Thursday, 31 May 2012

Why Higher Bond Yields Don't Matter - Part 1

The Government has placed huge emphasis on the need to keep yields on UK Government Bonds (interest rates) at low levels. This, they say, is why there is no alternative (TINA) to the draconian austerity measures. If they pulled back from austerity they claim that the markets would punish them, rapidly sending UK Gilt yields up to those of Greece, Portugal, Spain and Italy. It is, of course, nonsense.

Simply look at the facts. UK Gilt Yields far from being on the verge of soaring to record high levels, they are at record low levels. They have barely been at such levels at any time in the last 100 years! In fact, this phenomena is referred to as financial repression (though no actual repression is required by Government to force money hoarders to accept such low returns). As I have pointed out previously, and as the FT's Martin Wolf wrote again recently, these record low levels are nothing to do with the Government's austerity measures or investors confidence in their economic management. They are the result of a combination of factors.

Global Financial Repression. Financial Repression is a condition which exists when creditors face negative real returns on their lending. In the last decade, in particular, a rising Rate of Profit for capital has combined with a huge global boom (of all the goods and services produced in Man's entire history, almost a quarter have been produced in just the last ten years) to produce a vast quantity of profit. The money form of these profits sits as cash balances on the books of the big corporations, and in sovereign wealth funds. With the Financial Meltdown of 2008, and the political and economic uncertainty that followed it, there has been an understandable reluctance of companies to invest in new production because they cannot be sure of sufficient demand for an increased or new output. For the same reasons, the holders of Money Capital (Banks, Financial Institutions – fictitious capital) are reluctant to lend to those who might want/need to borrow, particularly small firms, and home buyers. They might not get their Capital back. In fact, with tighter bank rules, as a result of Basle III, the banks are cutting back their lending further.

This is not, as some have suggested, an example of a 'crisis of overproduction'. In Marx's analysis, in a crisis of overproduction of Capital, Surplus Value has moved through the Money form back into production. It has been used to buy more Constant and Variable Capital. The crisis arises because the circuit from this point forward cannot be completed. The output cannot be sold at prices that enable the Capital consumed to be reproduced. No such situation exists. Economic growth continues in the vast majority of the global economy, and at a rapid pace in parts of it. The US is growing, and so is the core of Europe. Where economies are not growing, in the UK and peripheral Europe, this is a consequence of deliberate government policy – Austerian economics. What we have is not a crisis of overproduction, but a condition of money hoarding. Money that is not converted into Capital. In fact, it is an indication of what Engels describes in his Critique of the Erfurt Programme, where he says that with the development of the huge Capitalist enterprises, the Trusts etc. the element of 'planlessness' within Capitalism comes to an end.

It is this money hoarding which creates, under current conditions, the financial repression.

Money which does not re-enter the Circuit of Capital does not simply disappear. If it sits simply in Bank deposits then the increased Supply (especially with reduced money demand) causes interest rates to fall – which is why savers find it impossible to get any meaningful return on their money. What is more, the fact that the money is spent does not destroy it either because whoever spends the money does so by buying from someone else who then deposits the payment in their Bank. This is illustrated in the diagram below, which shows the way that money that is not productively invested, remains within a circuit of money, which can create fictitious Capital, chasing after a limited number of assets – shares, bonds, houses etc.

So, for example, hoarding Gold does not reduce the amount of money on deposit or in circulation because if I buy £100,000 of gold coins, bars, or shares in a Gold ETF, my £100,000 goes into the sellers bank account. The same is true of other forms of financial asset. Suppose I decide to become a Landlord. If rents provide a 5% return on the Money invested, with the average price of rental property at £100,000, then if that price rises to £200,000, the return will fall to 2.5%. But, it is precisely the added demand for property to Rent which will and has increased property prices. As with any other investment, at some point, these falling returns alongside the risk of losing your Money, as the bubble in property prices bursts, will cause such investors to sell their property, which will then burst the bubble.

The same is true with Bonds and Shares. Companies pay a dividend on shares out of the profits they make, and Governments/Bond Issuers pay a fixed amount of interest (Coupon) on the Bonds they issue. In both cases the amount paid out remains constant. If a share or a Bond costs £100, and pays a dividend/coupon of £10, then the yield is 10%. However, if Money is attracted to these financial assets, (which tends to happen when there is monetary easing) increasing the demand for them in the secondary markets, the price of the share/bond will rise. If the price rises to £200, then the £10 dividend/coupon will now represent a yield of only 5%. This process of the creation of fictitious capital, whose extension through the operation of the credit multiplier I will elaborate later, is one area of confusion for those economists like Andrew Kliman who advocate the “Historic Pricing of Capital”, as opposed to its valuation according to its cost of reproduction, as Marx advocated.

Kliman advocates a model in which although commodities are valued according to their current reproduction costs, the Capital which was used to produce those commodities is valued according to the money price that was originally paid for it. The obvious problem with this is that, if this Capital is revalued, so as to become more valuable, then the produced commodities will include this higher value (Capital Gain). It means that even though the living labour-power used to produce those commodities remains the same, and the rate of exploitation of that labour-power remains the same, the difference can only be made up by increasing the amount of Surplus Value produced! This introduces a source of Surplus Value (Capital) in addition to the living labour-power. It undermines the whole basis of Marx's economic theory, and the theory of Capitalist exploitation, and class struggle that flows from it. To illustrate:

C 1000 + V 1000 + S 1000 = K 3000.

Assume now that the Value of the Constant Capital rises to 2000. This 2000 is transferred into the value of the final commodities produced, but because the Capitalist has already paid out the £1000 for the C, the historic pricing model values it at this price for the purpose of calculation of the Rate of Profit. We then have:

C 1000 + V 1000 + S 2000 = K 4000

In one of his comments, in a recent debate, Andrew Kliman shows exactly this confusion in failing to distinguish between fictitious and real capital, and Capital Gain/Loss with Profit. He writes,

“It means exactly what it says. You buy a bond for $10,000. Your investment is $10,000. You get $500 interest at the end of 1 year. But meanwhile, the price of the bond has fallen to $500. Your rate of return isn’t $50/$50(sic) = 100%. It’s -90%. In other words, your assets (bond + interest) are worth only 10% of the value that you invested.”

(Michael Roberts Blog comment of January 19th 2012, 11:57 a.m.)

This is of course, the classic viewpoint of the speculator. That can be witnessed by the fact that even in terms of a framework of fictitious capital it is extremely limited. In fact, it suffers from exactly the same problem as his approach in relation to the valuation of productive capital i.e. it is an exercise in comparative statics, taking merely a snapshot rather than analysing a process. As I pointed out to him in that debate,

“So now we have moved entirely away from Marx’s theory based on commodity production, to the favoured ground of the Neo-Classical economist, that of the Stock and Bond Markets.

The laws that determine the prices of Stocks and Bonds are quite different to those determining commodity production, so this example is absurd. What Marxist analysis is concerned with is the process of Capital formation and reproduction. That is with the production of Surplus Value, and its re-investment in on going productive activity. That is quite different from the concern with looking at discrete periods of production as though this reflected the true nature of Capitalism.

But, even were we to take the example given it does not entirely fit the requirement AK wants of it. If we look at the position in the way a Marxist rather than a neo-classicist would then for Capital as a whole, we would find that a fall in the price of the Bond from $10,000 to $500 provides them with an excellent investing opportunity. Now each Capitalist will make a 100% return on each $500 investment they make in these now much cheaper Bonds, and so the overall “Rate of profit” on such investments will soar!

If we take the instance even of the original investor, then if their intention is to generate income – which is more in tune with the purpose of capitalist production – rather than Capital Gain, then over time, they will also be able to utilise their $50 (sic) Yield, to each year buy an additional Bond, which previously would have cost them $10,000. That may well be the case for a Pension Fund, for instance. If we take a 40 year investment period, then this may well mean that overall returns are much higher than had the price of the Bond and the Yield on it remained unchanged!”

(Comment of 19th January 2012, 3:23 p.m.)

It is this process of a squeeze on new productive investment, combined with an increase in the value of fictitious capital, which drives down yields, and results in Financial Repression. What Kliman and speculators see as “Profit” (or in the case above Loss) and, therefore a driver for further “investment”/speculation, is in fact an illusion a fiction. But, in an economy where Money Capital (Banks and Financial Institutions) form a significant sector of economic activity, and make their own profits from lending to such ”investors” (including other Banks and Financial Institutions), then the huge amounts of such “profits” generated by this activity form a powerful basis upon, which to make loans, create credit money, and thereby create the very conditions, which ensure that these increases in fictitious capital continue!

A large amount of hoarded money, instead of entering the Circuit of Capital, and thereby expanding production and real wealth, remains in the Circuit of Money, and creates increasing amounts of fictitious capital through the Credit Multiplier, as every deposit acts as the basis for an ever larger amount of credit, or as fictitious capital assets, for example bubbled up property, provide an expanded Capital base upon which the Banks issue credit.

Forward To Part 2

No comments: