Interest Rates

In the near future I will be producing a more detailed blog post on interest rates, covering why they have been low, and why they are set to rise. Here I just want to try to briefly explain why the cause for low interest rates is not money printing, as commonly believed.

According to Marx, interest rates are determined by the supply and demand for money-capital. On that basis, its clear that for Marx, simply printing money token cannot be a means of reducing or raising interest rates, because whilst central banks can print those money tokens, and credit, they cannot print capital. But, just because Marx said it does not mean it is right. So, let me try to show that what he says is right.

Let us start by assuming two firms, which represent the two sector model that Marx sets out in Volume II of Capital. 

1) C 4,000 + V 1,000 + S 1,000 = E 6,000

2) C 2,000 + V 500 + S 500 = E 3,000

Here firm 1 produces means of production to a value of £6,000, which is equal to C for 1 & 2, i.e. £4,000 + £2,000.

Firm 2 produces means of consumption = £3,000. That is equal to the consumption of workers and capitalists in both firms, i.e. £1,000 + £1,000 (firm 1) and £500 + £500 (firm 2). This is the situation under simple reproduction, where the surplus value is all consumed unproductively by the capitalists rather than accumulated. 

Both firms sell their commodities in the market, and receive payment in the form of £1 gold coins.

Assume that firm 1 wants to consume unproductively their surplus value, but also wants to invest an additional £500. Firm 2, by contrast, does not wish to consume their surplus value at all. That could be because they need to have £2,500 of capital, before they can actually expand their production, for instance. So, its obvious that under these conditions firm 2 could lend their surplus value to firm 1, so that they could invest the additional £500.

So, in the next cycle we would have:

1) C 4,250 + V 1,250 + S 1,250 = E 6,750

2) C 2,000 + V 500 + S 500 = E 3,000

There appears to be an imbalance of £500, because the value of output of firm 1 is £6,750, whereas the value of demand is only £6,250 but that is only because £500 of surplus value from firm 2 that would have bought means of consumption, was lent to firm 1, to fund additional means of production. So, firm 2's output of £3,000 is consumed £1,250 + £1,250 (Firm 1) plus £500 (V from firm 2). Firm 1's output of £6,750 is consumed £4,250 (Firm 1) + £2,000 (Firm 2) + £500 (Firm 1, lent from firm 2).

However, firm 2 will not lend this money to firm 1 for nothing. They will expect to receive interest.

Suppose, on this level of supply and demand for capital, firm 2 will lend £500 to firm 1 for 5%, and firm 1 is happy to pay it. In that case, in future years, firm 1 will pay £25 a year interest out of its surplus value to firm 2, making a transfer of surplus value in the opposite direction, and will repay the £500 capital sum, at the end of the period of the loan.

But, in reality, both firm 1 and 2 will pay the proceeds of their sales into the bank, as will the workers with their wages, and will draw them out again as payments to the sellers of commodities. So, the loan from firm 2 will not be made directly to firm 1, but will actually appear as a loan from the bank.

Now, however, assume that the central bank in order to stimulate investment, reduces interest rates by printing money. They do this by agreeing to provide the bank with paper money tokens, which they may do by simply lending these tokens to the bank, on the basis of the bank's assets, or they may even exchange some of these money tokens for gold coins. If 1 money token exchanges for 1 coin normally, the bank may agree to exchange 2 tokens for each coin, loaning the bank the difference. On this basis, the bank may feel that because they now have £1,000 rather than £500 to offer to lend they can and need to offer this money at a lower rate of interest.

Two things can happen. Either, firm 1 may decide it wishes still only to borrow £500, in which case the bank will be left with £500 sitting as a money hoard in its vaults on which it is paying interest but receiving no interest, or it will be able to lend the £1,000 out, either all of it to firm 1, or some to both firm 1 and 2. In the first instance, there is no reason for the bank to borrow this money, or to offer a loan to firm 1 at a reduced rate.

If, however, firm 1 decides it will borrow now £1,000 instead of £500, the bank may do this, lending it at a rate of say 3% to firm 1. The bank then earns interest of £30, instead of £25. However, this additional £500 put into circulation has not resulted in any additional value being created. Its possible that if there are unused and unemployed resources, the borrowing by firm 1 might bring them into use, and create £500 of additional value in the economy as an equivalent of the additional money put into circulation. But, there is no guarantee this is the case.

Consequently, we now have from the first cycle £9,000 of value to be circulated, and £9500 of money and money tokens in circulation (£9,000 in coins £500 in notes). The result is that the money is depreciated i.e. inflation. Although the value of all production remains the same, the money prices rise. The increase is equal to 9500/9000 = 1.055. So, the money prices of the values in cycle 1 would be

1) C 4222 + V 1,055 + S 1,055 = E 6332

2) C 2111 + V 523 + S 523 = E 3157

In other words, in nominal money terms capitalists 1 and 2 will now demand additional money capital to cover these higher nominal money prices. The additional £500 of money put into circulation, therefore causes a rise in the demand for money-capital of an equal amount, not to expand production, but merely to account for the rise in nominal money prices. The end result is that there is no real change in the supply and demand for capital in constant money terms, and so there is no basis for any reduction in interest rates.

Put another way, when firm 1 throws their additional £500 of money-capital into the market, it finds no increased value as its counterpart. Monetary demand rises, but with no increase in supply able to meet it, money prices rise.

In fact, in the real economy, such a situation may result in interest rates rising above where they were prior to the injection of additional money tokens. That is because, holders of money-capital who decide to invest it in Government, or commercial bonds, may decide that such inflation, will be persistent. The consequence of that is that the real value of their bonds will fall over time. Consequently, the real rate of return on those bonds will fall. Bond buyers will then offer correspondingly lower prices for bonds, increasing their yield, which then means that the interest rate offered on all newly issued bonds will have to rise.  An indication of this, and of the problems central banks will face is what has happened in Japan.  There the central bank has committed itself to creating inflation, to end the 20 year deflation the country has been suffering.  It has committed itself to doubling Japanese money supply.  In the last month, rather than falling Japanese interest rates have tripled!!!  On Thursday, Japanese JGB's rose to over 1% for the first time in more than a year.  That was part of the reason that on the same day, the Japanese stock market crashed by more than 7%!!

In my future blog post, I will show how the low interest rates, and the secular down trend in interest rates of the last 30 years, is actually the result of a rising rate and volume of profit, increasing the supply relative to the demand for capital. The money printing that has occurred has in fact, been another consequence of the factors which led to that.

The reversal of those factors will now lead to a rise in interest rates whether or not central banks continue to print money tokens and credit. Instead, continuation of those actions will simply lead to a rise in inflation.  

Capital II, Chapter 1 - Part 6

As stated earlier, profit can only arise because a surplus product is created within society. Distribution/exchange then determines how that surplus is appropriated. So, Merchant Capital might secure profits, but only by securing for itself a share of the surplus product produced by slaves, or peasant producers. It does so by unequal exchange i.e. it pays the producers of these commodities less than the value of the commodities it buys from them, or else it sells to these same producers commodities above their value. 

Money capitalists are able to make profits in the same way. They lend money to slave owners, or to peasant producers and then receive back from them a greater sum of money.

Provided these actual producers – be they slave owners or peasants – produce a larger surplus product than is taken from them by the merchants and money capitalists, and by other exploiting classes, such as the aristocracy, then they can plough this surplus back into production. When it is not, future production will be curtailed.

That is what happened in the Mediterranean City States, when the merchants and money capitalists bled the peasant producers dry, and thereby prevented the nascent capitalist production from developing.

But, when industrial capital develops it is the centre of production, it becomes the source of society's surplus production.

“Its existence implies the class antagonism between capitalists and wage-labourers. To the extent that it seizes control of social production, the technique and social organisation of the labour-process are revolutionised and with them the economico-historical type of society. The other kinds of capital, which appeared before industrial capital amid conditions of social production that have receded into the past or are now succumbing, are not only subordinated to it and the mechanism of their functions altered in conformity with it, but move solely with it as their basis, hence live and die, stand and fall with this basis. Money-capital and commodity-capital, so far as they function as vehicles of particular branches of business, side by side with industrial capital, are nothing but modes of existence of the different functional forms now assumed, now discarded by industrial capital in the sphere of circulation — modes which, due to social division of labour, have attained independent existence and been developed one-sidedly.” (p 57)

If we consider money-capital it proceeds through the circuit M-C-M', and yet for the individual money capitalist it has its own circuit that can appear as simply M-M'. A capitalist may employ their money-capital in the way previously described. They buy means of production and labour-power, engage in production creating commodities with a greater value, which they then sell for a larger amount of money than they began with.

But, consider a money-capitalist who provides this money to an industrial capitalist, in the shape of a loan. The money capital lent goes through exactly the same stages, and results in M' at the end. The industrial capitalist out of M' – M = m now has to pay the money capitalist the interest on the money they have borrowed. So, they are left with m-i (the interest). But, for the money-capitalist it appears as simply M-M' where M' – M = I. It appears to them that their profit has arisen not because of the production process which created the surplus value, but has arisen simply as a consequence of their lending out their money – their abstinence etc. Yet, their interest, in reality, has the same source whether it is paid to them by an industrial capitalist, a slave owner or a peasant producer. It is only possible because of a surplus product created in the process of production.

The formula M-C...P...C'-M' is the circuit of money-capital, and in it is also expressed the fact that the purpose of production here is exchange value not use value. The purpose of production here is not to produce more use values per se, which is the purpose of production in all other modes of production. It is to produce more exchange value, and thereby to maximise the surplus exchange value. More use values are produced only because competition forces each capital to do so in order to produce more exchange value!

The real purpose appears M-M', with production appearing almost as an inconvenient interruption of this movement.

“All nations with a capitalist mode of production are therefore seized periodically by a feverish attempt to make money without the intervention of the process of production.” (p 58)

But, it is precisely the production phase of this circuit which defines it as capitalist because it is this form of production that is distinctively capitalist.

Yet, it is the fact that the circuit begins with M and ends with M', a greater sum of money, which is most apparent, and which distinguishes the circuit of M from that of C and P.

“And money is the independent, tangible form of existence of value, the value of the product in its independent value-form, in which every trace of the use-value of the commodities has been extinguished. On the other hand the form P ... P does not necessarily become P ... P' (P plus p), and in the form C ... no difference whatever in value is visible between the two extremes. It is therefore characteristic of the formula M — M' that for one thing capital-value is its starting-point and expanded capital-value its point of return, so that the advance of capital-value appears as the means and expanded capital-value as the end of the entire operation; and that for another thing this relation is expressed in money-form, in the independent value-form, hence money-capital as money begetting money. The generation of surplus-value by value is not only expressed as the Alpha and Omega of the process, but explicitly in the form of glittering money.” (p 59)

This circuit is only the circuit of capital, and in M-C-M', it signifies the self-expansion of capital, because the only consumption it represents M-C is productive consumption, the purchase of MP and L, and their consumption in the productive process. It does not include the circuit for the labourer or the capitalist. For the worker, for example, M-C(L) appears as C(L) – M, or the sale of their commodity labour-power for money wages, which then becomes M-C, as they spend those wages on commodities for their own consumption. And, for the capitalist there is a similar circuit, as they take a portion of m – the surplus value – and use it to buy their own commodities for personal consumption.

Yet, the circuit for the worker C(L)-M-C begins within the circuit of capital i.e. C(L)-M is their sale of labour-power to capital seen in its circuit as M-C(L). The second part of the circuit for the worker M-C is premised by the circuit of capital because it is necessary, i.e. the worker must buy necessaries M-C, because without them their labour-power is not reproduced, and so the production process cannot continue.

In short, without wages, indeed sufficient wages, and without the food etc. the worker needs to buy with those wages, the workers cannot live, and without workers, capital cannot produce.

By contrast, the means of production bought at M-C(MP) are only consumed productively. It enters C' , which leaves the circuit, precisely because it is produced for consumption by others.

“Capital’s movement in circuits is therefore the unity of circulation and production; it includes both. Since the two phases M — C and C' — M' are acts of circulation, the circulation of capital is a part of the general circulation of commodities. But as functionally they are definite sections, stages in capital’s circuit, which pertains not only to the sphere of circulation but also to that of production, capital goes through its own circuit in the general circulation of commodities. The general circulation of commodities serves capital in the first stage as a means of assuming that shape in which it can perform the function of productive capital; in the second stage it serves to strip off the commodity-function in which capital cannot renew its circuit; at the same time it opens up to capital the possibility of separating its own circuit from the circulation of the surplus-value that accrued to it.” (p 60-61)

In other words, capitalist PRODUCTION is itself only possible on the basis of the circulation, i.e. exchange, of commodities. That is not true of previous modes of production. The peasant did not need there to be a market in order to produce, precisely because the aim of his production was his own consumption.

“M ... M' becomes a special form of the industrial capital circuit when newly active capital is first advanced in the form of money and then withdrawn in the same form, either in passing from one branch of industry to another or in retiring industrial capital from a business. This includes the functioning as capital of the surplus-value first advanced in the form of money, and becomes most evident when surplus-value functions in some other business than the one in which it originated. M ... M' may be the first circuit of a certain capital; it may be the last; it may be regarded as the form of the total social capital; it is the form of capital that is newly invested, either as capital recently accumulated in the form of money, or as some old capital which is entirely transformed into money for the purpose of transfer from one branch of industry to another.” (p 61)

This circuit can only continue on the basis of capitalist social relations, because the component parts of it – capitalist production, the existence of a class of wage labourers, who sell their labour-power as a commodity, and means of production themselves produced and sold as commodities, only exist under capitalism.

Back To Part 5

Back To Volume II Index

Osborne Converts To Socialism!!

In what appears to have been a Damascene conversion, George Osborne has apparently decided to make Welfare Socialism the basic principle of his economic policy. The change comes as a dramatic shift from his previous cuts in welfare spending.

A first use of this principle appears to be a proposal that flows from the use of the “cash for clunkers” scheme introduced several years ago to stimulate the car market. Under that scheme, the Government provided additional cash to encourage people to trade in their old banger, and buy a new car. The proposal is also similar to a recent development in the US. There, a new set of derivatives has been established that allow people to buy cars, they otherwise would not be able to afford, by obtaining sub-prime loans against them. The loans are then bundled up, with safer car loans, and then sold on to other banks and finance houses. The idea is that if, and probably when, some of these loans default, these sub-prime loans will be balanced out by the safer loans in the bundle. But, just in case they do not, the derivatives provide insurance from other finance houses, who will pay out in the event that too many loans default.

Osborne has extended this principle. As a means of stimulating car production and the economy a proposal is being considered to provide government underwriting of car loans. The idea is that lots of people have always wanted a car, but never been able to afford one, or even to save enough to put down a deposit for one. The Government plan is apparently to provide anyone who wants one with a 20% loan that they can use as a deposit on a new car. The ideology behind the scheme is pure welfarism. There are lots of things that people want that they can't afford, so the government is going to enable them to have them by guaranteeing their loans. Cars are a useful place to start because of the effect on the economy.

One 18 year old from Salford told reporters that he had passed his test last year, but couldn't afford a car. But, with the Government guaranteeing his loan, he had his eye on a nice silver Porsche Boxster, he said.

If the scheme is successful, its intended to extend it to a range of other things that people would like to have but can't afford, such as boats, Caribbean Cruises, and so on. The Government is also looking to use the idea to solve a series of other problems. For example, where people have bought houses in flood zones, and can't get insurance, the Government will now underwrite the risk, so the insurance companies will be free to take their premium, safe in the knowledge that their pay out will always be limited.

Asked about the potential for “moral hazard”, a spokesman at the Treasury commented, “Hazard shmazard. We've already printed so much money that you can use tenners as confetti, so printing a bit more money to cover all of these additional debts won't make any difference.”

But, an economist from Fathom Consulting said that the proposals were “Nuts!”

But, don't worry too much. Although, the US has seen the introduction of sub-prime car loans as described, the Government here is not really considering such underwriting of people's debts for cars etc. So far, they only have plans to do that for houses!

Capital II, Chapter 1 - Part 5

4) The Circuit as a Whole

The circuit of capital is M-C-M'. But, in reality, under capitalist production this circuit is interrupted after M-C, by P. The commodities bought in the first part of the circuit, M-C, (means of production and labour-power) are consumed in the production process, creating through it a new commodity. In reality, M becomes M' i.e. M plus an additional m, only because in the production process C has become C'. That is, this new commodity has greater value than the commodities that went to produce it. It has this additional value because of the surplus labour provided by workers during the production process.

“The circulation series therefore appears as 1) M — C1; 2) C'2— M', where in the second phase of the first commodity, C1, another commodity of greater value and different use-form, C'2, is substituted during the interruption caused by the functioning of P, the production of C' from the elements of C, the forms of existence of productive capital P.” (p 49)

This is different to the first time we encountered the circuit M-C-M' because there – the circuit of merchant capital – money buys a commodity, and this same commodity is then re-sold, but for a greater sum of money. In other words, the merchant made their profit not from the creation of surplus value, as the industrial capitalist does, but from unequal exchange. The merchant either buys the commodity (M-C) below its value, or sells it (C-M) above its value or both. This process of arbitrage – buying and selling in different markets to take advantage of price differences – is how Merchant Capital obtains its profit. Yet, as was seen in Volume I, for the system as a whole, this cannot be the source of profit. For everyone, who gains from an exchange, from such cheating, there is someone else who loses, by the same amount. In the end, profits can only be created for the system as a whole if an actual surplus is produced i.e. the total value of production must be greater than the total value of inputs used to produce it. All the various forms of exchange do then is to determine how the surplus is distributed.

This circuit of capital is also distinguished by the fact that in each of its stages, capital-value assumes different forms – money-capital, commodity-capital, productive-capital, commodity-capital, money-capital.

“The capital which assumes these forms in the course of its total circuit and then discards them and in each of them performs the function corresponding to the particular form, is industrial capital, industrial here in the sense it comprises every branch of industry run on a capitalist basis.” (p 50)

All of these three types of capital, therefore, have to be seen not as independent, but only as the forms of industrial capital assumed at successive stages of its circuit.

Marx then describes, on this basis, essentially the three forms in which a capitalist crisis can break out.

“Capital describes its circuit normally only so long as its various phases pass uninterruptedly into one another. If capital stops short in the first phase M — C, money-capital assumes the rigid form of a hoard; if it stops in the phase of production, the means of production lie without functioning on the one side, while labour-power remains unemployed on the other; and if capital stops short in the last phase C' — M', piles of unsold commodities accumulate and clog the flow of circulation.” (p 50)

But, capital necessarily is tied up in each of these stages, because it cannot move on to the next stage until it has assumed the necessary form. Money-capital has to buy the commodity-capital (MP and L) before that commodity capital can engage in production, and that production process must take place before the capital value can take the form of the new commodity-capital, and it must take that form before it can be sold.

But, we've seen that not all of the capital-value from one stage is passed on to the next. For example, if £1,000 is laid out for the purchase of a machine, which lasts for 10 years, then only 10% of this £1,000 (£100) is passed on each year as wear and tear into the value of the commodities it produces. So, only £100 of the value of the machine forms part of C' and, therefore, M'. In addition, we have seen that such machines suffer depreciation, and so their value diminishes and this value is not passed on at all into the value of the new commodities. It is a capital loss, which the capitalist must make good themselves, out of their own pocket, the same as if the machine had been stolen or destroyed in a fire.

For the former of these, all that is needed is to take as the production period the ten years of the life of the machine. Over that period, its full value will have been passed into C' and thereby recovered in M'. But, that is not so for the latter. Marx returns to how these instances modify the circuit of capital, later.

Marx then also deals with the situation of industrial capital that does not produce some material product. The example he gives is communication. For example, a railway transports people and goods, the Post Office transports letters and parcels. It is not some material commodity that is produced and consumed. What is consumed in a sense is the actual process of production itself. The production process is the act of transportation, and it is that which is consumed, whether directly by passengers, or indirectly by those whose goods, letters, parcels etc. are transported.

His initial formulation I think is badly worded. He says,

“In the general formula the product P is regarded as a material thing different from the elements of the productive capital, as an object existing apart from the process of production and having a use-form different from that of the elements of production. This is always the case when the result of the productive process assumes the form of a thing, even when a part of the product re-enters the resumed production as one of its elements. Grain for instance serves as seed for its own production, but the product consists only of grain and hence has a shape different from those of related elements such as labour-power, implements, fertiliser. But there are certain independent branches of industry in which the product of the productive process is not a new material product, is not a commodity.” (p 54)

But, a commodity does not have to be a material product, as Marx says elsewhere. For example, Marx gave in Volume I, the example of a schoolteacher, providing education as a commodity.

“If we may take an example from outside the sphere of production of material objects, a schoolmaster is a productive labourer when, in addition to belabouring the heads of his scholars, he works like a horse to enrich the school proprietor. That the latter has laid out his capital in a teaching factory, instead of in a sausage factory, does not alter the relation.”

Capital I, Chapter 16

Elsewhere in discussing productive and unproductive labour, he talks about the labour of an actor being productive, even though it produces no material product. Its understandable why Marx was not so clear on this point given the time he was writing. At that time services formed only a small portion of the total social product, whereas today they form its majority. Marx seems to have fallen into the same trap here in relation to services that the Physiocrats did in relation to industry. Marx's further elaboration demonstrates why services such as transport constitute commodities in their own right, and that elaboration makes clear that there is no basis for saying that what is sold is not a commodity. Its not clear then that Marx really wanted to say that what is produced is not a commodity, or whether he simply wanted to say that it is not a commodity in a material product form. Either way, his analysis of the role of transport, I think is not clear, and possibly not fully formed (remember Volume II is compiled, by Engels, from piles of assorted notes, not by Marx himself). That leads, I believe to an error later.

“But the exchange-value of this useful effect is determined, like that of any other commodity, by the value of the elements of production (labour-power and means of production) consumed in it plus the surplus-value created by the surplus-labour of the labourers employed in transportation. This useful effect also entertains the very same relations to consumption that other commodities do. If it is consumed individually its value disappears during its consumption; if it is consumed productively so as to constitute by itself a stage in the production of the commodities being transported, its value is transferred as an additional value to the commodity itself. The formula for the transport industry would therefore be M — C ... P — M', since it is the process of production itself that is paid for and consumed, not a product separate and distinct from it. Hence this formula has almost the same form as that of the production of precious metals, the only difference being that in this case M' represents the converted form of the useful effect created during the process of production, and not the bodily form of the gold or silver produced in this process and extruded from it.” (p 54)

Marx says this is essentially the same formula as for precious metals, but that was during a time when those precious metals acted as money. Today, the precious metals are sold as commodities in return for dollars as with any other products. But, what Marx’s formula here is significant for is the most important area of industrial capital in the modern world – the service industries. In these it is precisely again the production process itself that is most usually consumed. If as Marx says, the product is a “useful effect” then this product is a use value, in the terms, Marx previously defined it. A use value, that has exchange value, i.e. is the product of necessary social labour, undertaken for the purpose of sale is a commodity, whether it is a physical product or not.

“At first sight a commodity presented itself to us as a complex of two things – use value and exchange value.”

Capital I, Chapter 1

It is the performance by a comedian, actor, singer, footballer, musician, dancer and so on i.e. their production process that is consumed not some physical commodity arising from it. Even when those performances are captured on some form of medium, it is still the performance that is actually being consumed not the physical medium on which it has been captured. The same is true of the production process of a dentist, doctor, teacher, nurse, financial advisor and so on.

“Industrial capital is the only mode of existence of capital in which not only the appropriation of surplus-value, or surplus-product, but simultaneously its creation is a function of capital.” (p 57)

Back To Part 4

Forward To Part 6

The Great Property Market Conspiracy – A €55 Trillion Plus Problem! - Part 2

In recent days, Germany's Commerzbank has had to go to the markets to sell around €3.5 billion of additional shares to try to bolster its capital position. Its shares have already fallen by almost 40% over the last few months, and this share offering was put out, with a further discount of around 40%. But, the real fears surround Deutsche Bank. It is Germany's largest, private financial institution. The problem facing all of these banks now is not their speculative positions in gold, but their speculative positions in property! That applies at least as much to banks in France and Germany, and other Northern European economies, where a large rental sector means they have not suffered from house price bubbles, as it does to the southern periphery and UK, where they have.

In the UK, the latest casualty appears to be the Co-op Bank. It is not known for its recklessness and speculative activity, but a couple of years ago it merged with Britannia Building Society. The Britannia, like all other such institutions seems to have got carried away with the housing bubble. Just as years of falling gold prices led banks to believe that it was a forever one way bet, so years of rising house prices, as the bubble continued to inflate, seems to have convinced them that this was a one way bet too. Like the US mortgage lenders, like Northern Rock, and a multitude of other banks and financial institutions who thought they could lend out to people who might not pay back, because the value of the property, they were lending against, would always go up, so it seems, the Britannia has found itself with a lot of bad mortgage debt, on its books, debt the Co-op has now inherited.

But, these problems are dwarfed by the potential problems that could imminently manifest themselves amongst the bigger banks. The big UK banks, face the prospect that over 1 million people have borrowed from them, for property, but have no means of repaying the capital sum of their mortgages. Twenty or thirty years ago, that would be no problem. The bank would repossess the house, and invariably be able to sell it for more than the debt. But, today, outside London, house prices are falling by the week. Selling prices are around 30-40% below initial asking prices, and houses are staying unsold on the market for a year or more. Yet, even so, as unemployment rises, and real wages get hammered, even fewer people can afford to buy, and those who already have, hang on by their finger nails, only because of unsustainably low interest rates, and rising levels of other debt to cover their weekly spending. Osbourne's proposals will only worsen that situation, encouraging even more debt, but doing nothing to enable people to pay it back.

In fact, in Stoke, the Council has put up 35 houses for sale at just £1, and yet still couldn't get interest in eight of them!!! Under those conditions, its no wonder the banks are avoiding having to repossess properties, because to do so would mean not only that they would get back no monthly payments at all, but they would face having to sell these properties at prices way below the debt outstanding. That is if they could sell them at all!!! Instead the banks have engaged in a policy of “extend and pretend”.

But, as stated above, Deutsche Bank demonstrates the sheer scale of this problem, and why Governments and Central Banks are desperate to paper over the cracks, and stop the flood waters rushing in. German Banks, including Deutsche Bank, lent to other banks across Europe, including those in Greece, Ireland, Spain, Portugal and Italy. Those banks, in turn, engaged in a frenzy of reckless lending, to finance mortgages and to finance construction, that inflated a massive property bubble. In Ireland, that bubble burst and crashed the banks. Rather than let those foreign banks, finance houses, and investors pick up the tab, which is what Iceland did, Ireland, instead bailed out the banks with taxpayers money, thereby protecting all of those financiers and foreign banks. It then started to recoup that hole in its finances by massive cuts in state spending.

In Greece, a policy was adopted over several years, of letting those banks and finance houses get rid of their holdings of Greek debt, much of it bought up by the ECB and by the national central banks. One casualty of that seems to have been Cyprus, whose banks took a massive haircut on their Greek debt holdings. But, those European banks still hold vast amounts of debt in interlinked holdings that ultimately rests upon property that is effectively worthless across southern Europe, but which is still listed, on banks' balance sheets, at its bubble prices from several years ago. A good example is Spain where every month, now, banks hold “bank sales” of property, with villas being sold off for as little as €20,000. The prices of property in general in Spain has fallen by around 50% from the peak, so that on a like for like basis, you could buy a house on the Costa Blanca, away from the sea, for about a third of what it would cost in North Staffordshire. Yet, many analysts believe that Spanish property prices need to fall by another 50% from here. That would mean a 75% drop from their highs, to match what happened in the US and Ireland. The latest figures from the Bank of Spain show that banks bad loans ratio continued to rise last month, yet this official figure of nearly 11%, massively understates the real situation.

The bank stress tests were supposed to cover this, and the new Basle III regulations were supposed to ensure that banks increased their capital to ensure they could cope with such bad property loans. The Co-ops' downgrade, by Moody's, and its need to add capital, and Commerzbank's share sale, are part of that process. Yet, Commerzbank's need to offer its, already depressed, shares at a 40% discount, shows the problem banks face in raising this capital. Italian banks faced a similar problem in recent months, having to offer them at similarly huge discounts.

In fact, this is just one element of the development I have referred to recently of the fall in the supply of capital relative to demand. The banks are in this position for specific reasons. From the onset of the Long Wave Winter around 1986-7, the global rate of profit began to rise. From the onset of the new boom in 1999, that rise in the rate of profit was accompanied by a rise in the global volume of surplus value. More surplus value was produced than could be productively consumed. Huge corporations accumulated it as money hoards on their balance sheets. States in various parts of the world that ran huge trade surpluses, as a result of it, accumulated huge sovereign wealth funds – massive money hoards that sought a home across the global economy. This massive pressure of money in the money market, found a home as the provision of credit to governments and individuals in the west, and forced down global interest rates. Western central banks, were thereby able to print masses of money tokens, and extend credit without causing inflation, because the other side of this process was the huge volume of additional, cheap commodities pumped into those western economies from China and elsewhere, which soaked up the additional money. In fact, the additional money printing avoided what otherwise would have been an inevitable deflation of commodity prices. Instead, it inflated all those prices of things that could not be imported cheaply from China – houses, shares, bonds.

But, now the global long wave Spring has turned to Summer. The rate of profit, will begin to fall. Yet, global firms will continue to need to invest. In fact, the causes of the fall in the rate of profit may mean they need to invest even more, in an attempt to raise productivity and maintain or increase market share. The demand for capital will continue to rise, whilst the supply of capital will fall. The consequence will be a secular rise in global interest rates. Central Banks can print money tokens, and credit, but they cannot print capital. As soon as interest rates begin to rise, then as Mervyn King said a few days ago, asset prices will fall. But, under such conditions, they never fall in an orderly manner – they crash. Printing more money under such conditions will only raise inflation, and push nominal interest rates even higher.

The problem seems to be such that the European banks are engaging in various manoeuvres to hide the amount of debt they actually hold, so as to avoid having to obtain additional capital, or to reduce how much they have to obtain. One of these is once again to utilise derivatives. The banks argue that this is all fine, because these derivatives are hedged. In other words, they have insurance that, if any contract goes bad, some other financial institution will compensate them. The means by which that occurs are complex, such as holding one instrument that will rise in value if another falls etc.

But, this was precisely the problem that arose with the credit crunch in 2008. It is the problem with counter party risk. Nobody knows who is likely to go bust, who is likely to pay up, or who is able to pay on any of these contracts should the need arise. But, once some big event occurs, it becomes apparent that the Emperor has no clothes. A claims from B, who can't pay, because they have claimed from C and D who could not pay, who in turn had claimed from A, who couldn't pay, because they were waiting to be paid by B. And ultimately, none of them could pay, because they had themselves borrowed and lent huge sums of money, to people who could not pay them back, to buy property, that had no real value, that was anything approaching what it had been sold for, and which, in a fire sale, was reduced to prices even below what it might reasonably have been worth!

Its reported that Deutsche Bank's total global exposure to derivatives is €55 Trillion!!! To put that in perspective, Germany's annual GDP is only €3 Trillion. That is an exposure equal to 20 times German GDP. By contrast, the Cyprus Banks assets were 8 times annual GDP. Deutsche Banks exposure to these derivatives is on the same scale as the Luxembourg banks ratio of assets to GDP, and Luxembourg is likely to be one of the next economies to go the way of Cyprus.

The only thing preventing this house of cards from collapsing is the ability of governments and central banks to keep these property bubbles inflated. That is why they are engaged in such a massive conspiracy to portray property markets as stable. In Britain, the Government has plenty of reason to do that. On the one hand the property bubble here has been inflated for more than 30 years, and is well beyond the point where it should have burst. On past experience of such crashes in Britain, that would mean prices falling by around 75-80%. That would also be a fall on a similar scale to those seen elsewhere in the last few years, but less than the 90% fall that happened after 1997 in Japan. British banks are some of the most indebted and exposed to this property debt, but also to the debts of other banks across Europe. Moreover, the Government's natural support comes from those middle class pensioners whose property has inflated grotesquely since the 1960's when many of them bought it, and who are deluded into believing that it in some way makes them better off, rather than the truth, which is that higher house prices, like higher prices for any other commodity, only impoverish workers.

The wholesale collapse of those prices in Spain and other parts of Europe, let alone in Britain, has not happened yet, but, just as it did in the US and Ireland, it most certainly will. Whether that happens because some crisis sparks a run on the banks, or because interest rates rise, as the supply of capital falls relative to demand, or the run on the banks is sparked by a collapse in those house prices is only a question of what comes first the chicken or the egg.

Back To Part 1

The Great Property Market Conspiracy – A €55 Trillion Plus Problem! - Part 1

Its not just in Britain that the government, the banks, estate agents, the media, and the central bank are involved in a huge attempt to keep property prices high, to deny that selling prices are falling sharply and so on. Why is that happening? The answer is that it has nothing to do with protecting home owners, still less potential home buyers, both of whom lose out as house prices are artificially propped up. It has everything to do with trying to save the banks. Those banks are still massively in debt, and are once again trying to hide those debts using complex derivatives. One German Bank alone, as set out below, has exposure to global derivatives of €55 Trillion. That is almost 20 times the GDP of Germany, or more starkly, its more than the entire global GDP! These derivatives are being used to hide the extent of exposure to property debt; property debt that sits on banks balance sheets on the basis of hugely inflated property prices. If property prices fell to rational levels, the banks would be exposed as bankrupt, much as happened in the US, Ireland, Greece and Cyprus.

One of the latest economies that looks likely to suffer such a property bubble bust is Canada, whose central bank chief, Mark Carney, is about to take over as Governor of the Bank of England. Throughout, the financial meltdown of 2008, where property markets and other asset prices, in most other countries, at least halted their lemming like stampede, property prices in Canada continued to bubble up, driven on by the money printing pursued by Carney. Despite, being one of the most sparsely populated economies on the planet, Canada now has some of the most overpriced property on the planet. So much, for the argument that high house prices are caused by housing need, and overcrowding! Providing a glimpse in to the UK's future, one reason Canada's house prices were able to bubble up in this way, was the role of the state backed mortgage provider, CMHC, which performs the same function that Fannie May and Freddie Mac, do in the US. They perform the same function that Osborne's proposals for state backed mortgages are intended to perform here. These state backed organisations, did what Osborne hopes will happen here, they gave the support to ensure that Canada's banks would lend the money that was being printed by the central bank, out to all those people who otherwise no self-respecting bank would lend to.

On that basis just as happened with Northern Rock, and as happened with the US sub-prime crisis, which was then seen to have happened across every economy with a large non-rental sector, tens of thousands of people were lent money, who had no prospect of ever paying it back. The consequence for these latter we all know. It was two-fold. Firstly, it blew up a huge property bubble, and secondly, it ensured that thousands of ordinary people then could not afford to buy their first home, or to move up to a more expensive one. The end result necessarily followed. As soon as no more “bigger fools” could be found to buy the over priced houses, because, however, little they had to put down as deposit, however low the interest rates offered, they could not afford, the bubble burst. In a number of places, like Canada, the UK, and to an extent Spain, that has not yet happened. On the one hand, new buyers have more or less dried up, but huge intervention by the state, to prop up the banks, and enable them to avoid foreclosing on bad mortgages has delayed the inevitable consequences.

In Canada, over half of mortgages are now thought to be backed by CMHC. But, in addition, two other organisations, AIG, and Glenworth Financial, receive 90% backing from the state. In other words, nearly all of the C$1.1 trillion Canadian market, is backed by the state! Canadian house prices have risen by 123% since January 2000, and the average house price there is now 6 times earnings, whereas the historical average is around three. For two storey homes the Canadian average rises to seven.

The same trend applies to rental prices. According to The Economist, the ratio of rent to price is currently 78% higher than the long-term average. That compares with just 68% in Hong Kong, which is one of the world's most expensive places.

But, the inevitable cracks are beginning to show through. In Toronto, sales are already down 40% compared with a year ago. The government has attempted to engineer a soft landing. It has introduced various measures, such as requiring a 20% deposit. But, that has just led to people finding ways around the restrictions, such as splitting up their loans. According to one brokerage, half of all outstanding mortgages are “high risk.” This is the solution that Osbourne wants to bring to Britain. But, past experience suggests that this conspiracy will only delay the inevitable.

Between 1999 and 2002, Gordon Brown, as Chancellor of the Exchequer, sold nearly 400 tonnes of Britain's gold reserves. At the time, it was obvious that the price of gold had hit rock bottom, and was starting to rise. Brown sold the gold at prices between, $256 and $296 an ounce. The low price for gold came in 1999, at $250 an ounce, and from 1999, gold, like other metals and raw materials, saw its price rise relentlessly, as the new global, long wave boom got under way. By September 2011, gold had hit its peak of $1943 an ounce, or almost 7 times the average price Brown had sold it for. The Liberal-Tories have liked to portray this as just an example of Brown's economic incompetence. It was far from that. In fact, Thomas Pascoe argued, in this Daily Telegraph article last year, that it was part of a necessary conspiracy to protect the banks, whose speculative activities were already threatening to throw the world financial system into chaos, at that time, a chaos that erupted anyway, in 2008, and from which we are still suffering today.

I was aware of the rumours of such a conspiracy, back in 2000, and decided to make it a part of the novel, that I was writing at the time - See Chapter 1 Here - about the manipulation of markets for revolutionary purposes. But, the rumour, at the time, was not just that this was Gordon Brown that was involved in such a conspiracy, rather that it was central banks and governments in a number of major economies, including the US. The basis of the rumours was, as Pascoe sets out, that a number of very large banks had made big, short bets against gold, bets that were going bad, as the price of gold began to soar. Because many of these short bets are undertaken using leverage, i.e. the bank or other speculator borrows huge amounts of money to finance the trade, in the expectation that they can close out their position at a profit, before they need to make good on their margin call, a number of these banks were threatened with bankruptcy.

Two things were at play here. Firstly, there is the effect of leverage. Suppose I come to buy $1 billion of shares in Apple. In fact, I can buy these shares for just $100 million on margin. I basically put down 10% of the cost to buy the shares, borrowing the other 90%, which I only have to make up when I get the margin call some time later. If Apple shares rise by 1%, I sell my now $1.01 billion worth, pocket the $10 million gain, and have the rest to pay off the margin call. Great if the shares go up, not so great if they fall. But, secondly, there is the problem of shorting. Suppose, I buy that $1 billion of Apple shares, and they go bust. Nasty, I've lost my $1 billion, but if you are a bank or multi-billionaire you can survive. However, suppose I short Apple stock. That means I think their share price will fall. So, I sell Apple shares, I do not actually own, in the expectation that, at some point in the future, before I actually have to transfer ownership of those shares, I can buy the shares needed, at a lower price than I've sold them for. The problem here is its the same as spread betting. There is no limit to how much I can lose. If the value of Apple shares, rather than falling, goes up, I make a loss, and although a share price can only fall to zero, there is no limit to how high it can go.

This was the problem these banks faced with gold. For years, after 1980, the price of gold had gone in only one direction – down. The general view of financial analysts was that gold was an historical relic. Unlike even silver, it had few industrial uses. It was used for jewellery, and not much else. Global trade was financed now by dollars not gold. Unlike shares, or bonds, or even a cash deposit, gold paid no dividend or interest. Therefore, if you were going to hold it, it could only be if its value was going to rise to give you capital gain, but given the aforesaid, why would it. No wonder its price had kept falling for 20 years. It was a one way bet, and speculators love one way bets. It is what provides the basis of the kind of carry trade that Pascoe describes.

So, it is not surprising that these banks had exposed themselves, to such a massive degree, in short gold positions. Remember that this is not long after Long Term Capital Management, in the United States, had gone bust, and had to be bailed out, by other banks, to the tune of $3.6 billion. It too was supposed to have developed an infallible algorithm for making money. It was also not long after the Asian Currency Crisis, and the Rouble Crisis, and slap bang in the middle of this process came the Stock Market crash of 2000, that wiped 75% off the value of the NASDAQ index. Just before that crash, as happens now with property, there were no end of analysts, newspaper column writers and others, who claimed that the market could only ever go up, because this time it was different from every other bubble!

No wonder governments and central banks were worried. No wonder they decided to engage in some market manipulation, to ensure the banks did not go down. In fact, such manipulation and intervention is nothing new. In Hong Kong, the state has for many years directly intervened in both the stock and bond markets, buying shares when the stock market looked like it was going to fall sharply. The US Federal Reserve and Treasury deny that they do the same, and its probably illegal for them to do so, but many rumours abound that they do on a regular basis, coming in at the end of the trading day, when they can have most effect, for example. And, in the last few years, there has been no doubt that the US Federal Reserve and Bank of England, as well as other Central Banks have directly intervened in the market. That is what Quantitative Easing is. In fact, the Bank of England, and Federal Reserve, have intervened so much, that both own around 30% of the total debt, issued by their respective governments, and buy up around half of the newly issued debt.

What does this have to do with the conspiracy in the property market? Only that it sets out that such conspiracies are, in fact, quite common, and sometimes undertaken in plain sight. The common theme is protection of the banks themselves, almost at whatever cost to the rest of society, who always end up picking up the tab for the bail-out. Witness, Greece, Ireland, Portugal, Cyprus and coming soon Malta, Slovenia, Luxembourg, Spain, Italy, the UK and possibly France and Germany too.

The experience of Cyprus was perhaps most illuminating. It is literally only months ago that Europe's banks were “stress tested” to see if they could withstand some unforeseen shock. The first of those stress tests, three years ago, were widely seen as a sham. The last stress tests were, we were told, more rigorous. Yet, that didn't stop some of those banks, across Europe, failing. And the banks in Cyprus were given a clean bill of health. In fact, a couple of years ago, the IMF was commending Cyprus for its economic model! Yet, the Cypriot banks went bust, and not only Cypriot taxpayers, but also the depositors, in those banks, are the people who have been handed the bill. Looking at the situation of banks in those other economies listed above, including Germany, the situation does not look any better.

Forward To Part 2

Northern Soul Classics - You Ought To Be In Heaven - The Impressions

Brilliant classic from Curtis Mayfield, Gene Chandler and Jerry Butler.