources.

What is at debate here?  Marx spells it out in Volume One of Capital: “despite the enormous decline in the general rate of profit…the number of workers employed by capital i.e. the absolute mass of labour set in motion by it, hence the absolute mass of the surplus labour absorbed, appropriated by it, hence the mass of surplus value it produces, hence the absolute magnitude or mass of the profit produced by it, can therefore grow, and progressively so, despite the progressive fall in the rate of profit.”  He then adds: “this not only can, but must be the case…. The same laws “produce both a growing absolute mass of profit, which the social capital appropriates, and a falling rate of profit.” And then Marx asks:  How, then should we present this double-edged law of a decline in the rate of profit coupled with a simultaneous increase in the absolute mass of profit arising from the same causes?”

As Marx explains, his law of profitability has a double-edge.  As the rate of profit falls in a capitalist economy, it is perfectly possible, indeed likely, that the mass of profit will rise.  It’s arithmetical really: a falling rate can still imply a rising mass.  But a double-edge cuts both ways.  As Marx goes on to explain in Volume 3 of Capital (chapter 13).  The two movements not only go hand in hand, but mutually influence one another and are phenomena in which the same law expresses itself….. there would be absolute over-production of capital as soon as additional capital for purposes of capitalist production = 0.   at a point, therefore, when the increased capital produced just as much, or even less, surplus-value than it did before its increase, there would be absolute over-production of capital; i.e., the increased capital C + ΔC would produce no more, or even less, profit than capital C before its expansion by ΔC.”  So the mass of profit can and will rise as the rate of profit falls, keeping capitalist investment and production going.  But as the rate of profit falls, the increase in the mass of profit will eventually fall to the point of ‘absolute over-accumulation’, the tipping point for crises.

Nevertheless, Professor Harvey wants to argue that Marx saw the mass of profit as more important in any analyses of crises than the rate.  I think the above quote shows that they are integrally connected, in Marx’s view.  Crises erupt when the mass of profit drops, causing over-investment and overproduction, but that happens when the rate of profit falls sufficiently to cause a fall in the mass of profit.

Now in a You Tube video of a recent panel in New York entitled Anti-Capitalist Chronicles,, Professor David Harvey tells the audience of his latest views on China, imperialism and crises (see from about 50min). But then a little later, Professor Harvey makes a critical comment on the ‘rate of profit’ theorists, singling out me in particular (at about 1.08).  After supporting Paul Sweezy and Baran’s rival ‘surplus profit thesis’ over Marx’s law of profitability, Professor Harvey remarks that Michael Roberts is obsessed with the rate of profit falling all the time and went on to joke: “if it started falling in 1850, should it not have reached zero by now!”  

Amusing as this joke is, anybody that reads my material on the rate of profit knows that the world rate of profit has not fallen to zero and will not any time soon, if ever, although there is a long term secular fall in the rate.  And there are several reasons for that, as I explain in my work.  The first is that there are counteracting factors to the law of the tendency of the rate of profit to fall and these countertendencies can raise the rate of profit for whole periods, decades even, as they did from the early 1980s to the end of the 20th century.  The other main reason is that regular slumps in capitalism lead to the devaluation of capital, with companies going bankrupt, writing off fixed assets and laying off workers.  That leads to a rise in profitability possibly for several years.  So there is a cycle of profitability – again something that I explain in detail in the Long Depression, for example.  So the rate of profit does not fall in a straight line towards zero and Professor Harvey’s little joke at my expense does not hold to reality.  You can see in this graph below how that pans out.  Even if the rate of profit fell in a straight line from here, it would not reach zero before 2060 or so – and that won’t happen for the reasons above.  Indeed, there are plenty of periods when the rate of profit rises, often after major world wars or after long periods of economic depression.

A world rate of profit (%) – from the work Esteban Maito using 14 key countries.

In his presentation to the panel, Professor Harvey goes to say that he challenged me personally about why I don’t ever talk about the mass of profit.  Apparently, I replied: “oh, I talk about it, but it doesn’t really matter.”  But that’s not how I remember the discussion.  This discussion actually took place at a public session, a plenary debate between Professor Harvey and myself in front of over 200 people at the HM conference of 2019 in London, after Professor Harvey had sent me in advance a paper which follows the same arguments as in his article for the NLR above.  Now I fully documented (accurately I think) this debate between me and David here.  If you read this post closely, I think you will find the ‘challenge’ and my response was not quite as Professor Harvey portrayed it at the New York panel.

As I say in my post covering that debate with Professor Harvey back in 2019, “Indeed, we ‘falling rate of profit boys and girls’ have been well aware of Marx’s double-edge law (of rate and mass)”.  And in my presentation to that plenary, I outlined the law; and I cited various works by ‘rate of profit’ theorists like Henryk Grossman who have used Marx’s double-edge law to explain crises.  Indeed, Grossman’s whole argument is built around the view that eventually a falling rate of profit leads to a slowdown in the rise in the mass of profit to the point where there is not enough surplus value to sustain investment in production and take a share for their own living and breakdown follows. 

And I provided a batch of empirical evidence showing the close connection between the rate and the mass of profit in leading to crises.  For example, I refer to the work of Jose Tapia from Drexel University published in the book, World in Crisis, jointly edited by myself and G Carchedi, that shows the close connection between the changes in the mass of US corporate profits and investment, leading to successive crises.  Indeed, at the plenary, I also provided a careful modelling of Marx’s double-edge law and applied it to real data from the US economy to show its connection to the Great Recession.

But more important than who said what and when, is what is the best explanation of the causes of regular and recurring crises under capitalism?  In the post on the debate between DH and myself, I concluded that “I think Professor Harvey’s purpose (in his paper and now in his article) was to weaken the role of Marx’s law of profitability and its relevance to crises.  By bringing up the double-edge law, it seems to me, David was saying that a rising mass of profit or capital stock or GDP is the problem. And thus, the problem for capitalism is not insufficient profit due to a falling rate, but too much surplus due to rising mass. How are we going to absorb or cope with ‘too much’ is apparently the problem?  This connects with David’s view that crises under capitalism arise because of too much capital or profit relative to the ability of consumers to use it. Indeed, David argues that it is consumer confidence and the level of consumption that matters in triggering crises not the rate or level of profits and investment. But the evidence on that does not support David’s thesis as I have shown before.”  (See the posts identified at the end).

As readers of my blog will know, in the debates that I have had in the past with Professor Harvey, he rejects Marx’s law of profitability as the underlying cause of crises in favour of what he has called a multiplicity of causes (again see the posts below). He reckons those who focus on Marx’s rate of profit law are being ‘monocausal’. But he has had to admit that the empirical evidence of a falling rate of profit is compelling. So now he has moved the goal posts from the rate to the mass. But shifting the goal posts just leaves us with a new goal to score in.

Marx’s double edge law is not a refutation of the law of profitability as the underlying cause of crises; on the contrary, it is integrally connected. And alternative ‘multiple’ causes (like underconsumption, ‘too much surplus to absorb’, disproportion, financial fragility etc) remain unconvincing and unproven in comparison.

I leave the readers of DH’s new piece and my response to make up their own minds.

The Jackson Hole dilemma

Next weekend, the central bankers of the world meet in a slimmed down COVID annual jamboree at Jackson Hole, Wyoming US.  The bankers will hear from Fed chair Jay Powell and US Treasury secretary Janet Yellen and wade though academic papers commissioned from various mainstream ‘monetary economists’. 

The big issue is whether it is time for central banks to wind down on their purchases of government bonds and bills designed to pump credit money into economies, which had the aim of avoiding a meltdown of businesses during the pandemic slowdown.  In the COVID year of 2020, the Federal Reserve made purchases equivalent to 11% of US GDP, the Bank of England 14% of UK GDP and many other banks in the G7 of around 10% of national GDPs.

Source: IIF

These purchases are called ‘quantitative easing’.  Instead of lowering interest rates to encourage borrowing, since the onset of the Great Recession in 2008-9, central banks have gone for increasing sharply the quantity of dollars, euros, yen and pounds pumped into the banking and financial system.  ‘Policy’ (ie central bank short-term rates) interest rates had already been driven down to zero and below.  The only weapon left to central banks to stimulate economies was to ‘print’ money, in practice buying government and corporate bonds from financial institutions holding them and hope that banks lend that cash on to firms.

Throughout the Long Depression (as I call it) from 2009 to 2019, the level of central bank assets in these bonds rocketed.  By December 2019, the assets held by the Federal Reserve in the United States were valued at 19.3 percent of the U.S. economy’s gross domestic product. This compares to 39.6 percent for the European Central bank, and 103.5 percent for the Bank of Japan (as of November 2019).  And central banks have been purchasing $834 million an hour for the last 18 months. Since the start of the pandemic, the Fed’s balance sheet has more than doubled to $8tn. The European Central bank has total assets worth more than €8tn, the Bank of Japan has about $6tn, while the UK has doubled its QE programme to £895bn. Leading central banks now own more than £18tn in government bonds and other assets, an increase of more than 50% on pre-pandemic levels. 

The questions facing the monetary authorities are: whether this huge increase and level of credit is a) working to keep economies growing; b) whether it is necessary any more given the supposed recovery in economies as the pandemic ends; and c) whether it is increasing the risk of a financial crash unless action is taken to curb QE.

The Fed is still buying $120bn (£88bn) a month in US government bonds and mortgage-backed securities to keep longer-term interest rates low.  But the debate is underway among the Fed members about whether to keep QE going at this level to ensure recovery or whether this level of monetary injection should be curbed now before high inflation sets in, interest rates rise and a financial crash ensues.  But the last time the Fed tried ‘tapering’ their monetary largesse in 2013 on the grounds that economies had recovered from the Great Recession, it led to a collapse in stock markets and in emerging market currencies increasing their debt burden.  Even the just recent talk among Fed leaders on the issue took stock markets down last week.

And that’s the problem – it seems that banks, stock market investors and governments have become ‘addicted’ to solving their problems by getting central banks to ‘print’ more and more money.  Most important, far from helping to restore productive investment and productivity growth during the Long Depression all that zero interest rates and QE have done is to boost stock and bond market levels to all-time highs.  As one empirical study concluded: “output and inflation, in contrast with some previous studies, show an insignificant impact providing evidence of the limitations of the central bank’s programmes” and “the reason for the negligible economic stimulus of QE is that the money injected funded financial asset price growth more than consumption and investments.” 

All the monetary injections have done is allow banks and financial speculators to build up massive amounts of what Marx called ‘fictitious capital’ ie not investment into value-creating assets in the ‘real economy’ but into stocks and bonds and cryptocurrencies – a fantasy world where a very few become billionaires while working people who don’t have stocks or even houses of their own see no increase in real incomes or wealth.  QE has been a major contributor to rising inequality of incomes and wealth in the G7 economies in the last ten years.

Like the central bankers, mainstream economics is divided over whether continuing with government borrowing and quantitative easing is needed or whether continuance will lead to eventual disaster. 

The Keynesians, post-Keynesians (including Modern Monetary Theorists) remain strongly in favour.  There is no need to worry about rising government or even corporate debt.  If governments resort to trying to cut back their debts as they did during the Long Depression (without much success), such an ‘austerity’ policy will only delay economic recovery and even reverse it.  The Keynesians ignore the evidence that government spending and deficits have had little effect on achieving economic recovery anyway. 

But in this post-COVID period, some Keynesians are pushing another argument for QE and monetary and fiscal largesse.  Mark Sandbu, the European economics correspondent of the Financial Times has come up with what he calls a ‘novel idea’; namely that QE along with the sort of fiscal stimulus that US President Biden is pursuing will actually force up wages as inflation rises.  This will give new bargaining power to workers and restore ‘class conflict’ in the workplace. 

Sandbu recognises that employers will want to resist this situation as it might damage their profits and refers to the famous post-Keynesian paper by Michal Kalecki on why wage rises and full employment are resisted by capitalists.  But Sandbu is sanguine about that conflict.  Starting from the Keynesian premiss that what matters is not profits in an economy but sufficient ‘effective demand’, he reckons that rising wages “can encourage employers to increase both labour productivity and output if they expect demand growth to be strong.”  So it will be possible to have “what Kalecki called “full employment capitalism”, because we can promote “an enlightened view of capital owners’ self-interest”. So “far from class conflict being a zero-sum game, productivity incentives from greater worker power can boost profits as well.”  So it’s the most perfect of all possible worlds: workers get higher wages and capitalists get higher profits – all thanks to QE, Bidenomics and inflation.

This, of course, is not the view of the other side of the mainstream spectrum.  These are closer to the view that governments and central banks should not intervene in markets and economies and ‘distort’ natural interest rates and cause ‘overinvestment’ in financial assets leading to a crash.  In the same issue of FT that Sanbu presented his Leibniz view of capitalist economies, John Plender was severe in his condemnation of QE and all its works.  Plender remarked that “the central banks have been busy topping up the punch bowl through their continued bond purchases to keep interest rates low while conducting an interminable debate on when and how to remove support. Their protestations that the risk of inflation is “transitory” look increasingly questionable.”

Plender makes the point that “central bankers’ claims that QE would boost gross domestic product are less convincing…in the meantime, unconventional monetary policy is creating ever greater balance sheet vulnerabilities.”  The Keynesians fail to recognise that, although near zero interest rates keep the cost of servicing government and corporate debt low, QE shortens the maturity of that debt.  That means governments and companies are faced with renewing that debt at shorter intervals.  As Plender comments: “The Bank for International Settlements estimates that 15 to 45 per cent of all advanced economy sovereign debt is now, de facto, overnight. In the short run, that yields a net interest saving to governments. But their increased exposure to floating rates heightens vulnerability to rising interest rates.”

In the advanced economies, the IMF estimates that the government debt-to-GDP ratio went from under 80 per cent in 2008 to 120 per cent in 2020. The interest bill on that debt nonetheless went down over the period, encouraging a Panglossian belief that the debt must be sustainable. A similar surge in the global non-financial corporate sector led to debt hitting a record high of 91 per cent of GDP in 2019.

Plender goes on: “Against that background, investors’ search for yield has caused severe mispricing of risk, along with widespread misallocation of capital.” In true Austrian school mode, Plender predicts that: “The trigger now may be a lethal combination of rising inflation and financial instability. The difficulty is that central banks cannot take away the punch bowl and raise rates without undermining weak balance sheets and taking a wrecking ball to the economy”.

Former Indian central bank governor, Raghuram Rajan, raised the same worries in a piece for the Group of 30, a not well-known association of government and central bank institutions.  Entitled, the Dangers of Endless Quantitative Easing, Rajan also points out the risks of letting QE rip on. He reckons the raging desire to make money in financial markets with zero interest credit risks a financial crash down the road.  His worry is also that government interest costs could rise sharply with rising inflation.  “If government debt is around 125% of GDP, every percentage-point increase in interest rates translates into a 1.25 percentage-point increase in the annual fiscal deficit as a share of GDP… and what matters is not the average debt maturity, but rather the amount of debt that will mature quickly and must be rolled over at a higher rate.”

There is no doubt that net interest on government debt is currently very low historically, only slightly more than 1% of GDP a year compared to a GDP growth rate of 2-3% a year ahead.  But the Peterson Institute argues that those “who believe that rates will almost certainly not rise are too confident in their own views. The forces that have contributed to lower rates are universally difficult to predict, and, as noted above, even modest changes in rates can produce sizable movements in net interest as a share of the economy in the future.” 

There you have the mainstream debate.  On the one hand, rising government and corporate debt is nothing to worry about because QE and fiscal stimulus will achieve economic recovery and inflation will dissipate.  Moreover, rising wages might encourage capitalists to invest and so raise productivity to pay for any rise in interest rates when central banks ‘taper’ their spending.  On the other hand, goes the argument that all this QE is just going into financial speculation, causing malinvestment and inflation that will only be stopped by some financial crash of disastrous proportions.

What is the Marxist view on this debate?  Well, in my view, the Keynesians and Austrian are both right and wrong.  Rising government debt and even rising corporate debt does not have to be a problem if economies recover to achieve and sustain a good rate of real GDP growth and profits for companies.  Government debt to GDP ratios can be reduced or at least managed if GDP growth is higher than the going interest rate.  So the Keynesians are right and the Austrians wrong here. 

But the Austrians are right that the continual rise in fictitious capital rather than investment in productive capital is laying the basis for a crash down the road if economic recovery should falter.  Once a drug user is addicted, it is difficult to wean the user off the drug while ‘cold turkey’ could kill the patient.  As Plender put it: “The imperative should rather be to ensure that the post-pandemic debt splurge finds its way into productive investment.” Exactly, but how can that be done if capitalists do not want to invest productively?  What decides the level of productive investment is its profitability for capitalists and its profitability compared to the ‘search for yield’ from stock and bond market speculation that QE has bred. 

Let me repeat yet again the words of Michael Pettis, a firm Keynesian economist: “the bottom line is this: if the government can spend additional funds in ways that make GDP grow faster than debt, politicians don’t have to worry about runaway inflation or the piling up of debt. But if this money isn’t used productively, the opposite is true.”  That’s because “creating or borrowing money does not increase a country’s wealth unless doing so results directly or indirectly in an increase in productive investment…If US companies are reluctant to invest not because the cost of capital is high but rather because expected profitability is low, they are unlikely to respond ….by investing more.”

Profitability in the productive sectors of the major economies was near an all-time low before the pandemic struck.  The pandemic slump took profitability down further and no doubt it is recovering fast right now.  But will profitability get up to levels that will sustain productivity-enhancing investment in the next few years, especially if wage rises start to squeeze profit margins?

That issue will not be part of the debate at Jackson Hole this week.

The relative decline of US imperialism

The swift collapse of Afghanistan puppet government when US troops withdrew from the war with the Taliban and left the country after 20 years has been likened to the fall of Saigon at the end of the 30-year ‘American’ war against the Vietnamese people.  The scenes of Afghans trying to get onto US planes at the airport to escape seem startlingly familiar to those of us who can remember the last days of Saigon.

But is this a superficial similarity?  After all, America’s occupation of Vietnam was way more costly as a share of US national output and in terms of the lives of American soldiers than the attempt at ‘regime’ change in Afghanistan.  The Vietnam disaster led to the US government running deficits for the first time since WW2.  But even more important, it meant a diversion of investment into arms rather than productive sectors at a time when the profitability of capital had already begun to fall, the Golden Age of investment and profitability having peaked in the mid-1960s. 

Source: Penn World Tables 10.0, author’s calculations

Indeed, by the end of the 1960s, it was clear that the US could never win in Vietnam, just as it was clear at least a decade ago (if not from the very beginning) that it could not win in Afghanistan.  But the ruling elite continued under Nixon and Kissinger to prosecute the war for several more years, spreading it into neighbouring countries like Laos and Cambodia. 

But by the official end of the war in Vietnam, the economic consequences of this 30-year ‘intervention’ exposed an important turning point – the end of Pax Americana and the outright hegemonic position of American imperialism in the world economy.  From then on, we can talk about the relative decline (relative to other imperialist powers) of the US, with the rise of the European countries, Japan, East Asia and more recently China.  Despite the collapse of the Soviet Union in the late 1980s and early 1990s, the end of the ‘cold war’ did not reverse or even curb that relative decline.  The US no longer can rule the world on its own and, even with the help of a ‘coalition of the willing’, it cannot dictate a ‘world order’.

Economically, it all started before the fall of Saigon.  As the profitability of US capital started to fall from the mid-1960s, US industry began to lose its competitive advantage in manufacturing and even in various services to rising Franco-German capital and Japan.  This eventually meant that the economic world order after WW2, which had established the economic hegemony of the US economy and its currency, the dollar, started to crumble. 

Indeed, it is 50 years to the month when officials of President Nixon’s administration met secretly at Camp David to decide on the fate of the international monetary system. For the previous 25 years, the US dollar had been fixed to the price of gold ($35/oz) by international agreement.  Anybody holding a dollar could convert into a fixed amount of gold from US reserves.  But in August 1971, President Nixon took to national television to announce he had asked Treasury Secretary John Connally to “suspend temporarily the convertibility of the dollar into gold or other reserve assets.”

It was the end of the so-called Bretton Woods agreement, so painfully negotiated by the Allied powers, namely the US and the UK, over the heads of all the other countries in the world.  Conceived, along with the IMF, the World Bank and the UN, the agreement established a framework that committed all to fixed exchange rates for their currencies and fixed in terms of the US dollar.  The US in turn would fix the value of the dollar in terms of gold.  No country could change their rates without IMF agreement.

But with Nixon’s announcement, the fixed exchange rate regime was ended; it was the US that had abandoned it and, with it, the whole post-war Keynesian-style international currency regime.  It was no accident that the ending of the Bretton Woods system also coincided with the ending of Keynesian macro management of the US and other economies through the manipulation of government spending and taxation.  The post-war economic boom based on high profitability, relatively full employment and productive investment was over. Now there was a decline in the profitability of capital and investment growth, which eventually culminated in the first post-war international slump of 1974-5; and alongside this was the relative decline of American industry and exports compared to competitors.  The US was no longer exporting more manufacturing goods to Europe, Latin America or Asia than it was importing commodities like oil from the Middle East and manufacturing from Germany and Japan.  It was starting to run trade deficits.  The dollar was thus seriously overvalued.  If US capital, particularly manufacturing was to compete, the dollar fix to gold must be ended and the currency allowed to depreciate.

As early as 1959, Belgian-American economist Robert Triffin had predicted that the US could not go on running trade deficits with other countries and export capital to invest abroad and maintain a strong dollar: “if the United States continued to run deficits, its foreign liabilities would come to exceed by far its ability to convert dollars into gold on demand and would bring about a “gold and dollar crisis.”

And that is what happened.  Under the dollar-gold standard, imbalances in trade and capital flows had to be settled by transfers of gold bullion. Up until 1953, as war reconstruction took place, the US had actually gained gold of 12 million troy ounces, while Europe and Japan had lost 35 million troy oz (in order to finance their recovery). But after that, the US started to leak gold to Europe and Japan.  By end-1965, the latter surpassed the former for the first time in the post-war period in terms of gold volumes held in reserve.  As a result, Europe and Japan began to pile up huge dollar reserves that they could use to buy US assets.  The global economy has begun to reverse against the US.

The dollar reserves in Europe and Japan were now so large that if those countries bought gold with their dollars under the gold standard, they could exhaust US gold stocks in an instant.  Private financial outflows (outbound investment) from the US averaged roughly 1.2% of GDP throughout the 1960s—long term investment overseas through FDI or portfolio outflows. This served to finance net exports of US investment goods and a current account surplus, shown as negative here as an offsetting withdrawal of dollars.  Netting these, about 0.4% of US GDP in surplus outward investment was made available every year during the 1960s from the US. This surplus was available for current account deficit countries in Europe and Japan to liquidate US gold, replenishing their diminished reserve positive, or accumulate other financial claims on the US—as shown on the right side.

But throughout the 1960s, the US current account surplus was gradually eroded until, in the early 1970s, the current account was registering a deficit. The US began to leak dollars globally not only through outward investment but also through an excess of spending and imports as domestic manufacturers lost ground. 

US current account balance to GDP (%), 1976-2020

The US became reliant for the first time since the 1890s on external finance for the purposes of spending at home and abroad.  So US external accounts were driven less by real goods and services and more by global demand for US financial assets and the liquidity they provided.  By the 1980s, the US was building up net external liabilities, rising to 70% of GDP by 2020.

US net international investment position as % of US GDP

If a country’s current account is permanently in deficit and it depends increasingly on foreign funds, its currency is vulnerable to sharp depreciation.  This is the experience of just about every country in the world, from Argentina to Turkey to Zambia, and even the UK. 

However, it is not the same for the US because what is left from the Bretton Woods regime is that the US is still the main reserve currency internationally.  Roughly 90% of global foreign exchange transactions involve a dollar leg; approximately 40% of global trade outside the US is invoiced and settled in dollars; and almost 60% of U.S. dollar banknotes circulate internationally as a global store of value and medium of exchange.  Over 60% of global foreign exchange reserves held by foreign central banks and monetary authorities remain denominated in dollars. These ratios have not changed. 

Export surplus countries like the European Union, Japan, China, Russia and Middle East oil states pile up surpluses in dollars (mainly) and they buy or hold assets abroad in dollars.  And only the US treasury can ‘print’ dollars, gaining a profit from what is called ‘seignorage’ as a result. So, despite the relative economic decline of US imperialism, the US dollar remains supreme.

This reserve currency role encouraged US Treasury Secretary John Connally, when he announced the end of the dollar-gold standard in 1971 to tell EU finance ministers “the dollar is our currency, but it is your problem.”  Indeed, one of the reasons for the European Union, led by Franco-German capital, to decide to establish a single currency union in the 1990s was to try and break the dollar hegemony of international trade and finance.  That aim has had only limited success, with the euro’s share of international reserves stable at about 20% (and nearly all of this due to intra-EU transactions). 

International competitors such as Russia and China routinely call for a new international financial order and work aggressively to displace the dollar as the apex of the current regime. The addition of the renminbi in 2016 to the basket of currencies that composes the IMF’s special drawing rights represented an important global acknowledgment of the increasing international use of the Chinese currency.  And there is talk of rival countries launching digital currencies to compete with the dollar.  But although the dollar-euro share of reserves has declined in favour of the yen and renminbi from 86% in 2014 to 82% now, alternative currencies still have a long way to go to displace the dollar.

Having said that, the underlying relative decline in US manufacturing and even services competitiveness with first Europe, then Japan and East Asia and now China, has gradually worn away the strength of the US dollar against other currencies as the supply of dollars outstrips demand internationally.  Since Nixon’s momentous announcement, the US dollar has declined in value by 20% – maybe a good barometer of the relative decline of the US economy (but an underestimate because of the reserve currency factor).

The dollar’s decline has not been in a straight line.  In global slumps, the dollar strengthens.  That’s because as the international reserve currency, in a slump, investors look to hold cash rather than invest productively or speculate in financial assets and the safe-haven then is the dollar. 

That’s especially the case if US interest rates on dollar cash are high compared to other currencies.  To break the inflationary spiral at the end of the 1970s, the then Federal Reserve Chair Paul Volcker deliberately hiked interest rates (adding to the depth of the economic slump of 1980-2).  In the slump, investors rushed into high-yielding dollars. Bankers loved it, but not US manufacturers and exporters, as well as countries with large US dollar debts.  The slump was bad enough, but Volcker’s action was squeezing the world economy to death. 

Finally, in 1985, at a meeting at the Plaza Hotel, New York of central bankers and finance ministers in the then big 5 economies, it was agreed to sell the dollar and buy other currencies to depreciate the dollar.  The Plaza accord was another milestone in the relative decline of US imperialism, as it could no longer impose its domestic monetary policy on other countries and eventually had to relent and allow the dollar to fall.  Nevertheless, the dollar continues to dominate and remains the currency to hold in a slump, as we saw in bust and slump of 2001 and in the emerging market commodity slump and euro debt crisis of 2011-14.

The relative decline of the dollar will continue.  The Afghanistan debacle is not a tipping point – the dollar actually strengthened on the news of Kabul’s collapse as investors rushed into ‘safe-haven’ dollars.  But the monetary explosion and the fiscal stimulus being applied by the US authorities to revive the US economy after the pandemic slump is not going to do the trick.  After the ‘sugar rush’ of Bidenomics, the profitability of US capital will resume its decline and investment and production will be weak.  And if US inflation does not subside as well, then the dollar will come under more pressure.  To distort a quote by Leon Trotsky, ‘the dollar may not be interested in the world economy, but the world is certainly interested in the dollar.’

Climate change: the fault of humanity?

The sixth report from the Intergovernmental Panel on Climate Change (IPCC) runs to nearly 4,000 pages.  The IPCC has tried to summarise its report as the ‘final opportunity’ to avoid climate catastrophe.  Its conclusions are not much changed since the previous publication in 2013, only more decisive this time.  The evidence is clear: we know the cause of global warming (mankind); we know how far the planet has warmed (~1C so far), we know how atmospheric CO2 concentrations have changed since pre-industrial times (+30%) and we know that warming that has shown up so far has been generated by historical pollution.  You have to go back several million years to even replicate what we have today.  During the Pilocene era (5.3-2.6 million years ago) the world had CO2 levels of 360-420ppm (vs. 415ppm now). 

In its summary for Policy makers, the IPCC states clearly that climate change and global warming is “unequivocally caused by human activities.” But can climate change be laid at the door of the whole of humanity or instead on that part of humanity that owns, controls and decides what happens to our future?  Sure, any society without the scientific knowledge would have exploited fossil fuels in order to generate energy for production, warmth and transport.  But would any society have gone on expanding fossil fuel exploration and production without controls to protect the environment and failed to look for alternative sources of energy that did not damage the planet, once it became clear that carbon emissions were doing just that? 

Indeed, we now know that scientists warned of the dangers decades ago.  Nuclear physicist Edward Teller warned the oil industry all the way back in 1959 that its product will end up having a catastrophic impact on human civilization.  The main fossil fuel companies like Exxon or BP knew what the consequences were, but chose to hide the evidence and do nothing – just like the tobacco companies over smoking.  The scientific evidence on carbon emissions damaging the planet, as presented in the IPCC report, is about as inconvertible as smoking in damaging health.  And yet little or nothing has been done, because the environment must not stand in the way of profitability. 

The culprit is not ‘humanity’ but industrial capitalism and its addiction to fossil fuels. At a personal level, in the last 25 years, it is the richest one percent of the world’s population mainly based in the Global North who were responsible for more than twice as much carbon pollution as the 3.1 billion people who made up the poorest half of humanity. A recent study found that the richest 10 percent of households use almost half (45 percent) of all the energy linked to land transport and three quarters of all energy linked to aviation. Transportation accounts for around a quarter of global emissions today, while SUVs were the second biggest driver of global carbon emissions growth between 2010 and 2018. But even more to the point, just 100 companies have been the source of more than 70% of the world’s greenhouse gas emissions since 1988, according to a new report. It’s big capital that is the polluter even more than the very rich.

The IPCC material distils a massive pool of data into a report that it hopes is irrefutable and alarming enough to force more radical change.  And it provides various scenarios on when global temperatures will reach the so-called Paris target of 1.5c degrees above average pre-industrial levels.  Its main scenario is called the Shared Socioeconomic Pathway (SSP1-1.9) scenario in, in which it is argued that if net carbon emissions are reduced, then the 1.5C target will be reached by 2040 at the latest, then breach the target up to 2060 before falling back to 1.4C by the end of the century. 

But this is the most optimistic of five scenarios on the pace and intensity of global warming in the 21st century and it’s bad enough!  The other scenarios are way bleaker, culminating in SSP5-8.5 which would see global temperatures rise 4.4C by 2100 and continuing upward thereafter (Inset 1).  There isn’t a scenario better than SSP1-1.9 and these are ignored by the IPCC.

Shared socioeconomic pathways

SSP1-1.9 is the most optimistic scenario, global CO2 emissions are cut to net zero by 2050. There is a huge shift to sustainable development, with well-being prioritised over pure economic growth.  Investments in education and health rise and inequality falls.  Extreme weather continues to increase in frequency, but the world avoids the worst impacts of climate change.  Global warming is kept to around 1.5C, stabilising around 1.4C by the end of the century.

SSP1-2.6 is the next-best scenario, global CO2 emissions fall but net zero is not reached until after 2050.  It assumes the same socioeconomic shifts as in SSP1-1.9 are met. But temperatures are left 1.8C higher by 2100.

SSP2-4.5 is the “middle of the road” scenario (i.e. the most likely).  CO2 emissions hover around current levels before starting to fall mid-century, but do not reach net-zero until nearer 2100.  Shifts towards a more sustainable economy and improvements in inequality follow historic trends.  Temperatures rise 2.7C by the end of the century.

SSP3-7.0 is one where emissions and temperatures continue to rise steadily, ending at roughly double current levels by 2100.  Countries become more competitive national and food security is prioritised.  Average temperatures rise by 3.6C.

SSP5-8.5 is the apocalyptic scenario. CO2 emissions roughly double by 2050.  The global economy continues to grow quickly by exploiting fossil fuels, lifestyles remain energy intensive and average global temperatures are 4.4C higher as we enter the 22nd century.

No probabilities are offered for any of these scenarios – just the hope and expectation that SSP1 will happen.  But the pace of emissions growth and temperature is already on a much faster trajectory.  The planet has already warmed 1.0-1.2C depending on how you want to measure it (current or 10-year average).  The trend is well established and is tending to surprise on the upside, not the downside.  Furthermore, the rate of change in atmospheric chemistry is unprecedented and continues to accelerate.

Even at 1.5oC, we will see sea level rises of between two and three metres. Instances of extreme heat will be around four times more likely. Heavy rainfall will be around 10 percent wetter and 1.5 times more likely to occur. Much of these changes are already irreversible, like the sea level rises, the melting of Arctic ice, and the warming and acidification of the oceans. Drastic reductions in emissions can stave off worse climate change, according to IPCC scientists, but will not return the world to the more moderate weather patterns of the past.

Even if we assume the SSP1-1.9 objectives can be met by 2050, cumulative global CO2 emissions would still be a third higher than the current 1.2trn tons of CO2 emitted since 1960.  That would push atmospheric CO2 beyond 500ppm, or 66% higher than where things stood in the pre-industrial period.  That pathway implies 1.8C of warming by 2050, not 1.5C.

The reality is that the IPCC’s very low emissions scenario is improbable: and the global temperature is likely to hit 1.5C much earlier than 2040 and reach a much higher level, even with the conditions of SSP1 in place, namely a 50% reduction in CO2 emissions by 2050.

More likely, global warming will reach around 1.8C by 2050 and 2.5C by the end of the century.  That means even more drought and flood events than currently forecast and so even more suffering and mounting economic losses from the mix – a loss in world GDP of 10-15% on current trajectories and double that in the poor Global South.

António Guterres, the secretary-general of the United Nations, responded to the report by taking aim at the fossil fuel industry: “This report must sound a death knell for coal and fossil fuels, before they destroy our planet.” But how? First and foremost, it’s not enough to end the government subsidies and financing of fossil fuel sectors by governments around the world (and that is still going on). Instead, there must be a global plan to phase out fossil fuel energy production. 

Left Democrat Robert Reich, former official in the Clinton administration, reckons the answer is to stop oil company lobbying, oil exploration, ban oil exports and make the oil companies pay compensation.  He stops short of public ownership.  But how can a really successful plan to stop global warming work unless the fossil fuel companies are brought into public ownership?  The energy industry needs to be integrated into a global plan to reduce emissions and expand superior renewable energy technology.  This means building renewable energy capacity of 10x the current utility base.  That is only possible through planned public investment that transfers the jobs in fossil fuel companies to green technology and environmental companies, where there will be many jobs.

Second, public investment is needed to develop the technologies of carbon extraction to reduce the existing stock of atmospheric emissions.  The IPCC says that going beyond net zero by removing large quantities of carbon from the atmosphere “might be able to reduce warming”, but carbon removal technologies “are not yet ready” to work at the scale that would be required, and most “have undesired side effects”.  In other words, private investment is failing to deliver on this so far.  

Decarbonizing the world economy is technically and financially feasible.  It would require committing approximately 2.5 percent of global GDP per year to investment spending in areas designed to improve energy efficiency standards across the board (buildings, automobiles, transportation systems, industrial production processes) and to massively expand the availability of clean energy sources for zero emissions to be realized by 2050. That cost is nothing compared to the loss of incomes, employment, lives and living conditions for millions ahead.

End fossil fuel production through public ownership and a global investment plan – this is just utopia, critics may say.  But then, market solutions of carbon pricing and taxation, as advocated by the IMF and the EU, are not going to work, even if implemented globally – and that is not going to happen.

There is less than three months before the delayed COP26 conference in Glasgow. The previous two major conferences produced nothing at all: COP15 in Copenhagen in 2009, and COP21 in 2015 (the Paris Agreement) only committed nations to voluntary emissions reductions targets that would lead to about 2.9oC of warming if achieved. Glasgow is shaping up to be no less of a failure.

China’s crackdown on the three mountains

A December 2020 meeting of the Chinese Communist party Politburo, vowed to end what it called a “disorderly expansion of capital”.  The Chinese leaders were worried that the capitalist sector in China had got too big for its boots.  Companies like Jack Ma’s Ant Group had expanded into consumer financing and looked to raise foreign funds to do so.  In effect, the Ant Group aimed to take over household lending from the state banks.  Ant was going to do what it liked and said so with a lot of fanfare in the press.  Ant and other Chinese capitalist tech and media companies were increasingly engaged in typically ‘Western’-type mergers, secret contracts and other financial irregularities. 

China’s regulators had been turning a blind eye to all this for years.  Moreover, the financial faction in China’s leadership had got agreement to allow foreign investment banks to set up majority-owned companies in China for the first time, with the eventual aim of ‘freeing up’ the finance sector from state control and allowing unregulated cross-border capital flows.  In other words, China was set to become a full member of international finance capital.  The authorities were also allowing uncontrolled cryptocurrency mining and operations in the country.

But the COVID pandemic changed all this.  There was growing public anger at how the rich in China, as in the rest of the major economies, have gained hugely from the financial and property price boom during the pandemic, while the majority struggled through the lockdowns and faced increased costs in education, health and housing and a serious risk to decent jobs for graduates and others.  Education, health and housing are the ‘three mountains’ that all Chinese households aim to climb to get a better life – and yet costs for these were spiralling while the rich made millions. 

Now the Chinese leadership has been forced to zigzag back from ‘disorderly expansion’ and respond to the public backlash through a crackdown on the consumer tech and media giants and by introducing curbs on private education and speculative property development.  It has also banned cryptocurrency operations.

Take education. The vast majority of Chinese parents pay for extracurricular private tutoring – survey estimates range from 65% of families with school-aged children in 2016, up to 92% this year. A 2019 survey from recruitment firm 51job Inc showed nearly 40% of parents spent 20-30% of their income on children’s education.  The private classes come at eye-watering costs that contribute to an industry worth more than $150bn (£108bn). The quality and resource of education varies greatly between urban and rural areas, from province to province, and between top- and lower-tier cities. There are few university places relative to the number of students and even fewer at prestigious universities, which are concentrated on the east coast and in major cities. It is in these areas where private tutoring has exploded in the past decade. Now China’s state council is barring for-profit companies from tutoring in core curriculum subjects and foreign investment in such companies.

Take health.  Approximately 95% of China’s population is covered by a public insurance programme financed mainly from employee and employer payroll taxes, with minimal government funding.  This supposedly funds universal health care but it is very basic.  So most Chinese are forced to pay private fees to get better care, just as in many advanced capitalist economies.  And during COVID, Chinese households faced exorbitant costs for healthcare.

And take housing.  Property prices in coastal cities, where the best work and pay is, have doubled in the last ten years. In Shenzhen, the average apartment price has risen so much that some are finding it cheaper to live in Hong Kong, one of the most expensive property markets in the world.   Since 2015, residential property prices have appreciated by more than 50% in China’s largest cities. Over the past decade, average residential land supply per new resident in the top 10 cities is only 230 square feet—little more than the size of a typical hotel room—or less than 60% of the average per capita residential space in China.

Speculation has been rife as local governments try to raise funds by selling land to developers which then build estates through borrowing at low rates often from the unregulated shadow non-bank sector.  “Property is the single most important source of financial risk and wealth inequality in China,” said Larry Hu, head of China economics at the foreign-owned Macquarie Securities Ltd. And he is right.

So the government has had to respond to public disenchantment, echoing Xi Jinping’s famous words that “housing is for living in and not for speculation.” Vice Premier Han Zheng added that the sector shouldn’t be used as a short-term tool to stimulate the economy. The banks have been told to jack up mortgage rates.  Local governments are being directed to accelerate the development of government subsidized rental housing and have been told to increase scrutiny on everything from financing of developers and newly-listed home prices to title transfers.

But these mountains won’t be climbed easily by the Chinese leaders, if at all.  That’s because the Chinese authorities have leant ever more towards expansion through the capitalist sector and particularly into unproductive sectors like property and finance – at the expense of productive sectors like manufacturing technology, residential housing, public education and health.

Much of the property speculation has been to build ever more commercial developments rather than housing.  That’s because the main prerogative for local governments is to accrue revenue. If they can attract more businesses into their jurisdictions and if those businesses become profitable, then the local government can collect more corporate taxes.  At the same time, residential land supply is deliberately kept scarce so governments can make money on residential land sales. In effect, residential land sales serve as a cross-subsidy on local governments’ pro-business land policy that sells commercial land cheaply.

Beijing is pushing hard for implementing a long-delayed property tax, which could provide an alternative source of revenue for municipal governments and reduce their reliance on land sales. But a property tax is unlikely to come anywhere close to offsetting the revenue loss that would result from selling less land.  Given that average households will be exempt from the property tax, it seems unlikely to generate more revenue than income tax (1% 0f GDP), while annual land sales are currently on the order of more than 7% of GDP.

The real estate sector accounts for 13% of the economy from just 5% in 1995 and for about 28% of the nation’s total lending.  Given that local governments have $10 trillion in debt, land sales are the most crucial and reliable source of income for debt repayment.  So any drastic changes would seriously raise the risk of local government defaults.  So the new government crackdown on China’s capitalist sectors will not be enough to alter the huge inequalities of income, wealth and access to jobs, housing and education in China. 

Let’s be clear, China has a high level of inequality of incomes by international standards, although it is still lower than many other ‘emerging’ economies like Brazil, Mexico or South Africa – and the gini inequality ratio peaked just before the Great Recession and has been falling since.  

Source: National Bureau of Statistics

The main reason for the high inequality ratio is the disparity of incomes between urban and rural workers and between the wages in coastal and inland cities, as well as educational qualifications.

When it comes to inequality of personal wealth, China is not so unequal as many of its economic peers.  The gini inequality of wealth ratio is much higher in Brazil, Russia and India, and higher in the US and Germany.  According to the latest estimates, the top 1% of wealth holders in China take 31% of all personal wealth compared to 58% in Russia, 50% in Brazil, 41% in India and 35% in the US.  This is a good measure of the economic power of the top elite and oligarchs in these countries.

Much is made of the number of billionaires in China, but given the size of the population and GDP, the per capita ratio compared to the US and other major economies is relatively low. Despite the large expansion in the number of millionaires, millionaires in China remain relatively rare: about one for every 200 adults. Millionaires account for 3% of adults in Italy and Spain; France, Austria or Germany about 4%), and around 6% in social democratic Scandinavia; above 8% in the US and Australia and highest of all in Switzerland (15%)

And the inequality of wealth in China is centred on property, not financial assets (so far), unlike the main capitalist economies of the G7.  And that is because finance has not been fully opened up to the capitalist sector.

Source: Piketty et al

But the contradictions of China’s state-controlled economy alongside a large and growing capitalist sector intensified during the COVID pandemic.  And that was expressed by the factions in the Chinese leadership.  Officials in the financial and banking sector want to open up the economy to foreign capital and allow the renminbi to become an international currency.  They argue that the economy is too biased towards investment and exports over consumption.  Chinese economists trained in America and Europe, backed by resident foreign economists in Chinese universities and the World Bank, press continually for a ‘switch from investment to consumption’.  But has this worked in the G7 capitalist economies where consumption has failed to drive economic growth and wages have stagnated in real terms over the last ten years, while real wages in China have shot up? 

Source: Penn World Tables 10.0, author’s calculations

Indeed, consumption is rising much faster in China than in the G7 because investment is higher.  One follows the other; it is not a zero-sum game.  And not all consumption has to be ‘personal’; more important is ‘social consumption’ ie public services like health, education, transport, communications housing; not just motor cars and gadgets.  Increased personal consumption of basic social services is what is necessary.  And it is here that China needs to act.

Much is also made of China’s rising debt levels.  Mainstream economists have been forecasting for decades that China is heading for a debt crash of mega proportions.  It’s true that according to the Institute of International Finance (IFF), China’s total debt hit 317 per cent of gross domestic product (GDP) in the first quarter of 2020. But most of the domestic debt is owed by one state entity to another; from local government to state banks, from state banks to central government. When that is all netted off, the debt owed by households (54% of GDP) and corporations is not so high, while central government debt is low by global standards. Moreover, external dollar debt to GDP is very low (15%) and indeed the rest of the world owes China way more: 6% of global debt. China is a huge creditor to the world and has massive dollar and euro reserves, 50% larger than its dollar debt.

Source: IIF

A financial crisis is ruled out as long as the state controls the banking system, but there are dangers because of the recent attempts to loosen it up for private and foreign institutions to enter the arena (eg there are a growing number of bankruptcies in speculative financial entities).

Chinese leaders want to curb the debt level.  Controlling the debt level can come in two ways; through high growth from productive sector investment to keep the debt ratio under control and/or by reducing credit binges in unproductive areas like speculative property.  Japan’s secular stagnation was the result of the lack of applying these two factors in its capitalist economy.  But given the power of state control over the levers of investment, China can avoid the Japanese outcome. 

The basic contradiction of China’s economy is not between investment and consumption, or between growth and debt; it is between profitability and productivity.  The growing size and influence of the capitalist sector in China is weakening the performance of the economy and widening the inequalities exposed during the pandemic.  Indeed, it was the state sector that has helped the Chinese economy climb out of the pandemic slump, not its capitalist sector.

I did a little empirical test of the relation between the profitability of Chinese capital and real GDP growth (based on data from the Penn World Tables 10.0 – details provided on request).  What I found was that the state-dominated investment and capital stock in China meant that there has been no correlation between the profitability of Chinese capital and real GDP growth since the formation of the People’ Republic – indeed it was negative.  The profitability of capital did not decide the level of investment in productive assets and economic growth.

Source: Penn World Tables 10.0; IRR series for profitability; real GDP growth calculations

However, after Deng’s reforms in the 1980s, the correlation turned positive, although less positively correlated than in the rest of the G20 economies or the G7.  And since China entered the World Trade Organisation and privatised sections of its state sector in the late 1990s and early 2000s, there has been a significant correlation between the profitability of Chinese capital and real GDP growth.  So the Chinese economy has become increasingly vulnerable to its capitalist sector and to international capital and their profitability. 

This is the Everest facing China: how to raise productivity to meet the social needs of its 1.4bn people, in the face of vagaries of the profitability of its capitalist sector. China’s workforce is falling. productivity growth has been slowing and China faces a technology and trade war with the US and its imperialist allies. The three mountains will not be climbed unless that Everest is also conquered.

As part of its 2021-25 national plan to reduce inequalities, various provinces are engaged in building “a common prosperity demonstration zone”.  According to the plan, in Zhejiang province, labour compensation will be raised to more than 50 percent of GDP by 2025; the enrollment rate in higher education to more than 70 percent; and the proportion of personal health expenditure versus the total health expenditure will be managed to be below 26 percent.  Will this work and be applied to other provinces?  We shall see.

The Austrian Business Cycle

The Austrian school of economics is outside the mainstream. The Austrians start from micro-assumptions. This is not the neoclassical view of rational, fully informed human agents, maximizing their utility and profits. On the contrary, human actions are speculative and there is no guarantee of success in investment. According to Karl Menger, the founder of this school of thought, the further out in time the results of any investment are, the more difficult it is to be sure of success.  Thus it is easier to estimate the returns on investment for goods that are for immediate consumption than for those needed for capital goods. Saving rather than consumption is a speculative decision to gain extra returns down the road.

Austrians reckon that the cost of saving can be measured by the ‘market interest rate’, which prices the time involved in delivering future output from savings now. ‘Business cycles,’ as the Austrians call booms and slumps under capitalist production, are primarily caused by periodic credit expansion and contraction of central banks. Business cycles would not be a feature of a truly “free market” economy. As long as capitalists were free to make their own forecasts and investment allocations based on market prices, rather than by bureaucrats, there would be no business cycles. Cycles are due to the manipulation of credit by state institutions. This differs from the neoclassical/monetarist school, which sees recessions as minor interruptions from growth caused by imperfections in market information or markets—not busts caused by artificial credit booms.

The boom phase in the Austrian business cycle takes place because the central bank supplies more money than the public wishes to hold at the current rate of interest and thus the latter starts to fall. Loanable funds exceed demand and then start to be used in non-productive areas, as in the case of the boom 2002–2007 in the housing market. These mistakes during the boom are only revealed by the market in the bust.

The Great Recession was a product of the excessive money creation and artificially low interest rates caused by central banks that on that occasion went into housing. The recession was necessary to correct the mistakes and the malinvestment caused by interference with market interest rates. The recession is the economy attempting to shed capital and labour from where it is no longer profitable. No amount of government spending and interference will avoid that correction.

Crucial to the Austrian Business Cycle Theory (ABCT) is the notion of a “natural rate of interest” ie how much it would cost to borrow if it wasn’t for government interference.  In ‘free markets’, the supply and demand for funds to invest will set a rate of interest that brings investment and savings into line, as long as the markets for funds are fully competitive and everybody has clear knowledge on all transactions. 

Already, you can see that these assumptions are not realistic.  Even if the assumption of perfect competition was realistic, there is no reason to think that there is one interest rate for an economy. Rather there is one rate for houses, another for cars, another hotel construction etc. This point was even accepted by the Austrian school guru, Fredrick Hayek, who acknowledged that there is no one ‘natural rate’ of interest.

But without one natural rate of interest, you can’t claim the government is forcing rates too low and therefore the theory crumbles. Yes, the central bank controls a component of the interest rate that helps determine the spread at which banks can lend, but the central bank does not determine the rates at which banks lend to customers.  It merely influences the spread.  Aiming at the Fed’s supposed “control” over interest rates misunderstands how banks actually create money and influence economic output.

The primary flaw in the Austrian view of the central bank has been most obvious since Quantitative Easing started in 2008.  Austrian economists came out at the time saying that the increase in reserves in the banking system was the equivalent of “money printing” and that this would “devalue the dollar”, crash T-bonds and cause hyperinflation. None of this came about.  

Marx 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 only 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.  Actually, the main exponent of the ‘natural rate of interest’, Knut Wicksell conceded this point. 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.”

The leading proponents of the Austrian School usually shy away from considering empirical evidence for their theory.  For them, the logic is enough.  But a reader of my blog recently sent me a bag of empirical studies that purport to prove that the Austrian school business cycle theory is correct: namely that when the market rate of interest is driven below the ‘natural rate’ there will be excessive credit expansion that will eventually lead to a bust and crisis.

In one of these studies, Austrian economist James Keeler proxies the market and ‘natural’ interest rates by using short- and long-term interest rates in yield curves.   The natural rate of interest is proxied by the long-term bond yield, and if the short term rate remains well below the long term rate, credit will expand to the point when there is a bust.  That happens when the short-term rate shoots up and exceeds the long or vice versa ie there is an inverse yield curve.  This is what his empirical study shows. Indeed, JP Morgan reckons on this basis the current probability of a slump in the US economy within a year is about 40-60%.

But while it may be that an inverted yield curve correlates with recessions, all it really shows is that investors are ‘fearful’ of recession and act accordingly.  The question is why at a certain point, investors fear a recession and and start buying long-term bonds driving down the yield below the short-term rate.  Moreover, when you look at corporate bonds in the capitalist sector, there is no inverted curve.  Longer-term corporate bonds generally have a much higher yield than short-term bonds.

Another Austrian study by Ismans & Mougeot (2009) examined four countries, France, Germany, Great Britain, and USA between 1980 and 2006. This found that “the maxima of the ratio of consumption expenditures to investment expenditures are often reached during the quarters of recession or during the quarters just after recessions. This observation corroborates the Austrian hypothesis of overinvestment liquidation marking crisis.”  But again the study relies on short and long-term interest rates and argues that “the term spread inversions mark the turning points of the aggregate economic activity. When the term spread decreases, the structure of production becomes less roundabout as entrepreneurs reallocate resources away from production goods to consumption goods.”  In other words, when short-term interest rates rise or long-term rates fall, investors stop investing in capital goods and business investment falls while consumption rises or stays the same.  Again, why does the yield curve to start to invert?  Which is the causal direction?  Is it falling investment in productive goods and services that drives long-term yields down or vice versa?

Carilli & Dempster attempt to answer this query in another study by carrying out a Granger causality test on two chosen indices of the ‘natural interest rate’ : 1) the real growth rate in GDP 2) the personal savings-consumption ratio. But they find that there is a marked lack of correlation between interest rates and economic activity. 

Indeed, there is little evidence that the rate of interest is the driving force of capitalist investment and the price signal that capitalists look for to make investment decisions.  A recent study by Dartmouth College, found that:

“First, profits and stock returns both have strong predictive power for investment growth, persisting many quarters into the future. Second, interest rates and the default spread—our proxies for discount rates—are at best weakly correlated with current and future investment. In short, changes in profitability and stock prices appear to be much more important for investment than changes in interest rates and volatility.”

Similarly, the US Fed concluded in their own study that: A fundamental tenet of investment theory and the traditional theory of monetary policy transmission is that investment expenditures by businesses are negatively affected by interest rates. Yet, a large body of empirical research offer mixed evidence, at best, for a substantial interest-rate effect on investment…., we find that most firms claim to be quite insensitive to decreases in interest rates, and only mildly more responsive to interest rate increases.”

Some economists in the Austrian school have tried to gauge when the tipping point into recession might be by measuring the divergence between the growth in credit and GDP growth (see Borio and White, Asset prices, financial and monetary stability, BIS 2002).  Apparently, there is a point when credit loses its traction on economic growth and asset prices and then growth collapses. But why? The Austrians cannot answer this because they ignore the fundamental flaw in the capitalist process identified by Marx in his law of profitability.

What drives capitalist economies and capital accumulation are changes in profits and profitability.  Economic growth in a capitalist economy is driven not by consumption as the Austrians claim, but by business investment. That is the swing factor causing booms and slumps in capitalist economies.  And business investment is driven mainly by one thing: profits or profitability – not interest rates, not ‘confidence’ and not consumer demand. It is when the rate of profit starts to fall; and then more immediately, when the mass of profits turns down. Then the huge expansion of credit designed to keep profitability up can no longer deliver.