In the first post in this series, I introduced the question that has
perplexed worldly philosophers for centuries: Where does profit come from in a
capitalist economy, or, in other words, where does growth come from? Some
economic thinkers have suggested what I brought up earlier—that logically there
should be no profit in an efficiently functioning market system because
revenues and expenses in the aggregate should cancel each other out and market
forces should pressure both prices and wages into an uneasy truce. This is
generally true, but, in addition to the financial shenanigans addressed in last
week’s post, there are three notable mechanisms that disrupt the normally
seamless interchange of money, goods, and services that produces a profit-free
system of mutually canceling expenses and revenues.
Inventory. Because most
businesses use the accrual method of accounting, revenues and expenses do not
line up exactly over time. To illustrate with a simple example, revenue is realized by a producer when its product
is sold to another company, perhaps a
retailer, who then places it in inventory. But the retailer does not recognize
this purchase as an immediate
expense. The cost of this product is not recorded as an expense until it is
sold to a consumer. So the revenue experienced by the producer and the expense
recorded by the retailer may actually happen in different years. If inventories
increase over time, the natural result for an entire economy featuring such
transactions is profit. This is an example of how growth and profit are
dependent on each other.
Capital assets. Some purchases
are significant enough that they are capitalized and then depreciated over time
instead of being immediately expensed. For example, if a business purchases a
new office building, it does not immediately write the new building off as an
expense, although the seller may record the sale as immediate revenue.
Generally, the expense for these large purchases is realized over time as the
asset depreciates. Again, revenues for one company and expenses for the other
party in the transaction do not align. And if asset values increase over time,
the economy grows.
Purchasing with debt. Whenever
purchases are made using debt—either one business from another or consumers
purchasing from a business—a similar misalignment of revenues and expenses
occurs. The seller recognizes the sale immediately as revenue (if the credit is
provided by a third party), but the buyer doesn’t recognize the expense all at
once. That expense is spread over the life of the loan and generally takes the
form of installment payments. To use a familiar example, when I purchased a car
a few years ago, the auto dealer received full payment the day my credit union transferred
the funds. But for me, since I am not independently wealthy, this was not a
one-time expense. My expense was spread out over five years and occurred in
manageable monthly installments. And what about the loan from the credit union?
How did the credit union experience its expenses and revenues? Well, that is
another story altogether, which I will address shortly.
Money, Money, Money
The three exceptions mentioned above are helpful in explaining how a
capitalist economy grows, but in no way do they come close to accounting for
all the profits that are extracted from the flow of goods and services. So,
what else may account for this expansion? One pivotal mechanism that makes
growth possible is the expansion of the money supply. If the money supply does
not expand, the economy simply cannot grow. (This, by the way, was the fatal
flaw of Hannah Bell’s two-company economy: a static money supply, which made
profit impossible.) So, how does the monetary supply expand? There are perhaps
three ways. I say “perhaps” because one of these ways is an illusion.
First, the government prints money. If you listen to politicians and some
journalists, you get the impression that when government needs more money, it
simply cranks up the printing press. But printing money is actually a very
minor source of new funds, primarily because so few of our financial
transactions involve federal reserve notes (cash) in this digital age.
A much more fertile source of monetary growth is the financial sleight of
hand that takes place whenever commercial banks lend money into existence, and
this is the answer to the credit union question above. According to Herman Daly
and John Cobb, “Private creation of money by banks evolved long before it was
understood. Joseph Schumpeter claims that, as late as the 1920s, ninety-nine
out of one hundred economists believed that banks could not create money any
more than cloakrooms could create coats.”1 Although this practice
was not well understood for years, today it is fairly common knowledge. Anyone
who has taken an elementary economics course should understand it. Basically,
if a bank is required to keep only 10 percent of its deposits on reserve, it
can loan out $90 of a $100 deposit. If the recipient of the $90 loan deposits
the whole amount in his bank account, that bank can loan out $81, and the
process then repeats itself again and again. The potential new money from this
lending practice is $1,000. This new money, in general, is used to produce
products, purchase products, and generate revenues. As the revenues return to
the banks to pay off the loans, the banks skim off interest, which becomes
their profit. Of course, the lower the reserve ratio, the more the initial
asset can be leveraged and the more interest will be charged. The key to growth,
then, is for banks to keep lending money, preferably in forms that have low
reserve requirements, and to make sure that aggregate net debt increases over
time.
The reserve ratio for banks in the United States varies depending on
the institutions’ volume of transactions and type of deposits, but it ranges
between zero and 10 percent and excludes such ordinary categories as savings
accounts, CDs, and time deposits from corporations and foreign governments.
What this means is that financial institutions can leverage a good portion of
their deposits at astronomical rates. But what about the bizarre financial
instruments concocted by Wall Street? Well, they have not been regulated at
all. This is how Lehman Brothers was able to leverage its assets at a 35 to 1
ratio. And, of course, as financial institutions create this inverted pyramid
of debt, they charge interest or fees at every level. This is why banking is so
profitable.
Daly and Cobb question the whole notion of compound interest, insisting
that “money should not bear interest as a condition of its existence, but only
when genuinely lent by an owner who gives up its use while it is in the
possession of the borrower. When the commercial banking system lends money, it
gives up nothing, creating deposits ex
nihilo up to the limit set by the reserve requirement.”2 And if
there is no reserve requirement, the sky is the limit, until the air gets too
thin and the balloon collapses.
The third way new money is created (and at least some people subscribe to
this theory) is through the bidding up of asset values by speculation. The
stock market is only one element in the vast array of assets that attract
speculators, but understanding a few basic concepts about the stock market can
help us comprehend what is happening in the larger financial sector. Although
shares of stock represent ownership of corporations, the value of those shares
of stock have a very tenuous connection to the actual value of a corporation’s
assets, its ability to create and sell products, and even the money in its
liquid accounts. During the last few months of 2008 and the first part of 2009,
we saw the stock market’s major indices lose more than half their value.
Journalists and economic analysts were aghast over the vast amount of “money” that
was lost. I know something about this on a personal level. I had some of my
401k funds invested in the stock market. I lost about 20 percent of the value
of the 401k before I shifted everything to other types of investments. But did
I really lose anything? What about everyone else? What about all those
trillions of dollars of “wealth” that simply vanished into thin air during
these difficult months? A lesson from not-so-distant history may help us answer
these questions.
A smaller stock market crash occurred in 1987. Joel Kurtzman, in his book
The Death of Money, gave the
following assessment of the carnage:
If measured from the height of the
full market in August 1987, investors lost a little over $1 trillion on the New
York Stock Exchange in a little more than two months. That loss was equal to an
eighth of the value of everything that is manmade in the United States,
including all homes, factories, office buildings, roads, and improved real
estate. It is a loss of such enormous magnitude that it boggles the mind. One
trillion dollars could feed the entire world for two years, raise the Third
World from abject poverty to the middle class. It could purchase one thousand
nuclear aircraft carriers.3
In 2008, similar statements were made about the vast wealth that suddenly
disappeared. But what really happened? David Korten’s response to Kurtzman’s
lament is instructive:
Those who invested in the stock
market did indeed lose individual buying power. Yet the homes, factories,
office buildings, roads, and improved real estate to which Kurtzman refers did
not change in any way. In fact, this $1 trillion could not have fed the world
for even five minutes for the simple reason that people can’t eat money. They
eat food, and the collapse of the stock market values did not in itself
increase or decrease the world’s actual supply of food by so much as a single
grain of rice. Only the price at which shares in particular companies could be
bought and sold changed. There was no change in the productive capacity of any
of those companies or even in the cash available in their own bank accounts.4
Consider my own 401k to illustrate what really happened. I owned a few
shares of stock through an investment fund. Over time, these shares grew in
value. But did I actually have more money? Well, on paper, yes. The quarterly
statements I received for my 401k showed that my account was worth a certain
amount, and it was expressed in U.S. dollars. But that “money” wasn’t real
because it wasn’t liquid. It was merely potential money. Because someone was
willing to buy those shares from me at an inflated price, my account balance
ballooned. Such was the case with all investors in the stock market. But was
there actually more money in the stock market? Not at all. There was only an
increase in perceived value. In other words, in August 2008 did I really have
any more wealth than I did ten years earlier? No (leaving aside the additional
money I had earned and deposited into the 401k during those ten years). Could I
buy anything with those shares of stock? No. If I had cashed them in, then I
would have been able to spend the money I received from their sale on all sorts
of real goods and services. But I didn’t. And when I traded those shares for
some safer investments, they were worth a lot less than they had been worth a
few months earlier. My account balance was at that time about 20 percent lower
than it was at its peak. Other investors lost much more than I did. But did the
money supply actually decrease when the stock market plunged? No. So this sort
of monetary expansion is really just an illusion.
The stock market, as mentioned, is just a small segment of the financial
sector. Most of the economic expansion we have seen during the past few years
occurred in foreign exchange transactions, in the commodities markets, in real
estate, and in the nebulous world of phantom finance that encompasses
derivatives of every shape and flavor, everything from forward rate agreements
to credit default swaps. To put the financial sector in some sort of useful
context, consider that foreign exchange transactions alone amounted to about
$5.3 trillion per day in 2013, while the world domestic product rang in at only
$205 billion per day. Put another way, the total value of all final goods and
services produced in the world amounts to less than 4 percent of the money that
is traded every day in just the currency markets. Money did not become a
commodity until 1973, but now it is the most sought-after commodity of all. And
minute fluctuations in the rates of exchange between currencies yield mammoth
amounts of “profit” every day. This profit is somehow extracted from the system
without anything at all being produced. What allows this to happen? The
accelerated flow of money. I’ll explore this phenomenon in the next post, but
for today let me backtrack momentarily.
The Resource Factor
I mentioned above that the economy cannot grow if the money supply does
not grow. This is true, but expanding the money supply alone does not
necessarily translate into economic growth. There must also be an expansion in
the total mass of products created during a given time frame. And in order to
make this production possible, natural resources must enter the flow and,
through the instrumentality of labor and technology, be transformed from raw
materials into finished products, a process that generally involves several
steps and various industries. In essence, the two-company economy of Hannah
Bell can grow only if the money supply expands and if new natural resources enter the system and are transformed
into widgets. With these two factors in place, the two business owners can
extract a profit, and the total quantity of products for sale can increase.
If the business owners are shrewd, they will try to increase their
profits by doing two things: increasing the price of the widgets and decreasing
their labor costs. Increasing the price of the widgets is possible if they
either improve the product or create the widespread impression that all prices
must simply increase over time. Decreasing labor costs is made possible by
creating a surplus of workers looking for work over jobs available. In such
circumstances, desperate workers are willing to labor for less pay. A related
method for decreasing labor costs is to increase productivity, either through
more efficient work methods or, more commonly, through technological
innovation. Productivity improvement not only enables a worker to produce more
product in a given time frame, but it also allows a company to produce the same
amount of product with fewer workers. In this way, productivity improvement
helps create a surplus of labor, which places downward pressure on wages. The
result, of course, is more profit going into the pockets of the owners and
business executives. The downside is that the workforce has less disposable
income with which to buy widgets. This is the Hobsonian world we have come to
accept.
When an economy becomes highly productive, it requires fewer workers who
actually produce the physical products people need. The result is that the
surplus workers find lower-paying jobs in an expanding service sector, which
creates largely superfluous products. So, what happens when we need only 10
percent of the workforce to manufacture the products we need and want? What do
the rest of us do? Do we get up each morning, as Harvard business professor
William Abernathy once suggested, and press each other’s pants? Or, as an
economist friend of mine put it, “I’ll cut your hair, and you’ll cut my hair,
and we’ll both get rich.” A nation of superfluous service workers is not an
economically healthy nation and never can be. This is the dilemma of a
postindustrial society.
The crux of the issue is that increased productivity, aimed at making
companies competitive and profitable, is inadvertently creating a greater
division between the haves and have-nots and is therefore diluting our ability
to consume all that we produce. Corporate capitalism’s solution to the dilemma
of a shrinking manufacturing workforce is to introduce new products—primarily
services and technological gizmos—at an accelerating pace. This creates new
jobs (generally at lower pay) to replace the ones we have eliminated or
exported and thus curbs unemployment, though not misemployment; it also
pressures us to consume more than ever before (in an expanding economy,
consumption must perpetually increase) and keeps the wheels of capitalism
spinning—faster and faster.
And this brings us to a good stopping point, before we tackle the idea of
speed that masquerades as growth.
________________________
1. Herman E. Daly and John B. Cobb Jr., For the Common Good: Redirecting the Economy
toward Community, the Environment, and a Sustainable Future (Boston: Beacon
Press, [1989] 1994), 416.
2. Daly and Cobb,
For the Common Good, 426.
3. Joel Kurtzman, The
Death of Money (New York: Simon Schuster, 1993), 98.
4. Korten, When
Corporations Rule the World (San Francisco: Berrett-Koehler; Bloomfield,
Ct.: Kumarian Press, 1995), 192.
No comments:
Post a Comment