Wednesday, 13 June 2012

Why Higher Bond Yields Don't Matter - Part 5

In theory then its possible for a Government, if it controls the Banks, to finance its activities through the creation of additional money and credit, even if it does not control the printing of actual money. Moreover, because interest rates are a function of the demand and supply of money, an increase in the supply of money via money and credit creation are a means of reducing or restricting the rise in interest rates.

In practice it is not so simple. Firstly, the experience of John Law and Isaac Pereire show what is wrong with schemes which promote the idea of limitless credit creation, unrelated to the expansion of real value. Secondly, and partly related to the above, the State and international banking regulation sets limits on how much credit can be created by banks relative to their assets. But, having said that, its clear how an Hollande Government, and certainly a Workers Government, could, even within the realms of Capitalism, and the constraints of the Eurozone, finance a Keynesian response to the current conditions. The problem with Law's Mississippi Scheme was that it was a Ponzi scheme, which produced a bubble precisely because it was unrelated to the creation of any real new Exchange Value.

An Hollande Government could avoid that. Suppose such a Government nationalised all of the banks. If those banks had €100 bn. In deposits, then with a credit multiplier of 10, they could create money equal to €1 tn. Think of it like this. The Government employs 1,000 additional teachers. The cost of a teacher is €50,000 p.a. The Government borrows €50 million on the Bond market to cover this cost, and puts this money into its bank as a deposit. With a credit multiplier of 10 this makes it possible to create not just the €50 million needed to pay for the teacher, but €500 million of new money.

Although the original €50 million moves from the Government account, it moves into the individual teachers accounts whose salary it pays. As it moves from their accounts to pay bills it moves into the the accounts of those whose bills are paid. So, just at this stage we can see a Keynesian multiplier in effect. The €50 million of additional income provided to teachers has in turn created additional demand in the economy as they spend this income. This additional expenditure creates additional income for those who supply the goods and services to meet this additional expenditure. They in turn, spend this additional income, creating yet more demand, and yet more income and so on. The effect of this multiplier depends upon what is called the Marginal Propensity to Consume (MPC). All it means is that Keynes recognised that Say's Law is wrong. People do not spend all their income. Suppose, people on average spend 90% of their income and save the other 10%. In that case, the multiplier is 10, because the original recipients spend 90% of their additional income, which goes to the next set of recipients, who then spend 90% of that, and so on. The higher the MPC, the larger the multiplier. Of course, not all the expenditure goes on the purchase of goods and services. Some of it will go to investment by firms in order to meet the demands for additional goods and services. But, that still creates incomes as profits, rents, wages and interest, which in turn are spent. One limitation is the amount of spending which goes to buy imported goods, because that means that the additional incomes generated are overseas, and not in the domestic economy.

The graph shows how a given amount of stimulus creates additional expenditure, which creates additional income, and so on.

Because, this has stimulated real economic activity, the production of new Use Values, and new Exchange Values in the form of additional goods and services this is not the same as Law's Mississippi scheme. And, in fact, as Keynes demonstrated because this brings about this additional generation of income, one of the consequences is that tax revenues rise. So, the original Government expenditure and borrowing to finance it, could be repaid, as a consequence of its additional tax revenues. In a situation of Long Wave Boom such as we have now, and where fear is causing money hoarding, there is no reason why that fear cannot be eased, and the conditions created to reduce the money hoarding, and thereby stimulate economic activity – thereby reducing the fear further – by the application of such measures. In fact, this is very similar to the situation Marx described in Capital Vol. III, in relation to the operation of the 1844 Bank Act, and its role in creating the crises of 1847, and 1857, which led to its suspension.

As I have described elsewhere, however, this can only work in a period of Long Wave Boom such as that we have now. It is why Keynesian policies were able to cut short all of the recessions during the post-war Long Wave Boom from 1949 to 1974. That is because, it requires that Capital views any downturn as temporary. It then responds to additional demand by increasing investment in Constant and Variable Capital, and increased output. But, in conditions where Capital views any upturn as merely temporary, as happened in the 1920's, and early 30's, and in the 1970's and 80's, it will respond to it not by additional investment, but in higher prices. Where they can, workers will respond by demanding higher money wages to cover those prices. The additional money tokens put into the system will them be absorbed in these higher prices (the value of the money tokens will be devalued) creating the kind of stagflation that was seen in the late 1970's and 1980's.

But let's return to the example. In addition to creating additional demand, incomes and employment via the Keynesian multiplier, the teachers also create new productive capacity in the form of more educated workers which facilitates competitiveness, which in turn facilitates a rise in the Rate of Profit, which in turn stimulates accumulation of Capital, increased employment and so on. However, there is more. Ownership of the nationalised bank enables the Government to finance not just this €50 million expansion, but a €500 million expansion as a consequence of its ability now to create credit up to this amount! In fact, the Chinese State uses its ownership of the banks in precisely this way to regulate economic activity in the economy, alongside its control of local planning laws, and tax policies etc. to direct investment into those areas it has prioritised under the 5 Year Plan.

Provided such a Government used its ability to generate Credit Money so as to stimulate investment and increased economic activity then it will not result in a bubble. In fact, suppose such a Government used its ability to create credit money so as to build social housing to rent. Particularly if it was combined with the nationalisation of land and the removal of planning restrictions which facilitate monopoly land ownership, then, not only could thousands of building workers be provided with employment, not only would it stimulate demand for building materials, but also the supply of new housing would act to burst the existing property bubble. The consequent reduction in housing costs for workers would reduce the Value of Labour Power, enhancing relative Surplus Value and competitiveness. Even in capitalist terms this would be a sensible course of action.

By the same token, the ability to create credit money in this way would provide the funds required for the kinds of programme previously outlined for new infrastructural investment. Nor would such an approach lead to a “crowding out” of private sector borrowers. The problem at the moment is that not only do banks not want to lend to individuals and small companies, for fear of not getting their money back, but individuals are trying to reduce borrowing, whilst the majority of small firms that want to borrow need to do so to stay float, not to finance any major viable expansion. At the same time, large companies on balance, have plenty of cash, and can in any case borrow themselves directly in the Bond Markets at very low rates. Microsoft, despite having $40 billion of cash on its Balance sheet, last year borrowed another huge amount, simply because it could do so, for a long period, at just 3%! A Government borrowing from its own nationalised bank to finance its own investments would not have to fear not paying itself back.

Providing the credit money the Government created by such means went to stimulate investment and increase economic activity and competitiveness, it is possible to proceed on this basis without without control of the Central Bank printing press. Provided the increased economic activity resulted in rising deposits and an expansion of the Bank's Balance Sheet related to real assets then no bubble is created. A requirement for that is that money does not flow out of the economy i.e. the additional money does not become deposits in foreign banks.

Herein lies the danger with the application of Keynesian solutions on the basis of the existing nation state. It leads towards a nationalistic solution. That is why Marxists would not advocate any such solution. However, that is not to say that such a Keynesian solution on a European, or preferably an even wider international basis would not be possible, and under those conditions there is no reason that Marxists would oppose it. But, even on the basis of the current nation states, in a revolutionary situation with a Workers Government in place, there is no reason that such an approach should be opposed. With workers increasingly taking hold of the means of production under those conditions, then Marxists would clearly defend them against foreign and domestic Capital, in the same way that Lenin and the Bolsheviks became defencists as soon as they took power from the bourgeoisie and its State. Of course, such actions on a national basis by a Workers Government are subject to all the provisos that Marxists make in relation to “Socialism In One Country”, let alone State Capitalism in One Country.

Marxists would press an Hollande Government and certainly a Workers Government in Europe to seek to generalise that approach across the Eurozone, and then Europe as a whole. To be fair, Hollande has hinted at such a strategy, and there are indications from Social Democrats in Portugal, Spain, Germany, and Greece that such a struggle is possible. Even the technocrats such as Monti, and Draghi, put in charge of Italy, and the ECB are now pressurising Merkel to change course, in favour of closer Eurozone integration, the collectivisation of the debt, the establishment of Eurobonds etc.

But, it would be folly to suggest that a Hollande Government or a Workers Government should not press forward on that basis, and should have to wait for workers elsewhere in Europe to catch up. Even more ridiculous would be the suggestion that advancing the position of French workers by enhancing competitiveness would in some sense be a Nationalist solution. Marxists are in favour of the development of the productive forces, because it is a fundamental requirement for the building of Socialism. The more that happens, even within a national framework, the easier the transition to Socialism becomes. When the Bolsheviks seized power in 1917, they did so with the perspective of encouraging an international revolution. But, that perspective did not in any way inhibit Lenin and Trotsky from advocating they press forward immediately with modernising their own economy, improving its efficiency and its competitiveness against the other economies. On the contrary, the success in doing so, and enhancing the strength of the workers can be an important tool in winning the support of workers in other countries.

In an environment of huge global cash surpluses, a global boom, high rates of profit, and a plethora of opportunities for new productive investment, restricting economic activity in the UK, EU or anywhere else in the name of Austerian economics, on the basis that any other approach might cause historically low (and in real terms negative!) interest rates to rise is bordering on the insane. In his recent demolition of John Moulton and Tory MP Andrea Leadsom on Newsnight, Krugman drew out the real truth that the Liberal-Tory Government's policy is based not on economic theory, but purely on a right-wing small state dogma.

The Keynesian alternative to those policies of austerity is not our policy. It remains a Capitalist solution, which accepts the continuation of capitalist exploitation. But, it is a more rationale solution. We do not believe in Political Indifferentism, we choose the rational solution as against the irrational, the solution which offers workers the best conditions to advance their case, not that which threatens to consign them to a period of severe economic decline.

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