Ever since the Budget the media have been talking about how the huge amounts of borrowing are going to be paid for. The borrowing is certainly big and total debt even according to the Government is set to rise to around 80% of GDP by 2013. See: Budget . As I wrote last year, borrowing is not an alternative to taxation; it just means deferring the taxation to some point in the future when Governments think the economy can better pay for it.
In my blog, 1929 And All That I wrote,
“Compare that (the fact that European Governments tried to balance the budget during the long Depression that ran from the 1920’s until WWII) with the post-war period. As Mandel recounts in “The Second Slump”, there were a number of recessions during the post-war boom of 1949 – 74. Each was cut short compared to previous periods as a result of Keynesian intervention. How explain this? Keynesian intervention requires state spending. The state can only spend if it taxes. Borrowing does not change this, it merely defers that taxation to some future date when the borrowing has to be repaid. But, Marx tells us that taxes are a deduction from Surplus Value. If the state intervenes by spending it does so by – at least in the short term – making the bosses pay to resolve their crisis. It may do so for a number of reasons. Firstly, it may feel that it has to do so to buy off a revolutionary upsurge. A left Social democratic regime can be its best option before having to resort to fascism. Secondly, as with the US in the New Deal, or as in the post-war boom period – and now – such intervention can be a lesser evil than risking undermining faith in the bourgeois regime and bourgeois ideology through a prolonged or severe crisis. If it is a matter of a recession within the context of a period of prolonged growth then once the crisis is over reforms can be clawed back, profits restored, state intervention rolled back. This after all is the basis of Keynesianism. It assumes that over the longer term the intervention is cost free because the increased economic activity utilising unused resources provides the basis of the higher tax revenues that pay back the previous deductions from surplus value.
That was not the case for most of Europe in the 1930’s. It was not true in the 1970’s – 90’s.”
This, essentially is the argument Alistair Darling has set out. He says, we have to intervene now, but in a couple of years time, when the economy has recovered to, he suggests 3.5% growth, then we will be able to claw back what has been spent. But, its being suggested that this clawing back will have to be of a significant scale amounting to real cuts in Public Spending. Darling, has not said so himself. Whether it does or not depends upon how you view the prospects of economic growth in the years ahead.
My own view is that it may not. I think Darling is playing politics. The way he has structured the Budget puts the Tories in a difficult position. I think the path from here is fairly clear, and it is a path trodden many times before in history under similar conditions. Governments have frequently built up huge amounts of debt as a result of borrowing for various reasons – usually to fight some war or other, and they have usually ended up screwing the people from whom they borrowed the money. That is one reason that there is some unease in the Bond Markets. Yet that unease is not yet that marked, and I think for good reason.
In previous centuries, when money came in the form of Gold or Silver coinage, Government’s used to get around the problem by debasing the currency. Indeed, others used to engage in the same tactic by “clipping”, the coins – nibbling small amounts from the edge of the coins, which they could then accumulate as hoards of gold or silver. Government’s used to simply not so much precious metal into the coins. Those who received the coins took time to realise that they were being shortchanged, and so prices only adjusted after a bit of a time-lag. But, eventually they did adjust, and the economy suffered an inflation. But, the nominal amount of the Government’s debt remained the same, so its real value dropped as a result of that inflation, prices rose, so did its taxes!
The US has used a similar method ever since the dollar has performed the role of reserve world currency, printing dollars with which to pay its foreign creditors. It was the fact that “clipped” or debased coins continued to circulate for a while at their full value that eventually led to the realisation that currency did not need to be made up of these precious metals in order to function, because this currency only acted as a token for money, PROVIDED THAT, the amount of these tokens was restricted to the amount equivalent to the money on whose behalf they acted as representative.
Marx explains the process in his “Contribution to a Critique of Political Economy”
He writes,
“But the gold coin gave rise first to metallic and then to paper substitutes only because it continued to function as a coin despite the loss of metal it incurred. It circulated not because it was worn, but it was worn to a symbol because it continued to circulate. Only in so far as in the process of circulation gold currency becomes a mere token of its own value can mere tokens of value be substituted for it…
“The number of pieces of paper is thus determined by the quantity of gold currency which they represent in circulation, and as they are tokens of value only in so far as they take the place of gold currency, their value is simply determined by their quantity. Whereas, therefore, the quantity of gold in circulation depends on the prices of commodities, the value of the paper in circulation, on the other hand, depends solely on its own quantity.
The intervention of the State which issues paper money with a legal rate of exchange -- and we speak only of this type of paper money -- seems to invalidate the economic law. The State, whose mint price merely provided a definite weight of gold with a name and whose mint merely imprinted its stamp on gold, seems now to transform paper into gold by the magic of its imprint. Because the pieces of paper have a legal rate of exchange, it is impossible to prevent the State from thrusting any arbitrarily chosen number of them into circulation and to imprint them at will with any monetary denomination such as £1, £5, or £20. Once the notes are in circulation it is impossible to drive them out, for the frontiers of the country limit their movement, on the one hand, and on the other hand they lose all value, both use-value and exchange-value, outside the sphere of circulation. Apart from their function they are useless scraps of paper. But this power of the State is mere illusion. It may throw any number of paper notes of any denomination into circulation but its control ceases with this mechanical act. As soon as the token of value or paper money enters the sphere of circulation it is subject to the inherent laws of this sphere.
Let us assume that £14 million is the amount of gold required for the circulation of commodities and that the State throws 210 million notes each called £1 into circulation: these 210 million would then stand for a total of gold worth £14 million. The effect would be the same as if the notes issued by the State were to represent a metal whose value was one-fifteenth that of gold or that each note was intended to represent one-fifteenth of the previous weight of gold. This would have changed nothing but the nomenclature of the standard of prices, which is of course purely conventional, quite irrespective of whether it was brought about directly by a change in the monetary standard or indirectly by an increase in the number of paper notes issued in accordance with a new lower standard. As the name pound sterling would now indicate one-fifteenth of the previous quantity of gold, all commodity-prices would be fifteen times higher and 210 million pound notes would now be indeed just as necessary as 14 million had previously been. The decrease in the quantity of gold which each individual token of value represented would be proportional to the increased aggregate value of these tokens. The rise of prices would be merely a reaction of the process of circulation, which forcibly placed the tokens of value on a par with the quantity of gold which they are supposed to replace in the sphere of circulation.
“The rise or fall of commodity-prices corresponding to an increase or decrease in the volume of paper notes -- the latter where paper notes are the sole medium of circulation -- is accordingly merely a forcible assertion by the process of circulation of a law which was mechanically infringed by extraneous action; i.e., the law that the quantity of gold in circulation is determined by the prices of commodities and the volume of tokens of value in circulation is determined by the amount of gold currency which they replace in circulation. The circulation process will, on the other hand, absorb or as it were digest any number of paper notes, since, irrespective of the gold title borne by the token of value when entering circulation, it is compressed to a token of the quantity of gold which could circulate instead.
In the circulation of tokens of value all the laws governing the circulation of real money seem to be reversed and turned upside down. Gold circulates because it has value, whereas paper has value because it circulates. If the exchange-value of commodities is given, the quantity of gold in circulation depends on its value, whereas the value of paper tokens depends on the number of tokens in circulation. The amount of gold in circulation increases or decreases with the rise or fall of commodity-prices, whereas commodity-prices seem to rise or fall with the changing amount of paper in circulation. The circulation of commodities can absorb only a certain quantity of gold currency, the alternating contraction and expansion of the volume of money in circulation manifesting itself accordingly as an inevitable law, whereas any amount of paper money seems to be absorbed by circulation.”
In fact, the Government is already in the process of this. Its called Quantitative Easing, which really just means the Government, through the Bank of England, prints money, and then uses this money to buy back Government Bonds from banks, or to buy Commercial Bonds from Companies, thereby putting more of these money tokens into the economy, in the way Marx describes above. This also explains why although the Bond Markets are uneasy, they are not THAT uneasy.
A few weeks ago, the head of the world’s largest Bond Fund, Bill Gross of PIMCO, said that his tactic was simple – “Buy what the Government is buying, but buy it first!” The logic is straightforward. The Government is going to buy back a load of Government Bonds. The extra demand will then necessarily push up the price of those Bonds. Gross, by buying those Bonds first, makes a large profit when the price then rises! Both the US and UK Governments have another reason for buying back these Bonds, as well as pushing money into the economy. The Bonds they will buy back will be those at the Long End of the Curve – that is they will by back those due to mature in say 30 years time. Because, the interest rate or yield on a Bond is inversely related to the price of the Bond, by buying these Long Bonds, and pushing up the price, the result is to lower long term interest rates. And it is on these Long Term Interest Rates that Mortgage Rates are based!
By pushing them down, they also help to create the increase in demand for housing that both Government’s see as a fundamental aspect of bringing about a recovery in Consumer spending. This explains why the Bond market is not THAT uneasy at the moment. Bond Markets only get really worried if they think that the people to whom they have lent money are going to default. But, a country like Britain that controls its own money supply has no need to default, because it can always print more of its own money! That is not true of countries like Ireland or Spain, because they do not control the printing of Euros. But, its unlikely that the EU would let any of these countries default either.
So, we have Government demand pushing up the price of existing Long Bonds, and thereby reducing Long term interest rates that reduces mortgage rates, that encourages more house-buying, that stabilises house prices, that stimulates consumer confidence and consumer spending. The extra money put into circulation as a result of the Government printing money, monetises this extra demand, leading to higher prices. Higher prices, along with the corresponding higher profits and wages, means also higher tax revenues, which means that what appeared originally as a huge Budget Deficit, becomes after 3 or 4 years of 20% inflation, not so huge after all.
A similar thing happened in the 1960’s, which is why so many people who bought new houses in 1960, did extremely well, because the £2,000 mortgage they had on their new detached house within a matter of a few years was, in real terms, only a fraction of that, as wages rose rapidly. The people who lose out are always the people who lent the money, because they get paid back in worthless paper. But, that is also where the current buy-backs of Bonds come in, because they also enable the main holders of those Bonds, to sell them now at high prices, making substantial Capital Gains. When in 2 or 3 years time the resultant inflation from the printing of money materialises, interest rates will rise. In order for Governments to persuade anyone to buy their Bonds at that point they will have to offer high rates of interest to compensate for the losses due to inflation! So, all of those big players will be able to come back in and buy Bonds to replace the ones they are currently selling back to the Government, but will do so at a fraction of their current prices!
So, it may not be that the government introduces swingeing cuts in Public Expenditure. More likely, it will make nominal increases that amount to cuts in real terms as inflation rises rapidly. Its huge debt could be halved within a matter of only 3 years if inflation ran at 20% during that time! And, if the economy did resume real growth, and not just growth in nominal terms due to inflation, then that Keynesian trick of paying back debt, by higher tax revenues from the increased economic activity would have worked. The cost then would be much higher interest rates in 3,4, or 5 years time.
But, that is where Darling is able to play politics. By pursuing the current course he is able to attempt to spend the way out of the current recession without the need for tax rises or spending cuts. He can do that for the next two years. But next year, the Tories might win the election. So, he will not say now, “We intend to bury the deficit through high inflation”, because that would be unpopular, and would mean all those people currently being encouraged to save at 1% interest rates into ISA’s would say, “No, thanks.” But, it will leave that problem either for him to address should Labour win the next election, or for the Tories to come in and cut spending as their preferred option.
If, you believe that the current recession actually spells the end of the long period of expansion of the economy over the last ten years, then that latter option is the only one you can choose for the reasons I set out in my blog “1929 And All That”. But, as I have set out previously, I believe that the current recession is merely a blip in a 20-30 year Long Wave upturn that began in 1999. ON that basis, I think that, the likely path will be that of inflation, and what Schumpeter and Mises called “forced saving”, that is the inflation causes prices to rise faster than wages, so profits rise, and that will provide a fund from which the taxes needed to pay back the rest of the borrowing will come. The reason for that is also that if this period IS a period of continued Long Wave expansion, then the kind of increases in workers confidence and militancy that began to be demonstrated last year, and which always accompany this phase of the Long Wave expansion would mean that Government’s would want as much as possible to avoid conflicts with workers moving on to the offensive. They do so, because the evidence from similar periods in the past, for example in the period up to the end of the Long Wave boom that ended between 1914-20, and that which ended in 1974, is that not only do workers more frequently win during such struggles, but they are also during them far more quickly radicalised.
As I said, last year, the strategy for Capital will still remain to try to save the system without provoking such social conflict.
Boffy,
ReplyDeleteThanks for the comment on my blog in respect of this. If I've understood correctly, you seem to be making two distinct points, one, about the likelihood of inflation, which I think is tactical and empirically testable and another, because it is concerned with Long Waves and the general characterisation of the age we're in, is perhaps less so.
I think it is without question that the policy of Quantitative Easing is intended to be (mildly) inflationary, or at least act as a counter to the deflationary pressures in the system by boosting gross demand in a fairly classic Keynesian manner. Such mild inflation will, of course, also help gradually take the edge off the severely toxic debts held by the banks(& partly nationalised), at least at the margins. Deflation would increase real indebtedness I'm told.
At this point, I freely confess to closing in on the edge of my personal knowledge - I'm no economist. But I do note that people I respect tend to think that deflation remains more of a threat than the kind of 1970s level inflation (20%) you refer to so QE won't lead to anything other than the wider usage of resources than would otherwise be the case. But the right-wing, Austrian/ monetarist influenced bloggers think there is a direct linkage, similar to the sort you outline from Marx, between money supply and inflation. On the other hand, I'm impressed by Duncan'shttp://tinyurl.com/dcjjo4 Left Keynesian (he'd say post-Keynesian) explanation of why this isn't so,
"A monetarist would argue that if we double money supply then we simply double prices and have no real change on economic activity. I’d argue that if we double prices, we typically don’t double debt and so the debt burden on consumers and corporates is reduced in terms of spending power available after debt payments and economic activity will shift as a result. Similarly if prices move down, and debt stays constant in nominal terms, then spending power – and hence effective demand, is reduced. This is what worries me about the prospect of deflation – we step outside the typical bounds of the business cycle and face disaster.
I’d argue further that money supply in and of itself is not the crucial variable – the crucial variable is credit, i.e. lending. It is lending that drives economic activity not money."
But, as I say, which theory is more in touch with the real world is likely to emerge in the next couple of years - either we have very significant inflation or we don't.
The degree and harshness of the cuts will depend, in the short term, on whether you or I are right about the inflation rate, and partly about how far QE avoids a deflationary spiral. Keynesian counter-cyclical spending is just deferred taxation, I agree - its' claimed virtue is that it ensures that more resources are being used productively, so there is more to tax.In the longer term, the 'shape' of this recession (@'V' or @'U' or even a Japan-like 'L' etc) will clearly be influenced by where we might be in terms of any Long Wave. As I'm sure you know, it's not just marxists who have (re)discovered them - I quote Carlota Perez in this blog post(http://tinyurl.com/dn3spv). But I also contrast her view with those of the Monthly Review people, whose latest publication I reviewed here. http://tinyurl.com/cxj7qp. Given I'm no economist- though it must be obvious I'm trying to educate myself in the subject - all I can say is that these two contributions form the 'field of debate' on this matter as I currently understand it.
“Thanks for the comment on my blog in respect of this. If I've understood correctly, you seem to be making two distinct points, one, about the likelihood of inflation, which I think is tactical and empirically testable and another, because it is concerned with Long Waves and the general characterisation of the age we're in, is perhaps less so.”
ReplyDeleteYes, but I think both are testable, and in fact I think the latter is grounded in objective conditions, whereas the former is to a degree purely a matter of decisions taken by the Authorities.
”I think it is without question that the policy of Quantitative Easing is intended to be (mildly) inflationary, or at least act as a counter to the deflationary pressures in the system by boosting gross demand in a fairly classic Keynesian manner.”
Actually, this is not quite correct. Keynesian Demand Management is really about the Government spending more than it receives in income. It makes up the difference by borrowing money. I’ll produce a graph demonstrating the Keynesian argument at some point. Basically, Keynes argument is this. Income = Expenditure. Everything that is spent becomes someone else’s income. Marxists would actually challenge this view, but let’s run with it. So, if you know what the average income is, then for any level of national Income, you can calculate total employment. Unemployment will arise if National Income falls below the necessary figure. Now, Expenditure is made up of Consumer Spending, plus Investment Spending by firms (leave out Exports and Imports). So, if this figure (known as Aggregate Demand) falls – say because Consumers stop spending and start saving – then, unless firms use this saving to spend on Investment – which they might, but if consumer’s are cutting back why would firms invest? – unemployment will result. Neo-classical economics says the unemployment will cause workers to take lower wages, firms will charge lower prices, interest rates will fall and so on until the market clears. The 1930’s showed that argument was bogus. If wages fall, then consumer demand falls further, and investment falls further with it. As Marx says, AT SOME POINT, the crisis will end, because, at some point people have to spend, businesses have to replace equipment. But, a lot of Capital can be destroyed in the process, and a lot of peoples’ lives ruined.
So, Keynes argued that where aggregate demand fell in such a manner the Government comes in and makes up the difference. The problem is as some economists argued in the 1980’s – I think correctly – if in fact, there is an insufficient pool of surplus value out of which the Government can borrow, then at some point this borrowing by the Government, will “crowd out” borrowing by private investment. In other words the Government demand for funds will compete with private demand, thereby pushing up interest rates, and cutting back private investment leading to a curtailment in productive activity.
In fact, the idea of Monetary Easing is the Monetarist rather than Keynesian solution. It is where the Monetarists and the Austrians disagree. The Austrians basically say the depression was caused by too loose a monetary policy in the 1920’s, causing a Crack Up Boom, that is always followed by a bust. Milton Friedman in his analysis of the Depression argued that it was caused by TOO TIGHT a Monetary policy, and that if Central Banks had cut rates and printed money in 1929 it could have been averted or been lessened.
I don’t think that the Monetary Easing is intended to create mild inflation. Its intended a) to put money into the system now for the reasons that Friedman set out, but b) because of the reason you set out later – that its no good just printing money you have to get people to borrow and spend it, what Keynes called the problem of pushing on a string – Government’s have had to engage also in that Keynesian Demand Management as well, and the unprecedented borrowing that results means that they have to either a) claw it back in tax rises/spending cuts, or b) inflate it away. Millenia of experience shows that Governments choose to inflate it away.
I think the deflation argument is a non-starter. As I said in another recent blog if you look at the recent UK Price figures the RPI “deflation” was a statistical fluke. The more meaningful CPI figure showed Prices still considerably above the Government target! And that in the midst of the worst credit crunch in history, and a sharp downturn in economic activity with firms trying to clear inventories!
“Such mild inflation will, of course, also help gradually take the edge off the severely toxic debts held by the banks(& partly nationalised), at least at the margins. Deflation would increase real indebtedness I'm told.”
That is correct.
"A monetarist would argue that if we double money supply then we simply double prices and have no real change on economic activity.”
This isn’t correct, for the reasons I outlined above. Friedman argued precisely the case that by increasing Money Supply in 1929, it would have led to increased economic activity. The question is not so simple as just will increasing Money Supply raise prices. The Monetarist argument is not really much different than that given by Marx. Marx provides the formula that the amount of money needed to ensure commodities circulate is M xV = C x P, where M is the value of money (he was talking about Gold) V is the velocity of its circulation (so for example, a £1 coin might actually serve to exchange £100 worth of commodities if it was used 100 times during a year), C is the total number of commodities to be circulated, and P is the average price per unit of those commodities.
So, it clear that when you are using Gold, whose value is determined by its price of production, changes in others of these variables can result in widely different prices. If the velocity of circulation rises less money is required to circulate a given total value of commodities. Similarly, if the total volume of commodities rises, and their prices remain constant, then a greater amount of money is required to circulate them, and so on.
Now, the Monetarist argument is precisely that if there are unused resources, and you increase Money Supply, then if this results in increased economic activity then those unused resources will be used, and the total number of commodities circulated will rise to absorb that additional Money. As I’ve written elsewhere that is precisely what has happened over the last 20 years. Huge amounts of Money was pumped into economies. If not then we would have seen deflation. IN real terms we have had deflation over the last 20 years. Look at the prices of loads of stuff, from PC’s to Cheap Suits! The extra money was soaked up by vast amounts of EXTRA commodities produced in China at LOWER prices. The rest went into speculation on houses and share prices etc.
My point is, and this is where the Long Wave comes in. We had deflation during that period BECAUSE we were in a Long Wave downturn. Now we are not. Prices of basic materials, and foodstuffs have soared since 1999. Gold has soared too just as it did in the 1950’s at a similar conjuncture. China, even though it has huge resources in its reserve army in the countryside, began to run up against capacity constraints, and against those rising import prices for food and raw materials. It also needed to increase the value of its currency to offset those rising import prices, and the potential for inflation arising from its ballooning trade surpluses. China was suffering rising inflation last year. So, my point is that if this crisis is soon over – and every day we see new stats showing that it nearly is – that continuing rise in economic activity will see that increased money supply unable to mobilise the necessary resources to increase output of commodities rapidly enough, and inflation will necessarily ensue.
“I’d argue that if we double prices, we typically don’t double debt and so the debt burden on consumers and corporates is reduced in terms of spending power available after debt payments and economic activity will shift as a result.”
I agree. That’s why I think that is the tactic they will choose. But, longer term it means higher interest rates, which will also impact on consumers encouraged to take out mortgages etc.
“Similarly if prices move down, and debt stays constant in nominal terms, then spending power – and hence effective demand, is reduced. This is what worries me about the prospect of deflation – we step outside the typical bounds of the business cycle and face disaster.”
Again I agree, but I see no likelihood of deflation.
”I’d argue further that money supply in and of itself is not the crucial variable – the crucial variable is credit, i.e. lending. It is lending that drives economic activity not money."
That is true to an extent, but credit really functions as Money. Without Money there can be no Credit. But, its right as stated earlier that you can be “pushing on a string” if you print money, but can’t get anyone to use it. That is why we have unprecedented levels of Government Spending and Borrowing, because the Government CAN act to spend that money.
But, as I say, which theory is more in touch with the real world is likely to emerge in the next couple of years - either we have very significant inflation or we don't.
”The degree and harshness of the cuts will depend, in the short term, on whether you or I are right about the inflation rate, and partly about how far QE avoids a deflationary spiral. Keynesian counter-cyclical spending is just deferred taxation, I agree - its' claimed virtue is that it ensures that more resources are being used productively, so there is more to tax.In the longer term, the 'shape' of this recession (@'V' or @'U' or even a Japan-like 'L' etc) will clearly be influenced by where we might be in terms of any Long Wave. As I'm sure you know, it's not just marxists who have (re)discovered them - I quote Carlota Perez in this blog post(http://tinyurl.com/dn3spv). But I also contrast her view with those of the Monthly Review people, whose latest publication I reviewed here. http://tinyurl.com/cxj7qp. Given I'm no economist- though it must be obvious I'm trying to educate myself in the subject - all I can say is that these two contributions form the 'field of debate' on this matter as I currently understand it.”
As I’ve stated in my blog on Kondratieff’s Long Waves, I think there is no doubt that such a phenomenon exists, and I think it is quite easy to detect the periods and duration of these waves in general terms. I think the strength of the data showing the rise of the Long Wave from the late 90’s is pretty incontrovertible – some of the Austrians, who 25 years ago rejected the idea of the Long Wave e.g. Murray Rothbard – now want to argue that a down wave started in 99/2000, but that is absurd, the dates simply don’t tie up, and they base their argument not on the economy but on the Stock Market, besides which their position is highly ideologically driven – and its for that reason that this recession though deep, will be short, and the subsequent recovery powerful. I see, the measures now being taken in relation to GM, as part of that process of the necessary re-allocation of Capital away from unproductive, unprofitable areas, to the areas where that Capital will make a very high rate of profit, and stimulate further dynamic levels of growth.
I think, as soon as the end of this year we will begin to see that. As for the inflation, yes you are right, probably it will be the middle of 2010. If I’m right, don’t have any savings in the bank, but buy some Gold or other assets that will increase with the inflation.