David Gracey
As we slide into the first recession of the 21st century (the experts being in denial, as always), it is timely to reflect on its causes. First and foremost is the underlying debt which a modern economy is obliged to incur in order to grow. Sooner of later, depending on credit conditions and interest rates, that debt becomes unsustainable and must be repudiated. On this topic I have written before and today I will deal with one related aspect - capital investment.
Every period of growth is characterized by an investment boom. As capitalists see sales increase, they perceive an opportunity to raise profits by increasing output. Being naturally exuberant, however, they often expand beyond the capacity of the market to absorb the additional output. This process is exacerbated by the executive bonuses that are tied to growth and performance. When the expectations are disappointed, of course, retrenchment ensues, investment falls drastically and recession follows. The Loews theater fiasco is a case in point. I listened to the CEO on the radio explaining that his company had been overly ambitious in building too many theaters in recent years. There just aren’t enough customers to justify the expansion. Raising admission prices probably didn’t help either. So now Loews is closing one quarter of its theaters and laying off the workers who manned them.
In the 1980’s there was vast over-investment in real estate. As values rose, companies rushed out to build more. Investors were cajoled into MURB’s and other creative schemes by promises of high returns. When the bubble burst, most of the investors lost their shirts. One of my friends ended up owing $100,000 to a bank for a condo that was never built!
How does it happen? The human psychology involved - the irrational exuberance of the investor - is the usual explanation. But this exuberance would have no outlet if it were unable to avail itself of money. It is our system of credit hat gives expression to the exuberance. If money was created by the act of production - as was once the case - only the real savings of a society i.e., that production not consumed, would be available for investment. However under our privatized debt-money system, there is virtually no limit on the amount of credit available. Banks can monetize assets presented to them by credit worthy’ customers. In a boom, assets rise in price, often beyond this real value, and bankers are eager to extend loans and maximize profits. Then we have witnessed an enormous increase in corporate debt during the past decade. In the U.S., corporate debt is now 45% of GNP, a doubling in 8 years.
The exuberance has now ended. Financial institutions are raising the bar for borrowers as existing loans go south. Capital investment in the U.S. has fallen off a cliff, and Canada cannot be far behind. As consumer demand falls companies will be hard pressed to pay the interest owed. Many will downsize, some will go under.
It is an understatement to say that this is folly. There can be little doubt that it has been made worse by financial deregulation. Getting a grip on credit creation in order to smooth out the investment cycle must be a priority. Despite all the rhetoric about competition and free markets the present system benefits neither worker, or consumer, or the customer themselves.
-- from Economic Reform, April 2001