Saturday, 18 December 2010

Cuts, Inflation And Interest Rates - Part 4

In my post, Why QEII is Sunk, I argued that while QE had been an effective tool to bring the Credit Crunch to an end, it could not act to end an economic downturn. Where economic activity is robust, but there is simply a shortage of currency, it is fine, but under conditions where economic activity is in decline then as Keynes pointed out, it is like “pushing on a string”. QE could only work in conjunction with fiscal stimulus to achieve that end. At the time I wrote that blog, the chances of further fiscal stimulus in the US looked remote. Republicans were attacking the democrats for the deficit, and their Right was flanked by the Tea Party whose brand of right-wing populism mimicked that of the Tories in Britain. But as Harold Wilson said, a week is a long time in politics. In fact, now we have a 2 trillion dollar stimulus package put through Congress with the support of the Republicans, and with much of the opposition coming from the Democrats, because the package continues Bush era Tax Cuts for those earning over $250,000 a year.

But, in a sense its no wonder the Republicans supported this package. The reality is that the US Fiscal Stimulus is showing clear signs of working, whereas the European austerity measures are having the opposite effect. At the beginning of this week, there were signs that the “Bond Vigilantes” may have made an appearance sending the yield on US 10 year Treasury Bonds up by 24%. Even then it wasn't clear whether this was in response to what was seen as fiscal irresponsibility, or rather the fact that the measures were working, economic activity was picking up, and with it the likelihood that down the road inflation would rise. Either way, by the end of the week US Bond Yields had fallen back again to where they began. It could hardly be otherwise given QE, because one of its effects is that so long as the federal Reserve is prepared to keep printing money with which to buy Bonds, demand for them can always be made to equal or exceed Supply, thereby pushing up their price. Bond traders are smart enough to know never to get on the wrong side of what is a guaranteed one way bet.

Of course, down the road, the consequence of this policy WILL be that inflation will rise. But, as I pointed out in my blog Paying For The Crisis, that has always been the way Governments down the millennia have paid for their debts, by debasing the currency. That is what QE is, its printing money with which to pay your creditors, and because there is more of it, each unit of it becomes worth less, as Marx put it each piece of paper is reduced to becoming a token of a smaller amount of the money commodity for which it stands. As inflation rises the initial debt becomes devalued. The original debt remains measured in the money at the time it was incurred, but as inflation rises, the nominal values of prices of goods and incomes increases, and alongside that nominal increase goes a nominal increase in the Taxes received by the Government, which are used to pay the interest on the debt. As inflation rises the values of Bonds falls, and the interest rates demanded for future loans rises, but as I showed in that blog, with much of this lending being done by Big money Capital institutions, and indeed by Pension Funds, who need to have a high income stream over the longer term, to cover their future Pension commitments, this is not in any way a negative for Capital. Moreover, as the experience of Japan has shown in a deflation even zero interest rates are positive in real terms. Similarly, in periods of high inflation, even high interest rates can be negative. If I want to buy something that costs £1,000, and have to pay interest of 10% to buy it now rather than in a year's time, it will in fact cost me £1100 including the interest. But, if inflation is running at 20%, then waiting a year instead would have seen its price rise to £1200 leaving me £100 worse off than if I'd borrowed the money.

As I've pointed out before, the US is a different economy to the UK. It is very large and able to source much of its needs from within side its boundaries. The problem it is facing at the moment is not inflation but deflation. But, the UK is dependent on trade, and on imports. At a time when the countries from which we buy many of these things are raising their prices, and when the pound is falling in value, the UK is effectively importing inflation. The QE that the Bank of England has carried out, at a time now of fiscal restraint, is going not to cover those Government debts, or to stimulate economic activity, but is essentially going to monetise the higher prices of imported goods. It is essentially going to continue to finance private debt.

A reflection of that was seen in last week's inflation data, which continued to confirm the argument I made several months ago, that reduced economic activity would NOT lead to the falling inflation that the Bank of England has kept promising for the last 2 years. On the contrary, both measures of inflation CPI, and RPI once again began rising, and that is before the effects of large rises in utility prices, and other basic items, as well as the 16% hike in VAT, from 17.5%, to 20%, take effect in the next month. It is no wonder that at a time when the Liberal-Tories are freezing Public Sector wages, and when private sector wages are stagnant, they felt keen to offer to link Pension to Earnings rather than rapidly rising prices!!! Its no wonder that a central component of their Cuts strategy is to use inflation to reduce the real value of Pensions, and Benefits and wages. But, in reality, the two figures are both bogus. According to the BBC, CPI rose from 3.2% to 3.3%, while RPI rose from 4.5% to 4.7%. But, as I've previously set out each person's inflation rate is different, and it is different in different parts of the country. If you have little money, and most of it goes on those basic items which are going up massively in price, if VAT accounts for a large part of your spending, if you are dependent upon Council Services, which are likely to increase in price as part of the Cuts, then your inflation rate is going to be much higher than these official figures.

You would think, given the Liberal-Tory narrative that simplistically equates household finances with the national finances, and which repeatedly tells us that families in debt have to clear their debts, and so the State should do the same, that they would be keen to take action to encourage people to do precisely that. But, of course, they are not. In fact, they are doing the exact opposite. Far from telling people to clear their debts, they are telling people to go into massive and increasing amounts of debt in order to cover their increased University Tuition Fees, for example. Moreover, given that inflation has now been way above the Bank of England’s 2% target Rate for inflation for more than 2 year's now – a failure that most ordinary Council workers or NHS workers would not have been allowed to get away with – you would have thought that the Government would have been inisting that it acted responsibly and raised interest rates as MPC member Andrew Sentence has been calling for. That would encourage people to reduce their spending in the way the Government claims the State needs to do – after all as I pointed out in my blog UK Debt The Facts, Personal debt is more than double the amount of Public Debt – and would encourage them to save. But, the Government does not at all really want the State to follow the example of the average family, because the Government wants the average family to continue to spend like there is no tomorrow, and to go into debt to do it. It wants that, because if they stop then demand in the economy will collapse, and the economy will follow it!

That was made clear in an interview on Newsnight, with Liberal Treasury Minister Lord Oakshott. If you can find the video watch it because its hilarious. Oakshott does the usual Coalition mantra of trying to blame everything on Labour, but asked what they were actually doing to control the Bank bonuses, or to get the Banks to lend, he had nothing to say. Seeming to forget that he and not Labour was now in Government he trotted out the fact about two of the biggest Banks now being state owned! But, what worse worse, losing not just the Coalition narrative about debt, but apparently also his own about the problems caused by irresponsible Bank lending, he insisted that the solution lay in even more of that same irresponsible Bank lending. Julian Pendock of Senhouse Capital, pointed out that it would not be very responsible of those Banks to lend for the sake of lending to companies that might soon go out of business, particularly as many of them were suffering from the economic conditions created by the Government's austerity measures. Nor would it be a good idea to go back to the kind of lending to homebuyers that marked the actions of people like Northern Rock. As he pointed out, prior to the last 20 years or so, it was not at all considered unreasonable that people should save up around 25% deposit to put down if they wanted to buy a house.

But, Oakshott, whose Government is about to place large sections of the population in lifelong debt slavery, seemed to believe that there was nothing irresponsible in demanding that Banks and Building Societies lend huge sums of money to people who already have £50,000 plus of student debt hanging round their neck, plus all the other debt accumulated as a result, and who, therefore, are going to be very high risk of going bust, and not being able to make the payments. The real problem, which he did not seem to understand, is not that it is unreasonable that Banks should only lend if they have some prospect of getting depositor's money back, but that people cannot save that 25% deposit because house prices are around 4 times what they should! In part they have bubbled up to those ridiculous levels precisely because of the previous irresponsible actions of Banks and Financial Institutions after the Thatcher Government deregulated Financial Services in the 1980's and encouraged this huge expansion of private debt as a means of hiding the fact that real wages were stagnant.

As, I pointed out recently, A Momentous Change, some are recognising this fact, and see why and how it needs to be resolved, if a big reduction in the Value of Labour Power – i.e. the minimum amount that workers have to spend at a given time and place to reproduce their Labour Power in the same quantity and quality – is to be achieved. As Stephanie Flanders wrote,

“If the Bank of England were really serious about helping the economy, it would be trying to tank the housing market. That is not quite how the economists at Fathom Consulting would put it, but it's a key implication of their latest report on UK monetary policy. The Monetary Policy Committee are unlikely to follow their advice - or not directly, anyway. But the policy paper will make for sobering reading as they prepare for the start of their November meeting on Wednesday.

How, you might ask, could a sharp fall in house prices possibly help the economy? It would help because it would get it over with. Like many economists, the authors of the report, Danny Gabay and Erik Britton, believe that the British economy will not truly put the crisis behind it until it has fixed the banking system and dramatically lowered the amount of private sector debt weighing on the economy. Unlike some of their peers, they think that a correction in house prices is a crucial part of that process in Britain, and it has barely begun.”

Has this idea been taken on by the Bank of England? There is certainly a debate about raising interest rates going on inside the MPC. In theory, it is possible to both raise interest rates whilst at the same time expanding QE. In reality, the bank base rate is pretty meaningless when it comes to determining mortgage rates, which are more dependent upon Bond Yields, and as was seen in Part 3, UK Bond Yields are already increasing. The Bank seems to think that interest rates may have to rise much sooner than many would like to have the public believe. Hence, the The Bank Of England Warns 7 Million At Risk, as many people with mortgages will see their monthly payments rise sharply, at a time when house prices are already falling, and where the economic downturn being caused by the Government's austerity measures is likely to exacerbate that trend. Money Week has a very good article on the potential for sharp house price falls in the next couple of months. Moneyweek On House Prices and Consumer Confidence The, graph from Nationwide produced by Bloomberg is very interesting. It shows that its House price Index has almost exactly matched its Consumer confidence Index over a long period of time. The Consumer confidence index is showing a 15% fall in the next two months suggesting a fall of that amount in house prices during that time. Some are predicting falls of 50%, which would almost match the falls seen in Ireland.

The Government could respond to these events by recognising that it is not an idle spectator of economic events. It could change its narrative on the Cuts, and begin to give out the message that it now recognises that the message coming from US Capital has been proved right, that the solution lies in further stimulus, or at least not carrying through large-scale Cuts. It could join with the other European leaders such as Merkel, who have argued that the EU and its states, need to develop co-ordinated programs for growth. Within that growth taking place within the context of a more integrated European economy, it would be possible for British Capital to continue the process of restructuring already underway. Ideally, as part of that greater European integration, it would mean the UK also bringing its currency within the realm of the Euro, and the issuance of EuroBonds, which like the Euro could stand on the world economic stage in some kind of parity with the Bonds and Currency of the US.

Will, the Government do that? Probably not, for all of those political as opposed to economic reasons I have previously set out, which affect not just the British but all other Governments operating within the confines of a bourgeois democratic regime. But, in reality, although as Marxists we can outline what would be a rational solution for Capital to take – even within the limitations of its own system – our job is not to provide them with such solutions to their problems. We simply point out that they do not even make rational choices in their own terms. Marx, for example, in Capital Vol.III, goes into great length to relate the history of the economic crisis of 1847. That crisis stemmed from one simple fact, the introduction of the 1844 Bank Act. That Act, was based on a piece of flawed economic theory of David Ricardo. We should not turn oursleves into Functionalists, who see Capital and its representatives as essentially infallible, every act of Government, and so on, as being precisely designed to meet the needs of Capital. The 1844 Bank Act, as Marx clearly sets out, most certainly was not that. So much so that in order to resolve the crisis the Government had to suspend the Act!

Such a situation is inevitable in a political-economic system whose fundamental basis is that the economy is some kind of creature independent of Men's Will, rather than that it is an artificial creation by Man himself, and only acts to hide what it really is, a series of social relations between men, because instead of those social relations we are required to fetishise the “commodity”, and the relation between things. The first step in workers providing a solution to those problems that is in their own interests, is to cease in their own minds that “commodity fetishism”, and to begin to restore their relation between themselves as human beings. Instead of reducing themselves to being merely appendages of Capital, set in motion by it, they have to turn things back from off their head. They have to restore Capital to its rightful place as mere means of production set in motion by Labour, and not vice versa.

That is where the work-in of the workers at UCS are so important, why the occupations at Visteon and Vestas, and now at various Universities are so significant. That is why the experience of the Argentinian Workers, who faced with the closure of their factories, occupied them, turned them into Co-ops linked to their local communities and to the class struggle, can help to point the way forward.

Back To Part 3

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