The Phases of the Industrial Cycle (pt 4)

From boom to crisis

Marx sometimes called the stage of the industrial cycle just before the outbreak of the crisis the phase of fictitious prosperity. The economy is going gang-busters, the rate of profit appears to be high, and the mass of profit keeps growing. Unemployment compared to all other phases of the industrial cycle is very low and still falling. At long last, the balance of forces on the labor market are beginning to tilt in favor the working class.

But the continuation of the boom now depends on the increasingly unsustainable inflation of credit. As long as debts can be “rolled over” rather than paid, and terms of payment can be further extended, the boom can go on.

Later, after the boom’s inevitable collapse, the recriminations fly. Why was “regulation” so lax? Why were so many derivatives and exotic credit instruments created? How could so many loans have been extended to people who couldn’t possibly repay them?

But those questions will be asked later. While the phase of fictitious prosperity lasts, it can only be maintained by progressively eliminating regulations designed to prevent the reckless extension of credit and instead encouraging “financial innovation” to unfold without hindrance. (1)

For example, it is now clear that granting sub-prime mortgages to working-class families who obviously could not meet the payments made disaster in the residential mortgage market inevitable. Any schoolchild could see this. Why then did the Federal Reserve under the leadership of Alan Greenspan and Ben Bernanke fail to stop it? Couldn’t they see what was happening?

Well, assume they had stopped it. Wasn’t it precisely the willingness of the mortgage bankers to give working-class families the chance to realize the “American dream” of homeownership a good thing? (2) Didn’t the Clinton and then the Bush administration keep bragging about how the percentage of homeownership was reaching all-time highs under their respective administrations? Why would “the Fed” have done anything to stop a process that was integrating whole new layers of working people into the “middle class”?

Indeed, the “American dream” of widespread homeownership has been a cornerstone of the social policies of both the Republican and Democratic parties, but more so the Democratic Party since the days of Franklin D. Roosevelt. If Republicans like Alan Greenspan and Ben Bernanke had done something to check the inflation of home mortgage credit, the Democrats, especially their liberal wing, would have expressed outrage at the reactionary Republicans for trying to prevent the growth of the joys of homeownership for hard-working American families.

Wasn’t the booming residential construction industry providing jobs for millions of “blue-collar” construction workers—many of them so-called illegal workers from Mexico and other Latin American nations? (3) In the United States, the booming home construction industry was one of the few areas where the number of “blue-collar” jobs was actually growing. Any move to slow the inflation of mortgage credit would have thrown tens of thousands of these workers out of work.

These blue-collar construction workers came from Latin American peasant families who were losing their land. But thanks to the residential construction boom north of the border, these workers now had the opportunity to help build homes that were being purchased by newly “middle-class” American families. Perhaps in the future they, too, would be “legalized” and their children would be able to obtain mortgages and join the “great American middle class”? Isn’t this the essence of the American dream?

The residential construction boom also created many jobs for “white-collar” workers employed in the real estate and financial “services” industries. Many of these “white collar” workers were themselves the sons and daughters of the industrial workers who lost their jobs during the 1970s and early 1980s when much of U.S. basic industry collapsed.

As the value of homes—really the price of land that the homes were built on—kept rising, the homeowners could take out second or third mortgages, called home-equity loans. With these loans, the homeowners would purchase the commodities that were being produced by the rapidly expanding industries of China, India, Vietnam and other Asian countries. This enabled the daughters and sons of millions of poor Chinese, Indian and Vietnamese and other Asian peasants to make their way into the cities to work in the newly constructed factories that were producing the commodities that were being purchased by American “consumers” with their home equity loans.

But to keep this whole process going—in the absence of a huge rise in gold production, which showed no signs of happening—the credit balloon had to keep on expanding. (4) The Fed couldn’t simply print more money, because the dollar was getting quite shaky as it was.

This was shown by the soaring dollar price of gold on the world market. For example, in early September 2004 the dollar price of gold was $400 while by mid-May 2006 it had risen to over $710. If the Fed had accelerated the growth of its token money with the dollar price of gold already in a strong upward trend, the fall in the dollar’s value against gold would have accelerated. This would have bought a return to a 1970s-style inflation or worse.

Among other consequences would have been a collapse of the residential construction boom, since a return to a 1970s-style inflation would have meant soaring long-term interest rates, including the rates on mortgages. (5) Therefore, to maintain the home-buying and construction boom, the fall of the dollar had to be held in check.

But how to do this? Why through brilliant “financial engineering” and “deregulation” that unleashed the full “power of innovation” of the “private enterprise system.” (6) It seemed to be working in the summer of 2006. Why wouldn’t it continue to work? If it didn’t, what alternative—within the framework of the capitalist system, of course—was there?

So the central bankers and financial regulators did exactly what their predecessors had done in earlier times of “fictitious prosperity.” They shut their eyes tight and waited until the credit bubble collapsed under its own weight. Now that it has collapsed, the recriminations are flying. This will never be allowed to happen again, government officials from the newly elected Democratic President Barack Obama to Bush-appointed Republican Ben Bernanke proclaim.

Those who have studied economic history know that exactly the same promises were made after earlier “panics.” For example, in the wake the panic of 1907 the Federal Reserve System was created, and the 1929-33 disaster brought with it the numerous reforms of the New Deal—all designed to “prevent it from ever happening again.”

After these panics, a few particularly outrageous swindlers committed suicide. And a handful of others were sentenced to prison terms. For example, Bernard Madoff, former head of the NASDAQ stock exchange, has been sent to prison after pleading guilty on all counts. (7)

But Madoff isn’t the first head of a major U.S. stock exchange to serve time behind bars. Richard Whitney, one-time head of the New York Stock Exchange, spent several years in New York’s Sing Sing prison during the closing years of the 1930s Depression. Is there any reason to doubt—assuming the capitalist system continues to exist—that when in the fullness of time the the industrial cycle again rolls around to the phase of “fictitious prosperity” things will be any different? Won’t “financial innovations” once again keep the boom going while the regulators turn a blind eye until it once again collapses of its own weight? And then won’t recriminations fly again, and perhaps the president of a major stock exchange follow Messrs Whitney and Madoff as a guest of either a state or federal prison system?

Credit inflation

During the phase of fictitious prosperity, under the pressure of competition the industrial and commercial capitalists become increasingly reckless in extending credit. If they aren’t willing to extend credit on easier and easier terms, they will lose sales to competitors. The bankers, in order to hide the increasing insolvency of the banking system, are forced to roll over industrial, commercial and consumer loans. Nor do the bankers want to lose loan business—the loan business is to a banker what sales are to industrial and commercial capitalists—to competitors either.

As Marx said back in the 19th century—which also saw “financial innovation,” though of course on a much smaller scale than we see today—the whole system of payments and the means of settling them become “increasingly artificial” on the eve of the crisis. The system of payments is more and more removed from its base in “real money,” the ultimate hard cash, gold. According to Marx, the crisis doesn’t break out until this increasingly artificial payments system has become “fully developed.” (8)

Interest rates and speculation

As the bloated credit system is stretched to the limit, long-term interest rates rise more and more rapidly putting downward pressure on the profit of enterprise. But short-term interest rates rise even faster. In order to cover the commercial and consumer credit they are granting to keep up sales, industrial, commercial and financial companies take on an ever-greater burden of short-term debt and cover this by lining up short-term lines of credit. Any unfavorable movement in the prices of commodities or securities could wipe out the entire capital of many financial and trading companies. Indeed, many of these firms can remain “solvent” only by making absurdly optimistic assumptions on their books about the ability of their debtors to actually meet their debts.

As soon as one or two major market operators are unable to meet a debt coming due, the game will be up. Increasingly, the commercial capitalists are only maintaining sales by granting consumer credit at very generous terms to their customers, many of whom have no possibility of keeping up with their debt payments. The payments on these consumer loans are becoming slower and slower. Working-class and middle-class consumers get bogged down trying to meet mortgage and credit card payments and are finding it impossible to stay current on non-bank credit cards that represent the additional debts they owe to retailers.

The retailers and wholesalers must therefore round up more and more short-term credit in order to hold at bay their own bankruptcy. As the commercial capitalists have greater and greater problems meeting their debts, the industrial capitalists are threatened. The industrial capitalists are in trouble if they cannot collect on the debts owed them by the commercial capitalists. And the bankers are threatened by the bankruptcies of both industrial and commercial capitalists, and in these days of consumer credit, the ultimate consumers as well. (9)

As demand for short-term credit soars, so does its “price” in the form of soaring short-term interest rates, both absolutely and relative to long-term rates. This is why the yield curve—the relative levels of yields on long-term versus short-term debt—often becomes “inverted” during the final stage of the industrial cycle, just before the outbreak of the crisis.

Realizing they are about to lose much, perhaps all, of their capital, these capitalists will make desperate gambles that they would never consider under other circumstances. Perhaps a capitalist figures he can still save this situation if he can make huge amounts of money on the stock, real estate, commodity or other speculative markets. If he can, he might still be able to hold on and even increase his capital. Any risk is worth it if the alternative is certain ruin. Speculation is therefore whipped up into the final frenzy leading up to the crash.

The stock market and fictitious prosperity

The modern widely held corporation encourages speculation and swindling to go to the outer limits before the “crash” finally brings it to a halt. As long as industrial and commercial enterprises are owned or controlled by a capitalist family that actually owns the capital, honest accounting and financial statements are in the owners’ interests. If things are going badly, better face up to the situation and take prompt action. Perhaps the situation can still be saved.

But things are different with a modern “widely held” corporation that is controlled by “managers” who own only a very small part of the corporation’s capital. These managers are paid only partially in cash. To a great extent, they are paid in stock and stock options.

A stock option, a type of “derivative,” is a contract that enables the owner of the option to buy a stock at a given price, known as the “strike price.” If the price of the stock falls below this value by the time the option expires, the option is “underwater—that is, worthless. Who wants an option to buy the stock of X corporation at $50 if you can buy the stock for $45 on the stock market?

But if the stock rises to, say, $60 on the stock exchange, it is possible for an owner of the option to buy the stock for $50 and then sell it on the market for $60. The option is suddenly “in the money” and worth quite a lot. Prior to expiration, an “underwater” option will often trade at some small price on speculation that the share price will suddenly rise above the “strike price.” This does occasionally happen, producing huge gains for the options speculator.

While the practice of paying the salaries of the top corporate brass in stock, and particularly in stock options, is supposed to ally their interests with those of the stock holders as a whole—not those of the workers, of course—this practice can actually set up a conflict of interest between “management” and the stock holders when things start to go seriously wrong.

If that happens, “management” may figure that if they can hide the problems while they unload their stock and stock options, they can still walk away with large personal gains, even if the corporation goes under and the stockholders are wiped out. At the end of the day, their “duty” as capitalists” is to enrich themselves first and the corporate stockholders second. Or, as the expression goes, when the going get tough, look out for “number one.”

When things are going badly, “management” therefore has a great incentive to use every accounting trick in the book—legal if possible, illegal if necessary—to show high profits and maintain high dividend payouts, even if the cash of the corporation is being seriously drained. Nor will they want to take corrective action, such as cutting back on capital spending, that might tip off “the market” that things are not going as well as “management claims.” That would send the stock into a tailspin before “management” can dump their shares and options. In this way, they hope to keep the stock price high and their options “in the money” until they can liquidate them. (10)

The problem is compounded by the practice of Wall Street analysts making estimates on how much each corporation is expected to earn per share. For example, let’s say X corporation is expected to earn 45 cents per share. The corporation is then expected to “beat its numbers.” If it only “makes the numbers,” not to say if the earning per share come in lower than analysts expect, the stock will plunge in value on the stock market.

The problem feeds on itself, since as corporation after corporation keeps beating its “numbers,” the analysts raise their profit expectations further, which forces corporate managements to go further and further down the road of falsifying financial statements if they are not in fact making the profits they claim they are. If a corporation does not meet its “expected numbers,” its stock plummets wiping out much of the value of management’s stock and driving their options “underwater.” The corporation will then likely be taken over by a corporate “raider” or another corporation, and “management” will be fired.

Of course as long as the corporation really is doing well—in exploiting its workers and realizing the surplus value produced by the exploited workers—there is no problem as far as either “management” or the stock holders are concerned. (11) The profit is simply divided up among both the management and the stock holders. But as the industrial cycle approaches its peak, problems are multiplying throughout the economy. Payments on “receivables” are slowing down.

To make matters worse, long-term interest rates are rising putting downward pressure on stock market prices, since dividend flows are being capitalized at higher interest rates. If a corporation shows any sign of having difficulty in “beating its numbers,” its stock will crash. Therefore, the corporate management is under extreme pressure to hide any problems—such as payments on accounts receivables running late or unplanned inventory accumulation, for example—in order to maintain the appearance that they are indeed “beating” the expectations of the “Street.”

A related problem with the system of “widely held corporations,” in which the people who control capital are different than the people who own it and are largely in “stock options,” is that it encourages the corporate bosses to think only about short-term profits.

This was illustrated in the recent clash between the Rockefeller family and the management of ExxonMobile, the main corporate descendant of John D. Rockefeller’s Standard Oil Company. ExxonMobile has been making the highest profits of any capitalist enterprise in the entire history of capitalism, though the recent crash of oil prices has no doubt reduced these profits to a certain extent. However, I think that it can safely be said that ExxonMobile is not a candidate for bankruptcy anytime soon. But the Rockefeller family members, who remain among the largest shareholders of ExxonMobile, expressed concern that the corporation had no plans to develop other sources of energy once the world supply of crude oil is finally depleted.

However, if ExxonMobil were to spend billions on research and development on alternative energy sources—and investments that might or might not be profitable in the long run—it would run up an “opportunity cost” in terms of the huge super-profits it can earn right now by simply continuing to invest billions in oil drilling and refining.

The current management of ExxonMobile will be long gone by the time oil depletion reaches the point where the profitability of ExxonMobil is seriously endangered. But the Rockefeller family still expects to be around. They hope that ExxonMobile or its corporate descendants will continue to make super-profits that will keep on enriching them well beyond the “age of oil.”

The ExxonMobile management, on the other hand, are simply not worried about the future beyond their own retirement. (12) Management, not the Rockefellers, seem to have gotten their way. Though the ExxonMobile management claim to be working on alternative energy sources, for the most part they are sticking to oil and not “alternative energy.” The future, and even the mighty Rockefellers, will simply have to take care of themselves.

Another suggestive example is the U.S. auto manufacturing industry, which has long consisted of only three corporations: General Motors, Chrysler and Ford. Of the three, only Ford can be considered family controlled. Henry Ford, the classic example of an industrial capitalist, hated “finance capitalism” and saw to it that his heirs would inherit a special class of stock that would maintain family control of the corporation. Its current chairman, William Clay Ford, is a direct descendant of founder Henry Ford.

At this point, both General Motors and Chrysler are being kept alive only through government intervention. De facto government control of General Motors has grown to the point that the Obama administration simply fired GM’s CEO a few weeks ago. Only the family-controlled Ford Motor Company, though it is in grave difficulty, has been able to avoid government bailout money and de facto government control during the current crisis. Of the three remaining U.S. automobile manufacturers, Ford is the only one that has any realistic chance of surviving in anything like its current form without massive government aid.

When Marx was working on “Capital,” the modern “widely held” corporation was only in its infancy, largely confined to large transportation enterprises such as railways. Still, Marx noted that when the persons who control the capital are different than those who own the capital, they “tackle things” in a manner quite different than they would if they were the actual owners. He further pointed out that in such situations you have private property without the control of private property.

The stock market at the end of the industrial cycle

In the past, the stock market usually peaked some months before the crisis began, and was considered a leading indicator. The rise in long-term interest rates in the final stages of the boom would drive the stock market prices down during boom’s final months. A sharp fall in stock market prices, if it was accompanied by a sharp rise in long-term interest rates, generally indicated a recession was not far off. In more recent industrial cycles, there appears to be a growing trend for the stock market to keep on rising, almost to the cyclical peak. (13) Perhaps the spread of “stock options” and increasingly dishonest corporate financial statements account for this new pattern.

It’s possible that the generally downward trend of long-term interest rates since the beginning of the 1980s have contributed to this trend as well. We have not seen a sharp spike in long-term interest rates in the period immediately preceding the outbreak of recession like we saw in earlier cycles. Perhaps in future industrial cycles, the stock market will regain its role as a “leading indicator,” if, as seems likely, long-term interest rates begin to rise once again. (14)

The crisis arrives

The cyclical crisis usually becomes apparent first in the residential construction industry. (15) As the supply of credit begins to dry up, mortgage loans become harder to get. Therefore, housing construction begins to decline. Construction jobs in residential construction become harder to get as housing starts head downward. Other consumer durables such automobiles are soon affected as well. Declining residential construction and declining auto sales soon affect many other branches of industrial production.

For example, when people purchase a new home, they often have to purchase new furniture and appliances such as a refrigerator, an oven and washing and drying machines. Weakness in residential construction, therefore, begins to react on the many other industries that manufacture durable consumer goods.

Initially, therefore, the downturn seems to be largely confined to housing, auto and other durable consumer industries. Some Department I industries, especially those involved in producing raw materials for housing and auto industries are also affected during the initial stage of the downturn. For example, lumber—used to construct houses—and auto parts also begin to weaken as the industrial cycle peaks. The growth in employment that marked the boom levels out, and unemployment begins to rise. But at this stage the total number of jobs does not decline by much, and might even rise slightly for awhile.

During this initial stage of the downturn, discussion develops in the press on whether what they call a “slowdown” will develop into a full-scale “recession.” Business reporters interview the professional economists, some working for brokerage houses and other academic economics who are employed as professors by university economic departments. (16) The overwhelming consensus is that this time, unlike in the past, the slowdown will not develop into a full-scale recession. The consensus forecast is that in about “six months” business will be recovering from the “slowdown” and full recession will be avoided. (17)

It is interesting to examine the reasons the bourgeois economic weather people give for these optimistic forecasts, since the reasons they give for their sunny forecasts are generally the same from cycle to cycle. First, the economists claim that due to computer-driven inventory controls, the overall ratio of inventory to sales is at all-time lows. As I already mentioned in an earlier post, this is an elementary error. The economists forget that overproduction cannot develop on a large scale without credit-financed over-trading. In fact, while the inventory-to-sales ratio is at “record lows,” the absolute amount of inventory—unsold commodities—is at all-time highs.

The fact that sales of houses and autos are declining due to tight credit is a sign that the inflation of credit is now coming to an end. As soon as credit contracts, the credit-financed level of sales—the over-trading—collapses, and the inventory-to-sales ratio then rises sharply. By the time the ratio rises—especially considering the inevitable lag of statistical information—the recession is already well underway. The inventory-to-sales ratio, therefore, does not forecast an approaching recession, it only confirms that a recession has arrived.

An equally elementary error that our always optimistic bourgeois economists make involves capital spending. As the industrial cycle peaks, the bourgeois economists always point to the strong capital spending plans of business as a sign that this time a recession will be avoided. With investment strong and surveys showing that business plans to increase its level of capital spending further in coming months, our forecasters, armed with their “powerful computer programs,” determine that a recession is extremely unlikely. During recessions, the capitalist economists point out, capital spending declines, sometimes dramatically. Leaving aside the “tight credit” situation, the economic weather forecasters claim that the “real economy” is extremely healthy. (18)

In reality, capital spending is a lagging indicator. High levels of capital spending and surveys that show business plans to increase capital spending even further are no indication that the boom will continue and recession will be avoided. On the contrary, the increased level of capital spending and capital spending plans increase the likelihood of recession in the near future. (19)

As a recession unfolds, “excess capacity” develops first in Department II but then increasingly and at an accelerated pace spreads to Department I. Unlike the purchases of consumer necessaries, investment in new factories, mines and buildings of all kinds can be postponed indefinitely if such investment appears to have no prospect of yielding a profit.

How much “excess capacity” develops depends on the depth and the duration of the crisis. This is something that is difficult for the industrial capitalists to predict at the beginning of a downward movement in the industrial cycle. For example, the recession that began in 1929 and eventually turned into the Great Depression appeared to be a quite ordinary “slowdown” at first.

After the stock market crash of October-November 1929, President Hoover got all the top corporate chiefs of the time together in the White House. The president had them agree to maintain and indeed accelerate their capital spending. The vast majority of the bourgeois economists of the day claimed these agreements would avert a serious economic crisis.

But as the slump rapidly snowballed and the economy plunged into the Great Depression, these capital-spending plans were progressively scrapped. Whatever the corporations say about their capital spending plans, they are always conditioned on these projected expenditures being profitable.

During the boom, the industrial capitalists face the problem of “too little” excess capacity. As the boom gives way to recession, they have the opposite problem—too much excess capacity. Therefore, even if they can continue to finance the the building of new factories and enlarge existing ones—something that “tight” credit markets and rising long-term interest rates make increasingly difficult—such investments will only lead to more excess capacity.

The downturn, which was initially confined to consumer durables and those branches of Department I that produce raw materials and other means of production for the consumer durable industries, now spreads to the rest of Department I, especially those sectors of Department I that produce means of production for industries that produce for other Department I industries. The downturn, which at first affected only a few industries, now engulfs virtually the entire economy—with the exception of the gold mining and refining industry, which moves counter-cyclically to the rest of the economy.

But the error the bourgeois economic experts always make when they point to strong capital spending by business at the peak of the industrial cycle as a sign that a recession will this time be avoided is even more fundamental. Bourgeois economists, especially those of the Keynes school, believe that weak capital spending causes the recession. If only capital spending can remain high, a recession will be avoided, these economists believe.

The reverse is actually the case. As should now be amply evident to the reader, the recession is caused by the overproduction of commodities relative to monetarily effective demand. Long before the recession begins, the increasing reliance of the economy on credit is a sign that the development of generalized overproduction of commodities relative to maintainable monetarily effective demand is already well underway. Only the increasing sales of commodities on credit rather than for cash enables the appearance of prosperity—fictitious prosperity—to be maintained.

However, there is no way that the generalized overproduction of commodities can develop without at the same time overproducing the means for producing them. Indeed, the surplus means of production are themselves produced as commodities and are thus an organic part of the ongoing overproduction of commodities.

Overproduction simply cannot develop without “over-investment.” Therefore, any momentary success in maintaining and increasing over-investment will only make the inevitable recession worse.

As a boom begins to give way to recession, the fact that the high level of capital spending is, far from avoiding it, actually intensifying the crisis breaks though to the surface of economic life. The shortage of credit usually if not always manifests itself in the consumer durable sector as I explained above. Sales of new homes and cars declines, not because the perceived need for homes and cars is declining but because of the increased difficulty of obtaining the credit that is needed to purchase them. (20)

As the industrial cycle peaks, competition for the remaining supply of credit intensifies between industrial capitalists, commercial capitalists, banking capitalists, would-be buyers of consumer durables including houses, and Wall Street speculators, as well as local, state (or provincial) governments and the central government.

Under a situation where the demand for credit at prevailing interest rates exceeds the supply of credit, the more bonds that are floated on the market by the industrial capitalists to finance high levels of capital spending, the less credit will be available for home and automobile buyers. Or what comes to exactly the same thing, the more the industrial capitalists hog the remaining supply of credit in a bid to increase even more their ability to produce more commodities, the less credit will be available that will enable the final consumers to actually purchase these commodities.

As I noted, the competition for what is left of credit does not only affect the capitalists of various types plus the would-be purchasers of durable consumer goods. It also involves the government. The central government can as always borrow, even when credit is at its “tightest” at the peak of the industrial cycle, but it can only do so at an ever higher rate of interest. This will increase the costs of servicing the national debt in the years that follow. Since the overall supply of credit is less than the demand for credit at the already existing high rate of interest, government borrowing at the peak of the industrial cycle simply “crowds out” other borrowers.

Therefore, unlike at the trough of the recession or the depression-stagnation phase of the industrial cycle, deficit spending by the central government cannot increase overall monetarily effective demand. It can only redirect it towards industries that produce either for the needs of the government or its dependents.

The correct crisis theory

A popular explanation of crises is that crises are caused by the conflict between socialized production on one hand and the private appropriation of the product on the other. This is the crisis theory that I have been developing in these posts over the last five months. Socialized production implies the development of the productive powers of labor on an extraordinary scale combined with the increasingly socialized character of the labor used in industrial production.

On the other hand, the private appropriation of the product means that private ownership of the means of production still prevails and with it the necessity of the products to take the form of commodities, each of which must have both a use value and an exchange value. This must at a certain stage in development of capitalism lead to the periodic appearance of crises of generalized overproduction.

Once, however, the private appropriation of the products produced by socialized labor is abolished and labor is directly treated as the social process it already is, both the commodity character of production and with it the periodic crises of generalized overproduction disappear.

Some additional observations

We have seen how the periodic disproportion between the branch of industry that produces money material and all other branches of commodity production is not an accident but must be reproduced on an expanded scale during successive industrial cycles. If permanent prosperity could be achieved, prices would then rise forever and would lose all connection to their underlying labor values.

But this does not mean that accidental disproportions among the various branches of production made inevitable by the anarchy of production don’t occur as well. These accidental disproportions do profoundly affect individual industrial cycles.

In the section on the disproportionality theory of crises, I noted that disproportionate production has a particular tendency to develop between the branches of industry that produce primary commodities—raw materials—and the branches that produce the final product. The increase in production of primary commodities such as metals, petroleum and natural gas often involve the search for new mineral deposits, oil fields, and so on. Such exploration projects are unlikely to be undertaken except during periods of high profits in the primary commodity industries.

Since such exploration can take considerable periods of time, the rise of raw material production has a tendency to lag behind demand during the upward phases of the industrial cycle. Very often by the time new mines, oil wells and so on are ready for production, the crisis has arrived and the demand for raw materials suddenly slumps. Not until the next boom—or sometimes several booms later—will prices and profits rise to levels that cause new exploration to be undertaken.

This plays an important role in real-world crises. This is especially true because at the peak of the boom and the beginning of the recession the ability to further expand credit-fueled demand is exhausted. Therefore, the industrial capitalists are far less likely to be able to pass on any increase in cost prices than they were earlier in the industrial cycle. Growing shortages of raw materials are one of the best indicators of an approaching recession.

It should also be noted that this analysis also applies to a certain extent to gold production, though the peak profitability for gold occurs near the trough of the economic cycle rather than at the peak of the boom. As we have seen, during periods of prosperity prices rise, which means falling profits for gold. Capital flows out of the gold industry into other far more profitable branches of production. As a result, the gold mining industry slashes it exploration budgets. When the crisis arrives, the demand for gold soars. We have certainly seen this during the current crisis.

However, the gold industry has been forced to slash its exploration budgets during the preceding boom. Remember, for the countercyclical gold industry the boom means tough times. Particularly, if the existing mines are badly depleted—which seems to be the case in the current cycle—it might be difficult for the gold mining industry to rapidly increase gold production even if the profitability of the existing mines is increasing rapidly. If gold production cannot be quickly increased, the recession-depression phases of the cycle will last longer than would otherwise be the case. As falling prices—in terms of gold—make the gold mining industry profitable once again, the gold industry will certainly progressively increase its exploration budgets. But even if the gold capitalists are successful in finding more gold deposits, this might take a considerable period of time. I will examine this more closely when I take up the whole controversial question of whether there are “long cycles” in capitalist production.

New industries and overproduction

Overproduction tends to be most pronounced in the new rapidly developing branches of production. In old established industries such as automobiles, housing and so on, the industrial capitalists have an at least approximate idea of the size of the market and how rapidly it is likely to grow over time. But in new industries, this is much harder to gauge.

When the personal computer industry began to develop a little less than 35 years ago, it was not at all clear how many “consumers” there would be for the new devices. Up to then, everybody had done just fine without a computer of their own. Today, however, except for the very poor—still the majority of humanity—most people cannot do without some type of personal computer or at least a computer-related device such as a cell phone!

In a rapidly developing new-born industry, the industrial capitalists are struggling to keep up with the increasing demand, and the rate of profit is far above the average. Capital flows into the new industry with the expectation of making huge super-profits. This ends with massive overproduction in the new industry.

We saw this phenomena during the last—in most respects much milder—downturn of 2000-2003. Things are bad right now in California’s Silicon Valley as they are almost everywhere. Still, at least according to the local capitalist press, things are not quite as bad as they were between 2001-2004. During the “Clinton boom years” of the 1990s, capital flowed into high tech as though there was no limit to demand for high-tech commodities and related services. When the “high-tech” industries finally picked up again in 2004-2008, the capitalists who were severely burned in the high-tech crash were far more cautious. Therefore, despite the much greater severity of the current slump, this recession has been relatively milder in high tech than the recession of 2000-2003 was.

Finally, I should examine accidental disproportions that inevitably occur in all industrial cycles as industries successively overproduce and underproduce. As long as industry operates at a low level of capacity utilization, this won’t result in widespread bottlenecks and shortages. For example, according to the Federal Reserve Board U.S. capacity utilization is now just under 70 percent. But assuming for the sake of argument that the Federal Reserve figures are accurate, this would only be the average level. Some industries, let’s say the shoelace producing industry, is operating at 85 percent, but the shoe manufacturing industry is operating at only 40 percent.

Suppose before the crisis broke out that the high cost of shoelaces was dramatically reducing the profits of the shoe manufacturing industry. With the outbreak of the crisis, only the most productive shoe factories are in production. However, during the next period of prosperity, capacity utilization will rise.

Suppose during the next upswing, the industrial capacity utilization rate rises back to between 80 and 85 percent. During the previous boom, lets assume the shoelace industry was working all out and making exceptional profits while many shoes produced by the shoe producing industry cannot be sold. They cannot be sold not because of any general lack of monetarily effective demand but a lack of shoelaces. Nobody wants to buy a pair of shoes if shoelaces are not included.

However, the current period of bad business will allow such disproportions to be ironed out. The shoe producing industry is forced to curtail production during the recession not because of a lack of shoelaces but because so many people facing either partial or full unemployment are cutting back on their shoe purchases. The shoe industry that is operating at 40 percent of capacity will reduce its capital spending, which was perhaps already declining before the general crisis broke out, to virtually nothing. Idle shoe factories will be ruthlessly closed down and society’s capacity to produce shoes will shrink.

However, the shoelace industry that is at the relatively high level of operating at 85 percent will largely maintain its capital spending. Even during this time of terrible business, it is still using most of its productive forces. As soon as business picks up again, it will find itself again operating at 100 percent unless it continues to expand its productive capacity. So capital flows into the shoelace industry. New shoelace factories are being built and will come online as prosperity returns.

As a result, by the time the next boom arrives, it is shoelaces that are relatively overproduced relative to shoes. It is the shoe industry that can now make super-profits, since shoelaces are dirt cheap. (21) Therefore, one of the functions of general crises of overproduction under capitalism is to iron out the bottlenecks in production that inevitably develop during the boom.

Up to now, I have assumed that the world is one capitalist nation and I have avoided the question of foreign trade. However, foreign trade does play an important role in real-world capitalist crises. Such crises are, after all, world wide, and they are transmitted largely through foreign trade.

Before I can deepen the theory of the economic cycle further, I must examine the question of foreign trade. This will be the subject of the posts over the next few weeks. I will also begin the examination of the attempts of bourgeois economists to find remedies for crises without abolishing capitalist production.


1 The question that could be asked but is never raised is, why do commodities have to be sold increasingly on credit rather than for cash in the first place?

2 In fact, a case can be made that it wasn’t. The increasing value of homes reflects, for the most part, not additional labor put into homes but the rising value of the land underneath the homes—the capitalized ground rent. This is one of the ways the super-profits squeezed out the working class of the oppressed countries is shared with the “labor aristocracy” of the imperialist countries. Since it, along with interest, is a part of the surplus value produced by the workers of the world, ground rent based on private ownership of land shares in imperialist super-profits. Ground rent is just a form of super-profit. Because of rising home prices, the Democrats especially argue that American workers don’t need European-style social insurance and health care as rights. Instead, workers can rely on the increasing value of their homes, which at the end of the day really reflects the increasing exploitation of the world working class by American imperialism.

The tens of millions of workers who cannot afford to purchase homes, or who own only “mobile homes” and rent the land underneath not own it are out of luck. The “American dream” is actually based on the idea that the better-paid workers of the United States should share in the super-exploitation of workers around the world by American imperialism, a portion of which is reflected in the rising value of real estate. The Obama administration, along with the leadership of the Federal Reserve under Republican Ben Bernanke, is trying to find ways to get the American dream of ever-rising private home ownership accompanied by ever-higher home prices up and running once again. Instead of trying to revive the “American dream,” which was always politically and morally bankrupt and is now financially bankrupt as well, we should struggle to replace it with housing as well as full social insurance including medical care as basic human rights.

3 In the United States, manufacturing has long been in decline as new countries have been industrialized and industrial production has increasingly shifted out of the United States in search of lower wages and higher rates of surplus value. As a result, the number of workers employed in manufacturing has been declining since 1979. Before that date, back to the early years of the United States, manufacturing employment grew in prosperity and fell only in recession. Since 1979, however, manufacturing employment has grown only during the most favorable stages of the industrial cycle, if then. At all other stages of the industrial cycle, it has fallen. One of the few areas of “blue collar” employment that expanded has been construction. This is the one industry that cannot be shifted overseas. Therefore, many workers who would have in earlier times gotten jobs as factory workers ended up working in the construction industry instead.

4 Indeed, gold mining production was slowly but steadily declining as the world’s gold mines have become increasingly depleted.

5 During the 1970s, the dollar’s plunge against gold undermined credit in the United States, resulting in the highest interest rates in the entire history of capitalism. This all but killed the credit-driven residential construction industry. Since that industry was the center of the Bush “prosperity,” such as it was, the Fed was under great pressure to avoid a return to 1970s-style inflation, which would have sent long-term interest rates, including mortgage interest rates, soaring—thus once again killing off construction. The fact that the home construction industry collapsed anyway shows that overproduction—overbuilding—in the industry had reached such levels that there was no policy available to either the capitalist government or the Federal Reserve System to prevent its collapse.

6 Nothing illustrates the long-term decline of American capitalism more than the fact that innovation in recent years has been largely “financial” innovation. Or rather, the development of innovative forms of financial swindling.

7 Mr. Madoff is so hated by his many victims that Federal prison is probably the only safe place for him to reside.

8 Perhaps it would be more accurate to say “major crisis.” I will examine this in the posts taking up the controversial question of “long cycles.”

9 Remember, unlike traditional commercial banks, today’s commercial banks make loans directly to middle-class and even working-class consumers as well as making more traditional loans and discounts to the industrial and commercial capitalists.

10 Naturally, these types of swindles are never undertaken if the corporation really is making the expected profits. The one thing that “management” and the stockholders always agree on is that the workers should be exploited more.

11 In the days when trade unions were much stronger and relatively free to strike, corporations might have hid some of their profits. If the full profitability of the corporation were known, the unions might demand higher wages or shorter hours. These days, however, this is far less of a concern.

12 The managers of ExxonMobile are concerned about their families. If they can manage to drive up the stock of ExxonMobile during their own careers, their biological descendants—not to be confused with the corporate descendants of ExxonMobile—will be able to make a “decent” living as money capitalists. Their portfolios will be invested in whatever corporations are most profitable at that time. If any of the descendants want to pursue a career in corporate management, however, it doesn’t really matter whether ExxonMobile is still raking in the corporate billions and trillions or has joined the many bankrupt capitalist enterprises in the sky.

Of course, I hope that by then the descendants of the corporate management of ExxonMobile and of the Rockefellers will have long since joined the ranks of the associated producers, class society having been left far behind. But this is not, I believe, the current perspective of the Rockefellers or of ExxonMobile management.

13 In 1929, the stock market didn’t reach its peak until the the industrial cycle had definitely turned downward.

14 Something that the explosive rate of growth of the supply of the token money issued by the Federal Reserve System makes highly likely.

15 Not all industrial cycles follow this pattern. In July 1997, the collapse of the currency of Thailand triggered a general collapse of credit followed by a massive economic contraction of, first, many Asian countries such as Thailand, Indonesia, and South Korea and then Russia and Latin America. There was enough credit available on the world market to keep the booms in housing and to some extent in autos and other durable consumer goods going in the imperialist countries.

When the recession arrived after some delay in 2000-2003, it hit the new high-tech industries very hard. One of the reasons why the current collapse of home construction in the United States is so violent is that the current home construction slump combines the recession that “should have” but did not occur during 2000-2003 with the “normal” housing slump that would be expected to accompany the current recession. Remember, actual real world recessions always deviate from the “typical” recession to one extent or another, some more than others.

16 This group of economists are far from disinterested, since they are selling stocks, after all, whose rising value depends on continuing prosperity. The financial press rarely if ever mentions this obvious conflict of interest when they quote these economists, who with very few exceptions always predict prosperity.

17 This was exactly the forecast that most bourgeois economic experts were grinding out a year ago. They predicted at most a “very mild recession” for the first half of 2008 but probably only a “slowdown” followed by recovery in the second half of 2008.

18 As I will show later, there are minor downturns as well major recessions in the capitalist economy. So the “no recession” forecasts of the bourgeois economists are not always wrong. With few exceptions, they always are predicting prosperity and are correct as long as prosperity continues.

19 Some booms are much stronger and last longer than other booms for reasons I will explore later. Therefore, strong capital spending does not necessarily mean that a recession is imminent. But all things remaining equal, the stronger capital spending is the more likely a recession is in the near future.

20 As mentioned above, in the industrial cycle of 1990-1997/2000, the shortage of credit for countries in Asia, Latin America, and Russia largely replaced the shortage of credit for durable consumer goods and mortgages in the imperialist countries. This, however, was simply a variation on a theme.

21 While I have generally tried to use examples from recent industrial cycles in these posts to illustrates more general economic laws, this example I made up from the top of my head. It is merely designed to illustrate the working of economic laws that govern the capitalist economy. If it has any relationship to the development of the shoe and shoelace market during the current economic cycle, it is pure coincidence!

4 thoughts on “The Phases of the Industrial Cycle (pt 4)

  1. I apologize if you answered this question elsewhere, but after reading this section I could not help but wonder why it would not be possible to simply socialize gold production alone and have the state continue producing gold regardless of the industrial cycle. Would this not have a major impact on how the cycle functions?

    I gather from your comment that “If permanent prosperity could be achieved, prices would then rise forever and would lose all connection to their underlying labor values” this would not work, but I would like to know more about why this is the case.

  2. This excellent posting, “The Phases of the Industrial Cycle (pt 4) |
    A Critique of Crisis Theory” illustrates that u truly know exactly what you’re writing about! I actually absolutely agree with your post. Thanks a lot ,Mahalia

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