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US rate of profit update

November 18, 2017

The latest data for net fixed assets in the US have been released, enabling me to update the calculations for the US rate of profit a la Marx up to 2016.

Last year, I did the calculations with the help of Anders Axelsson from Sweden, who not only replicated the results to ensure their accuracy (and found mistakes!), but also produced a manual for carrying out the calculations that anybody could use.

As I did last year and in previous years, I have also updated the rate of profit using the method of calculation by Andrew Kliman (AK) that he first carried out in his book, The failure of capitalist production AK measures the US rate of profit based on corporate sector profits only and using the BEA’s historic cost of net fixed assets as the denominator.

I also calculate the US rate of profit with a slight variation from AK’s approach, in that I depreciate gross profits by current depreciation rather than historic depreciation as AK does, but I still use historic costs for net fixed assets.  The theoretical and methodological reasons for doing this can be found here and in the appendix in my book, The Long Depression, on measuring the rate of profit.

The results of the AK calculation and my revised version are obviously much the same as last year – namely that AK’s measure of the rate of profit falls persistently from the late 1970s to a trough in 2001 and then recovers during the credit-fuelled, ‘fictitious capital period’ up to 2006.  The 2006 peak in the rate is higher than the 1997 one.   My revised version of AK’s measure shows a stabilisation of the profit rate at the end of the 1980s, after which profitability does not really rise much (although there are various peaks up to 2006).  What the new data for 2016 do reveal, however, is that profitability (on both measures) has remained below the peak of 2006 (i.e. for the last ten years) and has fallen for the last two.  And, of course, the long-term secular decline in the US rate is confirmed on both measures, some 25-30% below the 1960s.

But readers of my blog and other papers know that I prefer to measure the rate of profit a la Marx by looking at total surplus value in an economy against total productive capital employed; so as close as possible to Marx’s original formula of s/c+v.  So I have a ‘whole economy’ measure based on total national income (less depreciation) for surplus value; net fixed assets for constant capital; and employee compensation for variable capital.  Most Marxist measures exclude a measure of variable capital on the grounds that it is not a stock of invested capital but circulating capital that cannot be measured from available data.  I don’t agree and G Carchedi and I have an unpublished work on this point.  Indeed, even inventories (the stock of unfinished and intermediate goods) could be added as circulating capital to the denominator for the rate of profit, but I have not done so here as the results are little different.

Updating the results from 1946 to 2016 on my ‘whole economy’ measure shows more or less the same result as last year, as you might expect.  I measure the rate in both historic and current cost terms.  This shows that the overall US rate of profit has four phases: the post-war golden age of high profitability peaking in 1965; then the profitability crisis of the 1970s, troughing in the slump of 1980-2; then the neoliberal period of recovery or at least stabilisation in profitability, peaking more or less in 1997; then the current period of volatility and eventual decline.  Actually, the historic cost measure shows no recovery in the rate of profit during the neoliberal period.  The current cost measure always shows much greater upward or downward movement.  On this measure, the post-war trough was in 1982 while on the historic cost measure, it is 2009 at the bottom of the Great Recession.

What is new about the 2016 update is that the US rate of profit fell in 2016, after a fall in 2015.  So the rate of profit has fallen in the last two successive years and is now 6-10% below the peak of 2006.

One of the compelling results of the data is that they show that each economic recession in the US has been preceded by a fall in the rate of profit and then by a recovery in the rate after the slump.  This is what you would expect cyclically from Marx’s law of profitability.

In a recent paper, G Carchedi identified three indicators for when crises occur: when the change in profitability; employment; and new value are all negative at the same time.  Whenever that happened (12 times since 1946), it coincided with a crisis or slump in production in the US.  This is Carchedi’s graph.

My updated measure for the US rate of profit to 2016 confirms the first indicator is operating.  The graph above shows that in the last two years there has been a 5%-plus fall.  However, new value growth is slowing but not yet negative; and employment growth continues.  So on the basis of these three (Carchedi) indicators, a new recession in the US economy is not imminent.  Also the mass of profit or surplus value rose (if only slightly) in 2016, and so again does not provide confirmation of an imminent slump.

What the updated data do confirm is my guess last year that 2016 would show a fall in the US rate of profit – and by all the measures mentioned. And, of course, Marx’s law of profitability over the long term is again confirmed.  There has been a secular decline in US profitability, down by 28% since 1946 and 15-20% since 1965; and by 6-10% since the peak of 2006.  So the recovery of the US economy since 2009 at the end of the Great Recession has not restored profitability to its previous level.

Also, the driver of falling profitability has been the secular rise in the organic composition of capital, which has risen nearly 20% since 1965 while the main ‘counteracting factor’, the rate of surplus value, has fallen 4%.  Indeed, even though the rate of surplus value has risen 5% since 1997, the rate of profit has fallen 5% because the organic composition of capital has risen over 12%.

Has the US rate of profit slowed further in 2017?  We can use quarterly data from the US Federal Reserve on the non-financial corporate sector to get a rough idea.  The Fed data suggest that the rate of profit in the first half of 2017 was flat at best.

So, if the rate of profit is a good indicator of an upcoming slump in capitalism, then the jury is out on the likelihood of slump in 2018.  However, the rate of profit is still down from its peaks of 1997 and 2006 and now appears to be flat lining at best.


Value, class and Capital

November 12, 2017

This year’s Historical Materialism conference in London focused on the Russian revolution as well as the 150th anniversary of the publication of Marx’s Volume One of Capital.  Naturally, I concentrated on presentations that flowed from the latter rather than the former.

Indeed, the main plenary at HM was on Marx’s theory of value and class – and the annual winner of the Isaac Deutscher book prize announced at the HM was William Clare Roberts’ Marx’s Inferno, which seemed to be a ‘political theory’ of capital seen through the prism of Dante’s famous poem.  Maybe, more on that later.

The plenary speakers were Moishe Postone, Michael Heinrich and David Harvey – an impressive line-up of heavyweight Marxist academics.  Postone is co-director of the Chicago Center for Contemporary Theory and faculty member of the Chicago Center for Jewish Studies.  His 30-min speech was difficult to understand, being couched in polysyllabic academic jargon. But I think the gist of it was that we cannot consider the class struggle under capitalism as just between exploited workers and capitalists any longer, as it now involves race, creed and gender and a new populism of the right.  So we need to rethink Marx’s theory of class.

For this reason, “orthodox Marxism” is a hindrance.  The old meaning of class struggle is not essential.  As for Marx’s theory of value, it is specific to capitalism, but it has changed and exploitation is now over the amount of time we all have rather than over the production of surplus value.  Now I think that is the gist of what he said, but frankly, I cannot be sure because Postone’s exposition was so incomprehensible.

The next speaker was Michael Heinrich, the well-known German expert of Marx’s Capital and close researcher of Marx’s original writings in the so-called MEGA project.  Now readers of this blog will know that Heinrich and I have debated before on whether Marx’s law of the tendency of the rate of profit is logical and whether Marx himself dropped it; and we published on this issue.

In his presentation, Heinrich agreed with Postone that value is a category specific to capitalism, but he reckons that Marx changed his conception of both class and value over his lifetime.  So it is not possible to pull quotes from Marx like random rocks in a stone quarry.  Each quote must be placed in its context and time.  For example, Marx’s definition of class struggle as found in the Communist Manifesto in 1848 differs with his later definitions of class at the end of Capital Volume 3.

Similarly, Marx’s concept of value changed over time.  Early on, value is seen to come from the production process and the exploitation of labour power by capital.  Later on, Marx revised this view to argue that value was only created at the point of exchange into money.  Similarly, Marx thought that a rising organic composition of capital would lead to a fall in the rate of profit, but later he recognised that more machines could raise the rate of surplus value and so the rate of profit may not fall.

Heinrich has the advantage over us in reading Marx’s original words in German, but they remain his interpretations of Marx’s meaning. Heinrich, in effect, argues that value is not a material substance, namely the expenditure of human energy in labour that can be measured in labour time, but only exists in the form of money.  In my view and in the view of many other Marxists, this denies the role of exploitation of labour in production, which comes first.  Yes, you can only see value in the form of money, but then you cannot see electricity until the light comes on, but that does not mean it does not exist before the light glows.  For an excellent critique of Heinrich’s interpretation of Marx’s value theory, see G Carchedi’s book, Behind the Crisis, chapter 2).

Does any of this matter, you might say?  Are we not just discussing how many angels are there on the head of a needle, as medieval Catholic theologians did?  Well, yes.  But I think there are some consequences from deciding that value is only created in exchange and also that class struggle is not really centred (any longer) on workers and capitalists in the production process.  For me, such theories lead to the idea that crises under capitalism are caused by faults in the ‘circulation of money and credit’ and not in the contradictions of capitalism between productivity and profitability in the production of surplus value, as I think Marx argued.  And the revisions of the nature of class struggle could lead to the removal of the working class as the agent for socialist change.

There is a similar problem with David Harvey’s presentation.  Again, Harvey has made a massive contribution to expounding and defending Marx’s ideas as expressed in Capital to explain the workings of the capitalist mode of production.  I have presented my critique of Harvey’s more novel propositions on this blog before and he has also criticised my ‘orthodox’ view.

In his presentation, Harvey again looked to be ‘innovatory’ in an attempt to raise new categories in Capital.  Yes, value is ‘phantom-like’ (can’t be seen), but objective (i.e. real) and only appears as money.  But Harvey wants us to consider new terms like ‘anti-value’.  What does Harvey mean by this?  Apparently, money and credit can be created without the backing of value.  Marx called this ‘fictitious capital’ because it was not real capital based on the production of value and surplus value by the exploitation of labour, but merely the title to assets that may or may not be supported by new value.  In that sense, investment in financial assets produces fictitious profits.

Now Harvey wants to change the name of this category to ‘anti-value’ because he thinks that in doing so it can show that there are obstacles to the flow of capital (value) in the realisation of value.  Thus crises can originate or be caused from breaks in the circuit of capital outside the production process itself.  Similarly, Harvey came up with what he called ‘value regimes’.  ‘World money’ as represented by gold no longer controls the value of fiat money (money ‘printed’ and backed by governments), particularly after the US dollar came off the gold standard in 1971.  So now we have ‘value regimes’ like the dollar area, the euro and more recently, the Chinese yuan.  Again, I think all this was saying was that various economic national state powers are trying to gain the biggest shares of global value and in so far as they are successful, their currencies will be stronger relative to others over time.  I failed to see why we needed new terms or concepts to ‘explain’ this.  But there we are.

Of course, things have changed over the last 150 years since Marx formulated his critique of capitalism and political economy and published Capital.  Capitalism is now global, finance capital has expanded dramatically, imperialist power blocs have developed and capital has become ever more concentrated and centralised.  But it seems to me that the laws of motion in the capitalist mode of production have not so fundamentally changed that we need new categories to explain them; or we need to drop Marx’s basic value theory or his main law of the contradiction between productivity and profitability to explain crises and instead search for other explanations in the money and credit circuit.

If we do that, then we also reduce the role of the proletariat as the main agency for revolutionary change.  And in my view, it still is, if only by the absence of success in the last 150 years.  Revolutions based on the peasantry (China) or isolated in one country (Russia) have not delivered socialism even if they have removed capitalism, for a while.  Only the global proletariat in unity can do that.

The idea that Marx’s theory of value and crises is out of date and needed amending was the theme of my own paper at HM.  I quoted John Maynard Keynes in commenting that Capital was “an obsolete textbook which I know to be not only scientifically erroneous but without interest or application for the modern world”.  I wanted to defend Marx against this view of Keynes, which is still prevalent not only in bourgeois analysis, but also in recent biographies of Marx by former Marxist historians who claim that Marx was a man of 19th century with little to tell us about the 21st.

My paper above all aimed to show that Keynesian ideas have nothing in common with Marx’s critique of capitalism and are thoroughly designed to restore capitalism in crisis and make it work better.  HM London November 2017 This, I think, is important, because Keynesian theory and policies dominate the minds of the labour movement everywhere, as though they were a workable and radical alternative, while Marxist theory is ignored.

Of course, this is no accident because if you accept Marx’s critique of capitalism, you are compelled to require a revolutionary transformation of the capitalist mode of production – something that remains frightening, not just to the leaders of the labour movement, but also to many activists who fear the risks involved in revolutionary change.

My paper argued that, contrary to Keynes’ view, the labour theory of value provides a logical and empirically verifiable explanation of the capitalist mode of production, while, in contrast, the mainstream ‘marginalist’ theory is false, indeed unfalsifiable.  Marx’s great discovery about capitalism is that it is a system of exploitation of labour power to appropriate value produced by workers as surplus value or profit through sale on the market for commodities.  That is where profit comes from.  Keynes, like all mainstream economics, denied profit is the result of unpaid labour.  For him, profit is the marginal return on investment and justified to the capitalist.

Marx’s theory of crises means that rising productivity of labour through increased investment in means of production relative to labour will lead to the contradictory fall in profitability, engendering recurring crises.  Keynes, instead, saw slumps or depressions as due to a collapse in the ‘animal spirits’ of entrepreneurs and/or to too high interest rates charged by financiers. Crises are a ‘technical problem’ that can be corrected by boosting the ‘confidence’ of capitalists and lowering interest rates, or in the extreme, getting governments to spend to prime the pump of private industry.

For Keynes, once such measures are used to deal with these occasional slumps, then capitalism will be set fair for a golden future where hours of toil will fall dramatically with the use of technology; scarcity and poverty would disappear; and the main problem would be how to use our leisure time.  Well, now 80 years after Keynes argued this, more than 2bn people are in dire poverty, inequality has never been greater, technology is threatening to take away many jobs and the average working life has not fallen at all.  Moreover, the Keynesian prescriptions of easy money (QE) and government spending have signally failed to revive capitalism in the major economies since the Great Recession.  The Long Depression, as I have called it, remains.

Indeed, in my session, veteran French Marxist Francois Chesnais presented his thoughts from his book, Finance Capital Today, which was short listed for the Deutscher prize.  Chesnais argued that the current depression would never end.  The rate of profit globally is still falling and global debt is steadily rising.  The Great Recession has not ‘cleansed’ the system. And now global warming threatens to destroy the planet.

Now I am not quite so ‘pessimistic’ (or is it optimistic?) that capitalism is in its last throes.  But it is possible that capitalism could sink into ‘barbarism’ or the collapse of living standards, as the Roman slave empire did after 400AD, without being replaced by a new mode of production.  As Carchedi put it in a recent paper at the Capital.150 symposium, ‘the old is dying but the new cannot be born’ (Gramsci).  But capitalism could also stagger on with some revival in profitability after new slumps and the renewed opportunity to exploit new sources of labour in Africa and the periphery.  It will require the action of the global working class to achieve socialism.  It won’t come just because capitalism flounders economically.

Marx’s Capital provides us with the clearest and most compelling analysis of the nature of the capitalist mode of production and also its irreconcilable contradictions that show why capitalism is transient and cannot last forever, contrary to what the apologists for capital claim.

I don’t think we need to invent new and often confusing terms or categories to explain modern capitalism 150 years since Capital was published; or deny the role of exploitation in the creation of value at the heart of capitalism; or reduce the role of the global proletariat in ending it.

Brazil: the debt dilemma

November 10, 2017

Brazil faces a presidential election in October 2018.  This will offer a new benchmark for which way Brazilian politics and the economy will go.  Will a coalition of pro-big business parties and a president win or will a coalition led by the Workers party return to power under a leftist president (possibly Lula, the former president)?

Nobody I met in my visit to Brazil last week was sure what would happen.  International capital is optimistic that the current neo-liberal administration will gain a four-year term, possibly under former vice-president Temer or maybe Sao Paulo Mayor Joao Doria, a businessman and former TV show host.  Doria has expressed presidential ambitions and urged ‘centrist parties’ (ie pro-big business) to forge a common platform to combat ‘extremist candidates’ (Workers party). He appears to be Brazil’s version of Donald Trump.  He wants to “gradually” sell off Brazil’s greatest state asset, oil giant Petrobras. “There is no need for Petrobras to keep being a state-owned company. Brazil is isolated in the world. We can’t be afraid to do what’s necessary to insert Brazil in the global and liberal economy,” he said.  He is also in favour of privatizing Brazil’s electricity utility Eletrobras, ports, airports, railways, and waterways.

And he backs the usual neo-liberal measures (called “structural economic reforms”) designed to boost the rate of exploitation: weakening the unions; making it easier to fire workers; reducing their rights and conditions etc.  He also wants to cut pension terms and cut taxes for the rich and corporations. “The next president will have to prioritize pension reform,” he says.

All this is much in line with the policies of the current President Temer who got the job after Congress (controlled by the right parties) managed to get elected Workers party President Dilma Rousseff impeached and removed on charges of corruption (operation car wash).

Interestingly, Doria does not agree with Trump on protectionism.  In contrast, he wants a more “open economy” and a floating exchange rate. “We must avoid any protectionism that limits the country’s economic growth.”   Doria also wants to preserve Brazil’s central bank independence – classic position of finance capital – keeping it out of democratic accountability.  All this is pretty similar to Temer.  Indeed, if Doria became president, he would probably keep the same economic and financial team as Temer has.

However, the problem for the pro-capitalist forces is that Doria and Temer’s economic platform is unpopular among the majority of Brazilians – not surprisingly.  Indeed, Doria is careful to say that he will ‘preserve’ the highly popular Bolsa Familia benefit scheme for the poor that the Lula administration introduced.  As the World Bank has shown, 62% of the decline in extreme poverty in Brazil between 2004 and 2013 was due to changes in non-labor income (mainly conditional cash transfers under the Bolsa Família program).

Also, Temer is extremely unpopular, with poll ratings well below even Trump’s in the US.  That’s because he usurped the job from Dilmar and also avoided charges of corruption because of the backing of the right-wing majority in Congress.  Lula is now the most popular politician in Brazil again and could win the presidency, except he too has been found guilty of corruption in the courts and thus faces being banned as a candidate.

Meanwhile, the big economic issue is whether Brazil can recover from the deep recession that it entered in 2014 and only now is making a mild and weak recovery.

Temer is relying on foreign investment from multi-nationals and speculative investor flows to sustain this limited recovery but he may well be disappointed.  As a result of the slump, public sector debt has rocketed along with successive large deficits on the annual government budget.

Discretionary spending (education, health, transport etc) has been cut to the bone and now Temer, Doria and their backers want to destroy the state pension scheme in order to reduce debt and ‘balance the budget’.

Together with the increase in retirement age, the government is proposing the elimination of pensions by length of service and increasing from 15 to 25 the number of years of contributions necessary to qualify for an old age pension.

Brazil’s 27 states are also in deep trouble. Rio de Janeiro has had to delay payment of civil servant salaries (currently with a two months’ delay) and defaulted on its debt repayments. Rio Grande do Sul and Minas Gerais are also close to insolvency, while almost all other states are facing liquidity constraints and several are running up growing arrears with suppliers and employees.  In response the Temer government wants to introduce a 20-year fiscal austerity plane and shift the debt of the states into the hands of a separate off-balance sheet agency that will ‘manage’ the debt using taxpayer revenues.

I participated in a public hearing at the Brazilian Senate committee on human rights and an international conference on this issue of debt.  Both events were organised by Brazil’s Citizens Audit, a group with labour union support, that has been campaigning to explain why Brazil’s public debt is so high and the iniquity of the planned ‘privatising’ of debt management into the hands of the banking sector with losses for taxpayers and major liabilities.

I presented paper along with many other academics and activists from Latin America attending.  In my paper, I emphasised the huge rise in public sector debt globally – the result of the bailouts of the global banking crash and subsequent global recession of 2008-9 – and the role played by international agencies in taking over the management of debt in distressed economies at the expense of public services.

In Brazil’s case, the public sector debt has always been high compared to other so-called emerging economies, despite public services being poor, because of very high interest rates on the debt and because tax revenues are relatively low.

The World Bank claims that “a large structural fiscal imbalance lies at the heart of Brazil’s present economic difficulties. While revenues are cyclical and have declined during the recession, spending is rigid and driven by constitutionally guaranteed social commitments, in particular on generous pension benefits.”  So it is the fault of too much spending and too generous pensions, according to the World Bank.  But this is ideological nonsense.

Brazil is the most unequal society in the G20 (apart from South Africa).  But its tax system allows the richest income and wealth holders to get off lightly while the poor pay more – in other words, the tax system is very regressive and the tax base avoids the rich.  As a result, interest costs on the public debt relative to tax revenues are the highest in the world.

Indeed, Brazil’s Oxfam has shown in a recent report that, if the tax system was made progressive; tax avoidance schemes were stopped; and tax evasion (including the use of offshore funds a la the Panama and Paradise papers) was ended, Brazil’s tax revenues would be more than enough to improve public services, protect pensions and social benefits.

The economic collapse of 2014-16 has been followed by a weak recovery.  Indeed, the latest report on South America by the World Bank makes dismal reading.  The bank says: “economic activity remains on track to recover gradually in 2017-18, but long-term growth remains stuck in low gear”Growth has only turned positive because the world economy has picked up in the last year.  As the bank says: “A favorable external environment is helping the recovery. Global demand is getting stronger and easy global financial conditions—low global market volatility and resilient capital inflows—are boosting domestic financial conditions.”

But “despite this ongoing recovery, prospects for strong long-term growth in Latin America and the Caribbean look dimmer. In the next 3-5 years, Latin America is projected to grow 1.7 percent in per capita terms. This growth rate is almost identical to the region’s performance over the past quarter century and only marginally better than those in advanced economies, raising concerns that the region is not catching up to income levels in advanced countries.”

The World Bank, along with the IMF, forecasts just 0.7% growth this year for Brazil and 1.5% in 2018.  The domestic economy remains very weak.  Industrial production is up only on exports.  Capital investment remains down.

Average real incomes are still below the peak of 2014 even though inflation has dropped off from the recession.

The underlying reality is that Brazilian capital is still suffering from a long-term fall in its profitability from which it seems unable to escape, despite squeezing the labour force.

The World Bank points out that corporate debt as a share of GDP increased from an average of 23% of GDP in 2009 to 25% in December 2016) and a large share of corporates are overleveraged.  It is Brazil’s capitalist sector that is in trouble.  Naturally, the World Bank and the IMF suggest as solutions the usual batch of neo-liberal measures already adopted by Temer and proffered by Doria.

When the Brazilian economy boomed with the commodity price explosion of the 2000s, Brazil “experienced an unprecedented reduction in poverty and inequality” (World Bank) and 24 million Brazilians escaped poverty. And the gini coefficient of inequality of incomes fell from the shocking height of 0.59 to 0.51.

But after the recession of 2014-16 and under the Temer presidency, it is rising again.  The international agencies, foreign investors and Brazilian big business want an administration in power for four more years from 2018 to impose austerity, labour ‘flexibility’ and privatisations.  That will drive up inequality further.  Ironically, it won’t reduce the public sector debt because economic growth and tax revenues will be too low.  Indeed, the IMF forecasts debt will be much higher by 2002.

The World Bank sums up the state of affairs: “As the 2018 elections approach, the unity of the ruling coalition is likely to be increasingly tested. The 2018 presidential race remains very open and may result in new alliances which could reshuffle the political landscape. Further, the debate on the need for and the appropriate strategy to carry out fiscal adjustment and microeconomic reforms remains polarized.”

The Russian revolution: some economic notes

November 8, 2017

It’s almost exactly 100 years to the day (on the modern calendar) since the revolutionary insurrection in St Petersburg that led to the Bolshevik wing of the Russian Social Democrats gaining control of the major organs of power and establishing the rule of workers Soviets.

There has been much written about the ‘Russian revolution’ since and in past few weeks and months.  As this is a blog about economics, I shall just make a few notes about the economic foundations of the revolution and the ‘experiment’ of a planned, non-capitalist economy in a poor country amid the world of capital.

In hindsight, that the Russian people decided to end the 370-year rule of the Ivanov monarchy in 1917 was no surprise.  The world was changing: capitalism was becoming dominant and, with it, industrialisation.  An absolute monarchy sitting on a peasant country that was industrialising in the cities was an anachronism.  What was unique was that the Russian people went on to establish a republic and eventually a state where capitalism and imperialism had no control within just a few months.

The objective conditions for change were ripe. Russia was a poor country. It had great resources but these were ‘locked in’ by the vast size of the country and the extreme climate. Even in 1914, 85 per cent of the population were still peasants. Peasants had to practise subsistence farming. Economically, the vast majority of the population contributed very little to Russian society.  Rural peasants had been emancipated from serfdom in 1861, but the land was still owned by a few: 1.5% of the population owned 25% of it.

Workers too had good reasons for discontent: overcrowded housing, long hours at work- usually as much as 10 hours a day, six days a week- very poor safety and sanitary conditions, harsh disciplines, and maybe worst of all, inadequate wages with concurrently rising inflation; a recipe for economic turmoil. In one 1904 survey, it was found that an average of 16 people shared each apartment in St Petersburg, with as many as 6 people in each room.

But from the 1890s, under a succession of Tsarist ministers railways were built, foreign investment attracted and landholdings partially reformed. Economic growth rates averaged 9 per cent from 1894–1900. These were huge rates of change, even though most industrial investment was wasted on armaments because Tsar Nicholas II wanted to protect Russia’s position as a great power in competition with Japan in the east and Germany in the west.

The Witte years of economic reform from 1890-1905 brought some certain modernization and industrialization with them, but this expansion was uneven and depended on foreign capital, mainly French bank loans. Then there were five consecutive years of bad harvests from 1901-1905.  And the defeat by Japan in the 1906 war was the straw that broke the camel’s back and sparked the 1905 revolution – the dress rehearsal for 1917.

From 1905-1914, the economy grew at an annual rate of growth of 6%. Between 1890 and 1910, the population of St Petersburg doubled from just over a million and Moscow experienced similar growth.  This created a new proletariat, a much more dangerous threat to Tsarism than the peasantry had been. From 1911 to 1914, political discontent grew.

The First World War only added to the chaos; the vast demand for war supplies and workers caused more strikes, at the same time as conscription stripped skilled workers from the cities, and had to be replaced by unskilled peasants. The war brought famine due to the poor infrastructure of the railways and the need for supplying soldiers at the front. Ultimately, the soldiers themselves turned against the Tsar, bringing him down and with the formation of a republic eventually under the Bolsheviks the war was ended through an agreement on harsh terms with the Germans.

In the two years following the Revolution, there was an economic catastrophe. By 1919, average incomes in Soviet Russia fell by half that of 1913, a fall that had not been seen in Eastern Europe since the 17th century (Maddison 2001).

Worse was to come. After another run of disastrous harvests, famine conditions began to appear in the summer of 1920. An average worker’s daily intake fell to 1,600 calories, about half the level before the war. Spreading hunger coincided with a wave of deaths from typhus, typhoid, dysentery and cholera. In 1921, the grain harvest collapsed further, particularly in the southern and eastern grain-farming regions. More than five million people may have died prematurely from hunger and disease. Russia suffered 13 million premature deaths from conflict and famine. This was one in ten of the population living within the future Soviet borders in 1913.  And all this while a savage civil war raged as invading foreign armies and reactionary domestic forces tried to displace Soviet rule.

Eventually, after the victory of the Soviet government in the civil war and the stabilisation of the regime, economic performance, particularly after the New Economic Policy reforms from 1924, began to pick up.

And then during the period up to 1945, there was a dramatic rise in GDP per capita with industrialisation under the planned economy. That accelerated after 1945 and up to the 1970s.  Indeed, from 1928-1970, the USSR was the fastest growing economy except for Japan!

And even compared to the Third World, its performance was remarkable.

In 1952, the Soviet Union was only behind Ireland and Western Europe as a whole. By 1975, the USSR had a higher GDP per capita than Mexico, Latin America, Colombia, South Korea and Taiwan.

The success of the Soviet extensive growth model in the 1950s and 1960s was undeniable. But a phase of economic stagnation began in the 1970s.  The attempt to move to a new regime of intensive accumulation to one based on high productivity growth failed. And the militarization of the economy because of the cold war used up valuable productive investment potential.  The Russian elite tried to alter the economic model to one relying on the export of resources, rather develop industry and technology.  The economy became a one trick pony.

The attempt of Perestroika to build ‘market socialism’ and dismantle the plan was the final straw. Gorbachev’s reforms disrupted the system of planning and distribution and provoked chronic excess domestic demand and in the need for foreign imports.

With the collapse of the Soviet state, the wealth acquired by Soviet state managers during the Perestroika allowed them to take advantage of the ‘shock therapy’ reforms in the 1990s, turning themselves into what we now call the Russian oligarchs.

The ‘shock therapy’ introduction of capitalism led to the worst peacetime collapse in a major economy since the Industrial Revolution. By 1998, Russia’s GDP was 39% below its 1991 level.

As the Russian economy imploded, the opposite was happening in China, where the relaxation of restrictions on private capital development was combined with state control and planned and state-led heavy investment.  In the subsequent 16 years China has enjoyed the greatest economic growth ever seen in human history.

The Russian capitalist economy eventually recovered with global commodity price boom after 1998, but by 2014, Russia’s average annual GDP growth was still only 1.0%.  Life expectancy in capitalist Russia has now been surpassed by the Chines economic model.

One key lesson that we can draw from the Russian experiment is that it could not succeed indefinitely in the face of world capital.  Marx and Engels remarkably anticipated the eventual failure of the Russian Revolution. Marx thought that successful communist revolution presupposed the existence of an integrated world economy.

“The proper task of bourgeois society is the creation of the world market … the colonisation of California and Australia and the opening up of China and Japan would seem to have completed this process. For us, the difficult QUESTION is this: on the Continent revolution is imminent and will, moreover, instantly assume a socialist character. Will it not necessarily be CRUSHED in this little corner of the earth, since the MOVEMENT of bourgeois society is still in the ASCENDANT over a far greater area?”

And yet Marx also saw that the socialist transformation would not have to wait for each national capitalist economy to ‘mature’.  As he wrote, “If the Russian Revolution becomes the signal for a proletarian revolution in the West, so that the two complement each other, the present common ownership of land may serve as the starting point for communist development.”

Unfortunately, the revolution in the West did not materialise.  While the planned economy succeeded in transforming the lives of millions, Russia was isolated, surrounded and very quickly the regime itself degenerated into a totalitarian dictatorship and finally into a corrupt capitalist autocracy far from the aims of the revolution of 1917.

These are just a few notes.  For a comprehensive description of how a socialist society might operate based on a commonly owned and controlled economy, see Ernest Mandel’s treatise, In defence of socialist planning.  And for a compelling arguments on the feasibility of a planned economy delivering the needs of people, see Cottrell and Cockshott’s paper, Socialist planning after the collapse of the Soviet Union.



Xi takes full control of China’s future

October 25, 2017

Xi Jinping has been consecrated as China’s most powerful leader since Mao Zedong after a new body of political thought carrying his name was added to the Communist party’s constitution.  The symbolic move came on the final day of a week-long political summit in Beijing – the 19th party congress – at which Xi has pledged to lead the world’s second largest economy into a “new era” of international power and influence.

At a closing ceremony in the Mao-era Great Hall of the People it was announced that Xi’s Thought on Socialism with Chinese Characteristics for a New Era had been written into the party charter. “The congress unanimously agrees that Xi Jinping Thought … shall constitute [one of] the guides to action of the party in the party constitution,” a party resolution stated.

At the same time, the new Politburo standing committee of seven was announced.  These supreme leaders are all over 62 and so will not be eligible to become party secretary in five years.  That almost certainly means that Xi will have an unprecedented third term as party leader through to 2029 and thus remain head of the Chinese state machine for a generation.

What this tells me is that, under Xi, China will never move towards the dismantling of the party and the state machine in order to develop a ‘bourgeois democracy’ based on a fully market economy and capitalist business.  China will remain an economy that is fundamentally state-controlled and directed, with the ‘commanding heights’ of the economy under public ownership and controlled by the party elite.

Foreign businesses don’t find this an appealing prospect, unsurprisingly. In a January survey of 462 US companies by the American Chamber of Commerce in China, 81 percent said they felt less welcome in China, while more than 60 percent have little or no confidence the country will further open its markets in the next three years.

Indeed, China still ranks 59th out of the 62 countries evaluated by the Organization for Economic Cooperation and Development in terms of openness to foreign direct investment. At the same time, FDI is becoming less important to the economy: in 2016 it accounted for a little more than 1 percent of China’s gross domestic product, down from around 2.3 percent in 2006 and 4.8 percent in 1996.

An even bigger cause for concern for multinationals are Beijing’s plans to replicate foreign technologies and foster national champions that can take them global. A program launched in 2015, called Made in China 2025, aims to make the country competitive within a decade in 10 industries, including aircraft, new energy vehicles, and biotechnology.  China, under Xi, aims not just to be the manufacturing centre of the global economy but also to take a lead in innovation and technology that will rival that of the US and other advanced capitalist economies within a generation.

Beijing aims to boost the share of domestically made robots to more than 50 percent of total sales by 2020, from 31 percent last year. Chinese companies such as E-Deodar Robot Equipment, Siasun Robot & Automation, and Anhui Efort Intelligent Equipment aspire to become multinationals, challenging the likes of Switzerland’s ABB Robotics and Japan’s Fanuc for leadership in the $11 billion market.

Under Xi, China has also redoubled efforts to build its own semiconductor industry. The country buys about 59 percent of the chips sold around the world, but in-country manufacturers account for only 16.2 percent of the industry’s global sales revenue, according to PwC. To rectify that, Made in China 2025 earmarks $150 billion in spending over 10 years.  A January 2017 report by the U.S. President’s Council of Advisors on Science and Technology detailed China’s extensive subsidies to its chipmakers, mandates for domestic companies to buy only from local suppliers, and requirements that American companies transfer technology to China in return for access to its market.

And American imperialism is scared.  U.S. Commerce Secretary Wilbur Ross has described the plan as an “attack” on “American genius.” In an excellent new book, The US vs China: Asia’s new cold war?, Jude Woodward, a regular visitor and lecturer in China, shows the desperate measures that the US is taking to try to isolate China, block its economic progress and surround it militarily.  But she also shows this policy is failing.  China is not accepting control by foreign multi-nationals; it is continually developing trade and investment links with the rest of Asia; and, with the exception of Abe’s Japan, it is succeeding in keeping the Asian capitalist states ambivalent between China’s ‘butter’ and America’s ‘arms’.’  As a result, China has been able to maintain its independence from US imperialism and global capitalism like no other state.

This brings us to the question of whether China is a capitalist state or not?   I think the majority of Marxist political economists agree with mainstream economics in assuming or accepting that China is.  However, I am not one of them. China is not capitalist. Commodity production for profit, based on spontaneous market relations, governs capitalism. The rate of profit determines its investment cycles and generates periodic economic crises.  This does not apply in China.  In China, public ownership of the means of production and state planning remain dominant and the Communist party’s power base is rooted in public ownership.  So China’s economic rise has been achieved without the capitalist mode of production being dominant.

China’s “socialism with Chinese characteristics” is a weird beast.  Of course, it is not ‘socialism’ by any Marxist definition or by any benchmark of democratic workers control.  And there has been a significant expansion of privately-owned companies, both foreign and domestic over the last 30 years, with the establishment of a stock market and other financial institutions.  But the vast majority of employment and investment is undertaken by publicly-owned companies or by institutions that are under the direction and control of the Communist party. The biggest part of China’s world-beating industry is not foreign-owned multinationals, but Chinese state-owned enterprises.

And here I can provide some new evidence that, as far as I know, has not been noticed by any other commentators.  Recently the IMF published a full data series on the size of public sector investment and its growth going back 50 years for every country in the world.  This data delivers some startling results.

It shows that China has a stock of public sector assets worth 150% of annual GDP; only Japan has anything like that amount at 130%.  Every other major capitalist economy has less than 50% of GDP in public assets.  Every year, China’s public investment to GDP is around 16% compared to 3-4% in the US and the UK.  And here is the killer figure.  There are nearly three times as much stock of public productive assets to private capitalist sector assets in China.  In the US and the UK, public assets are less than 50% of private assets.  Even in ‘mixed economy’ India or Japan, the ratio of public to private assets is no more than 75%.  This shows that in China public ownership in the means of production is dominant – unlike any other major economy.

A report by the US-China Economic and Security Review Commission ( found that “The state-owned and controlled portion of the Chinese economy is large.  Based on reasonable assumptions, it appears that the visible state sector – SOEs and entities directly controlled by SOEs, accounted for more than 40% of China’s non-agricultural GDP.  If the contributions of indirectly controlled entities, urban collectives and public TVEs are considered, the share of GDP owned and controlled by the state is approximately 50%.”  The major banks are state-owned and their lending and deposit policies are directed by the government (much to the chagrin of China’s central bank and other pro-capitalist elements).  There is no free flow of foreign capital into and out of China.  Capital controls are imposed and enforced and the currency’s value is manipulated to set economic targets (much to the annoyance of the US Congress and Western hedge funds).

At the same time, the Communist party/state machine infiltrates all levels of industry and activity in China.  According to a report by Joseph Fang and others (, there are party organisations within every corporation that employs more than three communist party members. Each party organisation elects a party secretary. It is the party secretary who is the lynchpin of the alternative management system of each enterprise. This extends party control beyond the SOEs, partly privatised corporations and village or local government-owned enterprises into the private sector or “new economic organisations” as these are called.  In 1999, only 3% of these had party cells.  Now the figure is nearly 13%.  As the paper puts it: “The Chinese Communist Party (CCP), by controlling the career advancement of all senior personnel in all regulatory agencies, all state-owned enterprises (SOEs), and virtually all major financial institutions state-owned enterprises (SOEs) and senior Party positions in all but the smallest non-SOE enterprises, retains sole possession of Lenin’s Commanding Heights.

The reality is that almost all Chinese companies employing more than 100 people have an internal party cell-based control system.   This is no relic of the Maoist era.  It is the current structure set up specifically to maintain party control of the economy.  As the Fang report says: “The CCP Organization Department manag(es) all senior promotions throughout all major banks, regulators, government ministries and agencies, SOEs, and even many officially designated non-SOE enterprises. The Party promotes people through banks,regulatory agencies, enterprises, governments, and Party organs, handling much of the national economy in one huge human resources management chart. An ambitious young cadre might begin in a government ministry, join middle management in an SOE bank, accept a senior Party position in a listed enterprise, accept promotion into a top regulatory position, accept appointment as a mayor or provincial governor, become CEO of a different SOE bank, and perhaps ultimately rise into upper echelons of the central government or CCP — all by the grace of the CCP OD.”

China’s Communist party is now writing itself into the articles of association of many of the country’s biggest companies. describing the party as playing a core role in “an organised, institutionalised and concrete way” and “providing direction [and] managing the overall situation”.

There are 102 key state enterprises with assets of 50 trillion yuan that include state oil companies, telecom operators, power generators and weapons manufacturers.  Xiao Yaqing, director of the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), wrote in the Central Party School’s Study Times, that, when a state-owned enterprise has a board of directors, its party boss also tends to be the board chairman. Communist Party members at state enterprises form the “the most solid and reliable class foundation” for the Communist Party to rule.  Xiao called the idea of the “privatisation of state assets” as wrong-headed thinking.

These 102 big conglomerates contributed 60 per cent of China’s outbound investments by the end of 2016.  State-owned enterprises including China General Nuclear Power Corp and China National Nuclear Corp have assimilated Western technologies—sometimes with cooperation and sometimes not—and are now engaged in projects in Argentina, Kenya, Pakistan and the UK.  And the great ‘one belt, one road’ project for central Asia is not aimed to make profit.  It is all to expand China’s economic influence globally and extract natural and other technological resources for the domestic economy.

This also lends the lie to the common idea among some Marxist economists that China’s export of capital to invest in projects abroad is the product of the need to absorb ‘surplus capital’ at home, similar to the export of capital by the capitalist economies before 1914 that Lenin presented as key feature of imperialism.  China is not investing abroad through its state companies because of ‘excess capital’ or even because the rate of profit in state and capitalist enterprises has been falling.

Similarly, the great expansion of infrastructure investment after 2008 to counteract the impact of collapsing world trade from the global financial crisis and Great Recession hitting the major capitalist economies was no Keynesian-style government spending/borrowing, as mainstream and (some) Marxist economists argue.  It was a state-directed and planned programme of investments by state corporation and funded by state-owned banks.  This was proper ‘socialised investment’ as mooted by Keynes, but never implemented in capitalist economies during the Great Depression, because to do so would be to replace capitalism.

The law of value of the capitalist mode of production does operate in China, mainly through foreign trade and capital inflows, as well as through domestic markets for goods, services and funds.  So the Chinese economy is affected by the law of value.  That’s not really surprising.  You can’t ‘build socialism in one country’ (and if a country is under an autocracy and not under workers democracy, that is true by definition).  Globalisation and the law of value in world markets feed through to the Chinese economy.  But the impact is ‘distorted’, ‘curbed’ and blocked by bureaucratic ‘interference’ from the state and the party structure to the point that it cannot yet dominate and direct the trajectory of the Chinese economy.

It is true that the inequality of wealth and income under China’s ‘socialism with Chinese characteristics’ is very high.  There are growing numbers of  billionaires (many of whom are related to the Communist leaders). China’s Gini coefficient, an index of income inequality, has risen from 0.30 in 1978 when the Communist Party began to open the economy to market forces to a peak of 0.49 just before the global recession. Indeed, China’s Gini coefficient has risen more than any other Asian economy in the last two decades.  This rise was partly the result of the urbanisation of the economy as rural peasants move to the cities.  Urban wages in the sweatshops and factories are increasingly leaving peasant incomes behind (not that those urban wages are anything to write home about when workers assembling Apple i-pads are paid under $2 an hour).


But it is also partly the result of the elite controlling the levers of power and making themselves fat, while allowing some Chinese billionaires to flourish.  Urbanisation has slowed since the Great Recession and so has economic growth – along with that the gini inequality index has fallen back a little.

The Chinese economy is partially protected from the law of value and the world capitalist economy.  But the threat of the ‘capitalist road’ remains.  Indeed, the IMF data show that, while public sector assets in China are still nearly twice the size of capitalist sector assets, the gap is closing.

Under Xi, it seems that the majority of the party elite will continue with an economic model that is dominated by state corporations directed at all levels by the Communist cadres.  That is because even the elite realise that if the capitalist road is adopted and the law of value becomes dominant, it will expose the Chinese people to chronic economic instability (booms and slumps), insecurity of employment and income and greater inequalities.

On the other hand, Xi and the party elite are united in opposing socialist democracy as any Marxist would understand it.  They wish to preserve their autocratic rule and the privileges that flow from it.  The people have yet to play a role.  They have fought local battles over the environment, their villages and their jobs and wages.  But they have not fought for more democracy or economic power.

Indeed, the majority still back the regime.  The Chinese people support the government, but they are worried about corruption and inequality – the two issues that Xi claims that he is dealing with (but in which he will fail).

A recent survey by the Pew Research Center found that 77% of those asked believe that their way of life in China needs to be protected from “foreign influence”.  Political scientist Bruce Dickson collaborated with Chinese scholars to survey public perceptions of China’s ruling Communist Party. Researchers conducted face-to-face interviews with some 4,000 people in 50 cities across the country.  Dickson concluded: “No matter how you measure it, no matter what questions you ask, the results always indicate that the vast majority of people are truly satisfied with the status quo.”

It seems that Xi and his gang are here for a long time ahead.


Abe’s mandate

October 23, 2017

The Japanese stock market rocketed to a 21-year high with a record 15-day winning streak after the result of the Japanese parliamentary election.  Japanese capital was pleased that Prime Minister Shinzo Abe’s Liberal Democratic Party (LDP) had won the snap general election and, with its Buddhist-affiliated Komeito, the incumbent coalition had retained the two-thirds majority necessary to pass legislation without recourse to the upper house.

This means that Abe can claim a mandate to change Japan’s constitution from a ‘pacifist’ defensive role for its military to a fully offensive imperialist stance for the first time since the end of the second world war.  Abe claims this is necessary to resist the growing danger of nuclear attack by North Korea and the insurgent presence of China.  In reality, it is an obsession within the ruling clique of the LDP to reassert Japan as an imperialist power and not just a lapdog of the Americans.

However, even with this vote, Abe will have to proceed cautiously because Japanese citizens are still divided on whether any constitutional change is necessary and Abe has had to agree not to move on this until 2020 at the earliest.  But now he has a longer-term mandate to do this.

If you can call it a mandate.  The reality is that Japan’s electorate had little to choose from among the parties.  The opposition was in total disarray.  The Democrat party, which had a brief run in government, offered no alternative policies, whether economic or political.  And when the conservative governor of Tokyo, Yuriko Koike decided to set up her own national party, The Party of Hope, the Democrats immediately split with half joining Koike and the other half forming a new party, the Constitutional Democratic party under Yukio Edano.  Actually, Edano’s party beat the Party of Hope to become the main opposition on a platform of opposing the constitutional change.  The Party of Hope turned out to be a damp squib with Koike not even running and leaving the country during the vote!

Once again, the real winner in Japan’s election was the ‘no vote’ party.  The voter turnout was just over 52%, the second lowest since 1945 and up only 1% on 2014 – a turnout even lower than in the US elections.  The majority of Japan’s working class, seeing no party representing their interests, just did not vote.  Indeed, Abe’s LDP gained less seats than in 2014 (down 6) as did Komeito (down 5).

In 2014, Abe also called a snap election but that time it was to get a mandate for his so-called Abenomics: a set of policies of monetary easing, fiscal tightening and ‘supply-side neoliberal ‘reforms’ designed to get Japanese capitalism out of its stagnation.

How has Japan done since then?  Well, on the main target of getting Japan out of deflation (falling prices), despite the advice of top Keynesians (Paul Krugman) and monetarists (Ben Bernanke) coming to Japan – and massive injection of money by the Bank of Japan – the monetary arrow of Abenomics has miserably failed.

The core inflation rate is still hovering around zero after three years of effort.

But maybe that does not matter – why strive to ‘cause’ inflation, as long as the economy is growing?  And Japan’s real GDP has been rising for six consecutive quarters.  Japan is now achieving modest economic growth after a nasty recession in 2014.

And when you take into account that the population has fallen by over one million since the end of Great Recession as Japanese get older, faster, then real GDP per person has risen even more. However, in dollar terms, Japan’s GDP has really stagnated because the yen has fallen substantially against other currencies.  Indeed, GDP in dollars is still below the level of the early 1990s – so the falling population has only compensated for that.

The second arrow of Abenomics was fiscal spending and no other G7 government is running such a large budget deficit, Keynesian-style.  The annual deficit had reached nearly 10% of GDP in 2012, although thanks to some recovery in real GDP, the deficit has fallen back to around 4%.  But the Japanese government has now run a deficit for over 25 consecutive years, while public sector debt (even when netted off for government assets) is well over 130% of GDP.  All that this Keynesian effort has achieved is a miserable average annual economic growth of under 1% in the last ten years.  And now Abe intends to introduce a huge sales tax increase to reduce the deficit further, at the expense of working-class consumption.  He also hopes to liberalise gaming and allow casinos to suck in more revenue at the expense of the poorest.

The real purpose of Abenomics was the third arrow of ‘supply-side’ reforms, namely to reduce labour costs (ie hold down wages) and boost the profitability of Japanese capital.  And here Abenomics has had some success.  Japanese capital’s rate of profit had been in long-term decline, driven by the classic Marxist law of a rising organic composition of capital as Japan became a leading industrial power after the 1960s.

The Koizumi Thatcherite measures of privatisation and reduction in labour rights did achieve a modest recovery in profitability in the early 2000s, although this was mainly fuelled by the global credit boom.  The Great Recession put an end to that.  But under Abe, real wages per person have been held down and profitability has begun to move up.

So far, Japanese capital has not responded by boosting investment.

Net investment (after covering depreciation) is very low and even gross private investment is crawling along. Japanese companies prefer to employ more labour at low wage rates rather than invest, or take their investment overseas (shades of the UK and the US).

Japan’s economy has picked up a little.  Industrial production growth has accelerated somewhat as exports pick up with a falling yen and as the world economy has an upturn.  Business sentiment has improved; and Japanese capital has become more optimistic about the future.  But it is all still very modest and any economic improvement is not being felt by the bulk of Japanese, with real wages stagnant and available jobs only part-time or poorly paid.

Abe may have won the election easily and the stock market may be hitting new highs.  But this is only hiding the frailties of Japanese capitalism: low investment, productivity growth flat (with levels still below 2007); and profitability still near post-war lows.  Abe will be in office when the next global recession comes.  Abenomics and his imperial ambitions will then be tested.

The global debt mountain: a Minsky moment or Carchedi crunch?

October 20, 2017

During the current Chinese Communist party congress, Zhou Xiaochuan, governor of the People’s Bank of China, commented on the state of the Chinese economy.  “When there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified…If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky Moment’. That’s what we should particularly defend against.” 

Here Zhou was referring to the idea of Hyman Minsky, the left Keynesian economist of the 1980s, who once put it: “Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.”  China’s central banker was referring to the huge rise in debt in China, particularly in the corporate sector.  As a follower of Keynesian Minsky, he thinks that too much debt will cause a financial crash and an economic slump.

Now readers of this blog will know that I do not consider a Minsky moment as the ultimate or main cause of crises – and that includes the global financial crash of 2008 that was followed by the Great Recession, which many have argued was a Minsky moment.

Indeed, as G Carchedi has shown in a new paper recently presented to the Capital.150 conference in London, when both financial profits and profits in the productive sector start to fall, an economic slump ensues.  That’s the evidence of post-war slumps in the US.  But a financial crisis on its own (falling financial profits) does not lead to a slump if productive sector profits are still rising.

Nevertheless, a financial sector crash in some form (stock market, banks, or property) is usually the trigger for crises, if not the underlying cause.  So the level of debt and the ability to service it and meet obligations in the circuit of credit does matter.

That brings me to the evidence of the latest IMF report on Global Financial Stability. It makes sober reasoning.

The world economy has showed signs of a mild recovery in the last year, led by an ever-rising value of financial assets, with new stock price highs.  President Trump plans to cut corporate taxes in the US; the Eurozone economies are moving out of slump conditions, Japan is also making a modest upturn and China is still motoring on.  So all seems well, comparatively at least.  The Long Depression may be over.

However, the IMF report discerns some serious frailties in this rose-tinted view of the world economy.  The huge expansion of credit, fuelled by major central banks ‘printing’ money, has led to a financial asset bubble that could burst within the next few years, derailing the global recovery.  As the IMF puts it: “Investors’ concern about debt sustainability could eventually materialize and prompt a reappraisal of risks. In such a downside scenario, a shock to individual credit and financial markets …..could stall and reverse the normalization of monetary policies and put growth at risk.”

What first concerns the IMF economists is that the financial boom has led to even greater concentration of financial assets in just a few ‘systemic banks’.  Just 30 banks hold more than $47 trillion in assets and more than one-third of the total assets and loans of thousands of banks globally. And they comprise 70 percent or more of international credit markets.  The global credit crunch and financial crash was the worst ever because toxic debt was concentrated in just a few top banks.  Now ten years later, the concentration is even greater.

Then there is the huge bubble that central banks have created over the last ten years through their ‘unconventional’ monetary policies (quantitative easing, negative interest rates and huge purchases of financial assets like government and corporate bonds and even corporate shares).  The major central banks increased their holdings of government securities to 37 percent of GDP, up from 10 percent before the global financial crisis.  About $260 billion in portfolio inflows into emerging economies since 2010 can be attributed to the push of unconventional policies by the Federal Reserve alone.  Interest rates have fallen and the banks and other institutions have been desperately looking for higher return on their assets by investing globally in stocks, bonds, property and even bitcoins.

But now the central banks are ending their purchase programmes and trying to raise interest rates. This poses a risk to the world economy, fuelled on cheap credit up to now.  As the IMF puts it: “Too quick an adjustment could cause unwanted turbulence in financial markets and international spillovers … Managing the gradual normalization of monetary policies presents a delicate balancing act. The pace of normalization cannot be too fast or it will remove needed support for sustained recovery”.  The IMF reckons portfolio flows to the emerging economies will fall by $35bn a year and “a rapid increase in investor risk aversion would have a more severe impact on portfolio inflows and prove more challenging, particularly for countries with greater dependence on external financing.”

What worries the IMF is that this this borrowing has been accompanied by an underlying deterioration in debt burdens.  So “Low-income countries would be most at risk if adverse external conditions coincided with spikes in their external refinancing needs.”

But it is what might happen in the advanced capital economies on debt that is more dangerous, in my view.  As the IMF puts it: “Low yields, compressed spreads, abundant financing, and the relatively high cost of equity capital have encouraged a build-up of financial balance sheet leverage as corporations have bought back their equity and raised debt levels.”  Many companies with poor profitability have been able to borrow at cheap rates.  As a result, the estimated default risk for high-yield and emerging market bonds has remained elevated.

The IMF points out that debt in the nonfinancial sector (households, corporations and governments) has increased significantly since 2006 in many G20 economies.  So far from the global credit crunch and financial crash leading to a reduction in debt (or fictitious capital as Marx called it), easy financing conditions have led to even more borrowing by households and companies, while government debt has risen to fund the previous burst bubble.

The IMF comments “Private sector debt service burdens have increased in several major economies as leverage has risen, despite declining borrowing costs. Debt servicing pressure could mount further if leverage continues to grow and could lead to greater credit risk in the financial system.”

Among G20 economies, total nonfinancial sector debt has risen to more than $135 trillion, or about 235 percent of aggregate GDP.

In G20 advanced economies, the debt-to-GDP ratio has grown steadily over the past decade and now amounts to more than 260 percent of GDP. In G20 emerging market economies, leverage growth has accelerated in recent years. This was driven largely by a huge increase in Chinese debt since 2007, though debt-to-GDP levels also increased in other G20 emerging market economies.

Overall, about 80 percent of the $60 trillion increase in G20 nonfinancial sector debt since 2006 has been in the sovereign and nonfinancial corporate sectors. Much of this increase has been in China (largely in nonfinancial companies) and the United States (mostly from the rise in general government debt). Each country accounts for about one-third of the G20’s increase. Average debt-to-GDP ratios across G20 economies have increased in all three parts of the nonfinancial sector.

The IMF comments: “While debt accumulation is not necessarily a problem, one lesson from the global financial crisis is that excessive debt that creates debt servicing problems can lead to financial strains. Another lesson is that gross liabilities matter. In a period of stress, it is unlikely that the whole stock of financial assets can be sold at current market values— and some assets may be unsellable in illiquid conditions.”

And even though there some large corporations that are flush with cash, the IMF warns: “Although cash holdings may be netted from gross debt at an individual company—because that firm has the option to pay back debt from its stock of cash—it could be misleading”.  This is because the distribution of debt and cash holdings differs between companies and those with higher debt also tend to have lower cash holdings and vice versa.

So “if there are adverse shocks, a feedback loop could develop, which would tighten financial conditions and increase the probability of default, as happened during the global financial crisis.”

Although lower interest rates have helped lower sovereign borrowing costs, in most of the G20 economies where companies and households increased leverage, nonfinancial private sector debt service ratios also increased.  And there are now several economies where debt service ratios for the private nonfinancial sectors are higher than average and where debt levels are also high.  Moreover, a build-up in leverage associated with a run-up in house price valuations can develop to a point that they create strains in the nonfinancial sector that, in the event of a sharp fall in asset prices, can spill over into the wider economy.

The IMF sums up the risk.  “A continuing build-up in debt loads and overstretched asset valuations could have global economic repercussions. … a repricing of risks could lead to a rise in credit spreads and a fall in capital market and housing prices, derailing the economic recovery and undermining financial stability.”

Yes, banks are in better shape than in 2007, but they are still at risk.  Yes, central banks are ready to reduce interest rates if necessary, but as they are near zero anyway, there is little “scope for monetary stimulus. Indeed, monetary policy normalization would be stalled in its tracks and reversed in some cases.”

The IMF poses a nasty scenario for the world economy in 2020.  The current ‘boom’ phase can carry on.  Equity and housing prices continue to climb in overheated markets.  This leads to investors to drift beyond their traditional risk limits as the search for yield intensifies despite increases in policy rates by central banks.

Then there is a Minsky moment.  There is a bust, with declines of up to 15 and 9 percent in stock market and house prices, respectively, starting at the beginning of 2020.  Interest rates rise and debt servicing pressures are revealed as high debt-to-income ratios make borrowers more vulnerable to shocks. “Underlying vulnerabilities are exposed and the global recovery is interrupted.”

The IMF estimates that the global economy could have a slump equivalent to about one-third as severe as the global financial crisis of 2008-9 with global output falling by 1.7 percent from 2020 to 2022, relative to trend growth.  Capital flows to emerging economies will plunge by about $65 billion in one year.

Of course, this is not the IMF’s ‘base case’; it is only a risk.  But it is a risk that has increasing validity as stock and bond markets rocket, driven by cheap money and speculation.  If we follow the Carchedi thesis, the driver of the bust would be when profits in the productive sectors of the economy fall.  If they were to turn down along with financial profits, that would make it difficult for many companies to service the burgeoning debts, especially if central banks were pushing up interest rates at the same time.  Any such downturn would hit emerging economies severely as capital flows dry up.  The Carchedi crunch briefly appeared in the US in early 2016, but recovered after.

Zhou is probably wrong about China having a Minsky moment, but the advanced capitalist economies may have a Carchedi crunch in 2020, if the IMF report is on the button.




Puerto Rico: when it rains, it pours

October 17, 2017

When it rains, it pours.  Hurricane Maria hit the island of Puerto Rico off the US mainland leaving the country devastated with no power, no food and water.

Puerto Ricans are US citizens, as the island is officially a ‘US territory’ – in effect,  a colony like the French overseas territories.  But the US mainland authorities did little to help and, when they did, it was inadequate.  Power remains lost; homelessness continues and President Trump visited the most well-off part of the island to hand out paper towels – to mop up no doubt!

But even before the hurricane, Puerto Rico’s 3.5m people were in a parlous state.  It had become a graphic example of what capitalism and colonial rule can do in exploiting resources and people, through distortions of the local economy and corruption of local and foreign institutions.

Puerto Rico was faced with bankruptcy even before the hurricane.  By bankruptcy, I mean that the public sector debt of the island had reached astronomical levels, making it impossible for the island government to service the debt and thus facing default on its bonds owned by local and foreign institutions (mainly hedge funds).

How did this come to pass?  Throughout the modern economic history of Puerto Rico, one of the central drivers of its economic growth has been the US tax code. For over 80 years, the US federal government granted various tax incentives to US corporations operating in Puerto Rico. Most recently, beginning in 1976, section 936 of the tax code granted corporations a tax exemption from income originating from ‘US territories’.  US corporations benefited greatly from locating subsidiaries in Puerto Rico – a ‘rich port’ indeed. Income generated by these subsidiaries could be paid to US parents as dividends, which were not subject to corporate income tax.

Puerto Rico thus became a large tax scam for multi-nationals.  The main ‘exporters’ to Puerto Rico were pharma and chemical companies in Ireland, Singapore and Switzerland.  Thus Puerto Rico imported pharmaceutical ingredients from low-tax jurisdictions like Ireland and then exported finished pharmaceuticals to high-tax jurisdictions in Europe and the US.

As top economist Paul Krugman recently noted: “Specifically, PR runs, on paper, a huge trade surplus in pharmaceuticals – $30 billion a year, almost half the island’s GNP. But the pharma surplus is basically a phantom, driven by transfer pricing: pharma subsidiaries in Ireland charge themselves low prices on inputs they buy from their overseas subsidiaries, package them, then charge themselves high prices on the medicine they sell to, yes, their overseas subsidiaries. The result is that measured profits pop up in Puerto Rico – profits that are then paid out in investment income to non-PR residents. So this trade surplus does nothing for PR jobs or income.”

This booming economy raised little tax revenue.  So Puerto Rican governments borrowed to provide public services rather than tax multi-nationals.  Due to these extensive tax credits and exemptions, Puerto Rico lost out on $250-500 million a year in revenue. It did this for four decades, encouraged by financial consultants.  Soon it entered the realm of Ponzi-financing, namely, issuing debt to repay older debt, as well as refinancing older debt possessing low interest rates with debt possessing higher interest rates.

Then disaster happened.  In the US, section 936 became increasingly unpopular throughout the early 1990s, as many correctly saw it as a way for large corporations to avoid taxes. Ultimately, in 1996, President Clinton signed legislation that phased out section 936 over a ten-year period, leaving it to be fully repealed at the beginning of 2006.

Without section 936, Puerto Rican subsidiaries of US businesses were subject to the same worldwide corporate income tax as other foreign subsidiaries.  They fled the island.  Between 1996 and 2006, the US Congress eliminated the tax credits, contributing to the loss of 80,000 jobs on the island and causing its population to shrink and its economy to contract in all but one year since the Great Recession.

At first, the Puerto Rican government tried to make up for the shortfall by issuing bonds. The government was able to issue an unusually large number of bonds, due to dubious underwriting from financial institutions such as Spain’s Santander BankUBS  and Citigroup.  According to a report from Hedge Clippers, Santander issued almost $61 billion in bonds from the Puerto Rican government through subsidiaries that served as municipal debt underwriters, obtaining $1.1 billion in fees in the process.

Santander officials were also officials of the Puerto Rico’s Government Development Bank.  Thus Santander officials in the Development Bank decided whether to issue debt for Puerto Rico and then arranged that Santander should pocket the fees for organising the bond issues!  They also decided that sales tax revenue that should have gone to the government should be siphoned off to service COFINA (PR Sales Tax Financing Corporation) bonds.  They even assigned government employees’ pension contributions to pay for bond issues.

Not coincidentally, 2006 also marked the beginning of a deep recession for Puerto Rico, which has lasted until today.  Between 2000 and 2015, Puerto Rico’s debt rose from 63.2% of GNP to 100.2% of GNP.  Eventually the debt burden became so great that the island was unable to pay interest on the bonds it had issued.  Puerto Rico’s $123 billion liabilities from debt ($74 billion) and unfunded pension obligations ($49 billion) are much larger than the $18 billion Detroit bankruptcy,

The tax regime remains paralysed.  The Department of Treasury of Puerto Rico is incapable of collecting 44% of the Puerto Rico Sales and Use Tax (or about $900 million).  Public spending is also distorted.  A public teacher’s base salary starts at $24,000 while a legislative advisor starts at $74,000. The government has also been unable to set up a system based on meritocracy, with many employees, particularly executives and administrators, earning large salaries while health workers struggle.

The Puerto Rico Electric Power Authority  (PREPA) provides free electricity to local governments.  The utility had improperly given away $420 million of electricity and that the island’s governments were $300 million delinquent in payments.  As a result, PREPA had no funds to invest in new technology and built up a debt of $9 billion.  In 2012, the Puerto Rico Ports Authority was forced to sell the Luis Muñoz Marín International Airport to private buyers after PREPA threatened to cut off power over unpaid bills.  Last July, PREPA filed for bankruptcy.

The island’s unemployment rate is now 14.8% with a poverty rate of 45%.  But the Puerto Rican authorities have been under pressure from the US government to apply vicious austerity measures. More than 60% of Puerto Rico’s population receives Medicare or Medicaid services but the US has a cap on Medicaid funding for US territories. This has led to a situation where Puerto Rico might typically receive $373 million in federal funding a year, while, for instance, Mississippi receives $3.6 billion.

The austerity programmes imposed on the Puerto Rican governments have meant taxes and fees went up on nearly everything and everyone. Personal income taxes, corporate taxes, sales taxes, sin taxes, and taxes on insurance premiums were hiked or newly imposed. The retirement age for teachers was raised.

As the debt mounted, the US government removed the power of managing and monitoring that debt out of the hands of the Puerto Ricans and put into a new monitoring body, PROMESA (The Financial Oversight and Management Board for Puerto Rico) – a bit like how the EU governments took control of Greek finances and provided bailouts with ‘conditionalities’ through the EFSF and ESM.  There is only one Puerto Rican on the PROMESA board. PROMESA’s main aim is to service the debt, not restore the economy.

What is to be done?  Since it was installed, PROMESA has begun outlining and implementing deep government spending cuts.  There is talk that the government should pay back its bonds before providing essential services to its citizens. Though repayment is still on hold, different classes of bondholders are now locked in a legal dispute about which of them is entitled to the revenue from the island’s sales tax, currently set at 11.5%.

PROMESA wants the Puerto Rican government to maintain a balanced budget for four consecutive years and carry out significant privatisations of state assets. For Puerto Ricans, that could mean austerity measures for the foreseeable future imposed by an unelected body based outside Puerto Rico.

As economist Joseph Stiglitz recently put it: “The PROMESA Board was supposed to chart a path to recovery; its plan makes a recovery a virtual impossibility. If the Board’s plan is adopted, Puerto Rico’s people will experience untold suffering. And to what end? The crisis will not be resolved. On the contrary, the debt position will become even more unsustainable.”

And yet the foreign bond holders do not think this is enough and condemn PROMESA for being too weak.  A group of 34 hedge funds that specialize in distressed debt —sometimes referred to as vulture funds—hired economists with an IMF background. Their report icalled for increased tax collection and a reduction of public spending and wanted public private partnerships and the ‘monetization’ (privatisation) of government-owned buildings and ports.

Another group goes even further. They called on the US Congress to “consider a tax credit for U.S. multinationals” and the “militarization of the island to provide short to medium [term] security.” They want PROMESA closed down and to be replaced by an “administrator who has broad authority to execute contracts, coordinate with federal agencies and oversee reconstruction.”  The bondholders want more police and the US army to enforce austerity.  “The U.S. military needs to supplement the 15,000 Puerto Rican police officers to maintain law and order”, while at the same introducing tax allowances at 100% of capital expenditures “required to rebuild after Maria or build new factories within a 2-3 year window.”

Another idea is for all the outstanding debt to be incorporated into a ‘super bond’ that would get interest directly from the tax revenues of the Puerto Rican government  This plan would have a designated third party administer an account holding some of the island’s tax collections and those funds would be used to pay holders of the superbond. The existing Puerto Rican bondholders would take a haircut on the value of their current bond holdings.  This is almost an exact replica of the private sector involvement (PSI) deal that was imposed on the Greek government in 2012 that led to a bailout of private bondholders and the shifting of the bulk of debt onto the government books.

Is there any way out for the Puerto Rican people or do they face permanent austerity and misery?  One solution coming from the left is for the US Federal Reserve Bank to buy up all the Puerto Rican bonds at current market value and then not impose any interest payment burden on the island.  This is both useless and utopian at the same time.  Even if it were applied, the debt would remain on the books and its servicing subject to the whim of the Federal Reserve Board (and who knows who the Fed Chair would be next year?).  Moreover, if the Fed offers to pick up the bill, the price of the bonds would rocket, enabling the ‘vulture funds’ to make a killing at the US taxpayers expense.  And it still does nothing to solve the economic problem for the island that created this debt in the first place.  And, second, it is utopian because it ain’t going to happen: the Fed will do nothing.

Clearly, the most effective immediate answer is to cancel the debt.  But that poses its own problems.  First, 40% of the debt is locally held, often by local banks and pension funds that could be bankrupted – so they would have to be brought under the public umbrella.  Second, cancellation would mean immediate confrontation with the US authorities and the hedge funds – which could lead to the closure of PROMESA and the imposition of a US administrator to take over the government.  In other words, cancellation would mean a major political struggle on the island.

And what sort of Puerto Rican economy is needed anyway? The model of a tax haven that encourages multi-nationals to engage in transfer pricing scams has failed to deliver incomes and jobs for those Puerto Ricans who have not left the island.

Puerto Rico was an important hub, in particular, for big pharmaceutical firms like Pfizer, which have kept many of their investments on the island even after ‘936’ was gradually ended.  But Puerto Rico is no longer competitive in areas where 75-80% of expenses come from payroll costs.  Puerto Rico needs to move up into higher-value manufacturing and services.  It has a large number of educated bilingual workers.  There is potential to turn the economy into a modern hi-tech service sector.  But that would require government investment and state-run firms democratically controlled by Puerto Ricans.  It’s the Chinese model, if you like.

Puerto Rico is a small island that was exploited by the US and foreign multi-nationals with citizens’ tax bills siphoned off to pay interest on ever increasing debt, while reducing social welfare – all at the encouragement of foreign investment banks making huge fees for doing so.  Now Puerto Ricans are being asked to keep on paying for the foreseeable future after a decade of recession and cuts in living standards to meet obligations to vulture funds and US institutions.  And the troops will be sent into ensure that!   When it rains, it pours.

The monetary dilemma

October 13, 2017

According to the minutes of the last meeting of the monetary policy committee of the US Federal Reserve Bank, the most powerful monetary authority in the world, the committee members are split and unclear on what to do.  “Some participants who counselled patience expressed “concern about the recent decline in inflation” and said the Fed “could afford to be patient under current circumstances.” They “argued against additional adjustments” until the central bank was sure that inflation was on track. On the other side, more hawkish members “worried about risks arising from a labour market that had already reached full employment and was projected to tighten further…..backing off from a steady diet of rate hikes could cause the Fed to overshoot its employment target and cause financial instability”, they said.

The problem is that the Fed’s economic models were failing to provide guidance on what to do.  The current mainstream model has two strands.  The first is the Wicksellian idea that there is a ‘natural rate of interest’ that brings a capitalist economy into harmonious equilibrium where economic growth and full employment and stable and low inflation are combined.  The Fed calls this R*.  The second is the Keynesian view that there is a trade-off between unemployment and inflation, so that as an economy heads towards ‘full employment’, this drives up ‘effective demand’ beyond any ‘slack’ in supply in the economy and so wages and price inflation ensues.  This is enshrined empirically in the so-called Phillips curve, named after a British economist of the 1960s.

The trouble with this mish-mash of a central bank model is that it is not working.   The trouble with the Wicksellian bit is that it is nonsense – there is no equilibrium rate.  Even worse, the Fed’s economists have no idea what it should be anyway.  The Fed’s central estimates of the real neutral interest rate has declined by nearly two-thirds in five years, from 2 per cent to 0.75 per cent. On that basis, the Fed has already exceeded the ‘natural rate’ and is in danger of causing a downturn in the economy.

But the figures are again little more than guesswork. As Ms Yellen said, “[the neutral rate’s] value at any point in time cannot be estimated or projected with much precision”.

The second half of the model is equally faulty.  The Phillips curve, measuring inflation against growth and full employment, was proven faulty in the 1970s when inflation rocketed but economies had rising unemployment and falling growth – ‘stagflation’. Indeed, the inadequacy of this Keynesian model led to a counter-revolution in mainstream economics, as economists and politicians swung over to monetarist policies like the quantity theory of money proposed by Milton Friedman and adopted by his epigone, former Fed chief Ben Bernanke.

This was eventually taken to its extreme in quantitative easing (QE).  This was the ultimate policy – if an economy is in a depression, it’s because of a lack of money.  So just keep pumping it out until things get better.Well, things have supposedly got better, so QE has been dumped and the old Keynesian Phillips curve has been restored as guidance to the Fed.  Unfortunately, just as in the 1970s, the model is not working.  Unemployment rates are near lows – at least in this current business cycle of 8-10 years – but higher inflation in prices and wages has not returned.

Indeed, it has been a quarter of a century since the Fed’s favoured measure of inflation — personal consumption expenditures excluding food and energy — last punched up above the still relatively sedate level of 3 per cent. It was just 1.4 per cent in the year to July. Wage growth, meanwhile, remains well below its pre-crisis pace at just 2.5 per cent.

Janet Yellen, chair of the US Federal commented: “Our framework for understanding inflation dynamics could be ‘misspecified’ in some fundamental way.” Mario Draghi, president of the European Central Bank, observed, “the ongoing economic expansion . . . has yet to translate sufficiently into stronger inflation dynamics”.  He’s still hoping.  And of course, Ben Bernanke, the monetarist extraordinaire, continues to believe that the Fed’s policy models will work, as he argued in a new paper presented to the Peterson Institute and the IMF this week.

But the evidence is not there.  Monetary policy has failed to ‘manage’ the capitalist economy.  Monetary policy did not avoid the global credit crunch or save capitalist economies from going into the Great Recession – even if non-stop zero interest credit saved the banking system from complete meltdown (and even that conclusion is open to doubt).

And QE did not revive the ‘real’ economy, the productive sectors, afterwards and instead only inspired a humongous new speculative boom in property, stocks and bonds that continues today (boosting the incomes and wealth of the top 1% everywhere).

In this Long Depression, jobs may have appeared in some economies, but only at low wage rates, only temporary, part-time or self-employed.  Real GDP growth has been strangled at no more than 2% a year in the US and even lower in other advanced economies.  Business investment has crawled along and, as a result, productivity growth, essential to a long-term revival in capitalist economies, is sluggish and even non-existent.

So what to do?  The Keynesians, still believing that the Phillips curve model works, conclude that ‘effective demand’ is still too low and the major economies are stuck in ‘secular stagnation’, not seen since the immediate post-war period (an idea developed by Keynesian Alvin Hansen and proved wrong by the revival of economies form 1947 onwards).  In their latest contribution, former IMF chief economist Olivier Blanchard and top Keynesian Larry Summers tell us in another Peterson Institute presentation that what is needed is a combination of monetary easing and fiscal spending:

“What we specifically suggest is the following: The combined use of macro policy tools to reduce risks and react more aggressively to adverse shocks. A more aggressive monetary policy, creating the room needed to handle another large adverse shock—and while we did not develop that theme at length, providing generous liquidity if and when needed. A heavier use of fiscal policy as a stabilization tool, and a more relaxed attitude vis-a-vis debt consolidation. And more active financial regulation, with the realization that no financial regulation or macroprudential policy will eliminate financial risks. It may not sound as extreme as some more dramatic proposals, from helicopter money, to the nationalization of the financial system. But it would represent a major change from the pre-crisis consensus, a change we believe to be essential.”

Actually, what the two gurus advocate is not “a major change”, but really just more of the same that has failed so far to revive the economy.

They had little to say about the Fed’s plan to sell off its huge stock of bonds that it built up under its QE policy of purchases.  The Fed wants to do this because it reckons the economy is sufficiently recovered to cope with a reversal of QE and a tightening of credit.  Well, you could argue that, as QE had little effect on boosting the ‘real’ economy, reversing QE will have little effect in dampening it.

Maybe so, but what also worries the Fed is that a near-decade of easy money Bernanke-style has so boosted levels of debt in the household and corporate sectors that any rise in interest rates and tightening of credit would drive up debt servicing costs and tip the economy into recession.  On the other hand, the Fed does not want to go on pumping yet more credit to make the situation worse.  As Janet Yellen put it: “Persistently easy monetary policy might also eventually lead to increased leverage and other developments, with adverse implications for financial stability.”.

This fear has been promoted by the Bank for International Settlements, the central bankers’ bank, which in true Austrian school of economics style, reckons that increased costs of debt servicing from rising interest rates driven by the Fed’s ‘normalisation’ policy could tip things over.

And the IMF in its latest Global Financial Stability report out this week, is also worried that the very size of global debt could eventually lead to serious defaults and retrenchment that would push the global economy back into recession.

The IMF comments that “a shock to individual credit and financial markets well within historical norms could decompress risk premiums and reverberate worldwide, as explored later in this chapter. This could stall and reverse the normalization of monetary policies and put growth at risk.”  So if the Fed and other central banks now decide to reverse QE and opt for ‘normalisation’ of their balance sheets, this could be damaging. Too quick an adjustment could cause unwanted turbulence in financial markets and international spillovers.”  On the other hand, “the expected process of normalization is likely to be gradual, with continued easy monetary conditions and low volatility that could foster a further buildup of financial excesses and medium-term vulnerabilities.”.  So heads you lose and tails you lose.

The IMF sets the dilemma: “Managing the gradual normalization of monetary policies presents a delicate balancing act. The pace of normalization cannot be too fast or it will remove needed support for sustained recovery and desired increases in core inflation across major economies …On the other hand, the likely prolonged period of low interest rates could further deepen financial stability risks as investors take on more risk in their search for yield.”

The IMF reckons such a debt disaster could hit global growth by up to 1.7% pts a year through 2022 – in effect, cutting current growth by more than half and taking it to levels not seen since the Great Recession.  The ensuing recession would “about one-third as severe as the global financial crisis”.

The Fed’s dilemma reveals that monetary policy has failed.  It failed to save the world economy from the Great Recession and it failed to get it out of the ensuing Long Depression.  Central bank models of the economy, based on a combination of monetarist neo-classical and Keynesian economics, appear to offer no guidance on what stage the major economies are now in and therefore what to do.  Should central banks hold back on hiking rates and reversing QE in case economies are still too weak; or should they act now to avoid a huge debt crisis down the road?  They don’t know.

Beware the ECB bearing gifts for Greeks

October 11, 2017

The announcement by the European Central Bank that it has so far made €7.8bn in profits from its holdings in Greek government debt reveals the true nature of the so-called bailouts of Greek government finances that the EU leaders organised in return for massive austerity measures from 2012 onwards.

Back in March 2012, five years ago, a so-called private sector involvement (PSI) deal was agreed under which French, German and Greek banks who held the bulk of Greek government bonds agreed to take a ‘haircut’ on the value of their bond holdings.  Under the PSI, they received in return new Greek government bonds with 30-year lives, paying about 3-4% a year in interest and guaranteed by the Eurozone financing operation, the EFSF.  And they also got some cash upfront for turning in their old bonds.  The Euro leaders and the IMF provided around €130bn in new money plus €34bn left over from the previous Greek package to fund the interest to be paid on the new Greek government bonds, repayments to the IMF, money to recapitalise the Greek banks and money for the cash on the PSI deal.

As part of the PSI, the ECB bought up some of these bonds, for which they were guaranteed repayment as they matured by the Greek government, as part of the bailout packages that ensued.  In total, the ECB and national central banks bought €56.2 billion of Greek debt, according to analysis by a University of Munich academic. Of this, €29 billion has been repaid, with €27 billion still outstanding.  The ECB bought bonds to be repaid up until 2028.

Well, not only have these bond purchases been repaid over the ensuing years as the Greek people took the pain of wage and pension cuts, a collapse in public services and the privatisation of public assets, but the ECB has made nearly €8bn in profits. The ECB said holdings of Greek sovereign bonds acquired under its Securities and Markets bond-buying programme (SMP) had resulted in €7.8bn of net income interest between 2012-2016. These profits are not being returned to the Greeks but distributed among the 19-country central banks in the eurozone.

Another cruel irony is that, having purchased these bonds from the French and German banks so the banks’ losses were minimised, the ECB has since refused to buy Greek government bonds as part of its quantitative easing programme to help the Greeks.  Why? Because the Greek government debt is not sustainable!

And that is certainly true.  When imposing the PSI on Greece, the Troika (ECB, EU, and IMF) aimed for Greece to get its public debt burden down from 166% of GDP before the debt default to 120% of GDP by the end of the decade through the austerity measures.  But it would not do this by writing off any Greek debt but only by squeezing the Greek people dry to pay back the ECB and the IMF for their ‘bailout’ loans.  Of the total €164bn funding in 2012, only €23bn went towards financing the Greek government’s budget.

So one hand gaveth and the other took it away.

Because the Greek economy imploded, Greek government debt, far from falling under the three bailout programmes, just rocketed further up to a peak of 180% of GDP.  Austerity did not work and still is not working to reduce the debt and stop the unending interest payments to private bondholders as well as the ECB.

It’s probable that the IMF and the ECB have made more profits from the ‘bailout’ loans.  An analysis from the Jubilee Debt Campaign in 2015 estimated the IMF had made €2.5bn in profits from its loans by then.  And the IMF and the ECB will make even more profits from the ‘bailout’ loans.  The JDC reckons that, based on the difference between the average effective interest rate the ECB has received on the debt of around 10%, the maturity of the debt, and the normal negligible cost of borrowing from the ECB, the accrued profit could be €22 billion in 2022, ten years since the PSI.

The IMF reckons that, without debt relief, Greece’s public sector debt to GDP ratio will not fall even with further austerity. Indeed, it would rise from around 180% now to nearly 300% by 2060 – in a ‘snowball’ effect where debt is repaid with more debt and interest payments keep rising on top.

And there is no sign of any such ‘relief’.