by Francis Lee for the Saker Blog
‘’The years since the 1970s are unprecedented in terms of their volatility in the price of commodities, currencies, real estate, and stocks. There have been 4 waves of financial crises: a large number of banks in three, four or more countries collapsed at about the same time. Each wave was followed by a recession, and the economic slowdown which began in 2008 was the most severe and most global since the great depression of the 1930s … Bubbles always implode, since by definition they always involve non-sustainable increases in the indebtedness of a group of borrowers and/or non-sustainable increases in the price of stocks/shares … Debt can increase much more rapidly than income for an extended period …’’ But ‘’… when eventually the rate of their indebtedness slows the ‘day of reckoning’ occurs, when there isn’t enough cash to pay the interest on outstanding loans the bust is inevitable.’’ (1)
Interestingly enough 1971 was the year when Nixon took the world off the gold standard, which had been in effect since 1944. At a stroke this was probably the most destabilizing event since the Wall Street Crash of 1929. But the full effects didn’t filter through the system until the decades beginning in the 1960s. The problem was the fact that the US economy had undergone a metamorphosis from being a surplus trading nation to being a deficit nation. Earlier, in 1944 to be exact, it was agreed at the Bretton Woods conference that a new trading system needed to be constructed, this in order to overcome the problems of the inter-war trade wars which had led to mutual impoverishment. The new global trade architecture was to be based upon a hierarchy of hard currencies, the British pound, the French Franc, the Italian Lira et cetera all aligned at a fixed rate of exchange with the US dollar which was to be convertible with gold at $35 per ounce.
The system worked for a while but excess US expenditures – namely the imperial expeditions in Korea and Indo-China, as well as a bloated system of some 800 military bases stationed in areas all over the world, and add in the social expenditures of the LBJ administration in the US, all of which meant that abundant US$s were turning up all over the place, particularly in Europe and Japan. Holders of these surplus greenbacks sought conversion into either their own currencies or the universal equivalent – gold. This gave rise to a run on gold since the US was required to honour the arrangement of convertibility. In its turn this led to a serious depletion of US gold reserves which necessitated the US (and by implication involve the rest of the world) to unilaterally suspend the gold standard. Henceforth US trading partners would, whether they liked it or not, take dollars which they were assured were as good as gold (a ridiculous proposition). This was described by the French politician Valery Giscard D’Estaing as an ‘Exorbitant Privilege’ and of course he was perfectly correct. At this point the Triffin Dilemma/Paradox kicked in. But I have covered this elsewhere (See The Rise and Fall of Empires).
It should be understood that booms and busts have always been normal in a capitalist economy. Two eminent political economists have put forward their explanation of this phenomenon as follows.
Karl Marx (1818-1883) explained that capitalists would try to boost their profits in new and more productive technology to save labour costs. In a letter to his close compatriot and friend – Friedrich Engels – he wrote: ‘’All of you note that from reasons I no longer have to explain, that capitalist production moves through certain periodical cycles.’’ He particularly identified the rate of profit to be the independent variable in capitalist production; this variable gave rise to a number of other dependent variables such as employment and unemployment, investment decisions, stock market booms and slumps, and capitalist companies borrowing monies by issuing shares/stocks or borrowing directly from banks. They also began to issue bonds as did governments. Thus the role of finance capital was enormously enhanced.
Joseph Schumpeter (1883-1950) reckoned that when capitalism went into a crisis or slump, it made much of the old equipment or plant obsolete. Other capitalists then began to turn to the new technology to gain advantage, so capitalist slumps led to innovations. Schumpeter called this process ‘creative destruction’. So a cycle of new technology would start after a major slump. But this new technology would not be developed until the profits cycle moved into upswing. Then there would be a take-off of the new technology. The next downward wave would mean a setback to the new technology cycle and an even worse situation for capitalists depending on the old technology. Finally, in another new upswing for profits, the new technology would take over as the dominant force. In the next downswing the new technology would become mature and capitalists would look for new systems and the whole process would restart.
These cycles, however, would very much vary in duration from fairly short-term business restocking, to longer term business cycles, property cycles, profit cycles and into longer and more profound upheavals which may have matured over decades. The Kondratiev cycle being a prototype which has lasted for at least 60 years. Nikolai Kondratiev himself was a Soviet economist who was able to identify such cycles. Four such waves were identified from the late 1700s and four complete waves were identified by Kondratiev. Such waves were occasioned by the usual boom-bust cycle but essentially these cycles were pushed forward by the production and diffusion of new technologies and the operationalization of new modes of production. From water powered, steam powered, electrification, Fordist organized production, and digital communications and computerization of the entire economy. These were the ongoing means of production, although the class nature of the capitalist system did not change.
Unfortunately Kondratiev found himself on the wrong side of the Stalinist nomenklatura and was arrested for suggesting that the US would not necessarily collapse in the great recession of ’29. Heresy! He was arrested and did 8 years in one of those grim Soviet prisons, and finally taken out and was shot by firing squad in 1938. These were grim times.
In recent years, however there has been a new development feature which has been exacerbated during crisis situations involving that part of the economy indicated by the acronym FIRE (Finance, Insurance and Real Estate) and its growing importance in the economy in both qualitative and quantitative terms.
Finance as it is referred to has always been part of the general economy. But it was always in a sense the junior partner to industry and subordinate as such. Its role was to support the productive sector in terms of credit and liquidity, but the relationship has now become almost inverted. Value producing Industry is now relegated to the second tier of the economy and finance now runs the show.
‘’To maintain the semblance of vitality Western capitalism has become increasingly dependent on expanding debt levels and on the expansion of fictitious capital … fictitious capital is made up of financial assets that are only symbols of value, not real values. For example company shares that are traded like goods and services do not in the same way embody value. They are tokens which represent part ownership of a company and the potential of a distribution of future profits in the form of dividends. The paper or electronic certificate itself is not a genuine value that can create more value. Rising share/stock prices are often presented as the evidence of a healthy economy, but the amount of money that a share/stock changes hands says nothing definitive about the value of the company’s assets or about its productive capacity. On the contrary, it is when real capital stagnates that the amount of fictitious capital tends to expand.’’(2)
Turning to financialisation proper and its genesis. This phenomenon was enabled through the holy trinity of privatisation-liberalisation-deregulation. This was a political/economic project which began to take root in the 1970s but came into full fruition in the 1980s led by Margaret Thatcher and Ronald Reagan. At both the political and economic level radical theorists such as those ensconced at the Chicago University department of Economics became the crucial protagonists in a movement led by Milton Friedman and which was to become known as the Chicago School. Its impact was profound. This insofar as it signalled the end of one epoch and the beginning of another.
‘’The expansion of the financial sector is the most recognisable aspect of financialisation. However a more telling part for how the workings of the economy change is the adoption of financial activities by the non-financial corporate sector, by the wider industrial economy. The core feature of financialisation is the fusion of industry with financial activity. (My emphasis -FL) Troubled financial firms turn to financial activity in order to raise cash and/or shore up profitability.
These activities start with raising debt to fund business operations working at sub-par profitability. They extend into financial engineering where buying and selling shares or acquiring companies take precedence over productive investment and organic growth in the underlying businesses. Financial services companies are often helpful in conducting these activities. The drive-through comes from the non-financial businesses that are obliged to pursue financial activities when their original productive ones are less profitable and remunerative.’’ (3)
The hegemon of deregulated finance had thus assumed a seemingly unstoppable momentum from the late 20th century, through to the 80s and 90s until the early 21st century. It has been a process whereby financial markets, financial institutions, and financial elites gain greater influence over economic policy and economic outcomes. It has impacted on the economy producing deep-going changes, not necessarily for the better. But its principal raison d’etre has been to elevate the significance and practice of rent-seeking activities relative to the real value-producing sector. Economic rent is essentially parasitic involving the tapping into those income streams which are producing real value. These consist inter alia of – banks, credit agencies, investment companies, brokers and dealers of commodities and securities, security and commodity exchanges, insurance agents, buyers, sellers, lessors, lessees and so forth – has now reached such a level that it has become larger, more ubiquitous, and profitable than productive industry.
In contemporary terms financial institutions had been involved in the acquisition of economic rent. This consisted of little more than a parasitic claim on real value as was produced in the production process. To cite a simple example. Parking meters don’t produce any new value, they merely transfer existing value from the motorist to whoever is collecting the meter charges. Other examples are rent from land, patents and copyrights, monopolistic pricing and so forth. This situation was initially outlined by David Ricardo (1772-1823) who argued that ‘’The interest of the landlord is also opposed to the interest of every other class in society – namely, capitalists and workers. Ricardo’s animus toward the land-owning classes was in part based upon this theory of economic rent as outlined in his definitive work, The Principles of Political Economy and Taxation first published in 1817. It was a theme that Keynes took up 2 centuries later with his recommendation of the early ‘euthanasia’ of the ‘rentier’ and the rentier class. The views of Ricardo and Keynes were unfortunately disregarded, and to this day, in the UK at least, the Monarchy, landed aristocracy and rentier class are still very much a power in the land. (The UK never had its bourgeois revolution, or rather it did in the civil war between Parliament and the King – 1642-49. Cromwell and Parliament won, and Charles 1 had his head chopped off in 1649, but there was a restoration whereby his son Charles 2 was brought back from France to claim the throne of England.)
But I digress.
The whole process of financialisation was to divert income from the real value-producing sector of the economy and transferring it through various rental manipulations to the financial sector. Needless to say this would purposely result in inequality and stagnant and/or falling wage levels.
Thus from 1970 onwards this part of the economy has grown from almost nothing to 8% of US Gross Domestic Product (GDP). This means that one dollar in every ten is associated with finance. In terms of corporate profits finance’s contribution now represents around 40% of all corporate profits in the US. This is a significant figure and, moreover, it does not include those overseas earnings of companies whose profits are repatriated to their countries of origin.
Finance operates at different levels in the economy: through changes in the structure and operation of financial markets, changes in the behaviour of nonfinancial corporations, and changes in economic policy
The increasing pervasiveness of finance in the contemporary world economy and its ever-expanding role in overall economic activities, and in addition to its ongoing growth in profitability, are the indicators of growth and spread of financialisation. Given the historical record, however, it seems highly probable that this financial ascendency will not be permanent and the whole house of cards will eventuate into a collapse into debt-deflation and a long period of economic depression.
The template for contemporary financial operations can be described from activities of Investment banks like Goldman Sachs as well as run-of-the-mill commercial banks. Of course, as stated, these venerated institutions do not create value as such; they are purely rent-extractive. Commercial banks can and do make loans out of thin air, debit this loan to the would-be mortgagee who then becomes a source of permanent income flow to the bank for the next 25 years. At a more rarefied level Goldman Sachs is reputed to make year-on-year ‘profits’ by doing – what exactly? Nothing particularly useful. But then Goldman Sachs is part of the cabal of central banks and Treasury departments around the world. It is not unusual to see the interchange of the movers and shakers of the financial world who oscillate between these institutions. Hank Paulson, Mario Draghi, Steve Mnuchin, Robert Rubin, and most recently from the IMF to the ECB, Madame Lagarde … on and on it goes.
This system now moves into ever more vertiginous levels of instability. But this was the logical consequence of deregulation. Regulation involves additional costs, but the last thing financial markets want is an increase in costs: ergo, deregulation. But this was to be wholly expected. As a result the history of regulation is that new types of institutions are developed that exist outside the scope of regulations, e.g., money-market funds were developed as a way to pay interest on demand deposits. The offshore market developed to avoid the costs that domestic banks incur in the form of reserve requirements and deposit insurance premiums; the offshore branches of US banks – i.e., the Eurodollar market – could pay higher interest rates than their domestic branches. The whole institutional structure – its rules, regulations and practises were deregulated, and finance was let off the leash. Thatcher, Reagan, the ‘Big Bang’ had set the scene and there was no going back: neoliberalism and globalization had become the norm. From this point on, however, there followed a litany of crises mostly in the developing world, but these disturbances were in due course to move into the developed world. Serial bubbles began to appear.
Ever mobile speculative capital was to move from one financial debacle to the next leaving a trail of wreckage and destruction in its wake. But, hey, that was someone else’s problem. The Savings and Loans crisis 1980’s and 90’s, Long Term Capital Management, 1998, dot.com bubble 2000/2001 and the property market bust in 2008 where the precursors of the current and even deeper blow-out.
But contrary to popular mythology – ‘this time it’s different’ – any boom and bust has an inflexion point where boom turns to bust. This is when buyers incomes, and borrowers inability to extend their loans could no longer support the rise in the price level. Euphoria turned to panic as borrowers who once clamoured to buy were now desperate to sell. 2008 had arrived. The same financial drama of boom and bust was to repeat itself. In the initial euphoria property prices went up but the market became oversold. At this point house prices and the prices of attendant derivatives – e.g. Mortgaged Backed Securities (MBS) – began to stall. The incomes and borrowing of would-be purchasers could no longer support the ever-rising property asset prices. The cycle had reached its inflexion point, now the whole thing went into reverse. Everyone was frantic to sell, prices collapsed. Some – a few – made money, quite a few lost monies. Investors were wondering what had happened to their gains which they had made during the up phase. Where had all that money gone? In fact the ‘gains’ were purely fictional as were the losses. Such gains/losses which had appeared then simply disappeared like a will ‘o’ the wisp. The gains and losses were never there in the first place given as an accounting identity they were balanced.
One would have thought that past experience would have chastened investors into a more conservative frame of mind. But no. Whenever there was a sniff of something for nothing the mob starts to move like Wildebeest on the plains of the Serengeti, an unstoppable stampede. Even such luminaries as Sir Isaac Newton perhaps one of the greatest scientific minds of his day who lost a cool £20000.00 on the South Sea Bubble lamented in 1720 that ‘’I could calculate the movement of heavenly bodies but not the madness of the people.’’ I suppose you could see this as being yet of another instance of human irrationalism – a recurring theme and instances in human nature, of which sadly there have been many.
And what has all of this to do with Coronavirus? Well everything actually. I take it that we all knew that the grotesquely overleveraged and dangerously poised world economy was heading for a ‘correction’ but that is rather an understated description. Massive downturn would be more accurate. This was already baked into the cake prior to the COVID-19s emergence and warnings were duly given and then routinely ignored. We are now left with a combination of a dangerous pandemic crisis combined with a huge financial and economic correction. The world was a combination of a unprecedently bloated paper money bubble and a rampant and virulent pandemic virus. Anticipated consequences can only be imagined.
(1) Manias, Crashes and Panics – Kindelberger and Aliber – P.1/2 – 6th Edition 2011.
(2) Phillip Mullan – Creative Destruction – p.22
(3) Mullan – Ibid, – p.22/23
*A note on fictitious capital:
Fictitious capital is a by-product of capitalist accumulation. It is a concept used by Karl Marx in his critique of political economy. It is introduced in chapter 25 of the third volume of Capital. Fictitious capital contrasts with what Marx calls “real capital”, which is capital actually invested in physical means of production and workers, and “money capital”, which is actual funds being held. The market value of fictitious capital assets (such as stocks and securities) varies according to the expected return or yield of those assets in the future, which Marx felt was only indirectly related to the growth of real production. Effectively, fictitious capital represents “accumulated claims, legal titles, to future production’’ and more specifically claims to the income generated by that production.
The moral of the story is that it is not possible to print wealth or value. Money in its paper representation of the real thing, e.g., gold, is not wealth it is a claim on wealth.
“We are now left with a combination of a dangerous pandemic crisis combined with a huge financial and economic correction”
What dangerous pandemic? Look at the numbers of dead and it is the same as last year in pretty well all countries. They simply changed the label on the death certificates. It was a hoax. A plandemic used to plunder the resources of the USA to the tune of $6-10 trillion – in favour of the financial sector.
I guess it is dangerous for the ones in their 70s probably because it was designed that way. I concur with the rest.
The one that stresses the hospitals to use or create resources they once did not have or need to have. human capital, ventilators and the like. The system works, or worked well, until the rentiers back is broken and they cause an expensive social unrest that cant easily be controlled.
It appears that we have turned that corner to find that every small mistake (like a cop shooting someone in the back) leads to a group of rentiers massively protesting which only adds to the straws being thrown on the back of gvt programs like law enforcement.
You get enough of these straws being thrown around and the pandemic mutates into a social one that cant be controlled only stressing the system further until an economic collapse is the outcome.
Yes recent US GDP growth figures I looked at for other reasons recently show not much real gain since the 1970s relative to rises in financial securities. Its mostly been intangible growth.
Kondratiev’s 60 yr cycle also needs to be considered with the 90 year one which recently rolled over from the1929 peak.
Its a cycle of debt build up and over production relative to capacity of average people to pay that comes to a head. Related to a cycle of durable goods that accumulate and dont need replacing that effects demand.
Also long term weather/climate cycles that effect crop production can come into play too.
The fundamental problem is the US has a chronic trade and monetary deficit problems that has lasted for a long time which must be addressed. And its not just with China but EU Japan too. Oil consumption issues too. And its dilemour is some of its eco entities (importers and offshore manufacturers) profit from that trade while other do not.
Recent moves by the US FED are in some ways akin to the 1920s German printing of Reichmarks which in the end became almost worthless.
There has been eco problems and chaos in EU & US since at least 2000 with a patchy weak recovery but China etc has done much better. That inequity will cause a bust in US & EU and will flow on to Asia. Also unneeded immigration caused by political control agendas has added to the problem. Inequities in the tax and wealth distribution along with usury for the past 50yrs has also caused this problem.
There is also the spectre that the NWO is wanting to crash things to implement One World Govt and currency and that is an extremely dangerous thing particularly for third world countries and Russia.
As the above writer notes there has been a buildup of problematic things the past 50 years which will in the end come to fruition.
A famous US cycle expert, stated that once a trend change begins nothing can stop it until it has run its course, as will the current situation.
The Highwayman: “A famous US cycle expert, stated that once a trend change begins nothing can stop it until it has run its course, as will the current situation.”
That’s pretty much an accepted truth. That’s why politicians claiming success in managing the economy are almost always claiming credit for effects that are not the result of their inputs.
In general, all that can be done in terms of managing the economy is to control the amplitude of changes and, to a degree the period of the cycle. That’s a relatively long term affair. One might look to the economic effects of the Thatcher government in the UK. There were changes but they were the result of inputs over many years, not the life of a single parliament.
Great read. It’s basically a concise roundup of Michael Hudson’s The Bubble and Beyond.
Although David Ricardo was animus towards the landed gentry and their ability to extract rent – and later in his life a relentless advocate of the repeal of the Corn Laws – he himself was one of the biggest rentiers (interest) at that time, being a lifelong stock- and loan broker and banker’s lobbyist.
Banks at that time – at least in the Anglo-Saxon world – were reluctant to make loans for productive purposes
and rather engaged in the the business of foreign trade. Inventors like James Watt were obliged to seek
funding for their inventions by raising money from wealthy private citizens and friends/family.
Agreed, a very good read, compliments to the author. I especially liked
“Finance as it is referred to has always been part of the general economy. But it was always in a sense the junior partner to industry and subordinate as such. Its role was to support the productive sector in terms of credit and liquidity, but the relationship has now become almost inverted. Value producing Industry is now relegated to the second tier of the economy and finance now runs the show.”
What would be interesting would be an academically grounded viewpoint espousing why there is this prominence of Finance these days. Some could argue that it is just the rich becoming richer, the oligarchs becoming oligarch-ier, the rentiers becoming more rentier-y, or maybe the purposeful curtailing of the productive value producing industry, by banks not wanting to loan to it for instance, is to extract value and control from the 99%, who live and work in the productive value producing industry, to give to the 1% to enable the weakening / enslaving and maybe even eventual elimination of the 99%, etc, etc.
As per Hudson, it is the Governments that are supposed to be interested in the productive value producing industry because that is where 99% of their constituents are located, but alas …
The answer to your question is already in the text. It’s an amalgamation of the falling rate of profit over time, the technological prerequisites that enable high speed trading, and compulsion of this which leads to making short-term profits and skipping the production part in the classical production process.
Academia couldn’t care less about these set of facts; they are bascially the public relation arm of the financial wizards except for some miniscule renegade economic departments.
Those are the benign process, technological and profit seeking considerations, but the 1% also actively promote Finance. As per the article “This phenomenon was enabled through the holy trinity of privatisation-liberalisation-deregulation”. Government is supposed to be there taking care of public services, health, utilities and assisting the classical production process through infrastructure development and public banking, not privatizing everything and so letting Finance, which is global, rule.
The 1% rule through their banks, through which they control resource allocation and make Finance prominent. And if the banks aren’t “private”, as in owned by the 1%, then the countries hosting those banks get bombed, sanctioned, coup’ed, and whatnot, to ensure that the banks are “private”. So global Finance rules.
So there are both passive process, technological and profit seeking considerations which lead to Finance’s prominence; and malicious, active agendas as well.
Agreed about the Academia.
The core feature of financialisation is the fusion of industry with financial activity.
And what of the oil industry an industry always in the red? According to Gail Tverberg over at ww.ourfiniteworld.com it is an industry in terrible financial shape that oscillates between the consumer who needs low prices and the producers who need high prices. According to her there is a coming inflection point which will collapse the entire economy. What we are facing is an affordability crisis right across the board. As she says it if wages of non elite workers could rise high enough to pay for the increasing costs of everything from cars, to homes, groceries etc etc we likely wouldn’t have a problem. That of course is clearly not happening.
I would love to hear more Francis Lee
As she says it if wages of non elite workers could rise high enough to pay for the increasing costs of everything from cars, to homes, groceries etc etc we likely wouldn’t have a problem.
In isolation, that might be true. It would, however, create other problems. The standard explanation is that it would create price inflation, which seems likely to be true. Hard to provide examples, since that kind of thing almost never happens. There’s also the considerable question of what these non-elite workers would be doing to earn those increased wages. Their jobs have long since been exported elsewhere, so absent share holders forgoing profits to recapitalize industry here and then share future profits thereafter with labor, none of that could possibly happen in the first place. Never mind the roles of high tech and robotics in modern production processes, which makes all that even more unlikely.
Capitalist economics, with its relentless focus on efficiencies, especially when it comes to profits, has priced its own consumers right out of the equation, just as Marx said it would. Took over a century for all this to play out in full, but he was definitely right. All true capitalists have already drawn the next logical conclusion, and now simply state (behind closed doors, of course) that it’s time for the infamous creative destruction cycle to be applied fully to the human element as well. Their jobs, and with them their ability to consume, have already been destroyed, so now its time for them to go too, since they no longer have any means whatsoever of serving the capitalist wealth pump. A ruthlessly efficient system, indeed!
Good point about the “infamous creative destruction cycle to be applied fully to the human element as well”, that certainly seems to be what is happening right now. “Their jobs, and with them their ability to consume, have already been destroyed, so now its time for them to go too”.
So Globalization which caused them to lose their jobs and earnings is perfectly aligned with the desire to reduce the world’s population to the 500 million mark as per the Georgia Guidestones. Once the more capable have been sufficiently reduced by Globalization and lockdowns and immigrant invasion, its easy to deal with those who remain and then even easier to deal with the innumerable less capable, by those empowered for just this task. Alas, some people’s plans (or should I say some Satanists’ plans) seem to be coming together.