By Zoltan Zigedy
September 19, 2014
Looking back on the ten years following the 1929 stock market crash, Marxist economist and Science and Society co-editor, Vladimir D. Kazakevich, wrote of the “chronic crisis” that persisted throughout the nineteen thirties in the US (“The War and American Finance,” Science and Society, Spring 1940).
Kazakevich drew attention to the stagnation that lasted over the decade, noting that after World War One, the United States became the most dominant economy in the world. Yet “[a]s the most powerful capitalist country, the United States developed particularly glaring financial weaknesses, attributable, for the most part, precisely to its foremost place in a capitalist world torn by economic contradiction and frustration.”
Kazakevich, a good Marxist instead of a born-again Keynesian, reflected on the collapse of growth of the capital goods sector through the New Deal decade: “These figures show how enormously capitalist activity had shrunk in the thirties as compared to the twenties. Most of the Federal expenditures of the New Deal period were directed towards sustaining the demand for consumers’ goods rather than for capital or producers’ goods… Although widely advocated, ‘priming of the pump’ from the end of consumers’ goods alone, has proved a complete failure as an economic measure for resuscitation of the capitalist organization harassed by a chronic crisis.”
Economic commentators today are increasingly nervous about a similar slump in capital goods accompanying our own “chronic crisis.” Because the growth of capital spending (and capital equipment spending) is running well below its long-term average of 8% (growing just 3% in 2013), the average age of industrial machinery and equipment in the US has surpassed 10 years, the highest average age since 1938 when Kazakevich was painting his dire picture! (The Wall Street Journal, 9-3-14) Thus, the slug-like motion of the US economy during the last seven years mimics in an important way the stagnation following the great crash initiating the Great Depression.
While capital spending may not now play quite the decisive role it played in the US economy during the 1930s, it remains a strong indicator of the hesitancy of managers to expand the productive core of the economy. They fail to see prospects for profit expansion in the extensive growth or retooling of the manufacturing sector.
Of course that does not mean that managers are not seeking profits or investors are not seeking a return on investment. Managers have plowed more cash into mergers and acquisitions during the first half of 2014 than any time since 1999. That also is typically a part of capitalist restructuring after a severe crash. This rationalizing of capitalist production serves and has served to restore the growth of profit following a capitalist misadventure.
In the wake of the crash of 2007-2008 the US economy experienced a dramatic jump in labor productivity (in the absence of capital investment, this necessarily came largely from an increase in the rate of exploitation). Massive layoffs, plant closings, and weak union leadership combined wage stagnation with extreme speed up of a shrunken labor force. Profits ensued. And consequently the previously depressed rate of profit resumed its growth.
Unfortunately for the prospects of capitalism, the growth of productivity has petered out: its past 5-year average is only slightly more than half of the 20-year average, with productivity actually falling 1.7% in the first quarter of 2014. So this road to profit recovery and growth is seemingly closed.
Of course if the past productivity gains had been shared with the working class, capitalism likely would have experienced an increase in revenues (folks would have purchased more goods and services) and a rosier earnings outlook. But that did not happen. Adjusted for inflation, the cumulative growth of median household income has dropped precipitously since the crash, settling at the level of 1990. Consequently, corporate revenue growth peaked in the third quarter of 2011 and has shrunk ever since.
Thus, three signal measures promising profit-rate increases– capital investment, labor productivity, and revenue increases– are failing the US economy.
Not surprisingly, reported corporate profit growth has suffered. From its peak in the last quarter of 2009 (over 10%), it has receded steadily.
Profits, Profits, Profits!
It is important to emphasize that it is profits that fuel the capitalist system. While it seems an obvious point, it is the starting point of the Marxist theory of crisis. The capitalist system only appears healthy when the capitalist both holds capital and expects a return. He or she dreads two things: idle capital (capital with no prospect of return) and a stagnant or declining rate of return. Consequently, capitalism generates systemic growth if and only if capital is abundant, investment opportunities are rife, and the rate of profit is sufficiently enticing.
But this law of capitalist accumulation contains the seeds of capitalist crisis. As noted above, the growth of the rate of profit has been declining for some time. At the same time, the accumulation of capital is expanding faster than the overall US economy. The relative mass of profits– measured by US corporate profits as a percentage of GDP– reached unprecedented levels in the second quarter of 2014 (a level of profit/GDP only approached twice since 1947: immediately before the crash and in 1950).
In other words, despite the fall in the rate of profit, the profit-generating capitalist engine is producing potential new capital faster than wealth is being produced. Three conclusions follow: capital is winning the class war, growth is lagging, and the mass of capital is growing relative to the size of the economy while the profit rate is declining.
And new capital must seek a home, a place to go to accumulate more capital.
Combine the profit-generated capital with the unprecedented cash held by corporations and the availability of cheap credit (nearly non-existent interest rates) and the capitalist class is faced with a daunting task of finding investment opportunities for a vast pool of capital.
If this sounds familiar, it is. Before the crash, many economic commentators noted that the investment world was awash in cash searching for opportunities. I wrote in April of 2007 (Tabloid Political Economy: The Coming Depression, Marxism-Leninism Today, April 5, 2007) that “Despite being awash in capital, financial power searches for investment opportunities to no avail. Economic theorists have been puzzled by the low returns available, even for high-risk or long-term investment. Under normal circumstances, risk and patience earn a premium in investment, but not today.
Instead, the enormous pool of wealth concentrated in fewer hands can only lure borrowers at modest rates. There is simply too much accumulated wealth pursuing too few investment opportunities.”
It is this paradox of accumulation– two much capital, too few opportunities– that collapses the already stressed rate of profit and courts structural crisis (or deepening crisis, in our case). It is this paradox of accumulation that drives capital-gorged investors to pursue riskier and more ephemeral schemes.
Once again a vast pool of capital chases diminishing investment opportunities. Once again, as in the prelude to the crash, yields have shrunk, leading investors into riskier and more speculative investments. Pension funds and hedge funds are moving toward more arcane and less safe bets, hoping that return will outweigh the danger. As Richard Barley perceptively observes in the Wall Street Journal (August 11, 2014):
…there is a dearth of high quality securities. Yet there is still a global glut of capital seeking a home… All this creates incentives for financial engineering. In credit derivatives markets, there are signs investors are delving into esoteric structures. Citigroup reports a “large increase” in trading of products that slice and dice exposure to defaults in credit-default-swap indexes… Precrisis, low yields and seemingly benign market conditions led to the creation of instruments that ultimately few understood. The longer the reach for yield persists, the greater the chance that investors revisit the unhappy past.
For some time, the elusive “reach for yield” has driven a re-vitalized junk-bond market. In the five years after the crash, four of the ten fastest-growing bond funds held substantial quantities of low rated debt, according to WSJ analysts. They note that this “…development underscores the intense demand for investment returns since the 2008 crisis.”
But the flow of cash to the high yield market depressed yields to levels unseen since late 2007. They are rising again as investors sense that global economic turmoil and low yields signal danger.
The mania for mergers and acquisitions has also swung into dangerous, risky territory. Despite Federal guidelines urging the limitation of leverage to six times gross earnings by banks financing acquisitions, forty percent of private-equity takeovers in 2014 have exceeded the 6X rule. This rate is fast approaching the pre-crisis level of 2007.
The Wealth Effect
A seemingly robust stock market and a relatively stable US debt market join to create the illusion of a healthy, prosperous economy. They have, to great effect, masked the serious cracks in US capitalism.
The long anticipated Federal Reserve retreat from QE (Quantitative Easing: the purchase of US and other debt by the Fed) has not brought the disaster that many in the punditry and on Wall Street feared. Seldom noted, however, is the fact that the Peoples Republic of China has escalated its purchase of US treasuries nearly dollar for dollar against the Federal Reserve’s retreat.
The “stellar” performance of equities is another matter. One moderately alarming sign is the steady march of equity price-to-earnings ratios to a territory greater than the long-term average and to a level equal to or above that of 2006-2007. Of course this alone does not explain the market’s performance.
A puzzling aspect of equity price expansion is the historically low market activity in the post-crash period. What, then, has jacked up stock prices?
Part of the answer lies in corporate repurchases of shares, a practice that elevates the market price by taking stocks off the table. The Wall Street Journal (9-16-14) reports that $338.2 billion of equities were bought back by corporations in the first half of 2014, the most since 2007. The same report noted that corporations in the second quarter of 2014 spent “31% of their cash flow on buybacks.”
Corporations are hoarding cash and amassing debt at unprecedented levels (thanks to low interest rates, corporate bond issuance may approach $1.5 trillion this year, having grown geometrically over the last twenty years).
Thus, corporate activity has shifted away from investing in future growth and toward mergers and acquisitions and stock buybacks, activities that bolster share inflation without creating underlying value.
Take Apple, for example. Sitting on vast quantities of cash, Apple nonetheless sold $12 billion worth of corporate bonds this year. At the same time, Apple repurchased $32.9 billion in Apple stocks, effectively driving up the price of those shares remaining in the market place.
Does this really create wealth? Or is it a ruse to keep the party going?
Interestingly, it’s not just the jaundiced Marxist eye that peers through the fog to see rocky shoals ahead. Rob Buckland, a CITIGROUP analyst, perceives the US economy as entering “phase three,” the phase preceding a marked downturn. Business Insider (August 15, 2014) summarizes Buckland’s phase three as follows:
Phase 3: This is the tricky part. Stocks are still flying high, but credit spreads are widening as investors become increasingly unwilling to finance further risk. Corporate CEOs have now experienced a lengthy period of gains and become risk-happy. (And we’d note that central banks are already talking about tightening credit by raising interest rates.) Bubbles can form in Phase 3, Buckland says, as the high-flying stock market ignores the early warning signs of the deteriorating credit market…. (http://www.businessinsider.com/citi-economy-phase-3-where-bubbles-form-prior-to-crash-2014-8#ixzz3DcJqF9tH)
It is against this backdrop that worries are surfacing among investors. Some bearish hedge fund managers are investing anxiously in credit-default swaps and retreating from high risk. Discounting the distractions and illusions fostered by the monopoly media, serious students see the intractable crisis in Europe, the slowdown of the emerging market economies, the recent setbacks to Abe-nomics in Japan, and the loss of momentum in the economy of the Peoples Republic of China as adding to the contradictions lurking under the surface of the US economy.
Vladimir Kazakevich expressed fears in his 1940 article cited above that “…powerful interests on both sides of the Atlantic are likely to regard a war economy as an immediate solution for the chronic crisis…” Certainly his fears were well grounded. Militarism did prove able to “solve” the contradictions of global depression, at the enormous, unprecedented human cost of World War Two.
One cannot but wonder today if a similar logic is operating in the minds of US and NATO leaders who seem determined to stir hatred and belligerency. The newly emerged ISIS demons seem almost too perfect of a foe — almost a caricature of evil that may well bring an unprecedented level of US military might back to the Middle East. The “limited” US air campaign has already cost over a billion dollars, a nasty piece of military “pump priming” for the US economy.
And bear-baiting– poking Russia with threats, sanctions, and military engagement– is the new obsession of NATO, even at great economic cost to a prostrate Europe. The actions contemplated by militarists would push the risk level back to some of the worst days of the Cold War.
Is it not more and more apparent that only the “specter” of socialism can offer an answer to the chronic global crisis of capitalism and its attendants, xenophobia and war mongering?