By AHMED KHAN
On Monday, March 9, the Dow Jones futures market immediately dropped 1800 points. This triggered an automatic “circuit breaker” in the market, in which trade was halted for 15 minutes. After the trading curb ended, futures contracts continued to fall until the total point losses were around 2000 points, or a loss of 7.8 percent. This was preceded by a longer, slower decline beginning in February, when the Dow Jones Industrial Average (DJIA) had reached a peak of 29,000 and declined 14 percent to 25,000 at the same time in March.
The fall in the American stock market was mirrored in international markets as well: the Brazilian IBOVESPA index fund lost 12%; the Chinese CSI 300 Index fell by 3%, the Hong Kong Hang Seng index fell by 4.2%, and the Japanese Nikkei 225 fell by 5.1%. In Asian markets specifically, stocks have been declining since December, signaling an end to the boom in financial capital prices.
The market collapse comes in the context of the escalation of two major events: the escalation of the COVID-19 coronavirus outbreak into a global pandemic, and an oil price war between oil-producing nations that has forced prices of crude oil down to around $35 per barrel. In this article, I’ll place these two short-term crises into the context of longer-term crises of production in the United States and Asia.
Spread of coronavirus and its economic impacts
I won’t spend too much time on the virus itself, but it helps to have a little context on how quickly the disease spread. COVID-19 disease was first identified in Wuhan, China, in late December 2019. It initially presented itself s a cluster of pneumonia cases of unknown cause. The disease is characterized by a symptom onset time of between two and 14 days, and the ability to transmit an infection before any symptoms are displayed. The initial spread of the virus was facilitated by the Chinese New Year, spreading symptomatic and asymptomatic carriers throughout both the country and the world. By Jan. 20, over 6000 people had developed symptoms, while the number of asymptomatic carriers remains unknown.
The Chinese government responded with relatively draconian but effective measures, quarantining several cities in Hubei province and enforcing social distancing, resulting in an eventual decline in newly reported cases by late February. By this time, however, new cases had begun to explode in Italy, Iran, and South Korea. Northern Italy in particular has been hit particularly hard; the province of Lombardy is under quarantine, and reports are that hospitals are almost completely overwhelmed.
One of the first-order effects of the pandemic is on global supply chains for manufactured goods, especially electronics. Since these supply chains are centered on largely Chinese manufacturing, the imposition of quarantine resulted in large-scale disruption to the production of manufactured goods. The economic meaning is that once available stocks have been shipped, we will begin to see shortages and price increases for certain manufactured goods, especially electronics. This is sort of the common-sense supply-side story.
There’s also a common-sense demand-side story as well. The response by governments to the pandemic will take the form of something of a continuum of two strategies: either (1) do nothing, and rely on individual measures like social distancing or self-quarantine, or (2) take extremely, shall we say, proactive steps to halt the spread of the virus. In either case, there will be a reduction in the amount of expenditure on the one hand of wage goods—because at the very least, the service sector will experience a major contraction. The slow down in service work will get worse as public health systems become overloaded. In countries with weak worker protections as well as non-existent public health institutions, such as the United States, this will also result in large numbers of people losing their jobs and their homes.
On the other hand, the price of capital goods will begin to fall as well, because underlying every demand crisis is a profitability crisis. This is a very important point, because the profitability crisis gives us the difference between “a public health catastrophe” and “a public health catastrophe that precipitates a global recession.”
Over the past decade, stock prices have grown enormously, much faster than dividends. The reason for this is investment capital flowing to its most profitable use, that is to say, the greatest return on investment. For the purpose of this article, we can consider financial instruments, in general, as futures contracts.
We purchase today a contract entitling us to a future return. We can then turn around and sell this contract based on the fact of that future, unrealized return and then make a profit. So financial positions based on future unrealized gains are used to cover the positions of other financial positions based on future gains. This can actually go on for quite some time, as seen by the long boom in financial asset prices seen after 2008.
However, this requires two things: the first is cheap credit. We can think of the interest rate as a sort of tool to discipline the financial market. If the interest rate I need to pay is 8% every year, then I’d better make sure that I am generating at least that much in profit. In fact, the interest rate has remained below 2% for almost the entirety of the past decade. This indicates that there are still very few productive avenues for investment in the real economy.
The second thing that is required is stability. The game of “financialization” can go on for quite a long time until credit-lubricated demand for both consumer goods and investment goods falters. The world is currently experiencing a shock to both from the coronavirus. Once demand collapses in a few key industries, such as airline travel, this usually leads to a chain reaction as financial profits based on future real returns fail to materialize.
Shocks and spills: The story of oil
The oil price shock comes at the tailwinds of several global trends that preceded the current crisis by a few years. The first of these is falling demand for oil globally; some of which is due to the small but growing switch to renewable energy worldwide. A larger factor is the long-term decline in Asian manufacturing. Even before the coronavirus, Chinese growth in GDP fell to its lowest point in 2019. The decision by oil-exporting nations not to cut production seems to be a decision to increase revenue by increasing output and putting the more expensive American and Canadian shale oil and gas producers out of business. Finally, the anticipated drop in demand due to the pandemic put pressure on primarily oil-exporting nations to try and cut production further in order to sustain prices. These talks failed, and the result is the collapse of collaboration between OPEC and Russian oil interests.
The fall in oil prices is causing financial contagion in the real sector through two channels. The first is the channel that I outlined above: investors that are heavily invested in oil priced their futures contracts in with the expectation of a given return that is now impossible given the dramatic fall in the price of oil. Another, largely unexplored, channel is the fact that American-Canadian shale oil is both extremely unprofitable and extremely debt-laden.
We know from Marx 101 that as the organic composition* of capital in an industry rises, the rate of profit tends to fall. Shale extraction, often accomplished by fracking, is one of the most capital-intensive industries there is. However, output from these projects declines much faster than anyone anticipated, and returns in the industry are low even when the price of oil is high. The industry has attracted enormous levels of capital investment to the tune of $200 billion of debt just in 2015, and likely much higher in 2019. A collapse in the shale industry would cause reciprocal falls in the prices of capital goods in the United States and worldwide.
Which way forward?
If the response is left in the hands of capital, in the short term, a nasty recession is all but assured, given the drastic falls in manufacturing output in the Asian countries over the past several months. In addition to this, Western countries may be facing down the barrel of a public health catastrophe, given the unpreparedness of governments here and elsewhere in responding to the coronavirus.
In the long run, because of persistently weak consumer and investment demand, both the European Central Bank (ECB) and the Federal Reserve have kept interest rates at historically low levels. Despite this, private capital is undertaking a “flight to safety,” meaning that capital is flowing into U.S. bonds at historically low rates—so low that, after accounting for 30 years of inflation, an investor is guaranteed to lose money. In other words, the outlook for the profitability of investment is so bad, they would rather hand it to the U.S. government at a modest loss than to risk it by putting it into the circuit of production. This means that monetary policy, either through quantitative easing or interest-rate reductions, which has been the primary tool of recession-prevention in past years, will be completely ineffective.
There is no way for capital to “manage” itself out of this crisis. The solution it puts forward will be to cut its losses as much as possible and put the rest on the backs of the working class. Instead of inaction, repression, and austerity, workers have the opportunity to demand unlimited sick time at full pay and immediate mobilization of medical workers to address the reality of the pandemic. Already, organized labor has been coming together to make these demands on citywide bases, such as in Chicago. The effort must be expanded and coordinated on a national scale.
So too must the demands take into consideration the reality of the coming recession. To stop the economic downfall from an oil war, trade unions, especially those involved with industries like pipeline construction, must demand an immediate transition to 100% clean, renewable energy within the next five years. In response to the already-begun recession, the solution involves, on the one hand, public ownership of housing to stave off a homelessness crisis, and on the other, the expropriation of all finance capital, whose only response to death and destruction is to re-inflate the burst bubble. Both actions must be taken without compensation for either the big landlords or the big banks.
The only social force that is capable of making such demands, either rhetorically or in action, is the working class. The corona outbreak proves the burning need for a labor party and a fighting union movement that can win the necessary solutions to the problems forced on us by the bosses.
*The Marxist Internet Archive defines the organic composition of capital as “the ratio of the value of the materials and fixed costs (constant capital) embodied in production of a commodity to the value of the labour-power (variable capital) used in making it.”
Photo: Mark Lennihan / AP