The Real Crisis: A Collapsing Capital Accumulation Process
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The Real Crisis: A Collapsing Capital Accumulation Process

Director, Risk Pricing

Private Capital needs to prosper in order to survive. But due to the inability of governments to alleviate widespread poverty, the domestic and global environment which created the compelling post-WW II process of capital accumulation (and related profits) had reached a peak, within the context of consumer demand, by the early 1990s. In fact, without the explosion of debt and leverage, asset values would have begun stagnating more than a decade ago. Today, capitalism, from the perspective of a free market, is struggling to survive. State capitalism is destined to rule the world for the better part of this century. What does that mean for share prices?

Almost one half of the world population lives on less than $2.50 per day. The combined GDP of the poorest 41 heavily-indebted nations is less than the wealth of the world’s nine richest people. Fifty percent of the world’s children live in poverty. The vast majority of families constituting the 900 million-strong middle class in the emerging markets are discovering the evils of debt, low-quality jobs and higher food prices at the stores. And, if defense-related expenditures are removed from the national budgets of the developing economies, GDP growth rates are less than zero, with few exceptions. (Late Friday, an official of the UN Development Program reported that poverty in Latin America will rise by 15% this year).

Furthermore, the advent of state capitalism in China and Russia, and in varying formats in countries run by despots, dictators and governments elected through heavily flawed electoral mechanisms, has fundamentally and irrevocably shifted the capital accumulation equilibrium for US and western capital. This is not the forum to engage in a detailed analysis of the crisis of capitalism. But, in brief, American corporations can no longer rely on their inherent strength, i.e. the ability to provide capital and expertise, to find new markets and to identify lucrative investment opportunities. In a dynamic which recalls pre-WW II Germany, Italy and Spain, private capital is no longer able to expand and thrive without entering into sustainable alliances with the “state”. In one respect, political risk insurance rates reflect that dynamic; blanket coverage for the emerging markets is simply unavailable and the insertion of substantive conditions in underlying insurance documentation is now seriously inhibiting capital movements and trade transactions.

Protectionism is at all all-time high, despite the existence of numerous international free-trade protocols. Food, energy and agricultural subsidies are commonplace throughout the developing world. Bureaucratic and legislative hurdles for foreign investments are being consolidated with each passing day. State-dictated interest-rate and currency fixings are wrecking the foundations of the international capital marketplace. And, as German Chancellor Angela Merkel stated last week, “stimulus packages are turning into the ultimate protectionist measures with countries dedicating an increasing amount of public funds to help domestic banks and businesses.”

The global demand contraction is not only being influenced by poverty levels and forced de-leveraging. Unemployment and underemployment in the developing world is breaking all records, particularly if “marginal” workers rooted in the agricultural sector are accounting for—figures from China, India and Brazil, to name just a few examples, are hopelessly inadequate in this regard. And, as far as restrictions on capital are concerned, the proponents of the Bolivarian Revolution in Latin America (Venezuela, Bolivia, Ecuador and Nicaragua at this juncture) are no longer interested in allowing their mining and energy assets to be developed by western companies according to traditional profit-sharing agreements.

Then, of course, there is Africa where the combination of a formidable regulatory umbrella, poor security levels and deeply-ingrained corruption has left the exploitation of vast segments of the continent’s natural resources to local militias and ethnic warlords. The result: more poverty, and more economic backwardness.

In this writer’s view the Obama Administration’s stimulus packages and bailouts are incapable of causing any meaningful reversal in a capital accumulation process which is now being directed by states, not by free-market considerations in relation to the movement of goods and machinery. And therein lays the risk to private equity. In certain business segments, like financials and insurance, private equity has no role whatsoever. In certain other corporate segments, asset values need to be rationalized in line with the new reality, e.g. the S&P500 (SPY) below 700. The risk for short traders is grounded in timing. At what point will the real crisis in capitalism overtake optimistic economic forecasts generated daily by stimulus and bailout announcements? Is it best to use forthcoming rallies to short the emerging markets (EEM)? Or is there more money to be made by staying negative on financials (BAC, C, JPM, MS) since the futility of Monday’s financial recovery plan will be proven well before the hard truth pertaining to the global economy unfolds?

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