The If Only Theory of Contemporary Capitalism

 

According to the International Energy Agency (IEA), the closure of the Strait of Hormuz has precipitated “the largest oil supply disruption in history”, eclipsing the oil shocks of the 1970s in severity.

We are like the characters in the film On the Beach (about Australians waiting for the radiation from a nuclear war to reach them), biding our time before the effects seep through. Clearly, not only industries that directly consume oil will be affected. As fertilizers rely on natural gas for their production, decimated crop yields and ensuing food shortages – in addition to flight cancellations and severe inflation – will become the norm.

Bankers JP Morgan predict global oil inventories will hit “Operation Floor” – when oil production stops functioning – in September.

Already faced with 1970s-style stagflation (weak GDP growth and inflation), economies will soon have to deal with slumpflation (falling growth and inflation) says economist Michael Roberts.

This will happen regardless of whether there is a “final agreement” with Iran.

But doom-laden concentration on the inevitable effects of war clouds our judgement. It leads to the feeling that if only these random geopolitical shocks didn’t happen, everything would be fine.

But maybe, rather than being the root cause of crisis, a ‘shock’ like the closure of the Strait of Hormuz is merely exposing fault-lines that were already there.

And maybe there’s a mutually reinforcing dynamic at work. In that the weakness of the economic system generates geopolitical responses which have the effect of further enervating the economy.

Looking again at the oil shock of October 1973 – up until the halting of shipping in the Strait of Hormuz, the worst disruption of the global oil industry in history according to the IEA – is instructive. This older shock involved an oil embargo on countries like the US and UK and a fourfold increase in the price of oil.

Unquestionably this ‘triggered’ a financial crisis and a recession in 1974-75, the first year-on-year fall in output in the West since the Second World War.

But if the problem was merely external (a large increase in the price of oil) once it abated, things should have returned to ‘normal’ i.e. steadily increasing growth and prosperity. But that’s not what happened.

According to historian David Gibbs, the crisis resulted decades’ long flat productivity growth in the US and impaired economic performance in most of the rest of the world

“If you look at long-term rates of GDP,” he says, “it was quite high up until 1973 and in 1973 you see a big drop. And rates of economic performance have never fully recovered from the earlier period.”

It was “a historic break point”.

The same illusion of the primacy of the external cause can be seen in attitudes towards the Global Financial Crisis of 2008. The crisis was caused, so goes the official story, by reckless bank lending leading to a seizing up of credit that the rest of the economy relies on. Now those causes no longer apply, businesses can get credit and the big banks, largely thanks to huge doses of Quantitative Easing, are no longer insolvent.

But if you look at UK economic growth in the pre- and post-crisis period, it is clearly debilitated, less than half as strong. In the 18 years since the 2008 crisis, the economy has grown by 22% compared to 53% growth in the 18 years before it.

Why should this be? Why, once the causes of the crisis are dealt with, should the crisis linger on, not in full-on crisis mode but in enfeebled performance?

Possibly because there was far more to the crisis than revealed by its surface ‘causes’.

To take medical analogy, if a person survives a heart attack but goes on to suffer worsening heart failure – not being able to walk far with running out of breath – the underlying problem should obviously be put down to heart disease, not sought in the particular circumstances that brought on the original heart attack.

But we do precisely this with the economy, continually, as economist Harry Shutt once said, mistaking symptoms for causes.

The former head of Goldman Sachs says he can “smell” a new financial crisis in the offing. This won’t happen, 2008-style, through the banks but in the burgeoning private credit industry where companies, such as private equity firms, lend to other companies.

If it does erupt, what will provoke this crisis will be a rise in interest rates to try and tamp down the inflation caused by the closure of the Strait of Hormuz.

According to chief economist of the World Bank, “the war is hitting the global economy in cumulative waves: first through higher energy prices, then higher food prices, and finally, higher inflation, which will push up interest rates and make debt even more expensive.”

But the external cause won’t explain the crisis. To do that we first need to explain why the global economy in the 21^st century is so much more dependent on trade (i.e. globalised) than it was 50 years ago. Trade now represents about 60% of world GDP compared to 25% in 1970.

Then we need to consider the fact that the economy is much more deregulated than last time, a process which is ongoing. Finally, we need to factor in that the economy runs on huge levels of corporate and personal debt, which makes it so much more susceptible to any increase in the cost of debt (i.e. through higher interest rates).

And these causes are in turn related to the ending, caused by the oil shock of October 1973, of the “thirty glorious years” of strong economic performance after World War Two, and why that turned out to be a “historic break point”.

You cannot understand external shocks like the interruption of the ‘life-blood’ of oil supplies without also understanding how, internally, we are more vulnerable to their effects.

Debt: The Last 30 Years

We are marginally less constipated than before. Ideologically speaking. Thanks in large part to Jeremy Corbyn British politics has begun to move on from the mendacious obsession with public debt being the cause of the last financial crisis (and the harbinger of future ones).

Political conservation has started to appreciate the seriousness of enormous levels of private debt, which was always the elephant in the room. The Bank of England has warned of a ‘spiral of complacency’ about growing household debt, while the IMF has cautioned that the ‘rapid growth in household debt – especially mortgages – can be dangerous’. Anthropologist David Graeber says ‘the household sector is a rolling catastrophe’. Around 17 million Britons have less than £100 in savings.  And with the BoE making noises about raising interest rates from rock bottom levels, there are worries that some mortgage-holders could default, precipitating a US-style sub-prime crisis.

The problem is that all attention is directed at one kind of private debt – personal debt. And while its seriousness should not be minimised there are other sorts of private debt that merit just as much, if not more, concern:

Personal debt is not the most extreme form of private debt

Private debt can be divided into three types – financial sector debt (i.e. banks & insurance companies), corporate debt and personal or household debt. All three have grown exponentially since the start of the 1990s. According to economist Michael Roberts, what he terms ‘global liquidity’, a combination of banks loans, securitized debt and derivatives, mushroomed from 150% of world GDP in 1990 to 350% in 2011. And while in some countries, colossal financial sector debt has declined to a degree following the financial crisis, and household debt levels fell before rising once more, corporate debt, nourished by near zero interest rates, has just snowballed over the last nine years.

According to figures released by management consultants McKinsey in 2015, all forms of private debt have grown since 2007 but corporate debt has increased by double the rate of both household and financial debt, which nonetheless rose but in a more subdued manner than before the crisis (see the graphic in this article). Government debt has also exploded as financial debt was transferred to state coffers. “Nonfinancial corporate debt remains the largest component of overall in the advanced capitalist economies at 113% of GDP,” says Roberts, “compared to 104% for government debt and 90% for household debt.”

The forms that corporate debt takes vary but one of the most common is for companies to use debt to buy back their own shares. This practice, which was illegal in the United States before 1982, increases the firm’s share price in a totally artificial manner, giving the appearance of financial health and success in the marketplace. Frequently, it also personally benefits the corporate executives who authorise it as they are paid partly in stock options. In fact the corporate sector has been the main buyer of US equities since the market meltdown of 2008, engaging in what has been described as ‘the greatest debt-funded buyback spree in history’. It was estimated that in 2017 the largest US companies would spend a record $780 billion on share buy backs, though, in reality, the forecast bonanza has apparently hit a snag.

Or possibly corporate debt takes the form of shareholder loans, the practice by which one company deliberately loads another company that they own (they are the main shareholders) with huge amounts of debt which the captive company is then obliged to pay back at high rates of interest; 15 or 20% for example. The Financial Times recently highlighted the case of Arqiva which owns 9/10ths of the UK’s terrestrial TV transmission networks and, in the three years to June 2016, paid around £750 million in interest to its controlling shareholders, payments financed by borrowing.  It is now £3 billion in debt. And that’s just one company.

Household debt did not cause the 2007-8 Global Financial Crisis

What household debt did was light the touch-paper. The nationwide implosion of the housing market in America after interest rates were raised signalled the demise of all those mortgage backed securities and collateralized debt obligations but the reason it proved so devastating for the US economy and spread the crisis around the world was because of the fatal combination of household debt with gargantuan financial sector and corporate debt. The Global Financial Crisis was sparked in August 2007 (‘the day the world changed’) when French bank BNP Paribas froze its funds because of its exposure to the mortgage backed securities of the US sub-prime market. The problem wasn’t defaulting French mortgage-holders but the effects were being felt by a French bank. BNP was one of three major French banks who were collectively overleveraged to the tune of 237% of French GDP. That level of indebtedness caused the crisis to spread to Europe as hugely indebted, and now effectively insolvent, European banks called in the loans they had made to southern European governments.

Nobody can say with any assurance what the trigger will be for the next financial crisis. It might be heavily indebted US college graduates or UK credit card borrowers or Australian consumers or Dutch mortgage holders (a country which has the most indebted households in the euro area).

But it’s equally possible that the fuse will be lit from another sector of the economy entirely – massively overleveraged corporations being unable to repay their creditors when interest rates rise, for instance. In that case, households will simply be spectators to the unfolding events.

All the focus is on personal debt because it represents a morality play

In Debt: The First 5,000 Years David Graeber points out that in Sanskrit, Aramaic and Hebrew ‘debt’, ‘guilt’ and ‘sin’ are all the same word. In modern German, the word for ‘debt’ – schuld – also means guilt. “If history shows anything,” Graeber writes, “it is that there’s no better way to justify relations founded on violence, to make such relations seem moral, than by reframing them in the language of debt – above all because it immediately makes it seem that it’s the victim who’s doing something wrong.”

The existence of enormous level of personal debt in advanced capitalist countries is a sure sign that the individual freedom these societies claim to uphold is skin deep. In reality, they are founded relations of coercion and control. To be in debt is to have someone’s boot on your neck. In the UK, high rates of personal debt are intimately related to the fact that real wages are 10 per cent lower than a decade ago. Rising personal debt is also strongly correlated to mental health problems like depression and anxiety.

From another perspective, personal debt is the symbol of our fatal addiction to consumerism, the consequence of an all-embracing need to maintain a modern lifestyle, decorated with the latest products, no matter what the cost to ourselves or the environment. Either way, personal debt unmistakably says something about the current state of society – what drives it and who is in control.

Corporate and financial sector debt, by contrast, is not only opaque, it is frightening neutral. Debt has simply become the way of doing business over the last 30 years. Debtors are frequently also creditors and companies may simultaneously indebt themselves and hoard cash. Indeed, increasing ‘leverage’ (to use the technical term) or loading debt onto captive companies (as in the Arqiva case) is often the primary means by which profits are made. No sense of shame or ‘doing something wrong’ attaches to it.

The question that should arise is why the corporate sector – financial and otherwise – has become so addicted to debt? Why is old-fashioned investment in new products or new technologies comparatively shunned?

It is possible to reduce personal debt but corporate debt is far more of an intractable problem

Theoretically it is possible to cut personal debt to more manageable and less dangerous levels.  Ending austerity, strengthening trade unions, instituting rent controls and directing efforts to raising the level of real wages should see the rates of payday loan and credit card debt diminish. I say theoretically because, interestingly, some of the highest quantities of personal debt, as a proportion of GDP, are in Scandinavian countries – nations that have impressive rates of trade union membership, collective bargaining and high personal incomes. However, those in debt in Nordic countries tend to be higher earners. In the US and UK, by contrast, personal debt often afflicts people much lower down the income scale – people who are much more likely to default given a slight change in the economic winds.

Corporate debt is a different matter entirely. The massive government bail outs of 2008 only succeeded in transferring debt from the financial sector to the state and, even then, only denting marginally the indebtedness of the banks. Corporations, whose debt had risen markedly over the previous twenty years, merely took advantage of the lower interest rate environment, to become even more indebted.

The writer and broadcaster Paul Mason says governments have to do something ‘clear and progressive about debts’. He advocates a policy of ‘financial repression’ – that is stimulating inflation and holding interest rates below the rate of inflation for 10 or 15 years as a way of writing off debt. But we can see the problems that a mild rise in the rate of inflation to the historically low level of 3% is currently causing people in the UK, with wages unable to catch up. Deliberately stoking inflation for a decade or more would surely precipitate the household debt defaults that so many people are warning about – inflation would erode the total amount of people’s debt but interest payments would still need to be met as real incomes plummeted. And if interest rates are below inflation – as they are now – the incentive for corporations to take on more debt is still there.

It is difficult to imagine how this system can gradually and progressively resolve its problems without provoking the economic collapse that everyone is so desperate to avoid.

Addendum

It's probably worth re-emphasising that when I speak about corporate debt, I'm not referring to the borrowing a company naturally needs to do to keep going and expand its operations. See - https://www.touchfinancial.co.uk/knowledge-centre/blog/4-reasons-why-successful-businesses-borrow-money

What's happening now is massive borrowing to either appear successful (share buy backs) or invest in debt to make more money. They're nothing to do with how capitalism is meant to function in the textbooks.


 

Living standards and economic growth; a depressing tango

At the risk of sounding like an anally retentive stat obsessive, I found some interesting figures about real wage growth in Britain, or its absence, on Saturday and put them together with statistics on GDP growth (alright I admit I’ve got a problem but it’s one way to spend your weekend).

Both sets of figures are from the Office for National Statistics. Real wages mean the increase or decrease in the value of wages taking account of the effect of inflation.

	UK GDP growth %	UK real wage increase %
1970-1980	2.55	2.9
1980-1990	2.67	2.9
1990-2000	2.22	1.5
2000-2010	1.82	1.2
2010-2014	1.32	-2.2

What’s interesting is that wage growth, and now wage decline, has tracked GDP quite closely, and GDP has fallen substantially since the end of the ‘80s and since the ‘60s. According to ONS figures, annual growth in Britain averaged 3.27% from 1960 to 1970. The figures are quite kind to Margaret Thatcher, it should be said, since the second Thatcherite recession began in the first quarter of 1990 when she was still Prime Minister.

The drop in the increase in wages was very definitely apparent in the 1990s and 2000s when virtually no-one thought there was a problem. Now there is wage decline, an awful lot of people have noticed the problem. The conventional liberal-left explanation is that Thatcher’s war on the unions and the decline in collective bargaining has belatedly fed through to how well employees are paid. I’m sure this is a factor – the precipitous drop in real wage increases from the 1980s to the 1990s, has doubtless a lot to do with the “Thatcher effect”. But that is not the whole story. Wages have faltered as growth has declined. Frances O’Grady, general secretary of trade union representative body, the TUC, said in response to the wage figures that “average pay rises have been getting weaker in every decade since the 1980s, despite increases in productivity, growth and profits”. But productivity and growth have also been getting weaker. I believe there is hardly any chance of the UK economy turning things around and returning to the growth levels of ‘60s, ‘70s or ‘80s. In those circumstances, real wages will either continue to decline or, at best, show slight increases.

The figures are evidence of an economic system in decline and the prospects for most people, while TINA is securely ensconced in the political consciousness, are not enticing. Consumer debt, which has trebled since the early ‘90s in the context of faltering wage growth, is likely to grow even larger, leading to further economic tremors.