Nosedives in fictitious and productive capitals Oct 24-25

[This is originally from my post at the Radical Perspectives on the Crisis blog, I thought I'd repost here too]


Recession fears manifested in plunging markets on Friday. Stock markets in Asia, Europe and finally the Dow Jones in the U.S. fell to five year lows. The Wall Street Journal fears there are no safe havens in the global economy left to hedge with.

Following Marx, I would argue that market falls and crashes are not destructions of value but rather are redistributions of value. What is destroyed is the title of ownership, which Marx called fictitious capital. If I own a $50 stock in a company, and the stock collapses to zero, I have simply transfered $50 to the company and received nothing. That is to say, stockholder ruin does not necessarily imply the destruction of real societal wealth. We can say there has been destruction of value only if the collapse generates the abandonment or depreciation of plants, machinery or other fixed investments.

The fallacy is thinking that a debt is a commodity with real value (despite the fact that it is traded on the market). Marx, in Volume III of Capital wrote that "unless this depreciation reflected an actual stoppage of production and of traffic on canals and railways, or a suspension of already initiated enterprises, or squandering capital in positively worthless ventures, the nation did not grow one cent poorer by the bursting of this soap bubble of nominal money-capital."

Of course, stoppages of production and traffic in the real economy have indeed been appearing across the globe. Data published on Friday revealed a significant drop in third quarter British output, the sharpest decline since 1990. Though a single quarter decline does not meet the technical definition of recession, there is virtual consensus that the country is in one. The Industrial and Commercial Bank of China announced a significant decline in third quarter profit growth. In expectations of declining demand, Chinese steel and aluminum industries have cut production by 20 and 18 per cent, respectively. Chinese car sales are expected to flatten. Despite Opec's production cut on Friday, oil prices continue to decline as fears of slowing demand growth mount.

In the US, amidst a 25 per cent drop in annual sales, Chrysler announced that by the year end it will lay off 25 per cent of its white collar workforce. Meanwhile merger talks with GM escalate.

Keynes and the liquidity preference

Will the Fed make another half point interest rate cut? If so, will finance react at all? Howard M Wachtel, an Economics professor at American University points to an important lesson from JM Keynes on the futility of monetary policy during a downturn:

Take one issue – interest rates. The U.S. Federal Reserve’s policy of lowering interest rates, from 5 and 1/4% in August 2007 to 2% in May 2008, was a grave mistake that could have been avoided if Keynes’ analysis had been part of the Fed’s policy making knowledge. The Fed’s error in interest rate policy was compounded when it followed interest rate reductions that did not work with large infusions of new money into the financial system.

Keynes taught us that when banks and other holders of vast sums of capital have what he called a “preference for liquidity” – a desire to hold cash and not invest it – lowering interest rates will not unlock this liquidity for investment. Instead any infusions of new money by the central bank into the system will simply be stashed away for two reasons: first, the mood of the financial market’s psychology is glum and not conducive to investment because rates of return are perceived to be too low. Second, new money injected will be held as cash in anticipation of a better day, so the new money will be seen as an arsenal to be held until markets improve.

Added to this is the character of this most recent bubble – inflated home prices and their accompanying high-risk financial instruments to insure these bad loans. Lowering interest rates simply poured fuel on the fire by keeping loan rates low, encouraging more imprudent lending and borrowing, and furthering the speculative bubble’s chain of bad debts.

This reasoning is counter-intuitive, but it fits the current paradox of lower interest rates and unprecedented chunks of cash interventions without their anticipated impact. The preference to hoard money by banks reinforced a psychological condition that was confirmed by the failure of the lower interest rates to have their intended effect. Credit markets in today’s language have frozen.

Keynes called this the liquidity trap – the most difficult position for an economy, one that characterized the Japanese economy in the 1990s, and threatens to engulf not only the U.S. but the global economy today.

It's still the mortgages stupid!

In those halcyon days when U.S. housing prices were rising, defaults didn't lead to systemic capitalist crises. In fact, they didn't impact much beyond the creditor and debtor in the contract. Creditors could appropriate your house and make a profit upon resell (hence the incentive for trumped-up loan applications, some of which inflated borrower incomes by up to 50 percent). And many debtors, even if they could make monthly payments, knew that creditors couldn't take any more than the home itself. As we know, everything changed when housing prices fell some 20 percent. Finance wonks tell us we can expect another 15 percent fall, which would double the amount of homeowners with loans greater than their home value. Any bailout or rescue plan that ignores this seems likely to fail.

Also scary is the so-called Alt-A mortgage threat. These mortgages are one notch less risky than subprime paper. And of course, they sound extremely enticing: borrowers were given an initial interest rate of 1 percent and were exempt from repaying the principal in the first several years. As is often the case, one day down the road, they will reset. Frédéric Lordon in the October issue of Le Monde Diplomatique describes the position of the average option adjustable rate mortgage (the Option-ARM category is just one breed of Alt-A):

The average Option-ARM borrower can expect to see repayments increase by 63% at a stroke. According to the financial services company Bloomberg, 16% of holders of Alt-A mortgages agreed since January 2006 are more than two months in arrears. Since there is a delay of between three and five years before the rate is reset, defaults can be expected to increase next year and continue until 2011.

Lordon also mentions that subprime loans totaled a mere $855bn where Alt-A mortgages amount to $1,713bn. I suppose this doesn't seem like much when leaders are desperately trying to avoid a financial collapse before Monday morning when stock markets open, but it's something to look out for in the coming months.

--

In other news two wonderful and brilliant friends put up a website called Radical Perspectives on the Crisis:
http://sites.google.com/site/radicalperspectivesonthecrisis/

It is extremely useful, please check it out!