The Debt Mountain

Financial debts are obligations to pay back the creditor. This may not happen, either because the debt is 'forgiven' (rarely) or because it otherwise gets written off in a deal to restructure future payment obligations in a way that looks more plausible to the creditors, who may be banks, insurance companies, pension funds or other private sector asset managers, or another government or public sector organisation. For the major powers, being in such a situation is a little tricky. They are meant to be on the disciplining, creditor end of the balance, even if they also happen to be in a lot of debt themselves. However, a recent set of data from the Bank for International Settlements indicates that, despite the much-vaunted recovery of the world economy from its acute crisis phase, debt ratios to GDP have generally gone up in recent years in the key countries. Even where the debt ratio appears to have fallen a bit, this hides a wide range of other, not-counted obligations (implicit debts) that may be hidden off budget, or are deep in the details of the relevant central bank accounts.

The following chart for five key countries shows the picture for the 2000-2015 period. Japan remains an outlier, with far and away the highest debt ratio of 388% of GDP in 2015. Having had such a long deflationary depression, even an earthquake and tsunami leading to dreadful nuclear radiation fallout from the Fukushima plant could not induce the comatose economy (and political class) to wake up.  The UK looks in a slightly better position, although its recent lower debt ratio ignores the run up of Bank of England liabilities, plus many other off-budget items. The US debt ratio has stabilised in the past five years or so, but this has been despite the supposed recovery of the economy, and also ignores the post-2008 accumulation of Federal Reserve 'assets', including nearly two trillion dollars of mortgage securities bought from banks. France's debt ratio has continued to rise. Germany's has fallen, helped by the stronger economy. But the latter calculation ignores the liability of Germany, at the heart of the eurosystem's finances, where endless volumes of dodgy 'assets' have been accumulated by the European Central Bank, whose main shareholder is the German state.

So, following my usual caveats about what data really cover and what is ignored, here is a chart of how the total debt ratio of the non-financial sector (including governments, households and non-financial companies) in five countries has developed in the past fifteen years:

Tony Norfield, 4 September 2016

Britain’s Brexit Limbo

Britain’s divorce from the European Union will be a tortuous affair.* The British establishment losers in the June 23 Brexit referendum were shocked by the vote to leave, as were the financial markets: sterling’s value slumped some 10 per cent on the foreign exchange markets and the UK’s credit rating was cut. But even many victors looked shocked too. Some, including several leading Conservative Party Members of Parliament, only wanted to gain some appeal with their populist stance against the EU, not really to go ahead with such an uncertain venture. Perhaps more importantly, world leaders were bemused that the British government could have let things come to such a pass. Long having been able to pose as the knowledgeable consigliere to the major powers and others, advising on disputes and helping to negotiate deals, the UK now looks like a reckless troublemaker. For them, the aftermath of the Brexit referendum is another unwelcome upset in an already crisis-ridden imperial landscape.

Article 50

The formal exit process begins when the UK invokes the never yet used Article 50 of the EU’s 2009 Lisbon Treaty to inform other members of its decision. In normal clubs, there is a procedure for a member leaving. But, as far as I know, this Treaty for first time gave one for the EU. (Let no one be so impolite as to mention that there is still no procedure at all for leaving the euro group of countries, since, of course, membership of the euro currency area is ‘irrevocable’) Article 50 is the explosive device, but it turns out that the UK does not have to trigger it any time soon. Even if it did so next week, to begin formal negotiations on the terms of exit, then there would still be a period of some two years before the final farewell. The latest reports suggest that it will not even be triggered until 2017.

There is now a developing conflict of interests between the UK and the European Union. In the referendum campaign, the UK ‘Leavers’ claimed that they could achieve more or less full access to the European single market, while making good trade deals elsewhere. Above all, they promised to get these advantages while stopping the unwanted immigration of workers from the EU, whom they claimed were putting ordinary Brits out of jobs, while adding to the queues for housing and welfare services. What never got a look in during these debates was the idea that capitalism, dysfunctional and averse to economic security, might be responsible for the problems, not the EU.

On the EU side, the last thing the main European powers want to do is to make an exit seem like an easy option, especially since they are also faced with political opposition to the EU and/or the euro in France, Spain, Italy and Greece. They have been cautious in their approach; perhaps thinking that the British Parliament might somehow disregard the result of the referendum, although this is politically a non-starter. But there have also been signs of irritation that the Brits do not just get on with the process of leaving.

Most observers reckon that a UK exit from the EU will not occur before the end of 2018 at the earliest, with German, French and Dutch national elections in 2017 likely putting a constraint on how flexible the UK’s partners will be for their sadly departing friend. Even if the main EU powers were conciliatory, they would be faced with the problem of a lack of clarity on the UK side. A recent Financial Times story cited an EU diplomat who was exasperated at this: ‘They have to sort themselves out. They come from London and they don’t know what they want. They don’t know what their government wants, what their parliament wants. They have not prepared.’ All this could be part of a cunning plan by the wily Brits to increase their room for manoeuvre in negotiations. But it looks more like reflecting that, beyond vague generalities, they do not yet really know what they are going to do.

Regime Changes

So much for a Brexit vote, one might think. However, changes are afoot, nonetheless. Already, Lord Hill, UK European Commissioner for Financial Stability, Financial Services and Capital Markets Union, resigned his post in the wake of the referendum. This means that there is more leeway for the EU’s other powers to try to undermine the position of the City of London in European financial affairs, something already attempted by the European Central Bank and France in 2011-2015. It will be plus c’est la même chose, plus ça change for the Brits in the next few years, because being not quite an EU member will mean British interests will be less protected by EU single market rules.

While things on the UK Brexit front have been very far from sorted out, some of the recent vagaries of British politics have been more neatly varnished over. The governing Conservative Party swiftly resolved its leadership contest in favour of Theresa May, after former Prime Minister Cameron resigned when his ‘Remain’ position failed. This was deftly executed and made the opposition Labour Party, under embattled leader Jeremy Corbyn, look like a bunch of nobodies going nowhere.

New Prime Minister May stamped her authority with an inaugural speech on the steps of 10 Downing Street that claimed to care for all in a striking one-nation approach. She gave her policy goals as improving social justice, being anti-the privileged few and helping workers. This was a clear appeal to the Brexit working class, especially in England, that had voted both against the establishment line and against EU immigration, and was effectively calling on the British state for support.[1] It also further undermined the opposition Labour Party’s claims to speak for the mass of people, a claim already weakened by its poor performances in the 2010 and 2015 general elections.

The Three Brexiteers

Theresa May has appointed three campaigners for Brexit to handle negotiations with the EU, although she will retain the commanding position on the British side, chairing the government’s Cabinet committee on Brexit. A major position, Foreign Secretary – Secretary of State, in US terms – was given to a Brexiteer, Boris Johnson, who had been the de facto head of the Leave campaign, and one-time challenger for the position of new Prime Minister after the Brexit vote. This former major of London is widely known internationally for his image-prepared tousled blond hair, his populist rhetoric and his PR prowess. But his new position puts him in a tricky spot, one so elevated that it will leave him gasping for air.

Like other celebrities who have captured popular attention, Johnson is known often only by his ‘first’ name Boris, although his real moniker is Alexander Boris de Pfeffel Johnson. He has joint UK-US citizenship, and is an alumnus, like others in the British elite, of Eton College, Oxford University and its infamous Bullingdon Club of riotous upper class yahoos. In contrast to many of his social peers, who are also in opinion-forming or government circles, his political career has been characterised by well-timed clowning and bombast to distract attention from his lack of attention to detail – or, commonly, his invention of details – plus his jibes at a multitude of world leaders when writing columns as a journalist. His qualifications for the position of UK Foreign Secretary, one that demands diplomatic nous, are so precisely wrong that the phrase ‘square peg, round hole’ comes to mind.

In one of his first international media encounters in his new job, alongside US Secretary of State John Kerry, Boris had to deal with journalists who wondered whether he still thought that Hillary Clinton was someone with ‘dyed-blonde hair and pouty lips, and steely blue stare, like a sadistic nurse in a mental hospital.’ The comment might have been a reference to Louise Fletcher’s role as Nurse Ratched in the movie, One Flew Over the Cuckoo’s Nest. If so, Boris must now fear he might suffer the same fate as Jack Nicholson’s character.

Just in case Prime Minister May’s chess strategy of putting a potential challenger in a zugzwang position became too problematic, she has downgraded this otherwise top political job. She has invented two more ‘foreign’ posts to distribute the burden, and the blame if things go wrong. Each of these has gone to other Brexiteers, as if to prove that she was not reneging on her democratic responsibilities.

Brexiteer Number Two, really Number One in practical terms, is David Davis, the new Principal Secretary of State for Exiting the European Union. Don’t worry if you have not heard of him; most people in the UK outside of the political circuit feel the same way. In his favour, he has a better record of keeping a consistent political position than the more famous Boris and, surprising though it is to note, he has even sometimes been progressive in his opinions. For example, he criticised a British policy of outsourcing torture to Pakistan.

Davis is unreasonably optimistic about the ability to secure favourable new trade deals quickly with non-EU countries, but in a recent article he showed a commitment in line with Theresa May’s new Brexit working class orientation. It was EU regulation of trade, not regulation of the labour market that, he said, that was stifling growth:

‘All the empirical studies show that it is not employment regulation that stultifies economic growth, but all the other market-related regulations, many of them wholly unnecessary. Britain has a relatively flexible workforce, and so long as the employment law environment stays reasonably stable it should not be a problem for business.

‘There is also a political, or perhaps sentimental point. The great British industrial working classes voted overwhelmingly for Brexit. I am not at all attracted by the idea of rewarding them by cutting their rights.’[2]

This stance fits neatly into the slightly more conciliatory approach of the British ruling class in the economic crisis. They sense the need to be cautious about political implications when there is a potentially disruptive populace. It has already led to a stepping back from the previous more direct approach to reducing government spending deficits. For example, instead of agreeing to balance the budget in the next few years, the new Chancellor of the Exchequer (Finance Minister), Philip Hammond, has said he would weigh up the evidence before committing to new spending plans in the Autumn. This was widely seen as a retreat from austerity policy, which, for similar reasons, is being followed in other rich countries. On 4 August, the Bank of England complemented the new post-Brexit policy with a cut in interest rates, promising more to come, and to expand so-called quantitative easing, including a plan to buy bonds from companies that ‘make a material contribution to the UK economy’. The latter pledge completely contradicted the ‘level playing field’, ‘free and fair market for all’ rhetoric of economic policy in recent decades. It is another sign, albeit a small one in this case, of a move towards a more nationalistic policy framework.

Liam Fox is Brexiteer Number Three, taking the newly invented position of Principal Secretary of State for International Trade. A return to frontline politics was always on the cards for this political operator, despite his previous misdemeanours. The black marks on his copybook have included him having to repay money that he had ‘over-claimed’ on expenses as a Member of Parliament – an easy mistake that all busy people are prone to commit when they view their profile in the state hierarchy as a source of unlimited funds for themselves. More damning for his reputation, and an issue forcing his resignation in 2011 as Defence Minister, was that he invited a business friend to numerous official meetings with diplomats and defence contractors. That friend posed as a government consultant to gain contacts, which was a step too far from official protocol.

Five years in the political wilderness was enough for Fox, and he saw his opportunity with the post-Brexit Conservative Party turmoil. His tactics were neatly executed: he put himself forward in the Conservative Party leadership election, although there was no chance he would win, then pulled out early and declared himself in favour of Theresa May, who was clearly set to top the poll. As a result, Prime Minister May rewarded him with the international trade position.

Fox has had no previous experience of the politics of dealing with international trade, unless one includes his promotion of arms deals, both when in office as Defence Secretary and when in a corresponding opposition role. It will be instructive to see if he can do his new job of reworking the web of UK-EU trade relationships – alongside promoting the much-vaunted non-EU trade deals too, of course. However, it has not been surprising to hear very little from him in his first month in office.

Plan 9 From Outer Space

One might wonder whether the new UK Prime Minister’s appointments for managing the Brexit process are part of some devious plan. Is the aim to string out the EU negotiations, helped by inept UK negotiators? But, if so, what would be the point? While settling a comprehensive deal quickly with the EU is not feasible, especially one that would be favourable to the UK, why muddy the exit route when British-based business would prefer a clearer path? However, the problem is not simply that the relevant expert negotiators are not available. It is worse than that: there is no easy, and perhaps no real solution to this impasse. In some form, the UK’s EU relationships will certainly continue, but the question is in what form? Political and economic factors offer plenty of room for conflict on both sides of the coming debates and, to say the least, there are no precedents from which to make a confident judgement on the likely outcome.

If it looks like the ruling elites in Britain, Europe and elsewhere are making it up as they go along, then that is because they are. At best, capitalist policymakers can exhibit something that could, very generously, be called ‘tactical flair’, as happened in the wake of the 2007-08 financial collapse and detailed in numerous memoirs by those involved. For example, in the famous ‘Lehman weekend’ in September 2008, the US Treasury and the Federal Reserve were faced with trying to rescue the financial system. They summoned banks and investment funds to emergency meetings and made desperate calls (including to the UK) to bolster their support for several US financial companies that were collapsing at the same time. Other examples abound, including many in Europe, from the European Central Bank’s policy initiatives to those of the Bank of England.

The Brexit aftermath is not as acute for the UK as was the 2007-08 debacle, but managing to avoid another collapse is hardly a sign of health. British economic policy is changing, as it is in other countries. This reflects how policy has adapted to what medical practitioners might call the chronic phase of an illness, after its acute phase, in this case the malady of modern capitalism. The patient – the British or other major economies – may now have good days along with the bad, leading to some short-lived optimism about recovery. But the illness is not going to go away and debt levels continue to rise. From the perspective of most of the population, economic ‘growth’ will look like stagnation at best.

This helps explain why politicians seem so incompetent or powerless these days. It is not a sign of a mysterious viral infection that especially impacts the closely-knit elites, however plausible that might sound, especially when looking at the choice US voters face in November. Instead, note that the current generation of politicians has been brought up not to question the operation of capitalist markets that seemed to bring them some prosperity. It is now faced with far more difficult choices. The ones that might now look more attractive – tactically, strategically, who can tell? – often threaten to dismantle the framework on which they have relied, with unpredictable consequences. This results in political disarray, with prolonged, bumbling hesitation and wild recklessness, even from the same politician. If the post-Brexit developments in the UK are beginning to look like scenes from a poor B-movie, with wooden actors spouting unconvincing dialogue and walking around crashing into the wobbly scenery, then that is just one reflection of a crisis-ridden world.

Tony Norfield

Note: * This article first appeared in the New York journal BrooklynRail, in the Fieldnotes section. 

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[1] See my analysis of the domestic politics of the Brexit vote here.

[2] See http://www.conservativehome.com/platform/2016/07/david-davis-trade-deals-tax-cuts-and-taking-time-before-triggering-article-50-a-brexit-economic-strategy-for-britain.html

Farewell European Finance?

The latest Bank for International Settlements survey of the global FX market offers some interesting insights into the development of the global economy. Currency trading is critical as a measure of market activity, since it encompasses all the deals between countries (assuming they have a different currency), whether for trade, investment, hedging or speculation. Deals are largely done between financial companies, but they also reflect the activity of non-financial ones and the economy in general. Between April 2013, the date of the previous survey, and April 2016, the latest one, the striking feature of the BIS report is the decline in the volume of currency trading for the first time in many years. On a net-gross basis (the measure used, there are others!), the volume of global FX trading fell by 2%.

The main casualty is the UK (basically, London) as a trading centre, although it remains by far the biggest in the world. The gainers in terms of market share are the US and Canada, but more significantly the Asian FX trading centres. To have a smaller share of a market in decline, as the UK has had, is a big problem for a previously lucrative financial business.

The UK's share of global currency trading fell from 40.8% in 2013 to 37.1% in 2016, a very sharp drop, although still above the level in 2010. Meanwhile, the US, in second position, rose by 0.5% to 19.4% from 2013 to 2016. The US rise in share nevertheless meant that its volume of dealing rose by less than 1% over the three years; the UK's volume fell by 11%. The UK decline reflects the weaker European economy and the related weakness in euro currency trading in London (some three-quarters of the total euro trading), while US banks were in a relatively strong position, but that was not saying much.

Overall, Europe's share of currency dealing fell between 2013 and 2016, not only due to the UK. France, the Netherlands, Luxembourg, Italy, Ireland and Switzerland also declined. Although Germany had a slight gain in market share over this period, its share in this financial business is minimal at less than 2%.

Asian trading centres are recorded as the winners from the latest BIS report. Despite the impact of the global crisis on 'emerging market' countries that are vulnerable to changes in developments in the world economy, several Asian trading centres have had success on this financial dealing measure. Singapore's share of the volume of trading rose from 5.7% to 7.9%; taken together, China and Hong Kong's rose from 4.8% to 7.8%. This is an astonishing result for China, especially, backed by the near-doubling of the use of the renminbi in global FX dealing to 4%, making it the eighth largest trading currency, just behind the more established Canadian dollar and the Swiss franc. Meanwhile, the euro slipped to its lowest share since its inception, to just 31%, while the US dollar rose slightly to 88% (note that with two currencies in each deal, the total shares add up to 200%).

Financial dealing is far from being a full picture of reality. But the shift in economic weight from Europe to Asia is a clear message from the latest BIS FX report, with the US holding its own. This is consistent with a wide variety of other economic assessments.

Tony Norfield, 1 September 2016

Rate of Profit, Rate of Interest

The rate of profit and the rate of interest are at the core of capitalism’s dynamic, but there is a huge amount of confusion in what is written on these matters. This article aims to clarify some key points. I outline the relevant aspects of some theories of profit and interest, but focus on how to understand profit and interest rates from the perspective of a Marxist understanding of capitalism. Underlying these abstract concepts are the realities of class and power in the world economy.

Rate of profit calculations

Profitability is obviously important for capitalism. Paying attention to the rate of profit, not just the amount, also makes sense, since this gives the amount of profit per unit of capital advanced, and the more the better. But this simple point hides two important complications.

Firstly, the calculation must be timed. Commonly, calculations are for the rate of profit per year, so that the amount of profit in a year is measured against how much capital is advanced at any one time to achieve it. Other things equal, this also means that the shorter the time period between advancing the money capital, buying the necessary means of production, producing and then selling the commodities at a profit, the greater will be the rate of profit per year. This can make shortening the buying/selling process also appear to be a source of value and profit, not just the production process itself. A quicker method of buying/selling will speed up the circulation process for the producer, raise the amount and rate of profit per year and allow a greater profit to be shared between the producers and the commercial capitalists who are more involved in this process.

Secondly, the rate of profit will be affected by how much of the capital advanced is from the company’s owners and how much is borrowed from banks or other money capitalists providing it with extra investment funds. If we assume a given, annual rate of profit of 10% for the company, then the return on its total investment will also be 10%. But if it has borrowed half its investment funds from banks at a rate of just 5%, or issued bonds with a yield of 5%, then the rate of profit on the funds that the company’s owners have advanced will be higher. For example, for 200 invested at 10%, the annual return is 20. But if the company’s owners have invested only 100 of their own money plus an extra 100 they have borrowed, the company then gets as its profit the 20 total minus the 5 it needs to pay on its borrowings, etc. The result is that its rate of return will be higher: 15 (20 – 5) over the 100 invested, or 15%.

This extra profitability depends on the rate of interest paid on the borrowings being lower than the underlying rate of profit on the total investment. That is not always the case, but it shows how profitability calculations for capitalist owners will tend to change when borrowing funds is taken into account.

What rate?

A company’s borrowed funds raise an ambiguity, one that has not been dealt with well by Marxist theory. If the money is borrowed via bond issues or bank loans, then the payment for the borrowing falls under the heading of interest, so the previous calculation will hold. But if the extra funds come from new money advanced by money capitalists buying any new equity the company issues on the stock market, then how should these extra funds be treated and what is the form taken by the deduction from profits?

If the money capitalists have put their funds into the company’s new equity issue, or even just bought previously issued equity from others, then they own part of the company, just as much as the original owners. To that extent, they will receive a share of the profits in the form of dividends on the equity they own, just like the others. However, there are some distinctions to take into account.

As newer entrants, unless the new equity buyers become big shareholders, they will have fewer claims on the company’s resources through the large salaries they might otherwise get by becoming executives and directors, with special bonuses or other payments. Small-scale equity owners also have little voting power in company decisions, and some of the equity sold and bought may even be devoid of voting rights on these decisions. Insofar as they are in this latter camp, the equity dividends for them are not so different from the interest payments on the company’s bond or bank loan borrowings. But they are still in a different economic situation from bond holders or bank lenders. They benefit from any rise in the price of the equity, and may suffer a loss from a collapse of equity prices. They have none of the usual debt holder or bank lender protection of being first in line for payments, if the company gets in trouble, and their dividends might be zero or very high, while interest and coupon payments are determined at a market level or fixed in advance.

Aside from any possible director benefits, the return on equity for the companies’ owners can be taken to be not only the dividends paid on the value of the equities purchased, but also on the change in the price of the equity itself. So, holding a company’s equity that pays zero dividends may be better than holding one with high dividends, if its equity price has risen far enough above the investor’s purchase price. For example, buying shares in a company at 100 and receiving no dividend for two years will be disappointing for money capitalists. But the outcome will nevertheless look attractive if the company’s share price rises to 150 over those two years, because a large capital gain has been made.

This is accentuated further by the way in which all equity prices (and, indeed, bond prices) tend to rise as interest rates fall, and vice versa, due to the lower, or higher, rates of discount on future earnings by money capitalists. Such calculations show how far capitalist views on what it a profitable investment can become divorced from a measure of the company’s actual return on capital or its underlying profitability.

Company reports usually standardise data with annual rates of profit, and also distinguish the profit due to shareholders after interest on borrowings and other special factors. These commonly lead to different rankings of companies, not necessarily only by their reported profits, but also, especially in recent decades, by the volatility of the returns they get. Extra borrowing usually leads to extra volatility of returns. These are other factors that influence the choices made by money capitalists, and thus the allocation of capital, but they do nothing to change the actual profits produced.

Rate of interest

At first sight, the rate of interest is more easily observable than the rate of profit on industrial or commercial investment. After all, the central bank’s key interest rates are published daily or intra-day, as are the yields on 3-month Treasury bills, 5-year or 10-year government bonds or rated corporate bonds. Nothing similar really happens for measures of company rates of profit. While there are many rates of interest – interbank borrowing rates, government Treasury bill or bond yields, corporate bond yields, borrowing rates for consumer loans or mortgages, etc – they are publicly observable in ways that a rate of profit on corporate investments is not.

How is this problem of many rates of interest dealt with in economic theory? Mostly, not at all. Instead, a sacred ‘rate of interest’ is often used in mainstream economic theory, with few, or no questions asked as to what kind of interest rate is meant. Financial theory may, for practical calculations, distinguish a corporate bond yield or government-borrowing yield, in order to determine the relevant price of a financial security, but there will be no serious investigation as to why this is at a particular level and not at any other. Instead, tautological assessments of ‘risk’ are offered, which make the banal observation that a more risky investment will probably have to offer a higher interest yield. But this does little to get around the problem that much mainstream financial theory, especially for financial derivatives, is based on the idea of there being, at bottom, a ‘risk-free’ interest rate, one that exhibits a zero, or negligible credit risk of not getting repaid by the borrower.

What rate is ‘risk free’? Usually this is assumed to be a government security yield, ignoring the inconvenient fact that governments have also been known not to repay in full. In the case of the US government’s security yields, the nec plus ultra of ‘risk free’ in financial theory, it is conveniently ignored that on several occasions the US government has run close defaulting on its debt repayments, owing to political turmoil in Congress. How far government yields can be seen as objective arbiters of the rate on ‘risk free’ debt is also questioned by a significant bias lower for this rate, especially in financial markets dominated by the major powers. Structural demand for the key government securities, from the domestic banking system, from international investor demand for the global currency security, and sometimes from their taxation policies (for example, exempting capital gains from tax), produces lower yields than would otherwise be the case.

The upshot is that ‘the’ rate of interest is as nebulous as ‘the’ rate of profit. Both sets of rates are determined in a chaotic capitalist market. Are there any laws determining these?

Relationships between interest and profit rates

A common view in mainstream economic theory is that the rate of profit and the rate of interest are either the same, or tend to equality over time. The logic is straightforward, but this logic also highlights the deficiencies of the argument. It is an example of the errors that arise when a focus on appearances is allowed to obscure the underlying processes of the capitalist economy. This happens when the social content of the relationship is ignored, with little attention paid to what the terms in an equation actually mean.

To illustrate this point, and even to make a mild concession to the argument, cast aside the messy reality that there are many rates of profit and many rates of interest, determined by all kinds of market pressures. Instead, assume that there is, in fact, one capitalist market rate of profit (r), available to industrial and commercial capitalists, and one market rate of interest (i) available to those putting funds into banks, buying bonds, etc. The basic case made by modern economics is that there is a tendency for r to equal i.

The rationale for this view is usually given from the perspective of the money capitalist. Let us call him (it is rarely her) Moneybags, and imagine him just sitting there with $1m in cash to play with. So what does Moneybags do with the cash when viewing the opportunities available?

            if i > r, just lend money in the market rather than invest directly in production

            if i < r, then invest in production rather than lend on the money markets

The actions of Moneybags supposedly tend to equalise the two rates, by investing or lending. How? The logic is rarely spelled out, but the mechanism assumed is as follows. If the rate of interest is above the rate of profit, the effect of offering more funds into the money market will tend to depress the rate of interest on loans towards the (lower) rate of profit. Alternatively, if Moneybags invested more in the higher rate of profit available on capitalist production, then that would tend to decrease the rate of profit on that activity towards the (lower) rate of interest on loans. Abracadabra, in a free market the rate of interest will therefore tend to equality with the rate of profit!

There is so much wrong with this argument, despite it often being taken as self-evident, or at least plausible. The problems can be seen in several steps.

Investment and ‘interest’

A money capitalist investor with funds of M can put them into a bank deposit, equity or bond investment, try to start up a business, or invest in someone else’s business. Assuming the investor is attracted by the relative yields, then this looks like a mechanism for equalising r and i, and the previous argument would hold.

However, that assumes there are diminishing returns on the M invested in industry and commerce, or in ‘financial’ ways, so that the flow of M into the different applications of funds will equalise the returns on the funds in each case. Rates of return may not initially move lower when M is applied a number of times to a particular type of investment, but eventually the extra supply of commodities produced, or of funds into an investment area, should presumably lower prices and reduce the rate of profit and also, in the alternate case, the interest return. Yet this seemingly valid logic ignores the nature of the investment that produces the return.

In one case, it is an advance of M to invest in means of production and labour-power to get a surplus value that results in a corresponding rate of profit. In the other case, it is an advance of M on the money markets, into bonds, etc, to get back a value of M plus interest. In the first case, the M may be advanced to expand the circuit of production. This could even raise the rate of profit if it boosted the productivity of a company versus its competitors, although, taken for the economy as a whole and over a period of time, probably not. The real problem for this proposed mechanism occurs for the advance of M for the ‘financial’ investment.

Moneybags wants to get back the invested funds, M, plus interest. But is Moneybags literally a bag of money hovering in the air, having no costs of investment that need to be deducted from the interest received? Also, what if Moneybags also borrows money from others to help fund the investment? Then the net investment return will depend on the difference between the borrowing and lending interest rates, as well as the deduction of his relevant costs. This means that the ‘rate of interest’, seen as a return on money capital advanced, is not as straightforward for Moneybags as the economists’ assertion of the letter i for interest would suggest.

Neither is the ‘r’ for the profit rate unambiguous. Industrial and commercial companies will borrow funds for investment as well as using their own funds. This means that their net profit is reduced by their interest payments; to give what Marx called the ‘profit of enterprise’. This latter profit is best measured over the money advanced by the industrial and commercial capitalists to get their ‘rate of profit’, but that will generally be a different number from the rate of return on the investment as a whole, as explained earlier.

The industrial and commercial capitalists will tend to borrow more, the lower is the rate of interest on borrowing versus the going rate of profit. They might also stop any extra borrowing when the rate of interest rises to equal the rate of profit that extra investment funds could generate. Yet, while that looks like a possible market mechanism for tending to equalise the rate of interest and the rate of profit, it is at best only a partial one. For example, companies would not borrow indefinitely with a lower rate of interest than the rate of profit. To do so would greatly increase their ‘leverage’ and expose them to the risk of having to service debt and pay interest even if the conditions of profitable production deteriorate. For such reasons, stockmarket investors usually frown upon highly leveraged companies.

In addition, there is the point, explained in my book, The City,[1] that the ‘profit rate’ of financial firms, such as banks who can create their own financial assets, or who depend upon attracting funds from other money capitalists and savers, such as asset managers, cannot sensibly be compared with the profit rate of industrial and commercial corporations advancing capital for their business. It is not comparing like with like.

Conclusions

In Marxist theory, there is no law determining the rate of interest, while profits are determined by the surplus value extracted from productive workers. That profit is measured over the capital invested, to determine a rate of profit for the system as a whole, and the profit remaining to the productive capitalists is determined after paying the amount of interest. [2] The only barrier to the rate of interest is that it cannot be sustained at a level that eats up all the profit of productive capital. In recent years, ‘real’ rates of interest have been negative (when compared to inflation levels), and have even been negative for some rates in nominal terms, but no statistician has so far claimed that corporate profitability has become close to zero or negative for the economy as a whole. This gives empirical support to the argument in this article that there is no equalisation of the rate of interest and rate of profit.

Developments in capitalist society mean that the 19th century picture of the industrial capitalist versus the money capitalist and, correspondingly, the rate of profit versus the rate of interest have taken on a new form today. While it is possible to identify capitalist entrepreneurs who have founded companies, from James Dyson (vacuum cleaners) to Mark Zuckerberg (Facebook), most of these have also evolved into being financial entrepreneurs, using borrowings from capital markets and financial operations to boost their market status and power. It is commonly the case that ‘entrepreneurs’ these days cannot readily be separated from ‘financiers’, given their often multiple shareholdings and other financial interests; still less can the initial investors in their projects from the financial elite be considered under the same heading as Marx’s industrial capitalists.

So there is not any longer, even if there once was in Marx’s time, a distinct class of ‘money capitalists’ versus the rest of the capitalist class. Individual capitalists will often have a portfolio of more important and less important holdings in companies, ones they pay more attention to and others, ones that are industrial, commercial or financial, together with the additional assets they hold in the form of government and corporate bonds, money market securities, bank deposits and so forth.

The activities of asset managers, insurance companies and pension funds complicate the situation further. In the rich countries, where financial operations are more prevalent, a significant proportion of the population indirectly owns a large share of corporate equity. No individual among these feels in control. Rightly so, since their monthly payments or accumulated savings are used to boost the corporate elite. But they nevertheless also benefit from and have a stake in the fortunes of the capitalist corporations in which they have invested. This has an impact on the politics of the populations concerned. But I do not cite this as the only political problem faced, since in the richer, imperialist societies the poorest will also commonly be among the most aggressive supporters of their state’s power.

Tony Norfield, 26 August 2016

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[1] See here.

[2] Even this simple summary ignores the question of rent on land ownership, dealt with in the latter parts of Volume 3 of Capital. In this article, I do not cover the separate question of the tendency of the rate of profit to fall. My book, The City, discusses how measures of the rate of profit are impacted by financial developments, state intervention and, especially, by the position of a country in the world economic system.

World Beaters

With the close of the Rio Olympics, I was surprised to note a pretty close correlation between the ranking of countries who won gold medals in Brazil with ... the power ranking of the respective countries in the world economy! The data are taken from the official Olympic data and from an index that was updated for my new book, The City: London and the Global Power of Finance.

My book gives a chart derived from 2013-14 data for the top 20 countries for their GDP, FDI, global use of their currencies, their military spending and prominence in international banking. The rank is determined by the score that each country has under each of the five measures. It gives a score of 20 for each country in which it is top, and if one country is half the level of the top country, then it gets a score of 10, and so forth. Below is a cut down version of the chart showing the top 10 countries in the ranking:

Top 10 Power Index Ranking

Countries are listed by their two-letter ISO code, so that GB is the UK, CN is China and DE is Germany, for example. In recent years, China has risen in the rankings, based upon its GDP growth and other measures. The US, not surprisingly, is top overall, although it is second to the UK in terms of international banking. In the power chart, the order of the top three is: US, UK and China.

For the Top 10, this power ranking picture is very close to the Olympic gold medal results! To standardise the two pictures, I have made the US gold medal score (the highest at 46) equal 100, while the UK's at 27, in second position, is then equal to 59 (being 59% of 46), and so forth. The outcome for the top 10 gold medal-winning countries is below:

Top 10 Rio Olympic Gold Medal Ranking (Index, US = 100)

(Note, this was updated on 22 August to correct the US number from 45 to 46)

Compared to the power ranking, South Korea (SK) and Russia (RU) make it into the Top 10 for gold medals, while the Netherlands (NL) and Switzerland (CH) do not. But the top three are the same, and in the same order, in both rankings. Germany, France, Japan and Australia also make a showing in both Top 10 rankings. South Korea makes it into the gold medal ranking, but not the power ranking top rank.

It looks like having an ability to be first in an Olympic event has a close relationship to a country's position in the world economy, at least for the top countries in each ranking.

One aside on the UK is that there has been a ruthless 'medals mean money' approach to granting money to Olympic sports. In unashamed state planning, the UK's National Lottery has done much of the funding on this basis. This diverts money from the regular subscriptions of the masses betting each week, and their need for entertainment, into a national success story. As one might expect, this is principally enjoyed by the privileged classes, exemplified by the funds available for 'horse dancing', otherwise known as dressage.

Tony Norfield, 21 August 2016

Sputnik

On Thursday, 11 August I was interviewed by George Galloway on RT’s regular ‘Sputnik’ programme. The 15-minute discussion covered some topics in my book, The City, plus finance and government policy in the economic crisis. The video link is here.

Tony Norfield, 14 August 2016

The Bank of England's National Brexit Policy

The news media has highlighted how the Bank of England's policy move today was the first cut in UK interest rates since 2009. But this completely misses the important points. By itself, the 25bp drop in the official Bank Rate from 0.5% to 0.25% is largely irrelevant, either as a policy move or as having any real economic impact. Instead, the significant policy decisions are elsewhere.

First, is the Bank of England's move away from its official policy target of stabilising CPI inflation at close to 2%, usually taken as meaning over the next two years. Despite the drop in sterling's exchange rate, and the expectation that this will boost UK inflation, the Bank has decided to look further ahead and cut rates today in the expectation that weaker UK economic demand, employment and output will reduce inflation again by the end of the next three years!

This is another sign of the flexibility of policy in this chronic crisis. Of course, it would have been madness to raise interest rates in the wake of the Brexit vote and the likely impact on the UK economy. However, this policy decision shows how far the rejection of previous policy norms has gone. What it really boils down to is the view that wage demands will remain limited, despite a fall in living standards, so the problematic inflation for capitalists, that of wages, will not actually be a problem. The new Bank of England policy is now closer to that of the US Federal Reserve, which has a more mixed inflation/growth/employment mandate when setting US interest rates.

Second, is the extension of Quantitative Easing (buying up financial securities from banks and other private sector holders, to put cash into the system). Until now, the Bank of England had bought £375bn of UK government bonds, but had kept that figure unchanged in recent years. In the early years  of the 2007-08 crisis aftermath, it had had only a small, temporary holding of private sector bonds. That will change with the new policy. Further government bond purchases will occur, an announced £60bn that will take the total to £435bn. All this will do is reduce government bond yields further, as happened today, and further undermine the viability of pension schemes, both public and private, increasing their funding deficits. However, the new angle is for the Bank of England to purchase up to £10bn of corporate bonds.

The latter move is extraordinary, especially in the way the Bank of England poses it as looking to "purchase a portfolio of sterling non-financial investment-grade bonds representative of issuance by firms making a material contribution to the UK economy, in order to impart broad economic stimulus". Leave aside the point that the size of the corporate bond market targeted is only around £150bn, and that they hope that BoE purchases will increase the prices and lower the rates on eligible bonds, also reducing these companies' demand for bank loans that could then be taken up by others, especially smaller companies. The key point is that the Bank of England has now entered the process of deciding to buy bonds only from firms that make a 'material contribution to the UK economy'!

I cannot emphasise enough how far this policy contradicts all the logic that we have heard for decades from policy makers, central banks and governments, of how it is necessary to compete in 'free and fair' global markets. Here we have a central bank from a country at the centre of the world financial system explaining that a part of its new policy is to discriminate in favour of companies that are nationally valuable.

If anyone doubted that the pressures of the chronic global crisis are forcing the major powers to reconsider their positions, and that they are abandoning policies of cooperation - admittedly, cooperation that has been mixed with intense rivalry - then they should consider this latest Bank of England move. The significance is not indicated by the relatively small scale size of the £10bn funds, but in the outlook it offers for future imperial policy.

Tony Norfield, 4 August 2016