Taking stock of the February crash

March 8, 2018

Samuel Falcone-Coffin and Dylan DelGiudice offer an explanation for last month's plunging stock market, based on the writings of Karl Marx.

IN EARLY February, working Americans watched as stock values plummeted in a way that to many was reminiscent of the Great Recession of 2008.

On Monday, February 5, the U.S. stock market suffered its worst losses in over six years, with market indices taking a nosedive through the trading day and into Tuesday. By the end of the day on Tuesday, stock values had rebounded slightly, marking the end of the ominous two-day decline.

The week ended, as reported by the Financial Times, as one of the worst for the U.S. stock market since the 2008 financial crisis. Despite experiencing a slight recovery after Monday's slide, the S&P 500 closed on Friday 5.2 percent down from the previous week.

By the end of the week, the Dow Jones Industrial Average--which experienced a 1,175-point drop on Monday, marking the largest single-day point loss in history--and Nasdaq Composite also made small gains, but still ended the volatile five-day period down 5.21 percent and 5.06 percent respectively. The week's losses made them the worst since January 2016, and the eighth-worst since the 2008 financial crisis.

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Ironically, in the weeks and months preceding the week of market volatility and loss in stock market value, Donald Trump had hubristically touted recent growth in stock market indices as evidence of the success of his economic policy, most notably, his tax plan.

To make sense of this market volatility, we must pose a series of questions. Firstly, what do stock market values mean to working people? What do indices measure, and what do they mean in terms of the economic realities faced by the majority of society? Secondly, we must ask what this market volatility indicates about the future of the economy, both in the long term and short term.

FIRST OF all, what do stock market indices such as the S&P 500 and Dow Jones Industrial Average measure? In plain terms, stock prices are not accurate measures of general economic well-being (Marxists share this position with economists from the liberal Keynesian tradition, such as Paul Samuelson and Paul Krugman).

Most obviously, the ownership of stock is concentrated among the wealthiest in society. The vast majority of Americans own little to no stock, and therefore the earnings during periods of growth in the stock markets disproportionately benefit the very rich.

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This is not to say that workers have no stake in the stock market, as union pension funds, retirement accounts and other asset management funds are usually reliant on "active fund management." These funds can accordingly be completely destroyed during times of market volatility.

Stock market indices are weighted averages of stock values and offer a measure of the prospects of investors to make returns off of future investment--in other words, the profit-making potential of the market--not general economic growth and prosperity.

As Karl Marx observed, corporate profit rates are not a measure of general economic prosperity in society. In fact, the two have a tenuous (and often contradictory) relationship.

This critical observation has been empirically confirmed by data, collected since the dawn of "trickle-down", neoclassical economic policy in the 1970s, on the relationship between productivity (measured in average output per worker at the point of production), wage rates (measured in average hourly earnings) and corporate profits.

As the Economic Policy Institute reports, as of October 2017, productivity has continued along a steadily increasing path since 1973. Simultaneously, workers hourly compensation has remained relatively stagnant, and the gap between productivity and compensation has grown dramatically.

The same phenomenon of the lack of correlation between corporate income and wages has been the definitive characteristic of the economic "recovery" from the Great Recession of 2008. Since 2010, workers' share of corporate income, received in wages, has been at an all-time low. While the unemployment rate is low, that doesn't necessarily reflect wages or the people participating in the labor market. The labor participation rate is currently low by historical standards.

This is all to say that the recent boom in the stock market, while championed by the likes of Trump and his Wall Street cronies as an indication of a return to pre-recession levels of economic prosperity, is a false attempt to measure the economic well-being of society through corporate profit rates.

MARX MADE another critical observation about the stock market's fluctuations that gives us insight into our second question, which is what this recent market volatility indicates about the future of the economy.

In the third volume of Capital, Marx described the way in which stock values are based on expected returns in investment. When those speculative investments are met with actual rates of profitability, stock market values decline.

This form of capital--credit, debt, shares or anything that speculates value outside of what can be realized in actual material goods or services--is what Marx referred to as "fictitious capital." To Marx, the value of fictitious capital--that is, what drives stock market prices--is the difference between actual rates of profit and interest rates.

In the aftermath of the Great Recession, global central banks--in the U.S., the Federal Reserve System--brought down interest rates to historical lows (even to negative rates) in an attempt to encourage capital investment to bring the economy out of a crisis phase. The Fed also pursued a strategy of quantitative easing, or purchasing large assets with the intention of increasing the money supply and encouraging investment.

In the years since the recession, due to these low interest rates and increased money supply due to quantitative easing, the value of stocks have been steadily increasing because of increases in capital investment.

This was, of course, the case until February's crash. Beginning in December, the Federal Reserve began to pursue a new monetary policy of increasing interest rates. With Trump's recent nomination of Jerome Powell to replace Janet Yellen as the Fed Chair, it is possible that investors' anxieties over this change of policy could have sent the market into a brief moment of volatility.

Mainstream economists are not in consensus on the exact causes of the crash, or what its implications are for future economic growth or decline. There are, however, a few possibilities.

One possible source of concern is the high level of aggregate corporate debt, which has reached pre-recession rates and has the potential to undermine the recent upturns in corporate earnings, due to its increased risk of investment in high-leverage corporations.

Since the recession, the general (non-financial) state of the economy has been characterized by anemic productivity growth in the business sector, which may be causing fear among investors that the profitability of their stocks cannot last. Meanwhile, mounting debt is threatening to crowd out private investment in the non-financial sector.

While these factors don't necessarily mean the economy is in immediate crisis or that working class people's mortgages and pensions are currently in jeopardy, they do point to some misleading figures that display the economy's state and give reason for concern about the stability of the non-financial economy.

TO WHAT extent is a crisis imminent? There are two critical factors that must be evaluated to determine whether a stock market crash will translate into an economic crisis: this level of corporate debt and the profitability of real capital (in real terms, not relative to interest rates).

Marx's observation on the relationship between "fictitious capital" and the profitability of real capital is vital toward understanding volatility in the stock market.

Through this method of analysis, the value of stocks (and their subsequent decline) is not based solely on the irrational psychological behaviors of investors (in Keynesian terms, the "animal spirits"), as many liberal economists may argue. Rather, these fluctuations in value are an inescapable, inevitable and necessary aspect of capitalist production and the market economy.

To summarize, stock market values, contrary to Trump's claims, are not a measure of the economic realities faced by the majority of people. That is not to say that fluctuations in the stock market don't bring about real economic hardship for the working class--but that this hardship occurs when the profitability of real capital is impacted by market volatility in the financial sector.

As socialists, we must make the argument confidently that market volatility--and, ultimately, economic crisis--is not the result of misguided or irrational policy by financiers or political technocrats, but rather is deeply embedded in the structure of capitalism.

This system of perpetual crisis for the majority at the hands of the few is exactly the type of class domination that we have to organize against. It is this fluctuation that makes the for-profit mode of production so unstable, and is why we must fight for an economic system based on meeting the needs of people, rather than on speculative profits.

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