Tuesday, 5 June 2012

Why Higher Bond Yields Don't Matter - Part 2

The second reason we have low yields on Government Bonds is the low level of economic activity. The austerity measures have sent the UK economy into a double-dip recession, and that means that the demand for money is reduced. Bond investors calculate that, as a consequence, the Bank of England will keep official interest rates low, and will continue to print money. Low Gilt Yields are a bad sign not a good sign when they are an indication of low and falling economic activity.

Low Yields cannot be a result of the Government's debt reduction programme, and market confidence in it. UK debt is rising not falling. In the US and Japan, which both have much bigger debt than the UK, and both of whom are increasing borrowing and spending, yields on their Bonds are even lower than in the UK. The reason yields are low is because all these countries are able to print money, so creditors know they will be repaid – something they cannot guarantee in relation to Greece, Ireland, Portugal, Spain and Italy. A consequence is that investors are concerned with a return OF Capital, not a return ON Capital, which increases Financial Repression.

As with the US and Japan, the UK Central Bank, the Bank of England, has been printing large amounts of money. The way this is done is for the Bank to then buy Government Bonds. The basic law of Supply and Demand ensures that this large amount of additional demand raises the price of those Bonds, and as shown earlier, this reduces the yield on the Bond.  But, these reasons, for why the UK Gilt Yields are low, also provide the explanation of why it does not matter if they rise, and why the Government's focus on that one policy objective makes no sense, and consequently why the case for austerity falls. There are lessons here too for Francois Hollande, and the other EU leaders.

The first and most obvious point to make is that with the yield on the 10 Year UK Gilt hovering around 1.5%, it would not at all spell the end of the world if that were even to double to around 3-4%. In fact, the UK has had higher rates than that during much of the 20th Century. In the 1990's, the Bank Rate rose to 15% during the ERM crisis. 4% would still be way below the 6% level considered to be unsustainable. But, even this latter figure of 6% is arbitrary. It is only set at that level because of the current level of inflation.

Take the UK and the Financial Repression referred to previously. Suppose you had bought a 5 year Gilt back in 2007, maturing today. Let's say you paid £1,000 for it, and it had a 2% coupon i.e. it paid £20 a year interest. So, over the five years you would have received £100, and today you would get your original £1,000 back. But, back in 2007, inflation had started to rise. The Government was warning against workers seeking inflationary wage rises. In fact, back then I wrote about how the State would use inflation to pay off the debt (Paying For The Crisis) And, in fact, over the last five years inflation has been way above the Bank of England's 2% target. For a considerable period on the RPI basis it has been more than double that target. Let's say inflation averages 4% p.a., then over five years it is more than 20%. That means that each year your £20 interest was worth a bit less. More significantly, your initial £1,000 is now worth less than £800. In other words, you invested £1,000 and for your trouble you have received back less than £900. That is Financial Repression. That, of course, assumes you were a UK investor.

If you were a US or Eurozone investor you have fared even worse. The pound has fallen from a high of around $2 a few years ago, to around $1.60 today. It has fallen from around €1.47 to around €1.23 today. In both cases a fall of around 20%. As a result, your original £1,000 investment will now again have netted you less than £900. And, of course, the financial repression in both these cases has the same cause – money printing by the Bank of England. It is QE and low interest rates, which have caused the value of the pound to fall, and which has stoked inflation – partly through higher import costs for things such as oil, gas, food etc. and increasingly higher prices for Chinese manufactured goods.

In other words, those who lend money to the British Government (be they UK pensioners from their savings and Pension Funds, Banks and Insurance Companies, or foreign banks and institutions) are actually making a Capital Loss i.e. they are paying the Government to borrow their money! Would it then be really terrible if the Government had to start paying them for borrowing this money, via higher Bond Yields? Would it be bad if the British Capitalist State, which has borrowed money to bail out the Banks, had to pay us, as Pensioners and future Pensioners, a decent return on our savings and Pension Funds? If the Government is so concerned about the state of our Pension Funds, they should stop effectively stealing our money via Financial Repression imposed via Bank of England policies.

But, the real reason for the Financial Repression is the fact that money is continuing to be hoarded i.e. is continuing within its own circuit, building up fictitious capital, rather than entering the Circuit of Capital, increasing productive activity and real wealth. Money used to buy rental property (or owner occupied property) only bubbles up the price because it is bidding for a restricted supply of houses/building land. If land were released and houses built on a large scale, then prices would fall significantly. Fictitious Capital would be destroyed, but real Capital and real wealth in the form of additional houses would be created.

Similarly, if new businesses were created or existing businesses expanded, buying more Constant Capital (factories, machines, materials) and Variable Capital (Labour Power) then the new shares/bonds issued to finance this investment would soak up some of the money currently pushing up share and bond prices. In fact, the FT of 24th May 2012, has an article entitled “Out Of Stock”, which contains a graph of Net Annual Equity Issuance for the US, Europe and Japan. It shows a marked reduction for all three economies from the early part of this decade, with a negative figure for several years after 2005. Again, the consequence of an increase in real productive investment would be to destroy fictitious capital in the form of bubbly share and bond markets. Real Capital, and real wealth in the form of additional goods and services would increase.

Moreover, the conditions which preclude such a solution for Capital in a crisis of overproduction do not exist here precisely because this is NOT a crisis of overproduction. As Marx describes, a Crisis of Overproduction can be partial or generalised. The former arises where the production of a particular commodity expands faster than the demand for it rises. In Marx's terms, more abstract labour-time is expended in its production than is socially necessary. So, this capital is forcibly devalued. Such situations are commonplace under Capitalism and are resolved by the continual revaluation of individual Capitals, and the subsequent re-allocation of Capital. A generalised crisis occurs when such a situation applies across a wide range of commodities, and where, as a consequence, it is impossible for capital to respond by a re-allocation to other productive activity. As I have demonstrated elsewhere, such a situation is more likely to occur during a Long Wave downturn than a Long Wave Boom, precisely because one of the factors which makes the latter possible is the preceding Innovation Cycle, which produces a range of base technologies (the micro-processor, the Internet, decoding of the genome, and the consequent genetic and bio-technology) which provide the basis for the establishment of a wide range of new productive technologies (Dept. I industries) and commodities (Dept. II and III industries). The expansion of Capital is the expansion of Exchange Value, which is inseparable from the expansion of trade itself.

But, a look at the list of base technologies set out above (which is far from complete) demonstrates the huge potential for the continued expansion of Capital, which the current Boom presents. Couple that with the qualitative changes which the advance in computing power (which magnifies not just human productive power, but also mental and creative power) represents, together with the establishment for the first time of a truly global economy (now Africa is being drawn in as a major new source of productive capacity) it can be seen why the last ten years has seen that explosion in the production of goods and services along with the huge and rapid growth of consumption in Asia, Latin America and parts of Africa, as millions of new workers have been created each year, with the working class now being the largest class on the planet for the first time. And that process, this Boom, has only just begun!

The generalised crisis of overproduction is marked by a a severe and sudden fall in the Rate of Profit, and a subsequent destruction of vast amounts of Capital. But, the Rate of Profit remains high across the majority of industries. A generalised crisis is manifest in huge amounts of unsold commodities, but across the globe we see no such glut. The generalised crisis is manifest in mass unemployment, but apart from individual countries such as Greece and Spain, we see no such phenomena, and in these countries it is a consequence of political decisions (austerity) as much as anything else. In fact, taken as a global system, despite the revolutionary changes in productive potential, employment is rising sharply not declining. According to the ILO, World employment in Agriculture has fallen marginally from 1056 in 2000 to 1053 in 2011. In Industry it has risen by around 30% from 533 to 681. In Services it has risen by around 35% from 1021 to 1351 (all figures in millions).

The Marxist objection to a Keynesian solution to a crisis of overproduction is that it fails both to recognise the true nature of of the crisis (believing it to be one of under-consumption, lack of demand) and the dynamic of Capitalism as a system driven by profit, as the means for the self-expansion of Capital. A crisis of overproduction cannot be resolved as the Miseans and Neo-Classical economists believe, by cutting wages, because that merely reduces demand for goods and services, further making the realisation of profits harder. Nor can it be resolved as the Keynesians believe by stimulating aggregate demand, because the latter involves some form of compulsory reduction of Surplus Value by the State to be handed to consumers of one kind or another. Faced with yet a further reduction in their profits then (outside the conditions of a Long Wave Boom, where any such crisis is likely to be seen as temporary) Capitalists are likely to curtail investment further, transfer production overseas, engage in speculation, or simply sit on their money.

But, in conditions where what we have is not a crisis of overproduction, but one of confidence, especially in conditions of a Long Wave global boom, then much of what the Keynesians prescribe is correct – at least within the confines of a Capitalist solution. In fact, with all of the necessary changes, in relation to workers ownership of production of useful goods and services etc. it would mostly apply to the kinds of policies a Workers State, or a Workers Government would need to introduce currently too.

Back To Part 1

Forward To Part 3

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