Archive for the ‘Profitability’ Category

It’s greed and fear

September 18, 2018

Larry Summers is one of the world’s leading Keynesian economists, a former Treasury Secretary under President Clinton, a candidate previously for the Chair of the US Fed, and a regular speaker at the massive ASSA annual conference of the American Economics Association, where he promotes the old neo-Keynesian view that the global economy tends to a form of ‘secular stagnation’.

Summers has in the past attacked (correctly in my view) the decline of Keynesian economics into just doing sterile Dynamic Stochastic General Equilibrium models (DSGE), where it is assumed that the economy is stable and growing, but then is subject to some ‘shock’ like a change in consumer or investor behaviour.  The model then supposedly tells us any changes in outcomes.  Summers particularly objects to the demand by neoclassical and other Keynesian economists that any DSGE model must start from ‘microeconomic foundations’ ie the initial assumptions must be logical, according to marginalist neoclassical supply and demand theory, and the individual agents must act ‘rationally’ according to those ‘foundations’.

As Summers puts it: “the principle of building macroeconomics on microeconomic foundations, as applied by economists, contributed next to nothing to predicting, explaining or resolving the Great Recession.”  Instead, says Summers, we should think in terms of “broad aggregates”, ie empirical evidence of what is happening in the economy, not what the logic of neoclassical economic theory might claim ought to happen.

Not all Keynesians agree with Summers on this.  Simon Wren-Lewis, the leading British Keynesian economist claims that the best DSGE models did try to incorporate money and imperfections in an economy: “respected macroeconomists (would) argue that because of these problematic microfoundations, it is best to ignore something like sticky prices (wages) (a key Keynesian argument for an economy stuck in a recession – MR) when doing policy work: an argument that would be laughed out of court in any other science. In no other discipline could you have a debate about whether it was better to model what you can microfound rather than model what you can see. Other economists understand this, but many macroeconomists still think this is all quite normal.” In other words, you cannot just do empirical work without some theory or model to analyse it; or in Marxist terms, you need the connection between the concrete and the abstract.

There is confusion here in mainstream economics – one side want to condemn ‘models’ for being unrealistic and not recognising the power of the aggregate.  The other side condemns statistics without a theory of behaviour or laws of motion.

Summers reckons that the reason mainstream economics failed to predict the Great Recession is that it does not want to recognise ‘irrationality’ on the part of consumers and investors.  You see, crises are probably the result of ‘irrational’ or bad decisions arising from herd-like behaviour.  Markets are first gripped by ‘greed’ and then suddenly ‘animal spirits’ disappear and markets are engulfed by ‘fear’.  This is a psychological explanation of crises.

Summers recommends a new book by behavioural economists Andrei Shleifer’s and Nicola Gennaioli, “A Crisis of Beliefs: Investor Psychology and Financial Fragility.”  Summers proclaims that “the book puts expectations at the center of thinking about economic fluctuations and financial crises — but these expectations are not rational. In fact, as all the evidence suggests, they are subject to systematic errors of extrapolation. The book suggests that these errors in expectations are best understood as arising out of cognitive biases to which humans are prone.” Using the latest research in psychology and behavioural economics, they present a new theory of belief formation.  So it’s all down to irrational behaviour, not even a sudden ‘lack of demand’ (the usual Keynesian reason) or banking excesses.  The ‘shocks’ to the general equilibrium models are to be found in wrong decisions, greed and fear by investors.

Behavioural economics always seems to me ‘desperate macroeconomics’.  We don’t know why slumps occur in production, investment and employment at regular and recurring intervals.  We don’t have a convincing theoretical model that can be tested with empirical evidence; just saying slumps occur because there is a ‘lack of demand’ sounds inadequate.  So let’s turn to psychology to save economics.

Actually, the great behavourial economists that Summers refers to also have no idea what causes crises.  Robert Thaler reckons that stock market prices are so volatile that there is no rational explanation of their movements.  Thaler argues that there are ‘bubbles’, which he considers are ‘irrational’ movements in prices not related to fundamentals like profits or interest rates.  Top neoclassical economist Eugene Fama criticised Thaler.  Fama argued that a ‘bubble’ in stock market prices may merely express a change in view of investors about prospective investment returns; it’s not ‘irrational’.  On this point, Fama is right and Thaler is wrong.

The other behaviourist cited by Summers is Daniel Kahneman.  He has developed what he called ‘prospect theory’. Kahneman’s research has shown that people do not behave as mainstream marginal utility theory suggests. Instead Kahneman argues that there is “pervasive optimistic bias” in individuals.  They have irrational or unwarranted optimism.  This leads people to take on risky projects without considering the ultimate costs – against rational choice assumed by mainstream theory.

Kahneman’s work certainly exposes the unrealistic assumptions of marginal utility theory, the bedrock of mainstream economics.  But it offers as an alternative, a theory of chaos, that we can know nothing and predict nothing.  You see, the inherent flaw in a modern economy is uncertainty and psychology.  It’s not the drive for profit versus social need, but the psychological perceptions of individuals. Thus the US home price collapse and the global financial crash came about because consumers have irrational swings from greed to fear.  This leaves mainstream (including Keynesian) economics in a psychological purgatory, with no scientific analysis and predictive power.  Also, it leads to a utopian view of how to fix crises.  The answer is to change people’s behaviour; in particular, big multinational companies and banks need to have ‘social purpose’ and not be greedy!

Turning to psychology is not necessary for economics.  At the level of aggregate, the macro, we can draw out the patterns of motion in capitalism that can be tested and could deliver predictive power.  For example, Marx made the key observation that what drives stock market prices is the difference between interest rates and the overall rate of profit. What has kept stock market prices rising now has been the very low level of long-term interest rates, deliberately engendered by central banks like the Federal Reserve around the world.

Of course, every day, investors make ‘irrational’ decisions but, over time and, in the aggregate, investor decisions to buy or to sell stocks or bonds will be based on the return they have received (in interest or dividends) and the prices of bonds and stocks will move accordingly. And those returns ultimately depend on the difference between the profitability of capital invested in the economy and the costs of providing finance.  The change in objective conditions will alter the behaviour of ‘economic agents’.

Right now, interest rates are rising globally while profits are stagnating.

The scissor is closing between the return on capital and the cost of borrowing.  When it closes, greed will turn into fear.

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The state of capitalism at IIPPE

September 14, 2018

This year’s conference of the International Initiative for the Promotion of Political Economy (IIPPE) in Pula, Croatia had the theme of The State of Capitalism and the State of Political Economy.  Most submissions concentrated on the first theme although the plenary presentations aimed at both.

I was struck by the number of papers (IIPPE 2018 – Abstracts) on the situation in Brazil, China and Turkey – a sign of the times – but also by the relative youth of the attendees, particularly from Asia and the ‘global south’.  The familiar faces of the ‘baby boomer’ generation of Marxist and heterodox economists (my own demographic) were less in evidence.

Obviously I could not attend all simultaneous sessions so I concentrated on the macroeconomics of advanced capitalist economies.  Actually my own session was among the first of the conference.  Under the title of The limits to economic policy management in the era of financialisation, I presented a paper on The limits of fiscal policy (my PP presentation is here (The limits to fiscal policy).

I argued that, during the Great Depression of the 1930s, Keynes had recognised that monetary policy would not work in getting depressed economies out of a slump, whether monetary policy was ‘conventional’ (changing the interest rate for borrowing) or ‘unconventional’ (central banks buying financial assets by ‘printing’ money).  In the end, Keynes opted for fiscal stimulus as the only way for governments to get the capitalist economy going.

In the current Long Depression, now ten years old, both conventional (zero interest rates)and unconventional (quantitative easing) monetary policy has again proved to be ineffective.  Monetary easing had instead only restored bank liquidity (saved the banks) and fuelled a stock and bond market bonanza. The ‘real’ or productive economy had languished with low real GDP growth, investment and wage incomes.

Maria Ivanova of Goldsmiths University of London also presented in my session (Ivanova_Quantitative Easing_IJPE_forthcoming) and she showed clearly that both conventional and unconventional monetary policies adopted by the US Fed had done little to help growth or investment and had only led to a new boom in financial assets and a sharp rise in corporate debt, now likely to be the weak link in the circulation of capital in the next slump.

Keynesian-style fiscal stimulus was hardly tried in the last ten years (instead ‘austerity’ in government spending and budgets was generally the order of the day).  Keynesians thus continue to claim that fiscal spending could have turned things around.  Indeed, Paul Krugman argued just that in the New York Times as the IIPPE conference took place.

But in my paper, I refer to Krugman’s evidence for this and show that in the past government spending and/or running budget deficits have had little effect in boosting growth or investment.  That’s because, under a capitalist economy, where 80-90% of all productive investment is by private corporations producing for profit, it is the level of profitability of capital that is the decisive factor for growth, not government spending boosting ‘aggregate demand’.  In the last ten years since the Great Recession, while profits have risen for some large corporations, average profitability on capital employed has remained low and below pre-crash levels (see profitability table below based on AMECO data).  At the same time, corporate debt has jumped up as large corporations borrow at near zero rates to buy their own share (to boost prices) and/or increased payouts to shareholders.

Government spending on welfare benefits and public services along with tax cuts to boost ‘consumer demand’ is what most modern Keynesians assume is the right policy.  But it would not solve the problem (and Keynes thought so too in the 1940s).  Indeed, what is required is a massive shift to the ‘socialisation of investment’, to use Keynes’ term, i.e. the government should resume responsibility for the bulk of investment and its direction.  During the 1940s, Keynes actually advocated that up to 75% of all investment in an economy should be state investment, reducing the role of the capitalist sector to the minimum (see Kregel, J. A. (1985), “Budget Deficits, Stabilization Policy and Liquidity Preference: Keynes’s Post-War Policy Proposals”, in F. Vicarelli (ed.), Keynes’s Relevance Today, London, Macmillan, pp. 28-50).

Of course, such a policy has only happened in a war economy.  It would be quickly opposed and was dropped in ‘peace time’.  That’s because it would threaten the very existence of capitalist accumulation, as Michal Kalecki pointed out in his 1943 paper.

Now in 2018, the UK Labour Party wants to set up a ‘Keynesian-style’ National Investment Bank which would invest in infrastructure etc, alongside the big five UK banks which will continue to conduct ‘business as usual ‘ i.e. mortgages and financial speculation.  Under these Labour proposals, government investment (even if implemented in full) would rise to only 3.5% of GDP, less than 20% of total investment in the economy – hardly ‘socialisation’ a la Keynes at his most radical..

But perhaps President Trump’s version of Keynesian fiscal stimulus (huge tax cuts for the rich and corporations , driving up the budget deficit) will do the trick.  It is an irony that it is Trump that has adopted Keynesian policy.  He certainly thinks it is working – with the US economy growing at a 4% annual rate right now and official unemployment rates at near record lows.  But an excellent presentation by Trevor Evans of the Berlin School of Economics poured cold water on that optimism.  With a barrage of data, he showed that corporate profits are actually stagnating, corporate debt is rising and wage incomes are flat, all alongside highly inflated stock and bond markets.  The Trump boom is likely to fizzle out and turn into its opposite.

Also, Arturo Guillen of the Metropolitan University of Mexico City,( IIPPE 2018 inglés) reminded us that the medium term trajectory of US economic growth was very weak with productivity growth very low and productive investment crawling.  In that sense, the US was suffering from ‘secular stagnation’, but not for the reasons cited by Keynesians like Larry Summers (lack of demand) or by neoclassical critiques like Robert Gordon (ineffective innovation) but because of the low profitability for capital.

In another session, Joseph Choonara, took this further. Choonara saw the current crisis rooted in a long decline in profitability in the period from the late 1940s to the early 1980s. The subsequent neoliberal period developed new mechanisms to defer crises, notably financialisation and credit expansion. In the Long Depression since 2009, driven largely by the central bank response, debt continues to mount. The result is a financially fragile and uncertain recovery, which is creating the conditions for a new crisis

There were also some sessions on Marxist economic theory at IIPPE, including a view on why Marx sent so much time on learning differential calculus (Andrea Ricci) and on why Marx’s transformation of value into prices of production is dialectical in its solution (Cecilia Escobar).  Also Paul Zarembka from the University of Buffalo, US presented a paper arguing that the organic composition of capital in the US did not rise in the post-war period and so cannot be the cause of any fall in the rate of profit.

His concepts and evidence do not hold water in my view.  Zarembka argues that there is a major problem concerns using variable capital v in the denominator in the commonly-expressed organic composition of capital, C/v. That is because v can change without any change in the technical composition. Using, instead, what he calls the ‘materialized composition of capital’, C/(v+s), movement in C/v can be separated between the technical factor and the distributional factor since C/v = (1 + s/v).  With this approach, Zarembka reckons, using US data, he can show no rise in the organic composition of capital in the US and no connection between Marx’s basic category for laws of motion under capitalism and the rate of profitability.

But I think his category C/(v+s) conflates the Marx’s view of the basic ‘tendency’ (c/v) in capital accumulation with the lesser ‘counter-tendency’ (s/v) and thus confuses the causal process.  This makes Marx’s law of profitability ‘indeterminate’ in the same way that Sweezy and Heinrich etc claim.  As for the empirical consequences of rejecting Zarembka’s argument, I refer you to an excellent paper by Lefteris Tsoulfidis.

As I said previously, there were a host of sessions on Brazil, Southern Africa and China, most of which I was unable to attend.  On China, what I did seem to notice was that nearly all presenters accepted that China was ‘capitalist’ in just the same way as the US or at least as Japan or Korea, if less advanced.  And yet they all recognised that the state played a massive role in the economy compared to others – so is there a difference between state capitalism and capitalism?  I cannot say anything about the papers on Brazil except for you to look at IIPPE 2018 – Abstracts.  Brazil has an election within a month and I shall cover that then – and these are my past posts on Brazil.

There were other interesting papers on automation and AI (Martin Upchurch) and on bitcoin and a cashless economy (Philip Mader), as well as on the big issue of imperialism and dependency theory (which is back in mode).

The main plenary on the state of capitalism was addressed by Fiona Tregena from the University of Johannesburg.  Her primary area of research is on structural change, with a particular focus on deindustrialisation. Prof Tregena has promoted the concept of premature deindustrialisation.  Premature deindustrialisation can be defined as deindustrialisation that begins at a lower level of GDP per capita and/or at a lower level of manufacturing as a share of total employment and GDP, than is typically the case internationally. Many of the cases of premature deindustrialisation are in sub‐Saharan Africa, in some instances taking the form of ‘pre‐industrialisation deindustrialisation’. She has argued that premature deindustrialisation is likely to have especially negative effects on growth.

As for the state of political economy, Andrew Brown of Leeds University has explained some of the failures of mainstream economics, particularly marginal utility theory. Marginal utility theory has not to this day been developed in a concrete and realistic direction not because it is just vulgar apologetics for capitalism, but because it is theoretically nonsense. Marginal utility theory can provide no comprehension of the macroeconomic aggregates that drive the reproduction and development of the economic system.

‘Financialisation’ is the word/concept that dominates IIPPE conferences.  It is a concept that has some value when it describes the change in the structure of the financial sector from pure banks to a range of non-deposit financial institutions and the financial activities of non-financial corporations in the last 40 years.

But I am not happy with the concept when it used to suggest that the financial crash and the Great Recession were the result of some new ‘stage’ in capitalism.  From this, it is argued that crises now occur not because of the fall in productive sectors but because of the speculative role of ‘’financialisation.’  Such an approach , in my view, is not only wrong theoretically but does not fit the facts as well as Marx’s laws of motion: the law of value, the law of accumulation and the law of profitability.

For me, financialisation is not a new stage in capitalism that forces us to reject Marx’s laws of motion in Capital and neoliberal economics is not in some way the new economics of financialisation and a different theory of crises from Marx’s.  Finance does not drive capitalism, profit does.  Finance does not create new value or surplus value but instead finds new ways to circulate and distribute it.  The kernel of crises thus remains with the production of value.  Neoliberalism is merely a word invented to describe the last 40 years or so of policies designed to restore the profitability of capital that fell to new lows in the 1970s.  It is not the economics of a new stage in capitalism.

Sure, each crisis has its own particular features and the Great Recession had that with its ‘shadow banking’, special investment vehicles, credit derivatives and the rest.  But the underlying cause remained the profit nature of the production system. If financialisation means the finance sector has divorced itself from the wider capitalist system, in my view, that is clearly wrong.

Sweden in deadlock

September 10, 2018

Sweden has long been the poster child of the ‘mixed economy’, the social democrat state – where capitalism is ‘moulded’ to provide a welfare state, equality and decent working and living conditions for the majority. The 2018 general election result has put that story to bed.

In yesterday’s election, the Social Democrats, the supposed standard-bearer of the ‘mixed economy’, remained the largest party with just over 28% of the vote.  But this was its lowest share in an election since 1908.  The main pro-business party, the so-called Moderates, also lost votes, coming in with 19.7%.  Cutting through both these parties, who have alternated for decades in controlling government, was the rise of Sweden’s so-called Democrats (an oxymoron), an anti-immigrant party with neo-Nazi roots, which polled 17.7%.  The smaller parties of the centre-right and the left also gained – the Left party jumping to 8%.  The middle-of the road Green party was run over and nearly failed to gain the 4% necessary to enter parliament.  The two alliances of the social democracy and the pro-business parties are virtually tied with 40% of the vote each – leaving the Democrats with the balance of power in the new parliament.  Such is the impasse.

It was an illusion anyway about Sweden being the ‘third way’ between untrammelled free market capitalism and command economy autocratic Communism.  The great gains of the Swedish labour movement in the early 20th century have slowly been reversed.  And the post-war diversion to public services of some of the profits of the Swedish engineering and manufacturing (owned by a handful of families) stopped decades ago.  Just as in other capitalist economies, the polices of neoliberalism – a reversion to free markets, low taxation for the rich and corporations, cuts in the welfare state and in real wages, rising inequality etc – have been operating in Sweden since the mid 1990s.

Why were neo-liberal policies introduced in Sweden? As in other capitalist economies, the profitability of capital fell sharply from the mid-1960s (to the mid-1990s in the case of Sweden).  After a credit boom that went bust and a major banking crisis, Sweden’s famed manufacturing sector took a massive dive.  It was then that Sweden’s major parties, the Social Democrats and Moderates, firmly adopted policies to boost the rate of profit for capital at the expense of the welfare state and public services.

Sweden may still have a more ‘equal’ income and wealth distribution than the US and the UK, but it is still very unequal – and inequality has been rising the fastest since the 1990s of all advanced capitalist economies.  In 2012, the average income of the top 10% of income earners was 6.3 times higher than that of the bottom 10%. This is up from a ratio of around 5.75 to 1 in the 2007 and a ratio of around 4 to 1 during much of the 1990s. Sweden’s richest 1% of earners saw their share of total pre-tax income nearly double, from 4% in 1980 to 7% in 2012. Including capital gains, income shares of the top percentile reached 9% in 2012. During the same time, the top marginal income tax rate dropped from 87% in 1979 to 57% in 2013.

In Sweden, like in most other Nordic countries, tax reforms over the 1990s have decreased the tax burden for wealthier households, e.g. by decreasing capital taxation and lowering or abandoning wealth taxation. At the same time, there have been cuts in welfare benefits for the poor.

What is not often known is that Sweden is no longer an epitome of state provision. The country is one of the world leaders in having public services supplied by the private sector, paid for by the government.  About one-third of all Swedish secondary schools are so-called ‘free schools’, with the majority of them run by for-profit companies, while about 40% of primary healthcare providers are privately owned. Public provision has been outsourced to the detriment of quality.  Sweden’s schools have slipped from being one of the world’s best in international ratings to “one of the most mediocre”.

The rise of the Democrats follows the pattern of so-called populism that we have seen in Germany, France, Italy, Denmark and other EU countries, as well as with Brexit in the UK and Trump in the US.  It is the product of the failure of capitalism to deliver after the end of the Golden Age in the mid-1960s, but particularly after the global financial crash, the Great Recession and the ensuing Long Depression.

Swedish capitalism, somewhat like Germany (only much smaller), has done better than most other capitalist economies since 2008.  But even in Sweden, the rate of economic growth has slowed in the last few decades and particularly since 2008.

Unemployment may be low by EU standards but the official figure hides those on work programmes  (German-style) and those on sick benefits.  As in Germany, many jobs are now ‘precarious’ and low-paid, particularly in the small towns.  And there have been significant public spending cuts on hospitals, schools, housing, pensions and transport.

And then there is immigration. Over 600,000 immigrants from the Middle East have entered the country since the Syrian/Iraq disaster (graph below).  Many immigrants are young single men and they have helped capitalist enterprises and the state sector overcome an acute labour shortage for low skilled work.  But the amount of immigrants per head of population is way more than in any other European economy and it has increased pressure on those public services, already suffering from neo-liberal measures.

There has been a massive housing boom driven by low interest rates and credit.  That has benefited the middle and upper classes but the working class and immigrants struggle for proper housing (graph – waiting list for rented housing in Stockholm).

Sweden is still growing much faster than much of the rest of Europe, but it is highly dependent on the growth of world trade and the strength of economic activity in Europe.  The strong growth has been driven again by a credit-fuelled consumer boom as in the 1980s, as well as from the extra value from immigrant labour.

Stockholm has the second most inflated housing market in the world, while the banking sector booms. The Swedish banks currently have assets that are four times the national GDP, second only to Switzerland.  The 1980s are repeating themselves.

Real GDP growth seems strong at over 3% a year.  But if you strip out the impact of extra immigrant labour, real GDP growth per person is much lower (below 1% in 2017).  Real per capita growth is seen averaging just 1% in the decade through 2026, according to the Swedish National Institute of Economic Research.

The small towns in Sweden have experienced low wages, poorer services and then were faced with an influx of new immigrants.  This was the breeding ground for the Democrats’ racist and nationalist message of ‘Sweden for Swedes’.  The Social Democrats are now paying for their support of capitalism and neo-liberal policies of the last 20 years.

Trump’s profits bonanza

August 30, 2018

Warning – graphics alert!

Yesterday, we got the data for US corporate profits in the second quarter of 2018, along with a revised estimate for US real GDP growth.  On the GDP front, the ‘annualised’ rate of growth was revised up to 4.2%, the strongest rate on that measure since the middle of 2014.  But this was after some very poor annualised rates (below 2%) in 2015 and 2016.  So it’s a bounce back from poor growth.

This 4%-plus growth rate sounds strong and President Trump is making much of it.  But it is likely to be the peak of the annual growth rate for this year and beyond.  If it is, then as John Ross and others have pointed out, this would be the lowest peak annual growth rate of any president since the second world war.

A more realistic measure of US growth is the year-on-year rate, in other words, how much the economy has expanded in Q2 2018 compared to Q2 2017.  On that measure, US real GDP growth was 2.9% in Q2, up from 2.6% in Q1 and the fastest since early 2015.  So that also sounds good – but remember that growth rate is still below the long-term average rate for the US economy of 3.3% and it is likely to be the peak rate going forward.  And when you strip out population growth and just look at real GDP per person, then the rate is just 2.2%, pretty much where it has been since the end of the Great Recession.

Why is this likely to be peak growth? Well, when we see where the growth came from in Q2, it was mainly from a rise in household spending, particularly on services.  Business investment (particularly software and ‘intellectual property’) also contributed but in less of a proportion than in the previous quarter.  And there was a big jump in net exports, partly because the cost of imports fell (energy prices subsided).  And the upcoming trade war could hit that.

Business investment was led by more shale oil construction and intellectual property.

The driver of this investment was the sharp increase in corporate profits in the second quarter – and that was all down to Trump’s corporate tax cuts and subsidies to the large corporates.  Corporate profits rose $72bn in Q2 compared to a rise of $27bn in Q1.  Corporate profits are up 7.6% from the same time last year.  If you strip out financial sector profits, the growth in profits in the non-financial sector was still 6.6% yoy.  And, after tax, corporate profits in Q2 were up 16.1% yoy!

But while in the first half of 2018, profits have jumped, thanks to the tax cuts, before-tax corporate profits are still below their peak in 2014.  After the effect of the downswing in 2015-6, US corporate profits have basically been flat for four years.

Cash flow has poured into US corporations from Trump’s tax cuts (the tax bill is down 33% from last year!).  But much of this extra money has ended up in dividends to shareholders and share buybacks (likely to reach $1trn this year).  The jump in profits has stimulated faster business investment growth but not anywhere as much it has driven corporations to buy their own shares or invest in other financial assets.

While corporations were mopping up a flood of cash into their coffers, there was little improvement in average real earnings for most Americans.  Indeed, real weekly earnings are still below levels reached this time last year, while after-tax profits are up 16%.

No wonder the majority of Americans feel no benefit from Trump’s growth ‘success’ – it’s all going to the top.

At the same time, the much-Trumpeted program to reverse the crumbling and increasingly dangerous infrastructure in the US shows no signs of emerging.  Government investment continues to be squeezed.

Q2 2018 will be the peak in US growth as it will be for corporate profits as the effect of Trump’s one-off cuts dissipate.   And we still have the impact of Trump’s protectionist policies on global growth to factor in.

Economic activity is weakening again in Europe.  The composite PMI is a survey of perceived activity.  Anything above 50 means growth, below is contraction.  In this third quarter of 2018, the PMI dropped back in the Eurozone (54 from 59 at the beginning of the year), was slightly down in Japan (52); and was flat in the US (55).  So all three areas are still growing but the pace is decelerating.

And then there is the emerging ‘emerging market’ debt crisis – Argentina, Turkey, Venezuela onto Brazil and South Africa.  So the last quarter is not going to be exceeded this quarter.

The Fed’s star-gazing

August 26, 2018

US Federal Reserve Chairman Jerome Powell spoke at the annual Jackson Hole symposium on Friday.  This annual symposium brings together all the top central bankers in the world who hear papers by mainstream economists on the issues and problems facing the major economies.  Powell was expected to deliver a speech in which he would appear cautious about the progress of the US economy.  He did not disappoint in his caution.

The Fed is still expected to raise its policy rate by another quarter point at its September meeting.  Indeed, it is projecting four hikes for this year, so the December meeting is also expected to be another when the Fed hikes again.  Earlier in the week President Trump  expressed his displeasure with the Fed and Powell, by name, saying he disagreed with the Fed’s interest-rate hiking because it could hurt the economy and vowed to keep criticizing the central bank until it stops.

At Jackson Hole, what did Powell think was the state of the US economy and what he would do with the Fed’s plan to raise interest rates this year and next?  He started by saying that “On the doorstep of the period now referred to as the Global Financial Crisis, surely few, if any, at that symposium would have imagined how shockingly different the next 15 years would be from the 15 years that preceded it.”  In other words, how wrong we were that the US capitalist economy could go on growing, the housing boom would continue and the credit-fuelled financial sector would keep on spiralling up.

But never mind, continued Powell, “over the course of a long recovery, the US economy has strengthened substantially”.  His ‘long recovery’ means a slow and weak one, something I have described better as a ‘long depression’.  But all is well now, because “there is good reason to expect that this strong performance will continue.”  And this justifies the decision of the Federal Bank to “gradually raise the federal funds rate from its crisis-era low near zero toward more normal level” and to end the policy of quantitative easing (buying government and corporate bonds by printing money),Powell reckoned that “this gradual process of normalization remains appropriate”.

So Powell reckons the ‘long depression’ (sorry, ‘recovery’) is over.  But he remains worried that the “US economy faces a number of longer-term structural challenges that are mostly beyond the reach of monetary policy. For example, real wages, particularly for medium- and low-income workers, have grown quite slowly in recent decades. Economic mobility in the United States has declined and is now lower than in most other advanced economies.  Addressing the federal budget deficit, which has long been on an unsustainable path, becomes increasingly important as a larger share of the population retires. Finally, it is difficult to say when or whether the economy will break out of its low-productivity mode of the past decade or more, as it must if incomes are to rise meaningfully over time.”  Hmm, so still a lot of problems for US capitalism to overcome and nothing much that the Fed can do about it.

Interestingly, then Powell discussed how accurate the Fed was in gauging whether the US economy was growing too fast (that might engender accelerating inflation and a squeeze on profits), or whether it was still growing too slowly (that hiking interest rates could actually push the economy back into a new recession, which would also hit profits).  He suggested that following the usual conventional ‘stars’, namely NAIRU, the natural rate of unemployment (when the economy is at full speed), or the natural rate of interest (where the cost of borrowing is about right) or some inflation target like 2% a year (the current Fed target) may not be of any use.

That’s because these natural rates for harmonious non-inflationary keep moving about!  “Navigating by the stars can sound straightforward. Guiding policy by the stars in practice, however, has been quite challenging of late because our best assessments of the location of the stars have been changing significantly.” The supposed strong relationship between economic growth and low unemployment (Okun’s law) seems to have shifted as the US economy crawls along at 2% while unemployment drops well below any previous estimates of NAIRU; or between falling unemployment and price inflation (the Phillips curve) as price inflation stays below the Fed Target although the official unemployment rate keeps dropping.

“Experience has revealed two realities about the relation between inflation and unemployment, and these bear directly on the two questions I started with. First, the stars are sometimes far from where we perceive them to be. In particular, we now know that the level of the unemployment rate relative to our real-time estimate of NAIRU (u*) will sometimes be a misleading indicator of the state of the economy or of future inflation. Second, the reverse also seems to be true: Inflation may no longer be the first or best indicator of a tight labor market and rising pressures on resource utilization.”

Inflation has not appeared in the ‘real economy’ but “destabilizing excesses appeared mainly in financial markets “ and so what is happening with debt or credit growth and the spiralling stock market may be more important indicators of whether the economy was about to ‘overheat’ and go bust.  Indeed…

So Powell concluded that moving interest rates up should be considered cautiously and even slowly, just in case: “when you are uncertain about the effects of your actions, you should move conservatively”.  However, in the next breath of his speech, he went on: “we have seen no clear sign of an acceleration (of inflation) above 2 percent, and there does not seem to be an elevated risk of overheating.”  So “further gradual increases in the target range for the federal funds rate will likely be appropriate.” 

Having spent a large part of his speech saying that the usual mainstream economic indicators of the health of the economy were not helpful because “the stars” kept moving and that the inflation indicator was less important than any ‘bubble’ signs in the financial sector (as they were in the 2008 crash), he then goes back to the inflation target to argue that more rate rises are ok!

Well, are they ok?  I have raised before that a capitalist economy goes into a slump or recession when profitability (rate of profit) starts to fall and profits (total profits) slow to a crawl or fall.  A slump in investment will follow eventually.  If the level of debt (particularly corporate debt) is also high and interest rates rise to push up the cost of borrowing, then profits available for investment will be squeezed more, perhaps to breaking point.

The Fed started hiking rates in late 2016. So far, that has not triggered a downturn or slump.  That’s because there has also been a sharp reduction in corporate taxation and other subsidies to US companies from the Trump administration – and it also appeared that economic growth was picking up in rest of the world, particularly Europe and Japan.  However, that optimistic spiral upwards from a seeming trough in 2016 appears to have peaked as I suggested last April.  Economic growth in Europe (2%) and Japan (1%) is slowing again.  And so is China.

As I offered in a previous post, the price of industrial metals, particularly copper (because it is sensitive to global investment in raw materials) is a very good high frequency indicator of the state of the global economy.  The copper price started to fall back in June – not yet back to the ‘recession’ level of 2016, but on its way.

At the same time, corporate debt in the US is still rising, as it has been in most ‘emerging economies’. At $8.6 trillion, US corporate debt levels are 30% higher today than at their prior peak in September 2008.  At 45.3%, the ratio of corporate debt to GDP is at historic highs, having recently surpassed levels preceding the last two recessions.

Rising interest rates, driven by the Fed, have already sparked serious emerging market debt and currency crises in Argentina and Turkey; and others are on the horizon.

And profits in the non-financial sector of the US have been falling while global corporate profits have slipped back into negative territory on my estimates (average of the top five economies). This is something not seen since 2015 which was followed by a near recession in 2016.

The US stock market jumped up after Powell’s speech because he seemed to be suggesting a relatively slow pace of interest rate hikes ahead.  The stock market reached an all-time high last week, fuelled by low interest rates, Trump’s tax cuts, but also by companies buying back their own shares to boost prices. This year companies have spent over $1trn buying shares.

Rather than invest in productive assets, the large companies have increased debt and spent their cash on financial assets (fictitious capital, Marx called it).  The build-up in US corporate debt threatens to squeeze profits further as interest rates rise and if wage growth does finally pick up.

One reliable signal for the start of a slump in the past has been the inversion of the bond yield curve.  As I explained in a previous post, the interest rate for borrowing money for one or two years is usually much lower than the rate for borrowing for ten years for obvious reasons (the lender gets paid back quicker).  So the yield curve between the ten-year rate and the two-year rate is normally positive (say 4% compared to 1%).

The general idea is that a steepening yield curve, where long rates are rising faster than short rates, indicates that credit is easy to access and profits are high enough from faster economic growth. But when short-term yields rise above the prevailing long-term bond rate it indicates credit conditions have become unusually restrictive compared to profits and that there is a very high probability that a recession will arrive within about a year.

RBC investment strategist, Jim Allworth reckons that: There hasn’t been a recession in more than 60 years that wasn’t preceded by an inversion of the yield curve. On average, the yield curve has inverted 14 months prior to the onset of a recession (median 11 months). The shortest “early warning” was eight months. We are not there yet in the US and certainly nowhere near in Europe.  But the US curve is going in that direction.”  The gap between the 2-year yield and 10-year yield, is now at a very flat 22 basis points.

Powell, it seems, is not worried about an inversion of the yield curve. One financial analyst commented: “We know there’s a bunch of people who are saying this time it’s different,” said Sharif. “Yet they (the Fed) spent a good chunk of their July meeting listening to a staff presentation on whether their tool kit is sufficient if there’s another downturn. They’re kind of prepping their tool kit.”

The trouble is that the tool kit is pretty empty apart from reversing the current hiking of rates and going back to the failed policy of quantitative easing.

Crashed: more the how, than the why

August 24, 2018

Adam Tooze was in London this week to present his new book, Crashed, How a decade of financial crises changed the world. Tooze is the author of The Deluge and The Wages of Destruction. The Wages of Destruction won the Wolfson Prize for History and the Longman-History Today Book of the Year Prize. He has taught at Cambridge and Yale and is now Kathryn and Shelby Cullom Davis Professor of History at Columbia University. In my view, he is our leading radical economic historian.

Tooze’s new book makes a massive contribution to the economic history of the global financial crash of 2008-9.  Tooze shows what happened and how it came about that the great credit boom of the early 2000s eventually led to the biggest financial disaster in modern economies and the ensuing deepest slump in capitalist production since the 1930s.  And he concludes that the way this was dealt with by ‘the powers that be’, namely through bailouts of the banks and the general saving of the wealth of the rich at the expense of the rest of us, has provoked the emergence of a ‘populist’ reaction against ‘capitalism’, whether leftist as in Greece or Spain, or rightist as with Trump, Brexit and the Liga in Italy.  So the legacy of the first ten years of 21st century capitalism is still with us in the second decade.  And worse, the underlying problem of rising debt and an uncontrolled financial sector has not been resolved.  The financial crisis of 2008-9 could well return.

There have been other intriguing analyses of the great financial crash before Tooze’s.  The most popular was The Big Short by Michael Lewis (which was made into a movie).  Lewis tells the story of the investment banks who sold ‘toxic’ mortgage backed bonds to their clients (mainly other investment banks and rich individuals, often from Europe), knowing full well that they were rotten.  As the property bubble started to burst, these banks then secretly went ‘short’ (betting on a collapse).   As Lewis puts in his book, “Goldman Sachs did not leave the house before it began to burn; it was merely the first to dash through the exit – and then it closed the door behind it.” 

In my own book on this period, The Great Recession, which is a chronological account, month by month, of the crisis from 2005 to 2010, I describe how the big banks in particular completely escaped the consequences of this scam, thanks to the US government.  Indeed, the whole ugly story of the activities of Goldman Sachs and other investment banks before, during and after the credit crunch and the Great Recession beggars belief.

But Tooze’s long book covers the significant financial crises of the previous ten years in much more detail than Lewis or me – and is global in scope.  Its length does not mean it is boring at all, as he presents us with vignettes of the major players and their decisions.  He shows how they ensured that the stronger and luckier big banks gained at the expense of the weaker and smaller; and how government intervention provided funding for the culprits of the financial disaster at the expense of the victims, working people, tax payers and small businesses.  It was ‘socialism for the rich and capitalism for the poor’: such is the stuff of the capitalist order.

Tooze particularly emphasises that the crash was not so much a story of the US spreading its financial contagion to Europe. The credit boom was just as strong in Europe. And as Tooze notes, “The flow of funds around Europe, as around the global economy, was driven not by trade flows but by the business logic of bankers, who compared the cost of funding and the expected return.” Indeed, the credit crunch started with BNP in France and was soon followed by the run on Northern Rock in Britain.

What is no surprise to readers like me who have studied the failures of mainstream economics and the official authorities prior to the crash is that Tooze shows that the competent powers that be were not competent at all.  They failed to see the crisis coming, denied it was happening and could not explain afterwards why it happened.  I won’t cite all the idiocies of the great and good in their complacency before the crisis and stunned surprise during the crash.  Tooze does it all.  But there are two examples worth restating.

In January 2007, just six months before the beginning of the global credit crunch and the collapse of the British money lender Northern Rock, Gordon Brown, the finance minister (Chancellor) in the UK spoke to a dinner of bankers in the City of London, just before he became Prime Minister.  He said: “Over the ten years that I have had the privilege of addressing you as Chancellor, I have been able, year by year, to record how the City of London has risen by your efforts, ingenuity and creativity to become a world leader.. an era that history will record as the beginning of a new golden age for the City…Britain needs more of the vigour, ingenuity and aspiration that you already demonstrate is the hallmark of your success.”

After the financial meltdown and in the depth of ensuing Great Recession, the great helmsman and ‘guru’ of the preceding credit boom and supporter of ‘financial engineering’ and derivatives, Alan Greenspan, the former chairman of the Federal Reserve, was asked in the US Congress investigating the disaster, why it happened.  He responded: “I am in a state of shocked disbelief.” He was questioned further: “In other words, you found that your view of the world, your ideology was not right, it was not working”(House Oversight Committee Chair, Henry Waxman). “Absolutely, precisely, you know that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well”.

When you read that, it is a little surprising that Tooze seems to find the role of Alan Greenspan, Larry Summers (former Treasury secretary) or Hank Paulson (the head of Goldman Sachs who became Treasury secretary in the crash) and other players in the crash as people who did the best they could, rather than as arrogant supporters of the ‘financial engineering’ that led to the crash.  These players get off lightly compared to Tooze’s correct criticism of Keynesian economists like Paul Krugman, who also reckoned that the financial sector was stable and would not be the catalyst for a crisis.  Of course, after the slump, Krugman attacked mainstream economics for its failure to see it coming.

Crashed provides us with the most granular and fascinating account of the crash and its aftermath.  It powerfully shows what happened and how, but in my view does not adequately show why it happened.  But maybe that is not the job of economic history, but that of political economy.  For Tooze, the cause seems to be deregulation of the banking system, financial greed and incompetent authorities.  For me, these are symptoms or immediate catalysts of the underlying causes in the capitalist economy.

As Martin Wolf said in his review of Crashed, “Even a story this complete has omissions. Tooze focuses on the idea that the growth of the financial sector’s balance sheets was ultimately the cause of the crisis. He does not pay enough attention to why policymakers needed this to happen.”  Wolf presents his causal explanation in Keynesian terms. “The explanation, as I have argued in my own book, The Shifts and the Shocks, was the global savings glut and associated global macroeconomic imbalances. Huge external surpluses in some countries necessitated huge deficits in others. Central banks needed the credit growth if they were to hit the macroeoconomic targets.”

Wolf’s explanation is equally inadequate: what was the cause of this global savings glut and ‘imbalances’ that arose in the 2000s?  Actually, the savings glut was in reality an investment dearth.  And slowing global investment, particularly in the advanced capitalist economies, was a product of falling profitability, from the late 1990s onwards – something that I and others have documented.

In Tooze’s view, “These crises are hard to predict or define in advance,” and, short of more regulation, there is nothing we can do. In a way, as long as capitalism continues as the dominant mode of production globally, that is pretty much right.  That reminds me of what Greenspan said in his final summation of the crisis: “I doubt that stability is achievable in capitalist economies, given the always turbulent competitive markets continuously being drawn toward but never quite achieving equilibrium”. He went on, “unless there is a societal choice to abandon dynamic markets and leverage for some form of central planning, I fear that preventing bubbles will in the end turn out to be infeasible. Assuaging the aftermath is all we can hope for.”

Tooze is pessimistic about the future.  Economically, he sees a future crash, probably coming from a meltdown in debt-ridden China.  In my view, it is more likely in the heart of Capital: the corporate sector of the US and Europe.

Politically, he warns that the 2008 crash and the response of the ruling orders has created the conditions for “illiberal democracy.” The success of the Tea Party and the American far-right, he argues, has grown directly from it.  And now we have Donald Trump, Putin, Brexit, Erdogan and the rise of the far right in Europe.

But ‘populism’ as it is called by the mainstream, has also taken a left turn with Syriza (until the crunch came); leftist groups in Spain and other parts of Europe, as well as Corbyn in the UK.  Opposition to the main capitalist solutions to the crash (bailouts, austerity and free markets (‘business as usual’) has not come purely from the reactionary nationalist right.

China’s ‘Keynesian’ policies

August 6, 2018

China’s reaction to Donald Trump’s trade war has been to retaliate with its own tariffs on US exports to China, particularly agricultural/food exports like soybeans.  Also the government has allowed the Chinese currency, the yuan, to depreciate towards the bottom of its controlled range against the dollar.  This makes Chinese exports cheaper in dollar terms and so defeats the purpose of Trump’s tariff increases on Chinese goods coming into the US.

But there is a third move: a considered expansion in government investment in and funding of construction projects to boost domestic output to compensate for any decline in exports.  The policy of government investment was hugely successful in helping the Chinese economy avoid the consequences of the Great Recession back in 2008-9.  While all the major capitalist economies suffered a contraction in national output and investment, China continued to grow.  In 2009, when GDP in the advanced countries fell by 3.4%, Chinese growth was 9.1%. Only one capitalist economy also grew – Australia – an economy increasingly dependent on exports of its raw material resources to its fast-growing Asian giant neighbour.

Simon Wren-Lewis, leading British Keynesian economist and blogger, claims that China’s success in the Great Recession demonstrated two things: 1) that it was austerity that caused the Great Recession and the weak economic recovery afterwards in the major capitalist economies and 2) it was Keynesian policies (ie more government spending and running budget deficits) that enabled China to avoid the slump.

Well, it is no doubt true that after a massive slump in investment and production in the capitalist sector of the major economies in 2008-9, cutting back further on government spending would make the situation worse.  In that sense, ‘austerity’ was a wrong-headed policy for governments to adopt.  But as I have argued in many previous posts, austerity was not some insanity in economic terms for capitalism, as the Keynesians think.  It has a rational base: namely that with profitability in the capitalist sector very low, costs must be reduced and that includes reducing taxation of the capitalist sector.  Also the financial sector had to be bailed out.  It was much better to pay for that by reducing government spending and investment rather than raising taxes.  And the huge increase in public debt that resulted anyway would require controlling down the road.

But what about getting economies out of the slump with more government spending?  Wren-Lewis comments China is a good example of that idea in action. What about all the naysayers who predicted financial disaster if this was done? Well there was a mini-crisis in China half a dozen years later, but it is hard to connect it back to stimulus spending and it had little impact on Chinese growth. What about the huge burden on future generations that such stimulus spending would create? Thanks to that programme, China now has a high speed rail network and is a global leader in railway construction.

So you see, Keynesian policies work, as China shows, says Wren-Lewis.  But were China’s policies really Keynesian?  Strictly speaking, Keynesian macro management policies are increased government spending of any type (digging holes and filling them up again) in order ‘stimulate’ the capitalist sector to start investing and households to spend, not save, all through the effect of the ‘multiplier’.

Sure, Keynes talked about going further, with the ‘socialisation of investment’ as the last resort.  But no government of Keynesian persuasion has ever adopted that policy (if it meant taking over capitalist investment with state investment).  Indeed, the Wren-Lewis’s of this world never advocate or even mention the idea of the nationalisation or socialisation of capitalist sectors.  For them, Keynesian policy is government spending to ‘stimulate demand’.

China’s policy in the Great Recession was not just ‘fiscal stimulus’ in the Keynesian sense, but outright government or state investment in the economy.  It actually was ‘socialised investment’.  Investment is the key here –as I have argued in many posts – not consumption or any form of spending by government.  The Great Recession in the US economy was led and driven by a fall in capitalist investment, not in personal consumption or caused by ‘austerity’.  In Europe,100% of the decline in GDP was due to a fall in fixed investment.

As John Ross said on his blog at the time, China is evidently the mirror image of the US …If the Great Recession in the US was caused by a precipitate fall in fixed investment, China’s avoidance of recession, and its rapid economic growth, was driven by the rise in fixed investment. Given this contrast, the reason for the difference in performance between the US and Chinese economies during the financial crisis is evident.”  

Wren-Lewis thinks that Keynesian measures would have done the trick and it was “a failure of imagination” by the governments of major economies not to act, but instead impose ‘austerity’.

It’s true that the governments of the major capitalist economies did not follow China’s example partly because they were ideologically opposed to state investment – indeed, their first measure of ‘austerity’ was to cut government investment projects – the quickest way to cut spending.

But the main issue was not ideology or a “lack of imagination”.  It is that Keynesian stimulus policies do not work in a predominantly capitalist economy where the profitability of capitalist investment is very low and so investment is falling.  With government investment in advanced capitalist economies only around 3% of GDP compared to capitalist sector investment of 15%-plus, it would take a massive switch to the public sector to have an effect.  ‘Stimulating’ capitalist investment with low interest rates and welfare spending would not be enough.  Capitalist investment would have to be replaced by state ‘socialised’ investment.  That only has happened (temporarily) in war economies (as 1940-45).  In the last ten years, in the US, Europe and Japan, it has been capitalists who made the decisions on investment and employment and they did so on the basis of profit not economic recovery.  Quantitative easing and fiscal stimulus – the two Keynesian policy planks – were ineffective as a result. In contrast, China’s fixed investment increased rapidly because it was driven by a programme of both direct state investment and use of state owned banks to rapidly expand company financing.

This difference between Keynesian measures in capitalist economies and China’s state-directed investment is about to be tested again.  Most mainstream economists are predicting that China will take a hit from any trade war with Trump’s America and economic growth is set to slow – indeed, there is a growing risk of a huge debt-induced slump.  But the Chinese authorities are already reacting.  Ordinary budget deficits (fiscal ‘stimulus’) are being supplemented with outright state funding of investment projects (dark blue in graph).

Most of this government investment funding is coming from sales of land by local authorities.  Through local government funding vehicles (LGFV), they build roads, homes, cities by selling land to developers.  But funds also come directly from the national government (80%).

We can expect such funding to rise and investment projects to expand if China’s exports drop back from a trade war with the US.  State investment will keep China’s economy motoring, while the major capitalist economies flounder.

A new global credit crunch to come?

August 3, 2018

At the time of the general election in Turkey, I pointed out that Turkey was near the top of the pile for a debt and currency crisis. It was running a massive current account (trade and payments) deficit with other countries and its external debt (what it owes to other countries in credits) was over 50% of its annual output (GDP), the highest among major ‘emerging economies’, while it foreign exchange reserves to cover repayments and support the value of the currency, the Turkish lira, were just 12% of GDP.  The country was now being run a self-aggrandising autocrat in (what we now call) “Trump-style”, and who was refusing to allow the main monetary authority, the Central Bank of Turkey, to impose higher interest rates in order to ‘curb’ inflation and attract ‘hot money’ from foreigners; or to implement any fiscal austerity, orthodox capitalist style.

The only escape valve was a collapse in the lira.  And in the last few weeks, the currency has depreciated exponentially.  And fear that Turkish banks and corporations will not be able to pay their debts and the economy will suffer a meltdown has driven up the cost of its bonds and insuring against default (CDS).

Turkey’s CDS spread and bond spreads have risen nearly 350 basis points—the highest level seen since the peak of the Euro area debt crisis. Higher refinancing costs will put further strain on government budgets and corporate borrowers.

But Turkey is just the most extreme example of the growing debt crisis beginning to hit economies that depend on foreign capital flows and investment in order to grow (and that’s most).  I have raised this prospect of an emerging economy debt crisis in previous posts, most recently with the fall of the Argentine peso.  A strong dollar (the main currency of loans), rising interest rates (with the Fed and now the Bank of England hiking policy rates) and higher oil prices for those that must import energy (eg Argentina, Turkey, Ukraine, South Africa etc): are the factors triggering this impending crisis – not seen since the Asian/EM crisis of 1998.

According to the IIF, the international research body of major multi-national banks, global debt (including financial sector debt) has reached $247trn, nearly 250% of world GDP.  That would mean world debt grew something like 13% in the three years ended 2017.

And as I have argued before, the locus of this impending debt crisis is not to be found in household debt (as it was in the global credit crunch in 2007 that led to the Great Recession) or in public sector debt (where governments have been applying stringent ‘austerity’ measures), but in corporate debt (the heart of capitalist accumulation).

The global financial crash of 2008-9, ten years ago, did not lead to a total collapse of capitalism, even though it triggered the worst slump in investment and production since the 1930s.  The financial sector was bailed out by huge injections of credit and cash and the capitalist sector was supported by zero or even negative interest rate policy by the central banks and unprecedented levels of money ‘printing’, called quantitative easing.  The result was not much of an expansion in investment or production.  In the major capitalist economies, economic growth (real GDP growth) has averaged no more than 2% a year (slightly more in the US and less elsewhere).  In the so-called emerging economies, average growth rates also fell back.  But above all, debt in all sectors rose.  The result was inflated financial asset prices without the kind of “recovery” seen in previous ‘business cycles’.

Just a decade after the Great Recession, the average US non-financial business went from 3.4x leverage (debt to earnings) to 4.1x. They are now roughly 20% more leveraged than they were the last time all hell broke loose. While Trump boasts of 4% growth and the US corporate sector never having it so good, the level of corporate debt in the US, alongside rising interest rates, is setting the scene for a new debt crisis.

How will such a crisis emerge? In the next year, US companies must refinance about $4trn of bonds, almost all of it at higher interest rates. This will hit debt-burdened companies that are already struggling and make it almost impossible for some to keep operating. Lenders, i.e. high-yield bond holders, will try to exit their positions all at once only to find a severe shortage of willing buyers. Something, possibly high-yield bonds, will set off a liquidity scramble.

Almost half of US investment-grade companies are rated BBB (just above ‘junk’) and could easily slip into junk status in a downturn. Rising defaults will force banks to reduce lending, depriving previously stable businesses of working capital. This will reduce earnings and economic growth. The lower growth will turn into negative growth and we will enter recession.  That is the likely scenario ahead.

Returning to ‘emerging’ economies, already banks and financial institutions globally are cutting back on their loans to the likes of Turkey etc.

But also capital flows from the non-financial sector to invest globally have declined.  Global foreign direct investment (FDI) flows fell by 23% to $1.43 trn in 2017, according to the latest report by UNCTAD.  Investment in new projects fell 14%.  Interestingly, most of this fall was between the advanced capitalist economies.  FDI flows to developing economies remained stable at $671 billion, after a 10 per cent drop in 2016.  But inward FDI flows to developed economies fell sharply, by 37 per cent, to $712 billion.

Global capital movements, driven mainly by debt-related flows, increased rapidly in the run-up to the financial crisis but then collapsed from 22% of global GDP in 2007 to just 3.2% in 2008. The subsequent recovery was modest and short-lived. In 2015, flows were still only 4.7% of global GDP.  Cross-border capital flows remain well below pre-crisis levels.  Overall net capital flows to ‘emerging’ economies were actually negative in 2015 and 2016, before turning slightly positive in 2017.

According to UNCTAD, “projections for global FDI in 2018 show fragile growth”. Global flows are forecast to increase marginally, by up to 10%, but remain well below the average over the past ten years. Multi-national companies are cutting back on international investment, partly because of the risk of a future trade war after Trump’s protectionist measures; and partly because possible debt crises in the most vulnerable ‘emerging’ economies.  But a key reason is a fall in profitability from overseas investment.  UNCTAD found that the global average return on foreign investment is now at 6.7%, down from 8.1% in 2012. Return on investment is in decline across all regions, with the sharpest drops in Africa, Latin America and the Caribbean.

As a result, the rate of expansion of international production is slowing down.  Assets and employees are increasing at a slower rate. Growth in the global value chain (GVC) has stagnated. Foreign investor profit in global trade peaked in 2010–2012 after two decades of continuous increases. UNCTAD’s GVC data show foreign value added down 1 percentage point to 30% of trade in 2017.  It’s not just as profitable to trade or invest globally compared to before the Great Recession.

The story of the last ten years since the Great Recession is that the world capitalist economy has staggered on at low levels of growth and investment and with virtually no improvement in real incomes for the 90%.  And it has only staggered on because of a huge build-up in debt, particularly in the capitalist sector.  Now, monetary authorities are trying to reverse the credit binge and restore ‘normality’.  As a result, the cost of servicing that debt is on the rise and availability of more credit to finance is shrinking.

When we read the financial press, we see the huge profits being made by the top companies (mainly in the US – in Europe, profits are down even for the large), but the vast majority of companies are still not achieving the profitability they need to finance their debts if the cost of servicing rises sufficiently.  And globally, banks and corporate investors are reducing their loans and investments because of low profitability and concerns about declining trade growth and a global trade war.  And that pending trade war still has some way to go.

World trade and imperialism

July 30, 2018

There is a new dataset on world trade that looks at changes in exports and imports globally going back to 1800 and the beginnings of modern industrial capitalism.  Two authors, Giovanni Federico, Antonio Tena-Junguito have presented a number of papers on the trends found in the data.

Their main conclusions are that trade grew very fast in the ‘long 19th century’ from Waterloo to WWI, recovered from the wartime shock in the 1920s, and collapsed by about a third during the Great Depression. It grew at breakneck speed in the Golden Age of the 1950s and 1960s and again, after a slowdown because of the oil crisis, from the 1970s to the outbreak of the Great Recession in 2007. The effect of the latter on trade growth is sizeable but almost negligible if compared with the joint effect of the two world wars and the Great Depression. “However, the effects might become more and more comparable if the current trade stagnation continues”.

The data show that there were two major periods of ‘globalisation’, if you like.  The first was from 1830-70 when the export to GDP ratio, a measure of openness in trade, rose.  The second was from the mid-1970s to 2007 – the great globalisation period of the 20th century.  According to the data, the current level of openness to trade is unprecedented in history. The export/GDP ratio at its 2007 peak was substantially higher than in 1913.

There were two periods of stagnation or decline in global trade expansion: during the depression of the late 19th century up to the start of WW1 and then in the 1930s Great Depression.  Indeed, “openness collapsed during the Great Depression, back to the mid-19th century level.”

Now we appear to be in another downturn in globalisation and trade.  “Since 2007, the apparently unstoppable growth of world trade has come to a halt, and the openness of the world economy has been stagnating, or even declining. The recent prospect of a trade war is fostering pessimism for the future. Some people are hinting at a repetition of the Great Depression”, conclude the authors.

As you would have expected, the rise of industrial capitalism globally meant that the share of agricultural and mineral products in total exports declined for both advanced capitalist (imperialist) countries and (interestingly) for the peripheral (colonial) economies.  The share of primary products fell from about 65% in the 1820s to slightly above 55% on the eve of WWI, with an acceleration of the trend around 1860 (as industrialisation spread).

The big change was the move of America from an agriculture exporter to industrial giant in the 20th century.  The continued rise in industrial and services trade in the late 20th century globalisation has been in turn been led by China’s transformation from a poor agricultural peasant economy into the manufacturing (and increasingly hi-tech) workshop of the world.

Share of primary products on exports, baseline series, 1820–1938

The data in general confirm that my own study of globalisation and imperialism that I recently presented.

In my thesis, I argue that globalisation and increased trade are responses by capitalism to falling profitability and then depression in a previous period.  Globalisation of trade and capital took off whenever profitability of capital fell in the imperialist centres.

Between 1832-48, profitability of capital in the major economies fell; after which there was an expansion of globalization to drive up profitability (1850-70).  However, a new fall in profitability led to the first depression of the late 19th century (1870-90), during which protectionism rose and capital flows shrunk.  With economic recovery after 1890, imperialist rivalry intensified, leading up to the Great War of 1914-18.

Again after the defeats of various labour struggles post 1945 in Europe, Japan and in the colonial territories, capitalism entered a new ‘golden age’ of relatively fast growth and rising profitability.  Globalisation of trade (reduction in tariffs and protectionism) and capital (dollar-led economies and international institutions) revived, until profitability again began to fall in the 1970s.  The 1970s saw a weakening of trade liberalization and capital flows.  From the 1980s however, capitalism saw a new expansion of globalization in trade and capital to restore profitability.

The beginning of the 21st century brought to an end this wave of globalisation.  Profitability in the major imperialist economies peaked by the early 2000s and after the short credit-fuelled burst of up to 2007, they entered the Great Recession, which was followed by a new long depression.  Like that of the late 19th century, this brought to an end globalisation.  World trade growth is now no faster than world output growth, or even slower.

So the counteracting factor to low profitability offered by exports, trade and credit has died away. This threatens the hegemony of US imperialism, already in relative decline to new ambitious powers like China, India and Russia. With US President Trump now launching his attempt to put the US back in the driving seat for international trade, renewed rivalry threatens to unleash major conflicts in the next decade or so.

Mexico: violence, corruption and inequality – AMLO to the rescue?

July 2, 2018

The victory in Mexico’s presidential election of Andrés Manuel López Obrador (AMLO), under the rubric of his relatively new ‘progressive’ Morena party, is both unsurprising and surprising.  It’s unsurprising because AMLO had a huge and increasing lead in the opinion polls leading up to polling day.  And Mexico’s 88m voters (out of 127m people) have now given him the biggest win in post-war election history, with over 53% of the vote.  The candidates of the establishment parties were way behind.  For the first time, the parties of the elite and the status quo were split over who should be their standard bearer.  And the sheer anger and frustration at the state of Mexico’s economy and daily life for average citizens has swept AMLO into office.

But the result is also surprising because the ruling classes’ immense power to ‘fix’ the election (as they have done in the previous ones), or to find a way to stop AMLO politically has failed.  Of course, the Mexican courts may attempt to overturn the result on alleged ‘irregularities’ but such is the size of AMLO’s victory, that such a trick will probably not succeed. AMLO’s party Morena has also gained a majority in the Mexican Congress and has won at least five of nine gubernatorial races, with the winners including Mexico City’s first elected female mayor, Claudia Sheinbaum.  But Morena is in alliance with a small extreme Christian fundamentalist party which may moderate what the new administration will do, particularly in social and ‘family’ matters.

AMLO has won because he campaigned on three key issues that enrage and engage Mexicans: rising pervasive and daily violence across the country; endemic corruption among politicians and officials; and high and rising inequality between rich and poor.

On average, someone was killed in Mexico every 15 minutes during the month of May, putting the country on track to surpass last year’s grim milestone of 29,168 killings.

Political killings have also shot up, with 130 politicians, including 48 candidates for office, murdered since the beginning of the electoral cycle in September, according to political consultancy Etellekt.

Behind this violence lies the battle of the drug cartels, organised crime and general criminality which is often settled by assassination.  The police are either lacking in personnel or backing from the government; or both are in the league with the criminals.

Corruption is integrally linked to the massive profits made from drug trafficking and production, and other criminal activity.  Politicians of the establishment parties were up to their neck in this.  Mexico’s global corruption ranking has never been higher.

The country has been rocked by a succession of eye-watering corruption scandals, including that of Javier Duarte, a PRI governor who went awol in a government helicopter in 2016 after being accused of corruption and whose wife recently turned up living in luxurious exile in one of London’s poshest boroughs.  The government of President Enrique Peña Nieto was riddled from practically the moment he took office. His wife purchased a bespoke home from a government contractor on favourable terms. Then there was the cover-up of the horrific disappearance of 43 teachers’ college students, the use of sophisticated spyware purchased by the government to monitor journalists and human rights lawyers, while top officials embezzled public funds to pay for party electoral campaigns.

AMLO has pledged to end corruption – but how this is to be done remains unclear.  AMLO says he will allow a recall of officials in office after two years (including the presidency) and he will sell the presidential plane and only live in modest premises.

AMLO says he will stand up for the poor (over 50m Mexicans are designated as such) first over the rich.  And that is the third issue that has led to his election victory.  Mexico is one of the most unequal societies in the world in the 21st century – surpassed only by post-apartheid South Africa.  Recently the US Brookings Institution adjusted the standard measure of inequality in a country, the Gini coefficient.  The nearer the Gini is to 1, the higher the level of inequality. On its new estimates, Mexico’s Gini coefficient for 2014 rises from an already high 0.49 to a mega 0.69, close to that of South Africa, the world’s most unequal country.

Behind the shocking story of violence, corruption and inequality lies the stagnant state of the Mexican economy.  It’s the 15th largest in the world as measured by GDP and the second largest in Latin America.  It is sufficiently advanced to be included in the top 30 OECD economies.  And yet it is in a sorry state.

The inequality is not just between rich and poor but also in the uneven development of the economy under capitalism.  Cumulative economic growth in the best-performing Mexican states reached 32% between 2007 and 2016, about double the average for Latin America.  But this is about four times the rate of growth in the low-performing states. Per capita output shows the same diverging path.

In Oaxaca and Chiapas, for example, about 70% of the population is in poverty and 23-28% in extreme poverty, according to data from the National Council for the evaluation of socio-political development (CONEVAL).

Contrary to the views of mainstream economics, the 1994 NAFTA trade deal with the US and Canada has not taken the Mexican economy forward.  Indeed, whereas the Mexican economy more than doubled to reach 16% of the US output in the 30 years to the mid-1980s, it has declined to 12% since then.

Mexico’s output per hour worked relative to that of the US is near its lowest level since 1950.

NAFTA, far from boosting Mexico’s economic performance, increased its dependence on US trade and investment, locked in the neo-liberal measures of the 1980s and increased the disparities between the faster-growing US border areas with their special economic zones and the poor southern rural regions.  And now US President Trump is insisting on renegotiating to make it even more favourable to the US!

Moreover, as the excellent report by the CEPR argues, If NAFTA had been successful in restoring Mexico’s pre-1980 growth rate, Mexico today would be a high income country, with income per person significantly higher than that of Portugal or Greece. It is unlikely that immigration reform would have become a major political issue in the United States, since relatively few Mexicans would seek to cross the border.

Mexico’s poverty rate of 55.1% in 2014 was higher than the poverty rate of 1994. As a result, there were about 20.5 million more Mexicans living below the poverty line as of 2014 (the latest data available) than in 1994.  Real wages have made little progress since 1994.  There was a fall in real wages of 21.2% from 1994–96, associated with the peso crisis and recession. Wages did not recover to their pre-crisis (1994) level until 2006, 11 years later. By 2014, they were only 4.1% above the 1994 level, and barely above their level of 1980. The minimum wage, adjusted for inflation, fared even worse. From 1994 to 2015, it fell by 19.3%.

As a result of low profitability and investment, along with the impact of the NAFTA deal, the Mexican economy has basically stagnated.  The reason lies with the failure of Mexico’s capitalist sector.  Yes, the ‘neo-liberal period’ since the early 1980s, presided over by successive establishment, pro-business Mexican governments, did stem the fall in the profitability of Mexican capital to some extent, but it failed to turn profitability up, as was achieved in most other capitalist economies.

Slow economic growth in the post global crash period has led to a crisis in public finances as the state had to pick up the bill from the private sector’s failure.  Between 2008 and 2018, public debt grew from 21% of GDP in 2008 to 45.4% of GDP in 2018. Servicing this debt now absorbs 20% more government revenue than that allotted for health, education and poverty reduction in the federal budget. This is the burden that AMLO will inherit.

The OECD, the main promoter of neoliberal measures in Mexico, claims that “growth is set to pick up, underpinned by private consumption and exports.”  But even the OECD reckons “uncertainty (with Trump) will continue to restrain private investment”. However, “private investment could accelerate if the NAFTA negotiations end favourably.”  And it continues to demand “structural reforms” (ie neoliberal measures of government spending cuts and privatisations) “to strengthen the rule of law and improve institutional quality.” (!).

Despite the OECD’s optimism, capitalist sector investment has stagnated or fallen since the end of the Great Recession.

And that is because the profitability of Mexican capital has not recovered since the Great Recession, at least according to the net rate of return on capital data offered by AMECO.  Indeed, profitability is still some 18% below the level of 2007 and 28% below the 1997 ‘neo-liberal’ peak.

AMLO’s programme is fundamentally Keynesian, using public investment to ‘prime the pump’ of private investment and claiming that money saved from reduced corruption will deliver the funding. But he is unwilling to reverse the part-privatisation of PEMEX, the state oil company or end the proposed new ‘nightmare’ Mexico City airport – only to consider ‘reviewing the contracts’. But how can AMLO turn things round on corruption, inequality and violence without control of the banks (mainly foreign), renationalisation of PEMEX and taking over the major multi-national operations within Mexico?

Donald Trump congratulated AMLO on his win.  But Mexico’s northern neighbour is now being run by a nationalist, imperialist crazy bent on launching a trade war with all and sundry.  Mexico is right in the front line of this whirlwind, with a capitalist economy that is struggling amid poverty, corruption and violence.  Nevertheless, with a huge and young population, oil and gas resources and modern industry in parts, Mexico is in a much better position to succeed than Venezuela and Cuba was.   AMLO does not take over the presidency for another five months (December).  He has major challenges ahead.