The Era of Fictitious Capitalism

An English reader, who lives in France, recently passed on an interesting article written by a Chinese bureaucrat, published on a non-profit website hosted in Italy, sponsored by the government of Singapore. The aim of the site is to increase amicable relations between Asia and Europe in a U.S.-centric world. The purpose of the article: a strategic recommendation on how China ought to position itself while the U.S. and Europe – as the major players in the two-bloc international system the author predicts will eventually emerge – gear up for eventual war.

What could possibly interest us about a Chinese bureaucrat's white paper on impending global war? First of all, his conclusion: "In the last century," writes Wang Jian, "American people were pioneers of system and technology innovation. However, the interests of a few American financial monopolies now lead this country to war. This is such a tragedy for the American people.

"Clouds of war are gathering. Right now, the most important things to do for China are:

  1. Remain neutral between two military groups while insisting on an anti-war attitude.
  2. Stock up in strategic reserves
  3. Get ready for a short supply of oil
  4. Strengthen armament power
  5. Speed up economic integration with Japan, Hong Kong, Korea and Taiwan…"

It's a rather unsettling idea. China as the neutral power in a war between the United States and a united Europe. How did Wang get there? That's the subject of the second part of the article, which we find intriguing…and even more unnerving. Wang's view is disturbingly similar to our own understanding of the way the global economy works.

"War is the extension of politics and politics is the extension of economic interests," Wang asserts. "America's wars abroad have always had a clear goal; however, such goals were never made obvious to the public. We need to see through the surface and reach the essence of the matters. In other words, we need to figure out what the fundamental economic interests of America are. Missing this point, we would be misled by American government's shows and feints."

Wang's argument in a nutshell: By the mid 1970s, the U.S., the U.K., France, Germany, Italy, Japan and other major capitalist countries had completed the industrialization process now underway in China. In 1971, when Nixon closed the gold window, the Bretton Woods system collapsed, and the dollar – the last major currency to be tethered to gold – came unstuck. Economic growth as measured by GDP was no longer restricted by the growth of material goods production. Toss in a few financial innovations, like derivatives, and the "fictitious" economy assumed the central role in the global monetary system.

"Money transactions related to material goods production," writes Wang, "counted 80% of the total [global] transactions until 1970. However, only 5 years after the collapse of the Bretton Woods the ratio turned upside down – only 20% of money transactions were related material goods production and circulation. The ratio dropped to .7% in 1997."

As we note in our book, since Greenspan assumed the central role at the most powerful central bank in the world, he has expanded the money supply more than all other Fed chairmen combined. From 1985–2000, production of material goods in the U.S. has increased only 50%, while the money supply has grown by a factor of 3. Money has been growing more than six times as fast as the rate of goods production. The results? Wang's research reveals that in 1997 – before the top blew off in the U.S. stock market, mind you – global "money" transactions totaled $600 trillion. Goods production was a mere 1% of that.

"People seem to take it for granted that financial values can be created endlessly out of nowhere and pile up to the moon," our friend Robert Prechter writes in his book, Conquer the Crash. "Turn the direction around and mention that financial values can disappear into nowhere and they insist that it isn't possible. u2018The money has to go somewhere…It just moves from stocks to bonds to money funds…it never goes away…For every buyer, there is a seller, so the money just changes hands.' That is true of money, just as it was all the way up, but it's not true of values, which changed all the way up."

In the fictitious economy, the values for paper assets are only derived from the perceptions of the buyer and seller. A man may believe he is worth a million dollars, because he holds stocks or bonds generally agreed in the market to hold that value. When he presents his net worth to a lender, a mortgage banker for example, and wishes to use the financial assets as collateral for a loan, his million dollars is now miraculously worth two. If the market drops, the lender, now nervous about his own assets, calls in the note…and the borrower once thought to be worth two million discovers he is broke.

"The dynamics of value expansion and contraction explain why a bear market can bankrupt millions of people," Prechter explains. "When the market turns down, [value expansion] goes into reverse. Only a very few owners of a collapsing financial asset trade it for money at 90 percent of peak value. Some others may get out at 80 percent, 50 percent or 30 percent of peak value. In each case, sellers are simply transforming the remaining future value losses to someone else."

As we saw in the 2000–2002 bear market, in such situations, most investors act as if they were deer caught in the headlights of a speeding truck at night. They do nothing. And get stuck holding financial assets at lower – or worse, non-existent – values. Anyone suffering glances at their pension statements over the past few years knows their prior "value" was a figment of their imagination.

Back to Wang: "In the era of fictitious capitalism, a fictitious capital transaction itself can increase the u2018book value' of monetary capital; therefore monetary capital no longer has to go through material goods production before it returns to more monetary capital. Capitalists no longer need to do the u2018painful' thing – material goods production."

Real-life owners of stocks, bonds, foreign currency and real estate have increasingly taken advantage of historically low interest rates and applied for mortgages backed by the value of these financial assets. Especially since the rally began 8 months ago, they then turn around and trade the new capital on the markets. "During this process," writes Wang, "the demand of money no longer comes from the expansion of material goods production, instead it comes from the inflation of capital price. The process repeats itself."

Derivatives instruments, themselves a form of fictitious capital, help investors bet on the direction of capital prices. And central banks, unfettered by the tedious foundation set by the gold standard, can print as much money as is required by the demands of the fictitious economy. You can, of course, trade the marginal values of these fictitious instruments and do quite well for yourself. [See: 22 Trading Rules For The Fictitious Economy.]

But Wang sees a darker side to the equation. "Fictitious capital is no more than a piece of paper, or an electric signal in a computer disk. Theoretically, such capital cannot feed anyone no matter how much its value increases in the marketplace. So why is it so enthusiastically pursued by the major capitalist countries?"

The reason, at least until recently, is that the “major capitalist countries” have been using their fictitious capital to finance consumption of "other countries'" material goods. Thus far, the most major of the capitalist countries, the U.S., has been able to profit from the system because since the establishment of the Bretton Woods system, and increasingly since its demise, the world has balanced its accounts in dollars.

"Until now," writes Wang, "U.S. dollars [have counted] for 60–70% in settlement transactions and currency reserves. However, before the u2018fictitious capital' era, more exactly, before the fictitious economy began inflating insanely in the 1990s, America could not possibly capture surplus products from other countries on such a large scale simply by taking advantage of the dollar's special status in the world…Lured by the concept of the u2018new economy', international capital flew into the American securities market and purchased American capital, thus resulting in the great performance of U.S. dollar and abnormal exuberance in the American security market."

And here we arrive at the crux of Wang's argument that a war is brewing. "While [fictitious capital] has been bringing to America economic prosperity and hegemonic power over money," he suggests, "it has its own inborn weakness. In order to sustain such prosperity and hegemonic power, America has to keep unilateral inflow of international capital to the American market…If America loses its hegemonic power over money, its domestic consumption level will plunge 30–40%. Such an outcome would be devastating for the U.S. economy. It could be more harmful to the economy than the Great Depression of 1929 to 1933."

Japan's example suggests, as your editors have oft reminded you, that a collapse in asset values in a fictitious economy can adversely affect the real economy for a long time.

In the era of fictitious capital, Wang surmises, America must keep its hegemonic power over money in order to keep feeding the enormous yaw in its consumerist belly. Hegemonic power over money requires that international capital keep flowing into the market from all participating economies. Should the financial market collapse, the economy would sink into depression.

America's reigning financial monopolies, he believes, (whoever they may be), would not stand for it.

December 6, 2003

Addison Wiggin [send him mail] is the author, with Bill Bonner, of Financial Reckoning Day: Surviving The Soft Depression of The 21st Century.