Look at the entries under Assets at the top. They include cash, inventory, plant and machinery, office equipment, etc. What is in common between these disparate items that allow them to be added as “assets”? (In large corporations, where the composition of capital is more complex, the asset items are even more extensive. Look, for example, at IBM’s balance sheet).
You know the “apples with apples, oranges with oranges” adage. Adding presupposes grouping. Grouping presupposes a commonality among the group members. What is the commonality between building, inventory, office furniture and cash?
The answer is that they are the constituting parts of capital the way arms, legs and organs are the constituting parts of the body. This point needs elaborating; the analogy might not be obvious without some background accounting. To that end, let us build a balance sheet from “scratch”. We follow an entrepreneur who believes he can make a good profit producing and selling some “widget”, say, a toy, a pen or a particularly cheap wristwatch. So, he takes out $10 million that he had stashed in a safe place, incorporates a corporation and begins work.
Let us assume that he spends $5,000,000 to build the plant, $1,000,000 for an office from which to run his enterprise and $1,000,000 for the office furniture, supplies, systems,etc. We further assume that he pays $1,500,000 for raw materials and $500,000 in wages to workers to produce 100,000 widgets. The final $1,000,000 he keeps as cash for the day-to-day operation of the plant. The entrepreneur has set the widget price at $25. Since 100,000 widgets are produced, their total price is $2,500,000. In accounting parlance, that is the inventory.
At that point, the company’s assets will look as follows:
Note that the assets add up to $10,500,000; $500,000 more than the money our entrepreneur advanced. How this magic is performed does not at present concern us. Our focus is on the conversion of money to capital and its unity-in-plurality.
Beginning with the conversion, note that cash – money – is not capital. Stashed in a mattress or kept in a safe deposit box, it would not multiply; it would not increase by a penny. Our entrepreneur knew that, which is why he took $10 million out of a safe and invested it in the widget venture.
In a like manner, the $1 million cash on the balance sheet is considered “working capital” precisely because it stands with the other components of the widget-producing capital. Taken out of that relationship, it becomes money again. It could be spent as money, but it will never increase in size.
The same reasoning applies to other asset items. The plant, for example, is a component of capital by virtue of being a place where widgets are produced – but only if there is an office from which to manage the production: dispenses cash, hire workers, raw materials, etc. Taken out of that relation, the plant becomes a storage for idle machinery. It eventually crumbles and dies, which is how the decommissioned plants are literally referred to in English. The town such plants once operated become, taking another word that is meaningful with reference to once alive bodies only, ghost towns.
The concept of capital, we see, then, can only be understood as the coming-together of various qualitatively different parts in such a way that the integrated whole is capable of internal growth. That’s how $10,000,000 became $10,500,000. That is the characteristic of an organic entity.
But, as in all organic bodies, it is not all quantity. There is a quantitative relation as well between the parts. A man’s head or heart can grow larger or smaller only so much before the distortion becomes fatal.
The relation between the various asset parts, likewise, must remain within certain quantitative limits. We intuitively grasp that point with regards to the plant or the office space. It would be madness for a small company to build a high-rise headquarter in an expensive downtown lot or a car manufacturer to try to squeeze its assembly line into an area one-half the size of what is necessary.
The relation of cash and inventory to other asset components is less intuitively apparent – because there is a supposition that “more money” can never hurt – but that is precisely when the abnormality in the body capital begins.
Look at the assets above. The company’s inventory is its lifeline. It was produced by workers who were paid $500,000 in wages and used $1,500,000 worth of raw material in the production process. The value of inventory is $2.5 million; $500,000 more than what went for its production. For that profit to be realized and for the process to continue – for which the entrepreneur must order $1,500,000 worth of raw materials set aside $500,000 in wages – the inventory must first be sold. The workers and raw material suppliers do not want widgets. They want money. Selling, converting inventory to money, is vital to the survival of capital. Hence, the pressure on the sales force and the resulting psychosis.
If the widgets cannot be sold at $25 each, they would have to be discounted; offered at say, $20. In that case, the entrepreneur would have advanced $2 million in wages and raw material to withdraw the same $2 million. That would be an absurd and pointless exercise and very discouraging to our entrepreneur. (We ignore depreciation and other such technical considerations that have no effect on our discussion).
If there are still no takers, the discount would have to be deeper; the widgets would have to be offered at say, $15. In that case, the capital would fall below its original $10 million. That would be the destruction of capital.
No sane entrepreneur would tolerate the condition of throwing money into the production circuit only to see it diminish in size. The logical step would be to curtail the production. If the demand for widgets is soft, in the next cycle our entrepreneur will produce only half as many widgets. Consequently, he will need half as much labor and raw material. In that case, two things would happen. First, the demand for labor would fall, with the result that unemployment would rise. That story you know. Second, the cash on the balance sheet would rise.
If our entrepreneur gets $2.5 million from the sale of his inventory but produces half as many widgets as before, he would only need to spend $1 million on labor and raw material, one-half of what he would normally spend on these items. In that case, even if he pockets $500,000 as before, $1 million surplus cash will be added to the balance sheet.
That is what has been happening in the US and the EU. Look, for example, at the “short term investment” in the IBM balance sheet (3rd from top) which is where the company has parked its unused cash. Or check out the balance sheet of GE under “cash only” (2nd from top).
The development is widely reported in the press as “cash hoarding” by corporations. But the labeling itself shows how little the problem is understood.
Look at this Yahoo analysis, for example, under the heading Largest Public Companies Continue to Hoard Cash at Record Levels. The writer complains that companies have “unnecessarily” tied up cash in inventory.
The men and a few women in charge of finances of large corporations are high ranking executives who oversee thousands of staff and billions of dollars of budget. They have bankers, advisers, consultants, traders and portfolio managers who keep them abreast of any change in the market. It is laughable to suggest that they might “unnecessarily” tie-up cash – and do so all at the same time.
Or look at this Associated Press story which begins this way:
Americans’ wealth last summer suffered its biggest quarterly loss in more than two years as stocks, pension funds and home values lost value. At the same time, corporations raised their cash stockpiles to record levels.There is a relation between the decrease in the wealth of the Americans and stockpiling of cash by corporations, but not because of corporate wickedness, which is what the writer implies. Here is how I would rewrite the opening sentences to make the cause-and-effect relation clear: It is precisely because corporations were forced to raise their cash stockpiles that the wealth of Americans suffered its biggest loss.
Corporations’ cash stockpile has been increasing because they have been curtailing production. They have been curtailing production because their rate of profit has fallen. And this phenomenon has taken place across all industries. Imagine not being able to sell the widgets at $25 and having to reduce the price to $23, $21, $20 and then $17 and $15.
Under that condition, there would be no need for the same number of workers as before, and for the same office space and plant as before. They all must be reduced. The destruction of capital is thus set in motion. Depending on the severity and magnitude of destruction, the result is called a recession or a depression. From the Financial Times of January 9, 2012, under the heading Earnings growth falters for S&P 500:
US corporate earnings grew in the fourth quarter of 2011 at their slowest pace for more than two years … and are expected to slow even more in the first quarter of this year as profits are hit by global economic turbulence. The US earnings season begins today with Alcoa, one of the world’s largest aluminum producers, reporting fourth-quarter results after the stock market closes. Expectations of Aloca’s profits have been scaled back sharply in recent months … Alcoa said last week that it would take a charge of $155-$160m in the quarter for the cost of shutting down temporarily or permanently 12 per cent of its smelting capacity as it attempts to cut costs and respond to a weaker aluminum price.(How about Alcoa’s cash position, you might ask – Alcoa, too? Alcoa, too. Click here and check out the first two asset items.)
Destruction of capital and what follows from it – the rise in unemployment, the rise in corporate cash holding, the fall in interest rates, the rise in the number of unemployed, the factory closings, the savage cuts to government spending, lowering of wages – are all effects of the same cause, namely, the fall in the rate of profit across the industries.
This fall is a “macro”, socio-economic phenomenon. It could not be remedied by the actions of individual governments or corporations. It required a socio-economic solution. The solution was the EU, whose raison d’être is increasing the labor productivity principally through lowering its costs. That is what the EU is fundamentally all about. Everything else about it is incidental.
Why the profit across industries fall is a subject of Vol. 4 of Speculative Capital.
But I took a long detour to touch upon the composition of capital and corporate asset structure to highlight a point that I have made above only implicitly.
Capital is a social, living concept. Its components – workers and communities clearly, but also plants and buildings – are likewise social. They are the parts of body capital.
As long as capital is “alive”, as long as it is humming along and producing an agreeable rate of profit, there is prosperity. Men are employed, there is money to go around, cities are booming and everyone is happy.
When capital is destroyed, when it dies, the components die as well. Plants become idle, corporations go bankrupt, ships rust, towns become ghost towns and men become unemployed, poor and desperate.
To prevent such outcome, one must keep capital alive.
But capital is inherently self-destructive.
Now how do you deal with this menace?
Chekhov’s experience points the way. In his trip to the hellish Siberian penal colony, the perceptive author of Sakhalin Island learned that one must be extremely careful in taking on evil – careful not in the sense of being timid, but in the sense of knowing what to do and how to act. Not infrequently, the solutions which seem obvious on moral or social grounds make matters worse because they flow from the wrong diagnosis of the ills. If you believe, for example, that greed and corruption of bankers and financiers caused the current crisis, your solution would be to put God-fearing Christians and men of good moral standing in charge – men like Gingrich and Santorum.
Hence, the critical role of the theory which helps us see the cause. Theory delivers us from the passive acceptance of events just because they are and allows us to influence them by anticipating where they are heading.
Which brings me to our main subject.
There is a tremendous amount of noise around the EU. If you are following the goings on in your local paper, it is impossible to make head or tail of it. Some of the issues, like the imposition of austerity budgets, pertain to individual countries and local governments. Others, like the possibility of the EU members issuing eurobonds, are technical subjects of concern to only a small minority.Then there is the rumor of Greece going bankrupt. Then, Portugal. Spain, too, perhaps. The euro will survive. Strike in Hungary. The euro will not survive. France downgraded. Cameron blew it. Merkel is resolute. Sarkozy says the point is moot. ECB, Ireland, Draghi, England, Finland, the European Commission, the European Council. (Do you know the difference?)
It is truly confusing, even without the constant stream of nonsense that poltroons in the media and academia produce on the subject.
But, relax, I say! This undulated European phantasmagoria arises from a falling rate of profit and the efforts of capital to check and reverse it. When you see that, the chaos disappears. And that, our theory, has been made easy to see. Substitute the PR approved positive words “growth” and “productivity” for it and you will see it everywhere. From the Financial Times of January 9 under the heading Berlin and Paris move growth to top of agenda:
Germany and France are set to propose measures to revive economic growth in Europe and reduce youth unemployment, including actions to increase cross-border labour mobility, to complement budget discipline and debt reduction in the eurozone…. France wants measures to make it easier for workers to move between countries, for example from Spain, with 40 per cent youth unemployment, to Germany, with falling unemployment and a skills shortage.(Why is France concerned about Spanish youth finding employment in Germany, you ask, and why youth, when the adult heads of household are unemployed in millions? Because young workers, especially foreign, emigrant, young workers, could be hired at lower wages. In this way, they help reduce the general labor costs, just like women do.)
You want more? Headline from the Financial Times of January 6:
Sarkozy seeks to cut labour costs before election
More, still? Google “labor productivity in the EU” or “labor productivity” in general. You will see!
If you do not know this driving force behind the events, you will get in its way and get crushed. Just ask Viktor Orban, the Hungarian prime minister.
Dimly aware that under the EU mandates the country was losing its sovereignty, he introduced several mild measures to the country’s constitution which included supervision of the central bank by the government. That was a red line. Central bank “independence” is the primary control tool of finance capital as I explained in Vol. 1 of Speculative Capital. The quote from a New York Times editorial which I provided then, with the comment about the audacity of the government thinking of controlling the supply of money captured the gist of the issue. Here it is. For “investors in financial markets” read finance capital.
In May 1997 … under a descriptive heading, “Divorcing Central Banks and Politics: Independence Helps in Inflation Fight,” [the New York Times] wrote:
In granting more independence to the Bank of England, the new British Government is a later entrant in a trend that has seen nations give increasing autonomy to their central banks, distancing monetary policy from direct political control. The practice has spread across the globe in response to demands from investors in financial markets for proof that governments will remain committed to inflation fighting … The trend toward independence is rapidly eroding the practice, common only a few years ago in nearly all nations except the United States and Germany, of regarding monetary policy as the responsibility and right of the government of the day.
So controlling the supply of money and rate of interest is no longer deemed to be the responsibility of governments!
But how would a Hungarian know that, fresh from behind the Iron Curtain? He thought he had arrived because Hungary was a NATO member. He thought he had endeared himself to Sarkozy by preventing the plane carrying the Iranian foreign minister to land in Hungary for refueling. See Nicolas, we’re on the same side!
He must not have been prepared for what followed. From the Financial Times of December 21, 2011:
The International Monetary Fund and European Union have warned Hungary that they will not return to the country to negotiate a new credit facility unless Budapest commits to modifying two draft laws. EU and IMF officials broke off preparatory talks with Budapest a day early last week, after Hungary’s government moved to push the laws on central bank reform and fiscal stability through parliament despite negotiators’ concerns. One person familiar with the situation told the FT that negotiators had been “explicitly clear to the government” before the talks about their concern… In a letter sent to Viktor Orban, Hungary’s prime minister, by Jose Manuel Barroso, European Commission president, and described to the FT, Mr Barroso “strongly advised” Hungary to withdraw the two draft laws. In unusually blunt language, the commission president observed that Hungary’s domestic policy, and not the broader European debt crisis, were the origin of the country’s financial and economic difficulties.Look at the message: How dare you enact laws without our permission?
Look at the tone: The unusually blunt language, of the kind one uses to train dogs, to make sure that the Balkan understands the seriousness of the issue.
Look at the attitude: You people are the cause of your own misfortune.
Then the name calling began: Orban the Stalin, Orban the Mao. Orban the tyrant.
Then people came out to warn against the erosion of democracy.
Prime Minster Orban should have known that bargaining with George Soros is a two-way street.
Naturally, he gave in. He had the good sense to realize that fighting against the Soviet tanks in 1956 must have been easier. At least then there was a target one could throw a molotov cocktail at. How do you fight finance capital?
That is why I am nonchalant about events in the EU, which explains why this series has taken 6 months to complete! The almost daily crisis alerts and headlines are not for me. They are for traders to exploit the situation and net a basis point here and there. Or for telegraphing one’s position in upcoming negotiations. Or sending a message to politicians. In all events, they are a sideshow, which is why they leave me unmoved.
The real event is the march of capital towards the higher rate of profit which will continue resolutely, unabatedly and without regards for consequences.
What happens if in the process Greece defaults? Well, what happens if a Sanchez or a Brown dies in a war somewhere in the Middle East? Nothing happens. Life would go on.
What happens if Spain defaults? The same, meaning that nothing happens to the march of capital towards higher rates of return. People will not doubt get hurt but to make omelet you have to break a few eggs.
What if Hungary breaks away from the EU? Let them. They are begging to be made an example of. They will see what it means to pay back euro and Swiss franc debt in worthless forints.
And if euro does not survive? So it won’t. People lived for centuries without the euro.
But surely there is a concern for the EU breaking apart?
No, there is not. There is a fall back plan. We’d go back to the “Anglo-Saxon Model”.
The “Anglo-Saxon” model which the U.S. has adopted is, in a nutshell, based on the principle of refusing to pay for the cow when you could have the milk for free. In practice, that translates to bilateral agreements with individual countries, enabling the US to take advantage of low labors costs there without the hassle of integration. The North American Free Trade Agreement is Exhibit-A in that regard. NAFTA guarantees the free movement of capital across US-Mexico border but actual Mexicans are prevented from coming into the US. A combination of walls, thugs with guns and immigration offices see to that.
That is also the UK’s ideal. Hence its general displeasure with the EU, especially as it puts British manufacturing at a disadvantage compared to Germany’s. Under the circumstances, see how a total Mr. Establishment, in the person of Derek Scott, economic adviser to Tony Blair and the vice-chairman of “Open Europe” writes like a member of Occupy the Wall Street. He wrote in the FT, under the heading Germany is the loser from Greece’s wriggle:
More than 20 years ago, Nicholas Ridley was forced to resign from the British cabinet for describing economic and monetary union as a “German racket” … In so far as Mr Ridley’s “racket” had substance, it reflected the implicit collusion between German manufacturers, bankers and politicians.At least I do not believe in conspiracies! Hell hath no fury like an Englishman left out of a racket.
So, is the EU a fait accompli?
Yes, it is.
But there is more.
In a scientific experiment, we disturb the natural state of an object and force it to react to new, specifically created conditions. In so reacting, the object reveals new properties and thus, enhances our knowledge of it.
As with objects, so with societies. The EU is an economic end in itself. But it is also a complex project in social engineering, not so much by design but because of the consequence. Like objects, social organisms, too, when disturbed, react to new conditions in ways that were not known, anticipated or contemplated.
We have not heard the last word on the subject.
Stay with me.