The Great Recession: a Marx not a Minsky moment

The Great Recession: a Marx not a Minsky moment Paper to HM Conference, November 2016 by Michael Roberts “We are all Minskyites now.” Paul Krugman 1 Marx’s law is “the only credible competitor left in the contest to explain what is going wrong with capitalism”. Alan Freeman 2 Causes: the underlying and the proximate There is an unending debate among Marxist economists about the causes of recessions under capitalism and, in particular, the cause of the Great Recession of 2008-9, the deepest and most globalised of all slumps in capitalist production since the 1930s. Looking for a cause is scientific. 3 But dialectically there can be causes at different levels, the ultimate (essence) and the proximate (appearance). The ultimate is found from the real events and then provides an explanation for the proximate. The crisis of 2008-9, like other crises, has an underlying cause based on the contradictions between accumulation of capital and the tendency of the rate of profit to fall under capitalism. That contradiction arises because the capitalist mode of production is production for value not for use. Profit is the aim, not production or consumption. Value is created only by the exertion of labour (by brain and brawn). So profit comes from the unpaid value created by labour and is appropriated by private owners of the means of production. The underlying contradiction between the accumulation of capital and falling rate of profit (leading to a falling mass of profit) is resolved by crisis, which takes the form of a collapse in value, both real value and fictitious. Indeed, wherever the fictitious expansion of capital has developed most is where the crisis begins e.g. tulips, stock markets, housing debt, corporate debt, banking debt, public debt etc. The financial sector is often where the crisis starts; but a problem in the production sector is the cause. This paper aims to defend the view that Marx’s law of the tendency of the rate of profit to fall provides the best underlying explanation of recurring and regular crises, both theoretically and empirically, and is superior to alternative explanations such as underconsumption or lack of ‘effective demand’ (Keynesians); excessive inequality (post-Keynesians); disproportionality or overproduction (Sweezy and secular stagnationists); or financial instability (Minsky). In particular, the paper attempt to show that the Great Recession was not caused by excessive ‘financialisation’ or too much surplus or corporate savings that could not be absorbed i.e the overproduction of value and surplus value. On the contrary, it was caused by an insufficient amount of surplus value relative to capital invested. It was (ultimately) the result of falling profitability in the productive sector of the capitalist economy (herein the US) leading to a switch of investment into financial assets and fictitious capital. The fictitious nature of the profits in real estate and finance was eventually exposed in the global financial crash. So this was not a Minsky moment of financial instability leading to a collapse in the productive sector; but in contrast, a weak productive sector eventually forcing the financial sector back into line with the law of value and profitability in the productive sector, in other words, a Marxist moment. Marx’s law Let us start with a short outline of Marx’s law of the tendency of the rate of profit to fall. Individual capitalist businesses compete with each other to sustain and increase not only the mass of profits. To do so, they increasingly use new technology to boost the productivity of labour. But this is capitalism’s Achilles heel. The accumulated cost of investing in new plant, equipment etc. inexorably rises compared to the size and cost of the labour force. As only labour can create value, the value and surplus value generated by the capitals investing in new methods of production begins to fall relatively to the stock of capital. On the other hand, these capitals are more efficient and produce a greater output. By selling it to other branches at the same price as the lower output of the technologically backwards capitalists, they appropriate a share of the surplus value produced by the latter. Their rate of profit rises but that of the technologically less efficient capitals and of the economy as a whole falls. If other capitalists modernize as well, profitability falls even more. The less profitable capitals go bankrupt. Eventually the mass of profit falls as well. A crisis ensues. 4 Marx’s law is a law of a tendency, meaning that it generates counter-tendencies that can overcome the effect of the law for periods, sometimes long. The tendency is such because it is kept back and delayed by the countertendencies. But it eventually emerges when the countertendencies exhaust their counteracting power. Then the crisis emerges. Capitalists try to avoid the crisis in various ways: by trying to exploit workers more; by looking for yet more efficient technologies; and by speculating in unproductive areas of the economy e.g. the stock market and banking and finance, where they gamble for gain. National capitalist economies look for new sources of labour supply to exploit abroad and new foreign markets from which to appropriate (surplus) value. These are some of the counteracting factors to the main law of profitability, the ‘law as such’. But these counteracting factors can only work for a while. Eventually, the law of falling profitability will operate. The crisis creates the conditions for the recovery. The recovery emerges when these conditions have become sufficiently strong. Periods of growth alternate with periods of crises. Thus the rate of profit of capital in an economy does not go straight down but exhibits a cyclical movement within a secular decline. So capitalism does not develop production in a straight line upwards. Its movement is subject to recurrent cycles of ‘booms and slumps’ that destroy and waste much of the value previously created. For example, the 1880s and 1890s saw a massive destruction of US value and wealth; and the Great Depression of the 1930s also. Now we have suffered the Great Recession and are in the first Long Depression of the 21st century. 5 There is an increasing body of evidence that Marx’s law operates as both a secular and cyclical process. The US rate of profit has not moved in a straight line. After the war, it was high but decreasing in the so-called Golden Age from 1948-65. This was also the fastest period of economic growth in American history. Profitability kept falling also from 1965 to 1982. GDP growth was much slower and American capitalism (like elsewhere) suffered severe slumps in 1974-5 and 1980-2. Then, in the era of what is called ‘neoliberalism’ from 1982 to 1997, profitability rose. Capitalism managed to get the counteracting factors to falling profitability into play i.e. greater exploitation of the workforce (falling wage share); wider exploitation of the labour force elsewhere (globalisation), and speculation in unproductive sectors (particularly, real estate and finance capital). This ‘neoliberal period’ had less severe slumps, although economic growth was still slower than in the Golden Age, because profitability was still below the period of the Golden Age, particularly in the productive sectors of the US economy. 6 Much of the profit was diverted away from real investment and into the financial sector. Profitability peaked in 1997 and began to decline. This laid the basis for the Great Recession of 2008-9. There was a mild contraction in the US economy in 2001, followed by a mild boom up to 2008. Profitability started to fall in late 2005. Then we had the Great Recession of 2008-9. The slump and the ensuing Long Depression were more severe than anything seen since the 1930s because of the huge build-up of debt and financial assets in the previous two decades (and particularly after 2002). This capital accumulation was what Marx called ‘fictitious’ in that it did not create or represent real value. Instead, there were credit-fuelled bubbles first in hi-tech stocks (crash in 2000) and then in housing (crash 2007). By 2007, the unproductive financial sector accounted for 40% of all US corporate profits. Finally, this credit bubble burst, bringing down the banking sector and the economy. The high level of private sector debt was compounded by the state having to bail out the banks. The graph below shows the US (overall) rate of profit from 1948 to 2015, using either historic or current costs to value fixed assets 7. The rate of profit has four phases: the postwar golden age of high profitability peaking in 1965; then the profitability crisis of the 1970s, troughing in the slump of 1980-2; then the neoliberal period of recovery or at least stabilisation in profitability, peaking more or less in 1997; then the current period of volatility and slight decline. We can sum up the movements in the rate of profit as follows: (1 = base point): 1948-65 1965-82 1982-97 1997-15 1948-15 2006-15 HC 0.78 0.79 1.10 0.97 0.67 0.93 CC 0.93 0.64 1.30 0.97 0.75 0.96 So between 1948 and 2015, the US rate of profit declined 25-33% depending on whether you measure fixed assets in historic (HC) and current costs (CC). Between 1965 and 1982, the rate fell 21-36%; but from 1982 to 1997, it rose 10-30%; but since 1997 it is down 3% and 47% from 2006. 8 That the fall in the US rate of profit follows from Marx’s law is supported by a decomposition of the changes in profitability (s/c+v), according to changes in the organic composition of capital (c/v) and the rate of surplus value (s/v) - namely when the organic composition of capital rises faster than the rate of surplus value, the rate of profit will fall and vice versa. Over the whole period, 1946-15, the rate of profit fell 30% (historic cost measure), while the organic composition of capital rose 46% and the rate of exploitation rose 2%. This must be the context of explaining the post-war crises in American capitalism. Profit rates in most major capitalist economies rose from the early 1980s up to the end of the 20th century while investment growth and real GDP growth slowed. But most of that profitability gain was in unproductive sectors like real estate and finance. Manufacturing and industrial profitability stayed low, as several Marxist analyses have shown 9. Even mainstream economics, using marginal productivity categories, reveal something similar. Using marginalist mainstream categories, Dietz Vollrath found that the ‘marginal productivity of capital’ fell consistently from the late 1960s. 10 Capital has become less productive ‘at the margin’. Marxist economics can explain this as due to a rising organic composition of capital (more technology replacing labour) leading to a fall in the rate of profit (return on capital). Post the Great Recession, the marginal productivity of capital rose because the share going to profit rose. In Marxist terms, the rate of surplus value rose to compensate for the rise in the organic composition of capital. Here’s Vollrath’s chart showing the time path in capital productivity from 1960 to 2013. If you remove the effect of rising profit share, the falling ‘productivity of capital’ continued (dotted line). The profit cycle What is the process of the profit cycle under capitalism? The rate of profit tends to move downwards, impelled by the rising organic composition of capital as the reproduction of capital develops, but this downward trend is reversed periodically due to crises. Why? Because, as more and more capitalists introduce new technologies, increasingly less labour is employed and less surplus value is generated. Many capitals go bankrupt while a few prosper. The capitalist production relation is stopped. This is destruction of capital. Generalized bankruptcies and unemployment, and thus the crisis, follow. 11 Marx is clear on this: “In so far as the reproduction process is checked and the labour-process is restricted or in some instances is completely stopped, real capital is destroyed. Machinery which is not used is not capital. Labour which is not exploited is equivalent to lost production. Raw material which lies unused is no capital. Buildings (also newly built machinery) which are either unused or remain unfinished, commodities which rot in warehouses – all this is destruction of capital.” (Marx, 1968, p. 495-6). At a certain point, after sufficient capital has been destroyed, the conditions for rising profitability emerge again. The devaluation of the elements of constant capital itself involves a rise in the profit rate. The mass of constant capital applied grows as against the variable, but the value of this mass may have fallen. The stagnation in production that has intervened prepares the ground for a later expansion of production. And so we go round the whole circle again. When the profitability of capital falls, eventually, the mass of new value and profits will fall. This engenders a collapse in investment and it this which triggers a slump. The slump creates conditions for a subsequent rise in the mass and rate of profit that breeds a rise in investment and a new period of growth. This is the cycle of profit and investment under capitalism. Profit (income) leads investment and investment leads output and employment, contrary to the Keynesian/Minsky view that consumption and investment lead income and employment. 12 And if we look at the US economy, there were five recessions or slumps after 1963: 1974-5, 1980-2, 1990-2, 2001 and 2008-9. In each case, the rate of profit peaked at least one year before, but on most occasions up to three years before. And on each occasion (with the exception of the very mild 2001 recession), a fall in the mass of profit led, or coincided with, a slump. US corporate profits were falling some two years before the Great Recession began and investment dropped before GDP contracted. And in the recovery, again it was profits that led investment and GDP up. US economy: corporate profits, business investment and GDP $bn These conclusions are confirmed by other authors. Jose Tapia found that “data from 251 quarters of the US economy show that recessions are preceded by declines in profits. So the mass of profits stop growing and start falling four or five quarters before a recession. They strongly recover immediately after the recession. Since investment is (to a large extent) determined by profitability and investment is a major component of demand, the fall in profits leading to a fall in investment, in turn leading to a fall in demand, seems to be a basic mechanism in the causation of recessions.” 13 Yes, there was rise in the rate of profit and the mass of profits from 2002 to 2006. But profitability was still in a downward cycle from 1997and the rate and the mass of profits did start to fall from 2006 onwards. Carchedi reaches a similar result 14. “If crisis years are years of falling profitability, crises are determined by falling profitability in the crisis year whether the pre-crisis year belongs to an upward or to downward cycle.… in all cases the CE-ARP (constant rate of exploitation) falls from the pre-crisis year to the crisis year (the same holds for the overall ARP)” Carchedi argues that “To cause the crisis, falling profitability must cause a negative percentage increase in the new value produced, a slowing down of the rate of growth of employment and a slowing down of capital accumulation, i.e. capital destruction in the crisis year. This is how profitability determines investment in the crisis year… The crisis is not simply a fall in the rate of profit. The crisis emerges if the fall in the CE-ARP determines a fall in capital accumulation, in employment and in new value. It is only at this point that falling profitability determines the crisis. The crisis is thus determined by falling profitability in the crisis year, whether it is preceded by an upward or a downward profitability cycle. The years preceding the crisis only prepare the conditions for the OCC to rise, for the CE-ARP to fall and thus for the crisis to emerge.” Now my use of Tapia’s data has been criticised as ‘mechanistic’ because Tapia shows the only 44% of the variation in investment is explained by profits. What about the other 56%? 15 But Tapia’s data show that profits lead investment, and this is the point. The purpose is not to argue that variations in profits determine all the variations in investments. That would be a mechanistic approach. 16. In an unpublished paper, Tapia looks at US profits and investment again using annual data. 17 In this, he confirms his previous results. “Using the change in profits of US corporations as measured by NIPA, it appears very clearly that changes in profits have a major influence in determining the change in investment in the following quarters, with changes in profits predicting a change in investment in the same direction, that is, rising profits predicts a subsequent increase in investment, falling profits predict a decrease in investment.”. He concludes that “All this is extremely at odds with the views of Keynes, Kalecki and Minsky, who believed that investment is the basic macroeconomic variable, just determined by the whims of rich people ("animal spirits"). In the Keynesian view it is that condition of "entrepreneurial confidence" or optimism that together with government spending determines the evolution of the economy. Evidence shows however that investment is to a large extent determined by previous profitability. This relation was emphasized by Marx who said that the rate of accumulation depends on the rate of profit, a view that he arrived at from abstracting the main elements of the empirical reality of 19th century capitalism. That the rate of investment (or accumulation) depends on profitability was shown with statistical data more than half a century ago by Wesley Mitchell and Jan Tinbergen who were not following Marxian theory in any way.” I also did some analysis of the changes in profits and investment and changes in profits to GDP in the US economy in the post-war period and applied Granger causation techniques 18. My results confirm Tapia’s. After one year, a change in profits ‘causes’ a change in investment and after two years a change in GDP. A change in investment causes a change in GDP for two years out. Even mainstream economists have reached a similar conclusion that it is change in profit that is the main driver of changes in investment. Recent research by JP Morgan concluded: “both business confidence and profit growth are highly statistically significant in explaining capital spending.” JP Morgan reckons that business spending “is less a function of borrowing costs than of an assessment of the outlook and profitability. On balance, this model explains 7085% of the variation in business equipment spending growth”.19 Similarly, Deutsche Bank’s economists have noticed that “Profit margins always peak in advance of recession. Indeed, there has not been one business cycle in the post-WWII era where this has not been the case. The reason margins are a leading indicator is simple: when corporate profitability declines, a pullback in spending and hiring eventually ensues.”20 Deutsche goes on: “With that in mind, the historical data reveals that the average and median lead times between the peak in margins and the onset of recession are nine and eight quarters, respectively”. The Cleveland Fed’s analysis remains the most pertinent. 21 Emre Ergungor, the Cleveland’s senior economic advisor, has found that there is a very high correlation between the movement of business profits, investment and industrial production. He found that “the correlation between the change in corporate profits and the contemporaneous change in gross domestic private investment is 57 percent, but the correlation goes up to 68 percent if I use the one-quarter-ahead change in investment.” And he concluded that “firms seem to adjust their production and investment after seeing a drop in their profits.” His time gap between profits and investment is about three quarters of a year. My own estimate is slightly longer. Moreover, changes in expected profits depend on past profitability, so a BIS study concludes 22: “Corporate investment plans as well as actual investment are well explained by CFOs’ expectations of earnings growth. We also show that errors in CFO expectations of earnings growth are predictable from past earnings and other data…. return expectations appear to be extrapolative: they are high after a period of high market returns, and low after a period of low market returns …Consistent with previous evidence at the aggregate level, expectational errors of individual CFOs are also strongly correlated with firm profitability and general economic conditions, in a way that appears to be extrapolative.” As Anwar Shaikh says in his book, Capitalism, Marx recognised that accumulation was affected by the expected rate of profit but that expectation was ruled, for better or worse, by the actual rate of profit. 23 The Great Recession and fictitious capital But maybe the lead-up to the Great Recession has a different explanation from Marx’s law of profitability and the profits to investment cycle presented above? In particular, how can we explain the divergence between corporate profits and the level of net investment in the US that began from as early as 2002, if profits lead investment? There was a recovery in profitability up to 2006. It has been argued that this shows Marx’s law cannot provide an explanation of the Great Recession of 2008-9. In particular, there was a growing divergence between the rise in profits in the business sector and investment. Corporations were and are ‘awash with cash’ but do not invest in means of production. So the underlying cause of the Great Recession cannot be Marx’s law. The explanation must be elsewhere – perhaps in the huge rise in the financial sector and private sector debt causing ‘financial instability’ as described by Minsky. So, even if the causes of other post-war US recessions can be found to do with profits, the Great Recession was different. This was a Minsky moment not a Marx one. 24 The first issue here is the relation between the productive and unproductive sectors of the capitalist economy. The first 30 years of post-war US capitalist development were free from financial crises, except for the relatively minor crises of 1961 and 1963. But from 1974 to 2007, there were seven major financial crises. And there was good reason for that. If profitability falls in the productive sectors, then capital seeks higher rates in finance and speculation. The evidence for this can be found in the rise of the ratio of financial profits to total corporate profits. “Higher profits and profitability in the unproductive sectors are the other side of the coin of falling profitability in the productive sectors”. 25 But much of financial profits is fictitious. Peter Jones 26 has argued that “fictitious profits can also hide the consequences of a falling rate of profit for a time. Government borrowing can ‘artificially’ inflate the after-tax rate of profit on production (and the same effect applies to after-tax rates of profit from secondary exploitation); and fictitious profits can ‘artificially’ inflate investors’ wealth and rates of return.” Jones 27 adjusted the official US figures for profit for fictitious profits, namely those made by banks from lending to government (bond purchases) and from utilising the savings of workers (mortgages etc). to come up with a measure of profit that best represents surplus value created in production and realised by the corporate sector. When he puts this against net fixed assets, the result looks like this. So Jones argues that “The most relevant measure of the rate of profit to compare with the rate of accumulation is the underlying rate of profit, since this determines how much surplus value is ‘available’ to corporations to reinvest.” Thus Jones removes the fictitious profits created by financial speculation in bonds and stocks and finds that the underlying productive sector rate of profit continued from 1997 through the 2000s and this was closely correlated with net business investment. He found that the R squared coefficient of correlation at 0.77. So the post-2000 divergence between corporate profits and capex disappears and can be explained by a rise in investment in financial assets or what Marx called ‘fictitious capital’. The ratio of corporate internal funds (after tax and dividends) to corporate investment rose in the early 2000s. The graph below shows that the ratio of corporate funds available to invest rose above the average from 2002. Internal funds versus capex ratio 1.3 Recession 1.2 Hi-tech investment boom Recession Recession 1.1 Recession Switch to financial assets 1.0 0.9 0.8 2014 2011 2008 2005 1999 1996 1993 1990 1987 1984 1981 1978 1975 1972 1969 1966 1963 1960 1957 1954 1951 0.7 2002 Dot.com bust Usually, US corporations have invested more than they had available in corporate savings. The only period that this was not the case is 2000-07. But corporate savings did not grow faster (5.3% pa) than in other periods. What happened was that capex grew much more slowly (4.0%). That suggests that corporate savings were switched into financial rather than productive investment. Annual average change in corporate internal funds and capex (%) 12.0 9.7 10.0 Borrowing 7.2 8.0 6.0 5.4 5.6 5.6 Switch to financial Weak profits 5.3 4.0 4.0 4.2 2.0 0.0 1981-15 1981-00 Internal funds 2000-07 2010-15 Capex A recent study of the corporate ‘saving glut 28 found that the fall in corporate investment since the global financial crash was “in line with historical norms”. The ‘cash boom’ started before that in the early 2000s. This was an exception because over the whole previous period 19602000, it was “statistically significant that higher profits raise investment”. The IMF makes a similar point in their study of the rise in cash earnings. 29. The IMF notes that the increase in profits after 2002 was mainly due to lower taxes and interest payments rather than to a rise in gross operating profits. The change in the latter “does not appear to be out of line with previous cyclical episodes”. Moreover, the IMF found that the main reason for the divergence between corporate savings and investment was a fall in investment not excessive profits. 30 The role of fictitious capital This is confirmed when we add in the change in non-financial corporate financial assets to the ratio of internal funds to capex. After 2000, there appears to be excessive corporate savings not invested in capex (red line). However, adding in financial asset investment (green line) reveals a huge deficit, taking off after the end of the 1990s. Non-financials borrowed to speculate and not invest – in a period where the profitability of capital has peaked and the profitability of productive capital was still falling. Fictitious capital is another counteracting factor to the law described by Marx and was significant after 2000. But like other counteracting factors, it cannot last. Indeed, excessive credit will generate an even larger collapse in capital values in the crash as the Great Recession shows. Much of the rise in corporate profits was fictitious and proved to be so when financial crash began in 2007. Internal funds less capex and fin investment 1000000 500000 0 -500000 -1000000 The counteracting factor : financial investment or fictitious capital -1500000 -2000000 -2500000 2015 2012 2009 2006 2003 2000 1997 1994 1991 1988 1985 1982 1979 1976 1973 1970 1967 1964 1961 1958 1955 1952 Internal funds less capex Internal less capex and fin asset Capital exists either in liquid form (i.e., as money) or in fixed form as means and materials of production. Credit in all its forms increasingly substitutes for money in the general circulation of capital and commodities. The existence of this fictitious capital imparts flexibility to the economy, but over time it becomes an impediment to the health of the economy. 31 The more fictitious capital distorts the price signals, the more information about the economy disappears. Decisions about production become increasingly unrelated to the underlying economic structure. Pressures build up in the economy, but they are not visible to those who make decisions about production. Fictitious capital retains values that would evaporate if participants in the market were fully aware of the future. They also serve as collateral for a growing network of debt. In effect, the financial system becomes increasingly fragile. The drive for profit in the capitalist sector is behind the inexorable expansion of credit. A fall in the rate of profit promotes speculation. If the capitalists cannot make enough profit producing commodities, they will try making money betting on the stock exchange or buying various other financial instruments. The capitalists experience the falling rate of profit almost simultaneously, so they start to buy these stocks and assets at the same time, driving prices up. But when stocks and assets prices are rising, everybody wants to buy them—this is the beginning of the bubble on exactly the lines we have seen again and again since the Tulip Crisis of 1637. 32 This was recognized by even some mainstream economists. As Irving Fisher put it: “overindebtedness must have had its starters. It may be started by many causes, of which the most common appears to be new opportunities to invest at a big prospective profit, as compared with ordinary profits and interest.” But prospective profit eventually gives way to “an expansion of ‘the speculative element’ and enterprises keep up an appearance of prosperity by accumulating debts, increasing from day to day their capital account.” 33 Fictitious values accumulate during extended boom periods and are subsequently shed in the course of the bust. This shakeout “unsettle[s] all existing relations.” As Paul Mattick put it, “speculation may enhance crisis situations by permitting the fictitious overvaluation of capital,” which cannot satisfy the profit claims bound up with it. 34 So a debt or credit crisis is really a product of a failure of the capitalist mode of production as a monetary economy. 35 In the course of a crisis, the elimination of fictitious values serves to increase the rate of profit, at least to the extent that fictitious values and the burden they place on firms are eliminated at a rate that exceeds the fall of prices of tangible assets. The clearing away of these fictitious values removes an important barrier to investment. Consequently, with their elimination, the economy strengthens and the cycle of accumulating capital can begin again. The destruction of fictitious capital is thus closely bound up with the devaluation of tangible capital. And the problem of recovery under the capitalist mode of production is thus intensified when fictitious capital reaches such an unprecedented size that it takes a very long time to eliminate it. In effect, global liquidity is a measure of what Marx called fictitious capital. 36 On this definition, global liquidity rose from 150 percent of world GDP in 1990 to 350 percent in 2011. The pace of growth accelerated in the late 1990s, and after a pause in the mild recession of 2001, liquidity took off again up to the point of the start of the global credit crunch in mid-2007. The boom in credit went into residential property in the United States and other economies. By mid-2006, the residential property boom in the United States had reached mega proportions. Household debt expanded rapidly during the so-called neoliberal era as a result of falling interest rates that reduced the cost of borrowing and created the ensuing property boom in many advanced capitalist economies in the past fifteen years. The creditors were the banks and other money lenders. The assets (home values) eventually collapsed, placing a severe burden of deleveraging on the financial sector. The underlying position was worse than the debt figures show because companies shifted much of their debt off the balance sheet. Shadow banking (or nonbank credit institutions) covers money mutual funds, investment funds other than mutual funds, structured financial vehicles, and hedge funds. According to the Basel III Bank of International Settlements (BIS)-IMF Financial Stability Task Force, shadow banking grew rapidly from $27 trillion in 2002 to $60 trillion in 2007 and then declined to $56 trillion in 2008 before recovering to $60 trillion again in 2010. Shadow banking now covers 25–30 percent of the total financial system, or half the size of traditional banking assets globally. The United States has the largest shadow banking sector, with assets of $25 trillion in 2007 ($24 trillion in 2010). 37 Marx recognized that fictitious capital will enter into the calculation of profitability for capitalist production. Businesses attempt to follow price setting practices that allow for the recapture of past investments and to repay debt obligations. If they cannot, they face bankruptcy. In that regard, the value of this capital “will continue to be estimated in terms of the former measure of value, which has now become antiquated and illusory.” 38 We can measure the impact of fictitious capital on profitability if we measure profit against the net worth of companies, and not just their tangible assets. This incorporates financial liabilities (loans from banks, bonds and shares issued). Such a measure for US companies shows that from 1966 to 1982, profitability against net worth falls at a slower pace than profitability measured conventionally against tangible fixed assets. It recovered more quickly in the neoliberal era (1982–97), so profitability against net worth was higher than conventional profitability. In the latest period, 1997–2011, conventional profitability has been broadly flat, but against net worth, profitability has dropped significantly. Against net worth, US corporate profitability was nearly cut in half between 1997 and 2000. After 2000, the rate of profit based on net worth remained under the rate against tangible assets for the first time on record, suggesting that the “financial” part of the assets of the capitalist sector became a significant obstacle to the recovery in capital accumulation. Difference in rate of profit (net worth or tangible assets) % pts, NFC 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 2009 2006 2003 2000 1997 1994 1991 1988 1985 1982 1979 1976 1973 1970 1967 1964 1961 1958 1955 1952 Awash with Cash We now have an apparent conundrum of rising/record profits in the United States and some other major economies, with corporations apparently “awash with cash,” but still not investing enough in the “real economy” to achieve a sustained recovery. Cash reserves in US companies have reached record levels—just under $2 trillion. The level of corporate fixed investment as a share of corporate cash flow is at twenty-five-year lows. Comparing US corporate fixed capital formation to corporate operating surplus, Michael Burke found that: the increase in profits has not been matched by an increase in nominal investment. In 1971 the investment ratio (GFCF/GoS) was 62 percent. It peaked in 1979 at 69 percent but even by 2000 it was still over 61 percent. It declined steadily to 56 percent in 2008. But in 2012 it had declined to just 46 percent. If US firms investment ratio were simply to return to its level of 1979 the nominal increase in investment compared to 2012 levels would be over US$1.5 trillion, approaching 10 percent of GDP. This would be enough to resolve the current crisis. 39 Burke reckons that US companies have used their rising profits to either increase dividends to shareholders or purchase financial assets (stocks): “one estimate of the former shows the dividend payout to shareholders doubling in the 8 years to 2012, an increase of US$320bn per annum.” Burke goes onto to point out that cash hoarding is happening in other economies, too. 40 In Canada, Michal Rodworski has noted the same phenomenon, 41 as does Jim Stanford at Unifor. 42 Burke noted that this hoarding began well before the Great Recession, and this is significant. 43 In the past twenty-five years, firms have been increasingly unwilling to make productive investments, preferring to hold financial assets like bonds, stock, and even cash, which has limited returns in interest. Why is this? Well, it seems that companies have become convinced that the returns on productive investment are too low relative to the risk of making a loss. This is particularly the case for investment in new technology or research and development, which requires considerable upfront funding with no certainty of eventual success. There was a dramatic increase from 1980 through 2006 in the average cash ratio for US firms. Interestingly, cash hoarding was not taking place among firms that instead paid high dividends to their shareholders. On the contrary. 44 Some scholars argue that the “main reasons for the increase in the cash ratio are that inventories have fallen, cash flow risk for firms has increased, capital expenditures have fallen, and R&D expenditures have increased.” To compete, companies increasingly must invest in new and untried technology rather than just increase investment in existing equipment. That’s riskier. 45 So companies have to build up cash reserves as a fund to cover likely losses on research and development. In the 1980s, average capital expenditures as a percentage of assets were more than double average R&D expenditures as a percentage of assets (8.9 percent versus 3.2 percent). In contrast, in the 2000s, R&D exceeds capital expenditures (6.7 percent versus 5.4 percent). 46 Rising cash is more a sign of perceived riskier investment than a sign of corporate health. Liquid assets (cash and those assets that can be quickly converted into cash) may have risen in total. But US companies were expanding all their financial assets (stocks, bonds, insurance, etc.). When we compare the ratio of liquid assets to total financial assets we see a different story. US companies reduced their liquidity ratios in the golden age of the 1950s and 1960 to invest more. That stopped in the neoliberal period, but there was still no big rise in cash reserves compared with other financial holdings. The ratio of liquid assets to total financial assets is about the same as it was in the early 1980s. That tells us that corporate profits may have been diverted from real investment into financial assets, but not particularly into cash. Those cash reserves are very concentrated in a few companies and banks. The notion of US corporates being awash with cash does not hold up to scrutiny as a general market characteristic. 47 There has been a rise in the ratio of cash to investment. But that ratio is still below where it was at the beginning of the 1950s. Why did the cash to investment ratio rise after the 1980s? Well, it was not because of a fast rise in cash holdings but because the growth of investment in the real economy slowed in the neoliberal period. The average growth in cash reserves from the 1980s to now has been 7.8 percent a year, which is actually slower than the growth rate of all financial assets at 8.6 percent a year. But business investment has increased at only 5.3 percent a year, so the ratio of cash to investment has risen. If we compare the growth rates since the start of the Great Recession in 2008, we find that corporate cash has risen at a much slower pace at 3.9 percent year-on-year. That’s slightly faster than the rise in total financial assets at 3.3 percent year-on-year. But investment has risen at just 1.5 percent a year. Consequently, the ratio of investment to cash has slumped from an average of two-thirds since the 1980s to just 40 percent now. So companies are not really awash with cash any more than they were thirty years ago. What has happened is that US corporations have used more and more of their profits to invest in financial assets rather than in productive investment. If we decompose the components of US corporate net worth, we find that capitalists increased their borrowing to buy back their shares, and this was exponential after the early 1990s. Companies used the extra debt to buy back their own company shares to boost the share price. UK companies bought back equity at an annual rate of 3 percent of GDP and in the US at 2.3 percent. Up to 1985, US companies issued shares (i.e., they were sellers). Since then they have become by far the most important buyer. In effect, while corporate profitability relative to net worth has been falling, share prices have been boosted by company share buybacks. Debt is rising to raise stock market prices well out of line with earnings. Corporate debt was rising to raise stock market prices well out of line with operating earnings. Any financial collapse could bring the whole pack of cards down. This dilemma still applies post 2009. The second issue is whether the supposed sharp increase in cash reserves of major US corporations suggests that the Great Recession could not have been caused by a lack of profit, but on the contrary, by a lack of opportunities to invest or ‘absorb’ excessive corporate savings. The graph below shows the surge in cash reserves held by US corporations, something that took off at the beginning of the millennium. Cash $bn 2500000 2000000 1500000 1000000 500000 0 2015 2013 2011 2009 2007 2005 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 1969 1967 1965 1963 1961 1959 1957 1955 1953 1951 But this is misleading. S&P Capital IQ noted that a record stash of $1.84tn in cash held by US non-financial companies masked a $6.6tn debt burden. They made the point that the concentration of cash of the top 25 holders, representing 1 per cent of companies, now accounts for over half the overall cash pile. That is up from 38 per cent five years ago. Cash may have risen but not as much as financial assets held by companies. Only the post2000 period saw a faster rise in cash over financial assets and not by much. Annual average cash growth was little different from the 1980s. What was different was the slowdown in capex growth – now reversed since 2010. Average annual growth in cash, financial assets and capex (%) 12.0 10.3 9.7 10.0 8.0 6.0 8.0 8.4 8.4 7.3 8.2 7.2 5.6 5.3 5.4 4.0 4.0 2.0 0.0 1981-15 1981-00 Cash Investment 2000-07 2010-15 Fin assets The cash to assets ratio is near a post-war low. Cash/Financial assets ratio 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 2015 2013 2011 2009 2007 2005 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 1969 1967 1965 1963 1961 1959 1957 1955 1953 1951 Moreover, corporate cash is not evenly spread, and is in fact being held by an increasingly concentrated group of companies, according to a study by business advisory and accountancy firm Deloitte of Bloomberg data. At the start of the credit crisis in 2007, companies with more than $2.5bn each in cash and near cash items, such as short-term investments, held 76 per of the $1.98tn of cash reserves of the non-financial members of the S&P1200. By the third quarter of 2013, this had risen to 82 per cent (of a total $2.8tn), the highest percentage since before 2000. Of non-financial companies in the S&P Global 1200 index, just 8.4 per cent hold 50 per cent of the cash. Indeed, 40% of companies actually reduced their cash balances. 48. The Great Recession led to the hoarding of cash – a phenomenon that Marx identified with slumps. In addition, a recent IMF study reckoned that those companies with more cash tended to be hi-tech because borrowing was more expensive for investment in ‘non-tangible’ assets like software and IP. 49. Interestingly, cash hoarding was not taking place among firms that instead paid high dividends to their shareholders. On the contrary. 50 Some scholars argue that the “main reasons for the increase in the cash ratio are that inventories have fallen, cash flow risk for firms has increased, capital expenditures have fallen, and R&D expenditures have increased.” To compete, companies increasingly must invest in new and untried technology rather than just increase investment in existing equipment. That’s riskier. 51 So companies have to build up cash reserves as a fund to cover likely losses on research and development. In the 1980s, average capital expenditures as a percentage of assets were more than double average R&D expenditures as a percentage of assets (8.9 percent versus 3.2 percent). In contrast, in the 2000s, R&D exceeds capital expenditures (6.7 percent versus 5.4 percent). 52 Rising cash is more a sign of perceived riskier investment than a sign of corporate health. SUMMARY The conclusions of this paper are: 1. Marx’s law is empirically valid. 2. Marx’s law is the underlying explanation of crises and cycles. 3. The rate of profit, the mass of profit and new value are related and causal for changes in investment, and thus employment and growth – in other words, in the post-war slumps in production in the US. 4. The divergence between profits and investment after 2000 is explained by a switch to financial assets. Profitability in productive assets remained low and declining and that was the motivation. 5. Cash reserves rose no faster than in previous periods and less relative to financial assets of NFCs. The hoarding of cash is to be expected in recessions (and the subsequent depression). The evidence of the Great Recession is no different in degree. Every slump will have different characteristics and triggers: 1974-5 (oil prices); 1980-2 (high energy prices); 1990-1 (commercial property bust); 2001 (dot com bust); 2008-9 (housing bust and finance). But if crises are recurrent and if they have all different causes, these different causes can explain the different crises, but not their recurrence. If they are recurrent, they must have a common cause that manifests itself recurrently as different causes of different crises. Some conjunctural phenomena like ‘financialisation’ in the last 30 years or neoliberal policy regimes may seem to be the cause of crises but they are not alternative causes but are “themselves explained by the LTRPF” 53. A Minsky moment might explain the Great Recession but no other recessions. Only the Marxist explanation can explain the recurrence of crises. Marx’s law is the underlying driver of booms and slumps under capitalism. The Great Recession was a Marx not Minsky moment. 1 http://www.economist.com/news/economics-brief/21702740-second-article-our-series-seminal-economic-ideas-looks- hyman-minskys 2 Alan Freeman in The Great Financial Meltdown: Booms, Depressions, and the Rate of Profit: A Pluralist, Inductive Guide, http://www.e-elgar.com/shop/the-great-financial-meltdown 3 Roberts, Tendencies, triggers and tulips, presentation to Third economics seminar of the IRRE, Amsterdam, February 2014 https://fileserver.iire.org/Econosem14/Presentation%20to%20the%20Third%20seminar%20of%20the%20FI%20on%20the %20economic%20crisis.pdf 4 See G Carchedi, Behind and beyond the crisis, http://gesd.free.fr/carchedi11.pdf October 2011 5 M Roberts, The Long Depression, Haymarket books, 2016 https://www.haymarketbooks.org/books/693-the-long- depression 6 See Carchedi, Crises and the Law (August 2015) for the causes of the rise and fall of the Golden Age. http://gesd.free.fr/carchedi815.pdf 7 Roberts, The US rate of profit 1948-2015, http://pinguet.free.fr/usrop2015.pdf 8 Data and workings for these results are available from the author. Also see the manual of working here: https://thenextrecession.files.wordpress.com/2016/10/short-manual-for-downloading-rop-data-from-bureau-of-economicanalysis-1.pdf, as compiled by Anders Axelsson for me. 9 Carchedi op cit, Kliman, Peter Jones etc 10 Vollrath, https://growthecon.wordpress.com/2015/11/24/describing-the-decline-of-capital-per-worker/ 11 Carchedi op cit 12 Roberts,Tulips op cit 13 Jose A Tapia Granados, Does investment call the tune? and Empirical evidence and endogenous theories of the business cycle, Research in Political Economy, May 2012, http://sitemaker.umich.edu/tapia_granados/files/does_investment_call_the_tune_may_2012__forthcoming_rpe_.pdf) 14 Carchedi, Crises and the law, op cit 15 Jim Kincaid, Marx after Minsky, Capital surplus and the current crisis, Historical Materialism 24.3 (2016) 105–146, p118 and note. 16 Kincaid seems to interpret my statistical analysis in a quite particular way, as assuming the variation in profits determining 44% of the variation in investment necessarily means that other factors are determining the 56% remaining variation in investment. There is however a different and possible explanation, e.g., that both profits and investment are measured with error, and this error may distort the statistical relation. Maybe the variation in profits actually determines 99% of the variation in investment but because of error the measured variation of profits only determines 44% of the measured variation in investment. Errors in variable measurement do not tend to raise patterns, they tend to blur them. Oscar Morgenstern emphasized decades ago that measurement of economic variables have errors that may be quite substantial. 17 Jose Tapia, Profits encourage investment, investment dampens profits, and government spending has little effect — Business-cycle dynam-ics in the US, 1929-2013 18 M. Roberts, The relation between profits, investment and GDP in the US economy 1946-2015 using Granger causation techniques (unpublished but available from the author). 19 https://thenextrecession.wordpress.com/2016/07/12/america-jobs-profits-and-the-stock-market/ 20 http://www.zerohedge.com/news/2016-06-04/when-will-recession-start-deutsche-banks-disturbing-answer 21 https://www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/2016-economic- commentaries/ec-201609-recession-probabilities.aspx#U6 Cleveland Federal Reserve bank’s Ergungor: “The measure I propose is the inflation-adjusted quarterly change in pre-tax corporate profi ts.5 Intuitively, a change in corporate profits should be highly correlated with industrial production and investment. One would expect firms to produce and invest more if their profits are rising. The empirical question in this analysis is which comes fi rst: the change in profits or production and investment? ….A simple correlation analysis shows that the correlation between the change in corporate profits and the contemporaneous change in industrial production is 54 percent, but the correlation goes up to 66 percent if I use the one-quarter-ahead change in industrial production. Similarly, the correlation between the change in corporate profits and the contemporaneous change in gross domestic private investment is 57 percent, but the correlation goes up to 68 percent if I use the one-quarter-ahead change in investment. More formally, a Granger causality test indicates that the quarterly change in profits leads the quarterly change in production by one quarter, but the change in profits is independent of the change in production. A similar relationship applies to the quarterly change in profits and investment. Thus, firms seem to adjust their production and investment after seeing a drop in their profits.” 22 BIS Working Papers No 562 Expectations and investment by Nicola Gennaioli, Yueran Ma and Andrei Shleifer Monetary and Economic Department May 2016 23 Shaikh, Capitalism, p577-78 24 It is enough to observe that debt and financial instability, his main preoccupations, have become some of the principal topics of inquiry for economists today. A new version of the “Handbook of Macroeconomics”, an influential survey that was first published in 1999, is in the works. This time, it will make linkages between finance and economic activity a major component, with at least two articles citing Minsky. As Mr Krugman has quipped: “We are all Minskyites now.” Central bankers seem to agree. In a speech in 2009, before she became head of the Federal Reserve, Janet Yellen said Minsky’s work had “become required reading”. In a 2013 speech, made while he was governor of the Bank of England, Mervyn King agreed with Minsky’s view that stability in credit markets leads to exuberance and eventually to instability. Mark Carney, Lord King’s successor, has referred to Minsky moments on at least two occasions. 25 Carchedi op cit 26 Peter Jones PhD thesis, November 2014 The Falling Rate of Profit and the Great Recession p219 27 Peter Jones, The falling rate of profit explains falling growth, paper for the 12th Australian Society of Heterodox Economists Conference, November 2013 28 Gruber, Joseph W., and Steven B. Kamin (2015). The Corporate Saving Glut in the Aftermath of the Global Financial Crisis International Finance Discussion Papers 1150. http://dx.doi.org/10.17016/IFDP.2015.1150 29 IMF, 2006. 30 :”While higher profits explain part of the rise NFCs excess saving in recent years,the decline in nominal capital saving explains around three-quarters of the increase in net lending.” 31 “At low levels, debt is good. It is a source of economic growth and stability. But at high levels, public and private debts are bad, increasing volatility and retarding growth. It is in this sense that borrowing can first be beneficial. So long as it is modest. But beyond a certain point, debt becomes dangerous and excessive.” S. Cechetti, M. Mohanty, and F. Zampolli, “The Real Effects of Debt,” Federal Reserve Bank of Kansas City, 2011. 32 See E. Thompson and J. Treussard, “The Tulipmania: Fact or Artifact?,” UCLA Working Paper, 2002. 33 Irving Fisher, “The Debt Deflation History of Great Depressions,” Econometrica 1 (1933), 337–57. 34 Paul Mattick, Economic Crisis and Crisis Theory (Armonk, NY: M. E. Sharpe, 1981), p. 135. So for Marx: “The credit system appears as the main lever of overproduction and overspeculation in commerce solely because the reproduction process, which is elastic by nature, is here forced to its extreme limits, and so is forced because a large part of the social capital is employed by people who do not own it and who consequently tackle things quite differently than the owner, who anxiously weighs the limitations of his private capital in so far as he handles it himself. This simply demonstrates the fact that the self-expansion of capital based on the contradictory nature of capitalist production permits the free development only up to a certain point, so that it constitutes an imminent fetter and barrier to production, which are continually broken through by the credit system. Hence, the system accelerates the material development of the productive forces and the establishment of the world market. It is the historical mission of the capitalist system of production to raise these material foundations. At the same time credit accelerates the violent eruptions of this contradiction—crises—and thereby the elements of the disintegration of the old mode of production.” Marx, Capital, vol. 3, chap. 27. 35 “In a system of production, where the entire control of the reproduction process rests on credit, a crisis must obviously occur when credit suddenly ceases and cash payments have validity. At first glance therefore, the whole crisis seems to be merely a credit and money crisis.” But “what appears to be a crisis on the money market is in reality an expression of abnormal conditions in the very process of production and reproduction.” Marx, Capital, vol. 3, chap. 27. 36 Marx made it clear that credit and fictitious capital are not the same, but the rise in the measure of global liquidity is a good indicator of the expansion of fictitious capital, too. 37 See the FSB, Defining and Measuring the Shadow Banking System, April 2011. 38 Marx, Capital, vol. 3, chap. 27. 39 M. Burke, “The Cash Hoard of Western Companies,” Socialist Economic Bulletin (October 21, 2013). 40 “In 1995 the investment ratio in the Euro Area was 51.7% and by 2008 it was 53.2%. It fell to 47.1% in 2012. In Britain the investment ratio peaked at 76% in 1975 but by 2008 had fallen to 53%. In 2012 it was just 42.9% (OECD data).” And the cash hoards were up sharply: “The total deposits of NFCs in the Euro Area rose to €1,763bn in July 2013 of which €1,148bn is overnight deposits. This is a rise of €336bn since January 2008, nearly all of which is in overnight deposits, €306bn. In Britain the rise in NFCs bank deposits has been from £76bn at end 2008 to £419bn by July 2013.” Burke, “The Cash Hoard of Western Companies.” 41 M. Rozworski, “Canada’s Profitability Puzzle,” Politicalehconomy, December 3, 2013, http://politicalehconomy.wordpress.com/2013/12/03/canadas-profitability-puzzle/. 42 “Because corporations are taking in so much more than they are spending, liquid cash assets in the non-financial corporate sector continue to swell, and now total almost $600 billion.” J. Stanford, “Good Time to Rethink Corporate Tax Cuts,” Progressive Economics, November 14, 2013, http://www.progressive-economics.ca/2013/11/14/good-time-torethink-corporate-tax-cuts/. 43 “The ratio of investment to profits has been falling steadily for the past two decades and now sits at just above 60%. Companies are putting less and less of their earnings back into their stock of buildings, machinery and other equipment—the tools they use to produce goods and services. For every dollar earned before tax, only about 60 cents goes back into maintaining and expanding business capital. Compare this to 80 or more cents just a decade ago.” Burke, “The Cash Hoard of Western Companies.” 44 “We show that this increase is concentrated among firms that do not pay dividends, firms in more recent IPO listing cohorts, and firms in industries that experience the greatest increase in idiosyncratic volatility.” T. Bates, K. Kahle, and R. Stulz, “Why Do US Firms Hold so Much More Cash than They Used To?,” Journal of Finance 64 (2009), 1985–2021. 45 “The greater importance of R&D relative to capital expenditures also has a permanent effect on the cash ratio. Because of lower asset tangibility, R&D investment opportunities are costlier to finance than capital using external capital expenditures. Consequently, greater R&D intensity relative to capital expenditures requires firms to hold a greater cash buffer against future shocks to internally generated cash flow.” B. Broadbent, Costly Capital and the Risk of Rare Disasters (London: Bloomberg, 2009). 46 “R&D intensive firms require a greater cash buffer against future shocks to internally generated cash flow. In contrast, capital expenditures are more likely to generate assets that can be used as collateral and hence are easier to finance. As a result, capital expenditures may mostly consume cash, which would be consistent with their negative relation with the cash ratio.” Broadbent, Costly Capital. 47 C. Vistesen, “The Big Disconnect between Leverage and Spreads,” Seeking Alpha, March 25, 2014, http://seekingalpha.com/article/2107013-the-big-disconnect-between-leverage-and-spreads. 48 IMF op cit 49 IMF op cit. 50 “We show that this increase is concentrated among firms that do not pay dividends, firms in more recent IPO listing cohorts, and firms in industries that experience the greatest increase in idiosyncratic volatility.” T. Bates, K. Kahle, and R. Stulz, “Why Do US Firms Hold so Much More Cash than They Used To?,” Journal of Finance 64 (2009), 1985–2021. 51 “The greater importance of R&D relative to capital expenditures also has a permanent effect on the cash ratio. Because of lower asset tangibility, R&D investment opportunities are costlier to finance than capital using external capital expenditures. Consequently, greater R&D intensity relative to capital expenditures requires firms to hold a greater cash buffer against future shocks to internally generated cash flow.” B. Broadbent, Costly Capital and the Risk of Rare Disasters (London: Bloomberg, 2009). 52 “R&D intensive firms require a greater cash buffer against future shocks to internally generated cash flow. In contrast, capital expenditures are more likely to generate assets that can be used as collateral and hence are easier to finance. As a result, capital expenditures may mostly consume cash, which would be consistent with their negative relation with the cash ratio.” Broadbent, Costly Capital. 53 Alan Freeman, op cit.