1

OF OIL PIPELINES AND FINANCIAL PLUMBING.

We begin by examining quarter 2 (2019) profits outside the sphere of the corporate sector. All data

for the first three graphs can be found on the attached worksheet “PROFITS BY INDUSTRY Q2 2019”.

In line with the corporate sector, industry profits have all fallen sharply since 2014. This is particularly

true for manufacturing. In a previous posting, I estimated that the pre-tax rate of profit for non-

financial corporations had fallen to 4.7%. After the downwardly revised release of profits this week,

the figure is now 4.5%. The best time to estimate the rate of profit for manufacturing will be towards

the end of October when Q2 GDP-by industry data is released. It is bound to be well below 4.5%.

Graph 1.

Graph 2.

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Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

figu

res

in $

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4 INDUSTRIES: MASS OF NOMINAL PROFITS

manufacturing retail information financial

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Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

4 INDUSTRIES: MASS OF INFLATION ADJUSTED PROFITS

manufacturing retail information financial

2

Looking at profitability above, the reasons for Trump’s corporate tax cuts and the trade war, are laid

bare. The manufacturing sector is barely profitable, and without a manufacturing base their can be no

projection of military power. Rates of profit in the USA and China peaked in 2014 & 2013 respectively.

A number of points arise out of the graphs, particularly Graph 2. Up to 2014 manufacturing profits

rose faster and higher than financial profits. After 2014 they fall more steeply than financial profits.

From being above, they have ended below financial profits. The fall in manufacturing profits in real

terms since 2014 is of the order of 50%. An investment crunching fall.

Retail profits are flat despite the emergence of e-sales. Set against the sharp rise in retail sales

revenues and volumes since 2006, this implies a sharp deterioration in margins compared to the pre

e-sales era. In other words, e-sales have made retail sales in general less profitable, because their

labour costs are higher than brick and mortar shops. Finally the much vaunted information technology

sector has not increased its share of profits, despite all the hype.

Financialization.

Talking of hype, despite all the financialization (leverage) neither have financial profits grown at the

expense of non-financial. In other words, the one-off growth in financial profits between 2000 and

2007 has not been repeated. (The peak of 114% in 2008 reflects the collapse of financial profits in the

crash, not a spike in non-financial profits.) Over the last thirteen years the shares of each sector has

flatlined with nearly four out of five dollars continuing to be realised in the non-financial sector.

Graph 3.

On line 58 in the spreadsheet cited above, the reader will find the GDP item, “imputed rents for owner

occupiers” which in many years exceeds financial profits. This is one of the primary reasons why

deducting total compensation from Net National Product or National Income in order to arrive at the

Net Surplus is misleading. Using this all-economy-net-surplus to determine the all-economy-rate- of-

profit leads to an inflated rate of profit which is of little worth. The most informative rates of profit

are those found in commodity producing sectors of the economy.

0.0%

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100.0%

120.0%

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

NON-FINANCIAL PROFITS SHARE OF TOTAL

3

The financialization of the economy involves two concerns. Firstly, the change to the structure and

balance of fictitious capital resulting from the increase in leverage. Secondly, the substitution of debt

for equity. We begin with the first concern: fictitious capital and leverage. As I have pointed out a

number of times before, to make it intelligible fictitious capital must be divided into two tiers, Tier 1

or “primary” fictitious capital, and Tier 2 or “secondary” fictitious capital (where the leverage lies).

Tier 1 which includes shares, bonds and other instruments, is a direct claim on surplus value. It is

attached to a stream of income. Tier 2 is not. Rather it is a bet on the movement of the primary

instruments themselves such as share prices, interest rates and exchange rates. The word derivative

means they are derived from and are attached to an underlying “asset” which benefits from income.

Derivatives include; futures, swaps, options, puts etc. They are bets on the expected direction of share

prices, bond prices and so on. In terms of speculation their purpose is to amplify the gains made by

these movements. In terms of normal business practise, their purpose is to protect against or minimise

the effect of any future or unexpected price movements by offsetting risk to counter-parties.

In common with Tier 1 instruments, Tier 2 derivatives do not produce value. Rather they add to the

body of existing claims on surplus value, but in this case indirectly. Their presence serves to merely

dilute claims. All that has happened is there are more pigs on the banks of the river, but the river itself

is unaffected by the pigs. More pigs means smaller mouthfuls for all. The effect of Tier 2 claims is

therefore deleterious to Tier 1. The income they earn from each $ invested in shares or bonds is

reduced, from say 6 cents in the Dollar to only 5 cents, everything else being equal. The difference

falls into the hands of Tier 2 speculators when their contracts conclude or are terminated.

The size of the derivative markets are overstated by the uninitiated. We are told that the size of the

derivative market is ten times Global GDP. However this is the “notional value” of global derivatives

as found in Graph 4 below taken from the Bank of International Settlements up to 2018. The much

smaller “market value” is found in Graph 5. (I apologise for the quality of Graph 5.)

Graph 4, Notional Value of Global OTC Derivatives

https://www.bis.org/statistics/about_derivatives_stats.htm

4

The collapse of Lehman Brothers illustrates this divergence. When it collapsed in 2008, Lehman’s open

derivative book amounted to $35 trillion or 5% of the total global standing at $700 trillion. Now if this

$35 trillion represented the total loss following the collapse of Lehman Brothers, it would have

collapsed the global capitalist economy without revolution. Instead, once all the trades were netted

out, the total loss came in at $45.3 billion and some of that loss was due to the disorderly unwinding

of contracts and trades. Hence much closer to the actual market value of these trades. https://elischolar.library.yale.edu/cgi/viewcontent.cgi?article=1006&=&context=journal-of-financial-crises&=&sei-

redir=1&referer=https%253A%252F%252Fwww.bing.com%252Fsearch%253Fq%253Dlehman%252Bbrothers%252Bderivati

ve%252Bbook%252Bnotional%252Bversus%252Bmarket%252Bvalue%2526form%253DEDGEAR%2526qs%253DPF%2526cv

id%253D85f8a20fafbf4228b9823120ea243e3c%2526cc%253DGB%2526setlang%253Den-

GB%2526elv%253DAQj93OAhDTi%252AHzTv1paQdngNmqrEyfxFmXqBrYH4ccvDnW%252AD9OWtwP1stzbYw%252521fyi

My8IPZCGiCW17VgfafD1%25252160Wv3%252521kDt82QrX2C1coPoK%2526plvar%253D0#search=%22lehman%20brother

s%20derivative%20book%20notional%20versus%20market%20value%22

Graph 5, Market Value OTC derivatives

Thus when we compare the market value, or netted out value (Graph 5), it is only $10 trillion or about

2% the size of the notional market. This is the “capital” invested in this fictitious industry. In

comparison, the market cap of global stock markets was $93 trillion, and, were we to add in the total

bond market excluding personal debt of over $100 trillion, this would add up to $194 trillion in 2018.

(https://data.worldbank.org/indicator/CM.MKT.LCAP.GD.ZS

Thus the capital invested in Tier 1 fictitious instruments exceeds by many multiples the capital invested

in Tier 2. This means a 10% loss in Tier 1 capital limited just to Shares and Bonds will amount to $20

trillion or double the capital invested in Tier 2. Which is why the citation regarding Lehman Brothers

concludes that the main source of Lehman’s insolvency was unlikely to have come from its losses on

5

derivative trades, but direct losses from the insolvency of the housing and corporate market. True

Lehman was a lynchpin in the world of derivatives and its collapse provoked a seizure. Over-

speculation or over-extension is relative. It is the interaction of the pigs on the bank and the river.

Generally, it is changes to the river rather than the density of the pigs on the bank that causes

speculation to implode leading to the pigs stampeding for the exits.

If we were to assume an actual loss of $20 trillion the following holds true. Contained in this loss will

be all the losses found in Tier 2. Of course Tier 2 would have exacerbated these losses and contributed

to them, but its losses do not stand outside or above the net loss in value of Tier 1 instruments. The

reason for this is that when trades conclude either on due date, or prematurely, this involves the

transfer or settlement of the underlying asset. Keynes discovered this when he forgot to close a bet

on wheat before due date and had to accept the unexpected physical delivery of the wheat.

The real difference between the two Tiers is this. The life span of derivatives is generally measured in

months, whereas bonds are measured in years, and shares indefinitely as long as the corporation to

which they are attached remains productive of profits. So while Tier 1 investors suffer paper losses,

Tier 2 speculators mostly suffer cash losses. Once the derivative expires, and, should the speculator

have bet on the wrong direction, the losses need to be made up on demand. And because these losses

are leveraged, the cash loss can be immense. The general law remains, depending on the extent of

leverage, that is the size of Tier 2 to Tier 1, will be the influence exerted on the movement in prices of

the assets belonging to Tier 1 by the liquidations in Tier 2. And, not only extent but to rapidity as well.

Turning back to the two graphs, we note a sharp fall in both the notional and market value of

derivatives. This is mainly due to the fall in interest rates derivatives due to the benign nature of

interest rates until recently. More interestingly, the second largest market, foreign exchange, has

barely grown since 2014. The reason why this is particularly interesting, is that its growth has been

constrained by the stagnation in international trade and capital flows since that time. This proves that

the OTC derivatives market does not have a life of its own but is firmly anchored in real world flows.

Had foreign trade continued to blossom, then so too would the foreign exchange derivatives market,

because more hedging would have been required.

The final observation is the most consequential. The fall in the nominal and market value shown in the

two graphs has not been symmetrical. The market value of OTC derivatives has fallen faster than the

notional value, meaning that leverage has increased. Although both markets are smaller, the current

leverage of 50 to 1 is the same as the leverage found in the run up to the crash of 2008.

The growth of debt.

The question of debt leverage is now starting to loom large. Low interest rates have seduced

borrowers to swop equity for debt and to load up on debt. A couple of weeks ago the overnight and

short term REPO market seized up, sending interest rates soaring to 10% just as the FED Rate Setting

Committee was reducing its lending rate by 0.25%. It appeared that the FED had lost control of the

money markets.

A crisis in the REPO market, especially the overnight market is a breakdown in inter-bank lending.

Some commentators have argued this has to do with the supply side of funds. The was attributable to

the growing budget deficit, the treasury replenishing its depleted reserves and the need of

corporations to pay their taxes. These factors coalesced to drain the coffers of the banks. This has an

element of truth to it, but it is not the main story. Total liquid reserves in the banking system were

$1.4 trillion which is $400 billion above the critical level of $1 trillion.

6

The real problem is that much of this liquidity is centralised in the major banks, the closely monitored

banks whose size makes them a systemic risk. The firing of two senior New York FED officials shortly

after the REPO crisis broke out seems to suggest this could be due to the neglectful supervision of

non-core banks such as regional banks as well as non-bank players such as hedge funds.

It is therefore more likely that the REPO crisis is demand led and if this is the case then we are talking

of similarities with 2008 when banks refused to lend to each other because they were wary of the

solvency of the counter-party. This could mean that smaller banks and other financial entities may be

running out of funds and the larger cash rich banks are reluctant to lend to them even against high

quality collateral.

Banking is a murky business. The borrowing banks together with the FED are keeping their identities

secret. Clearly the need to draw on emergency FED funding can be interpreted as a sign that a bank is

in distress, which in turn could lead to a run on that bank. Additionally, what is interesting is the degree

of complacency around this issue on Wall Street amidst this emergency. Clearly the FED is the opiate

of the bankers doping any concerns and continuing to provide a feeling of financial well-being.

Two issues may have contributed to this REPO crisis which means it is not under control. The first is

the huge losses that followed the reverse in sovereign interest rates earlier in August when 10 year

yields rose 0.25%. This spilt over into shares causing a Quant Quake. The leverage behind the

derivative bets on interest rates and share prices would have come from the banking system, and it is

these losses that may be filtering into the REPO market. They presumably amount to tens of billions,

and while they have not wiped out all the gains, hedge funds for example, have made this year, they

represent a significant momentary trigger loss which needs to be made up.

The second issue concerns high yield bonds. This is particularly acute in the shale oil industry, which

is one of the major players in the high yield market. The shale oil industry is just as smeary murky as

the banking world. No analyst can say with any certainty whether or not the majority of the 6.5 million

barrels of oil extracted earns a real profit. The Dallas FED polls oil producers in Texas to determine

their break even levels. In 2017 it was $50, which rose to $52 dollars in 2018 and which then fell back

to $50 dollars in 2019. (The FED conducts this poll in March of each year.).

However instead of survey data, actual analysis shows how precarious the finances of the oil industry

are. Graph 6 below shows the cost base of the shale oil industry. It was compiled in Q3 in 2018. Even

with a $2 fall in well head cost price in 2019 and factoring in the current oil price of $56, it appears

that less than 50% of producers are profitable.

The real question is what determines profitability, is it well head operational costs only? Is it replacement cost? Does it include overheads, transport costs (although this has declined with additional pipeline infrastructure) and does it include finance costs? These are indeterminable. Finance charges are a case in point. “According to data by Thomson Reuters LPC, the oil and gas sector has a combined US$833.3 billion of loans outstanding.” The annual interest on this body of debt amounts to $20 billion a year equivalent to $8.40 per barrel of oil. So the original $50 a barrel break-even price now becomes $58-40 which is $3 dollars above the current oil price. https://community.oilprice.com/topic/2337-us-shale-oil-debt-does-refinancing-mean-paying-down-debt-or-adding-new-debt/

7

Graph 6.

https://www.investing.com/analysis/the-us-shale-oil-industry-bloodbath-spreads-as-oil-price-meltdown-continues-200369785

Thus well head break even plus finance charges, yields negative cash flows, even before other

overheads are factored in. Another consideration is how long this cash flow can be sustained. Tight oil

wells have a notoriously short shelf life as Graph 7 shows, though this data does not relate to Texas.

By December 2016 the annual average production of 93 was down to 83.

Graph 7.

https://seekingalpha.com/article/4050149-bakkens-average-production-per-well-collapsing-fast

8

In many zones well production falls by half in one year. I believe the latest Dallas Fed Energy survey

has now answered this important question about profitability once and for all. And it has done so at a

critical juncture because over this year and next, two thirds of the $833 billion outstanding debt needs

to be refinanced, or over $500 billion. The 25th September Dallas FED release is headlined: “Oil and

Gas Activity Contracts as Uncertainty Remains Heightened”.

The details are even more stark: “The business activity index—the survey's broadest measure of

conditions facing Eleventh District energy firms—fell to -7.4 in the third quarter from -0.6 in the second

quarter. Oilfield services firms drove the decline, with their business activity index slumping to -21.8

from 6.6.” Further: “among oilfield services firms, the equipment utilization index plummeted 27 points

to -24.0 in the third quarter, its lowest reading since 2016 and suggestive of a large contraction in

equipment utilization.” “The aggregate employment index slid to -8.0 from -2.5” (in the oil service

sector.) https://www.dallasfed.org/research/surveys/des/2019/1903.aspx

This illuminates the divergence between oil production which is increasing slightly and new wells being

dug which is falling sharply. This can be determined by evaluating how many rigs are in operation.

According to the latest Baker Hughes count, the number of oil rigs on land, has fallen twenty percent

from a total of 1029 last year. A significant and consequential fall. https://bakerhughesrigcount.gcs-

web.com/static-files/b79d8ec6-0a8b-43b2-9bb1-3f9a5e6cc07a

This divergence between production and replenishment, represents an industry in crisis. This crisis is encapsulated in the following prescient comment found in the March survey when conditions in the industry first began to unravel. “Our investors and we are discouraged by monetary loses in public equities (stock prices) and high-yield debt instruments (junk bonds) issued by small to medium-sized oil and gas companies. This shrinkage in market capitalization of some companies is breathtaking. These loses translate into a loss of interest in further direct investments in the drilling of new oil and/or natural gas prospects.” (My emphasis)

Since then of course, financial and production conditions have deteriorated even further. Clearly

drillers are milking their wells for all they can, in order to keep the bailiff from the door. One of the

most popularly cited concerns made by drillers is the pressure from investors to boost their cash flows.

But these wells have a very short shelf life and the situation can therefore escalate very quickly. This

is a large industry, excluding gas, current tight oil production is 6.5 million barrels a day. Ignoring

discounts and taking the current average price of $56 into account, tight oil has an annual turnover of

$134 billion.

Additionally, the rapid growth in the oil industry has contributed over a tenth to the average growth

in US GDP of 1.8% between 2016 and 2018. Its losses will not only affect the bond market but the

whole economy. So to the key question, how could such a risky industry be built up so quickly and

extensively on such shaky financial grounds? The answer is low interest rates and the hunt for yield.

The allure of high yield bonds and the promise of future economies of scale turning losses into profits

has been most attractive to investors. Low interest rates always drive greedy investors mad.

Investment based on low interest rates rather than a positive rate of profit is fool’s gold. The rate of

profit is not optional. Only when the rate of profit exceeds the cost of capital can debt be repaid.

However, when the rate of profit is non-existent, even the lowest rate of interest cannot prevent debt

from building up. It looks highly likely that a chunk of that $833 billion in debt will have to be written

off at some point. Given this confluence of lack of profit, debt needing to be rolled over; the problems

9

hiding in Texan oil pipelines may have contributed to the clogging up of the financial plumbing in New

York.

The oil industry may be an extreme example of the build up of debt. But it is not alone. If it comes to

pass that the actual pre-tax rate of profit for manufacturing as a whole has fallen to 4% then to be

sure there are industries in that sector with negative cash flows, living of debt. This is about more than

just Zombie corporations; it is an endemic problem.

This problem could be coming to the fore now. In a previous posting looking at the collapse in orders

for the large trucks that make up the freight backbone, the hypothesis that the contraction in

industrial production will accelerate once the backlog of orders has been completed, has come to

pass. The latest release by the Census Bureau reveals that orders have fallen 0.4% for the year while

shipments are up 2%. More significantly, turning to “manufacturing with unfilled orders”, we find that

while shipments are up 2% year on year, orders are down 2%, a critical difference of 4%. The latest

ISM reading of 47.8 for manufacturing released yesterday confirms this.

What is developing and which this article reports on, is that the hunt for yield is being eclipsed by the

importance of returns on investment. Thus investors are becoming less concerned with the cost of the

investment – the rate of interest – and more concerned with the return on their investment - the rate

of profit. This is a healthy development for capital, but its consequences will be a brutal shock to the

entire system and those who work in it.

In conclusion, the key question in the REPO market is this: has the banking system become reliant on

the FED pumping money into the REPO market for the foreseeable future? In other words, would the

REPO market become dysfunctional without it, and if this is the case, it would indicate a systemic

problem comparable to 2008, but one nipped in the bud. The other consideration facing the FED is to

ensure that its funding is limited to emergency funding only and that the REPO market does not

become a source of cheap funds used for speculative purposes by the likes of the Hedge Funds. In this

event, any over-funding by the FED would simply add fuel to the fire, destabilising financial markets.

Monopolies are the black holes in the economy.

In a recent post - A Rent Seeking Economy – Michael Roberts discussed the issue of monopoly rents,

which provoked a serious discussion in the comments section in which I participated.

https://wordpress.com/read/feeds/313842/posts/2428426179 It is not my intention to discuss the

issue of monopoly rents in depth. My intention is to examine what is currently happening in one of

the two industries generally associated with monopolies, patents and dense I.P. rights, the hi-tech

industry. (The other industry is pharmaceuticals listed under healthcare in the graph below.)

The tendency towards the centralisation of capital is undeniably, first at the national level and later at

the international level. The speed of this centralisation is governed by two factors. The first is how

developed the credit markets are. The maturity and depth of venture capital attracted to Silicon Valley

and its proteges has seen start-ups grow into multi-billion dollar corporations within a few years

despite being loss making in their formative years. What took decades now takes years.

Secondly, the propensity for new entrants to a market is generally conditioned by the business cycle

itself. New entrants tend to predominate in the upswing phase of the cycle. This is not only because

of rising confidence and risk taking, but because the bar to entrance is lowered. During the upswing

when demand is in full flow, market prices tend to be set by less efficient producers, rather than by

the most efficient. This is dealt with by Marx in Chapter 10 in Volume 3. It is the reason why technology

gestating during slumps only pushes into the market during the upswing.

10

Given the churn in corporations which has been ongoing since the 1990s, it is difficult to categorise

the current period as one of depression. But this is ending. The obverse also holds. Just as the upswing

encourages entrants, the ending of the business cycle raises barriers to entry, replacing the

accumulation of new capital with the purging of older capital. This could be happening now.

FactSet has set the ball in motion, and the game over third quarter reporting, has begun. Graph 8 is

based on the percentage of negative announcements made by corporations going into the 3rd Quarter

reporting season which is just weeks away. Interestingly, the two most cutting edge and monopoly

rich sectors, have the highest rate of negative forecasts.

Graph 8

Only the info-tech and health-care sectors have issued significantly above average negative forecasts.

29 tech companies have issued profit warnings, the highest since FactSet began compiling these

industry by industry figures in 2006. In addition the healthcare sector which includes big pharma has

negative announcements 50% above average .

https://insight.factset.com/record-high-number-of-sp-500-technology-companies-issuing-negative-eps-guidance-for-

q3?utm_campaign=Insight&utm_source=hs_email&utm_medium=email&utm_content=77399212&_hsenc=p2ANqtz-

_HhRFXWU567PUWmTfyQjfvVREHf92_7IK8ENRttIfFvbj3TfW9i4G4k63YW9rSi8EYAmG2iJ3c9Z4EB2yGtk2ChaAmxA&_hsmi=

77399212

It appears there is a crisis brewing in the info-tech industry. Not only are established corporations

more negative about their future but there has been a spate of IPO failures recently, connected to, or

associated with Silicon Valley. There was the 2019 launch of UBER, Lyft, Crowdstrike, Medallia, Zoom,

Slack, Peloton and others, most of whom have seen their share prices tumble recently, because either

their losses increased, or their profits disappointed.

Some IPOs no longer made it to the starting line. WeWork is emblematic for what is going wrong and

the changed attitude of investors. Despite losing $2 billion in 2018 and the millstone of £27 billion in

lease obligations, it was originally valued at $49 billion by the banking geniuses on Wall Street who

11

wanted to profit from its launch. Staring failure in the face, the founder Andy Neumann, sought to

rebrand what was essentially a property company into a high tech company in the hope of achieving

a higher valuation. This was a trick he must have learnt from many Chinese entrepreneurs. But in the

new climate investors were not convinced. Not only was the IPO pulled but the founder had to resign

as CEO and sell the corporate jet. In addition, given the large presence of WeWork, the failure of

WeWork’s IPO rattled the property markets in New York and London.

The penultimate graph below sums it up. The performance of IPOs has been dismal this year. IPOs

have performed worse this year than in any other, little wonder new issuance has ground to a halt.

Graph 9.

High valuations are no longer in vogue. Some analysists are comparing what is happening now in the

markets to the end of the dot.com era. The dot.com crash represented the switch from expectations

to actual profit performance. The era of super-sized valuations but no meat, is over.

This will affect all monopolies. When we look at the relative valuations of the FAANGS, they are of the

70% (Apple) to 450% (Amazon) higher than the S&P 500, to whose average they contribute. And yet,

all the FAANGS with the exception of Microsoft have flawed business models. Apple has become

unstuck with its expensive smartphones and thus the erosion of its user base on which its services are

dependent. Alphabet and Facebook depend on fickle advertising revenue. Amazon’s core business is

not making any real profits because it is more labour intensive than brick and mortar shops. Its margin

on e-sales is a paltry 4%.

During the upswing, momentum shares like the FAANGS rise faster than do the bulk of the market and

their frontrunning increases as expectations multiply. In a downswing they have further to fall and

faster too. When we take into consideration the market cap of these shares, this reversion to mean

involves market shattering falls. Currently, the top 5 Tech companies are valued at a combined $4.35

trillion. Even a 50% narrowing in valuation implies a loss exceeding the entire loan capital of the

fracking industry.

12

The discussion on rentiers thus misses the point at this juncture. The question is not whether the

monopolies stand apart from the market and drain profits. The question is what impact they will have

when sentiment changes as is happening now, bringing their valuations come into question.

In the longer term another issue arises. Machine learning is altering the balance between intellectual

labour and physical labour. Within the total value of output the share of intellectual labour is rising as

more software is being used in relation to hardware, for example smart factories. This has the double

and opposing effect of revaluing inputs (on the capital side) and devaluing outputs (on the revenue

side). This is particularly true for those companies, particularly in the manufacturing space who have

to either buy in this intellectual labour in the form of licences, or to commission it from external

contractors.

In absolute terms there will be a profound reduction in the total expenditure of labour. The reduction

in the physical expenditure of labour power in the output side will overwhelm the increased

contribution by intellectual labour on the input side. There will thus be an accelerated devaluation of

production. The scale of this reduction can be seen in the elegant graph below produced by Statista.

Graph 10.

It is true of course that capitalism in time will seek to reduce the intellectual input side. Programmes

are being developed whereby machines can learn to programme themselves for specific tasks or at

least to improve their efficiencies. But for the time being machine learning depends on intellectual

labour.

The changing mix of labour will have the most profound effect on the rate of profit via the pricing

system. For a socialist society this presents only opportunities not problems because such a society is

driven by falling prices. On the other hand capitalism is driven by rising profits, or more precisely,

profits rising sufficiently to raise the rate of profit. And in the context of a devaluation of output the

ability to raise profits from fewer and fewer productive workers becomes problematic.

I have been investigating this phenomenon for over a year. It could very well be the case that the fall

in the rate of turnover is partly due to this phenomenon. If software investment is in-house it will

13

increase the value of the final sales. Anything that raises final sales and therefore its share of gross

output will register as a fall in the rate of turnover. In turn this will yield a rise in working capital which

again is the correct result. Graph 11 below seems to confirm this hypothesis. It shows the upward

trend in the investment in soft-ware which is treated as capital rather than a cost since 2012 (revision).

Graph 11.

(Source: BEA Fixed Asset Table 2.7 released 8th August 2019. See spreadsheet “IN HOUSE SOFTWARE GRAPH”)

This upward trend is enhanced when we measure it against investment in equipment and structures

thereby excluding the rest of Intellectual Property investment.

Graph 12.

Graph 12 shows that investment in software compared to hardware, in this case machinery,

equipment and structures has tripled. (Note its share has plateaued since 2009.)

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20

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14

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18

SOFTWARE INVESTMENT SHARE OF TOTAL FIXED INVESTMENT

0.0%

5.0%

10.0%

15.0%

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25.0%

19

90

19

91

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92

19

93

19

94

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95

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96

19

97

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98

19

99

20

00

20

01

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20

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20

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18

SOFTWARE INVESTMENT % EQUIPMENT + STRUCTURES

14

Funnily enough it is the confounding revision of 2012, which in capitalising software and Research and

Development, underlines the point being made. On the one side capital is increased and on the other

side depreciation weighs more heavily on output whose value is falling. Together they have

contributed to the fall in the rate of profit because of the inflation of capital on the one side and the

deflation of profits on the other. What the SNA is revealing through misreporting, is not a false

positive, but an accentuation of a development, whereby the growth of intellectual capital at the

expense of physical labour is acting as a break on the rate of profit.

Returning to the question of monopolisation of Intellectual Property. The following graph shows the

increased dependency of the users of soft ware on Soft-ware Houses both in the form of proprietary

software (licences), or external contractors providing dedicated software.

Graph 13.

It is this dependency that creates the possibility of a redistribution of profits from the users of software

(particularly industry) to the producers of software. This will further exacerbate the fall in profitability

in sectors such as manufacturing. Whether in the end all this sustainable, is the question. We could be

dealing with an absolute limit rather than a relative limit to capitalist production.

Conclusion.

US capital is facing a perfect storm. Its epicentre comprises a collapsed rate of profit compounded by

an interest rate which remains stubbornly high in the US relative to the interest rates of competitors.

This is primarily due to the US deficit, courtesy of the Trump tax giveaway which is expanding the fiscal

deficit to 5%. The recent turmoil in the US sovereign debt markets has stabilised and the 10-year rate,

having fallen to 1.42%, is now trending at between 1.6 and 1.7%. This is placing US industry at a distinct

disadvantage to the interest rates enjoyed by its major competitors (excluding China) even when

taking the differences in inflation into account. It was corporates loading up with debt in August which

ended the rapid fall in rates, leaving the average investment grade rate of interest at 2.96%. Given a

rate of profit just above 4% and the cost of capital approaching 3%, the headroom for investment has

been eliminated.

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

IN-HOUSE SOFTWARE SHARE OF TOTAL

15

Graph 14.

(Sources: FRED Tables, IRLTLT01JPM156N japan, DGS10 USA, IRLTLT01DEM156N Germany.)

The vortexes are expanding. The bad industrial news finally made it past the algorithms. The first two

days of October were turbulent with the Dow Jones down 800 points, the worst start to a quarter

since 2008. It appears that sniffing FED funds may not be enough any longer. It looks likely an inflection

point has been reached. October may be the month the slow motion crash in markets accelerates as

the interest rate hand-brake finally burns out.

It is into this vortex that the new British Prime Minister has jumped. Against an imploding world

economy and a recessionary Britain, he dabbles with a no deal Brexit. This buffoon compared himself

to the Hulk, when in reality he is Thanos, responsible for wiping out half the electorate with a strategy

devised by crusader neo-liberals intent on turning this island into a prison house for labour. He and

his chums are the true recruiting sergeant-majors for revolution.

PostScript. There is no such thing as an intelligent algorithm. There is such a thing as prejudiced algorithm that reflects the prejudices and shortcomings of programmers. Similarly with financial algorithms. The programmers have no fundamental theory of how capitalism works. All they have are observations based on the movement and interaction of superficial phenomena. No doubt the algorithms are highly focused on the FED, the Trade War, consumer spending and the direction of share prices. But algorithms can become complacent when they are looking at the wrong indicators. No doubt, when the dust settles after this crash, its severity will be blamed on a reliance on algorithms rather than human experience.

Brian Green 2 October 2019.

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15-0

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US 10-year versus Germany and Japan