Monday, 10 June 2013

Ben Bernanke's Big Blunder - Part 2

Having stopped a banking collapse, there was absolutely no reason to continue money printing to prevent a collapse of stock markets, bond markets, or property markets. On the contrary, for the reasons I set out recently - The Circuits Of Money & Capital – such a collapse should have been welcomed.

In the US, a fall in property prices of around 60-70% meant that the houses once more returned to more reasonable historical levels. It meant people could once more begin to afford reasonable levels of deposits to buy those houses rather than have to take on astronomical mortgages.

Houses like this luxury, six bedroom property were up
for sale, in Florida, a year ago for around £70,000.
Its an indication of just how ridiculous the property market
in Britain has become, and how far prices will have to fall.
A collapse in share and bond prices, again means that workers pension contributions go further to buy the shares and bonds they require to fund their retirement. Pension funds should pay pensions out of the income they earn on their share and bond holdings, not from speculative capital gains. There is no reason a fall in share prices should cause a fall in profits. So, even with a stable level of income in the form of interest and dividends, lower bond and share prices mean a higher yield.

But, also with large amounts of money being printed, it has to go somewhere. It went where the Federal Reserve and Bank of England wanted it to go; into once more inflating those bubbles. US house prices are rising fast again as a result not of buying by home buyers, but buying by speculators. Share and Bond prices have risen to astronomical levels, despite the fact that economies have hardly grown, and the underlying productive-capital has expanded only marginally. Yet none of these things like property, shares or bonds produce any value. None create any new wealth. On the contrary, they divert potential resources away from investment in productive-capital that could create new value and real wealth, into purely speculative activity.

The argument is that by blowing up these asset price bubbles, consumers will feel more confident and will once more begin to borrow money so as to spend, and thereby stimulate firms into increased investment. But, consumers already have huge and unsustainable levels of debt. They are maxed out, and all these bubbles do is mean that their resources do not go as far. In fact, at a certain point, they become inflationary. Only for so long can workers real wages be squeezed by things like rising housing costs, as the costs of buying and renting rise relentlessly. At some point, the effect on increasing the value of labour-power, feeds through into higher wages. Workers who are finding that their pensions do not go as far, and who have to pay higher contributions, because share and bond bubbles have been inflated, will seek higher wages out of which to make those contributions.

Instead of stimulating economic growth, through productive investment, all that QE is doing is stoking up asset price bubbles that are making the situation much worse. I wrote some months ago that QE had already hit the buffers - QE etc.. Watching events over the last week or so confirms that. Back in November last year, the Japanese central bank announced that it was going to double the country's money supply, to try to create inflation. It sparked a massive stock market rally. The Nikkei rose by 45%. But then, just over a week ago, the realisation came over investors that if they succeeded in creating 2% inflation, then the large amounts of Japanese Bonds they held would actually be providing them with a negative rate of return.

Instead of Japanese interest rates falling as a result of the money printing, they trebled! Rising yields on Japanese Bonds then sent a shock wave through the stock market. Within the space of a week, the Nikkei has lost more than 50% of the gains it had made since November. But, similar concerns have started to affect the US markets. Just over a week ago, when Bernanke was giving testimony to Congress, a suggestion in his speech that the Federal Reserve might slow down or “taper” its money printing in a couple of months time, caused US stocks to sell off by 100 points. Then when, in the same speech, he seemed to row back from that position they rose by 100 points. In the last week, US share prices have been up and down like a fiddler's elbow, as the instability caused by money printing results in speculator's and investors not knowing where to put their money for fear that any day they might lose a huge chunk of it.

You can think about that at an individual level. After Northern Rock, governments introduced deposit guarantee schemes to protect savers funds under €100,000. Without it, savers would have flocked to withdraw their funds. After Cyprus, even that guarantee looks pretty worthless. But, even if you believe it, then the 30% of people in Britain now estimated to have wealth of more $0.5 million, will be looking for several accounts over which to spread their savings. That is not as easy as it seems when you also take into account the need to try to obtain some kind of minimal return on those savings. Most banks and building societies are offering “introductory” bonus rates on deposits, but these last for just a year, before the rate returns to just a bit more than bugger all. In the last year that has got much worse. A year ago, you could get around 3% with one of these introductory offers; today with the Government bribing banks to encourage people to go into debt, by giving the banks cheap money, you are lucky to get much more than 1%, as the banks have less need of depositors. Its increasingly a picture of whack-a-mole, or sticking fingers into every more porous dykes.

That leads to all sorts of absurdities. On Thursday last week, the non-farm payroll data was issued. It measures how many new jobs have been created, or lost. It is, all things considered, a fairly insignificant metric. Yet, the markets waited on it with baited breath. The reason, if the figure was very good i.e. lots of jobs had been created, this would mean that there was more likelihood that the Federal Reserve would slow down its money printing faster. If the number was bad the opposite would be the case, but it might mean the economy was becoming weaker. So, the markets favoured a number somewhere in between, but preferably worse rather than better! When the number came out about where they hoped, the stock market soared 200 points. But, the real import of the jobs number is actually what it means for interest rates, independent of what the Federal Reserve does. If, as seems to be the case, the US is creating more jobs, albeit slowly, that means the demand for capital is rising. As Marx says capital is a social relation between capital and wage labour, an expansion of capital is an expansion of the number of wage labourers.

That expansion will in part be a consequence of the ending of the Long Wave Spring, and start of the Long Wave Summer, where economic growth continues strongly, but productivity growth slows, so more workers are increasingly required to bring about a given amount of additional production, or else considerably more has to be invested in machinery to bring about higher labour-productivity. Either way, this increased demand for capital means that upward pressure is placed on interest rates.

Although, stock markets rose sharply, bond markets sold off, and interest rates rose. In fact, a tug of war now exists between bonds and stocks. As bonds fall, the yield on them rises. That means bond buyers earn more on what is a low risk investment. That means they are more likely to hold bonds than shares. On the other hand, because interest rates are likely to rise, and bond prices fall, that means people are likely to sell bonds, because they don't want to get caught, holding an investment that could fall quickly. If inflation rises, share prices rise, because firms nominal profits rise along with their nominal prices. But bonds suffer, because they pay a fixed rate of interest which becomes worth less, in real terms, as does the capital value of the bond, as inflation rises. Bond prices fall to reflect that, so that their yield rises.

This level of volatility as investors and speculators increasingly find nowhere safe to put their money is a direct result of the money printing. The key here is bonds. If bond prices fall sharply, interest rates rise sharply. That would cause share prices to sell off sharply, as well as property. That would not just be the case in the US, it would apply in the UK, Europe and elsewhere, because it would mean that all bond prices would adjust accordingly. This is one reason the Federal Reserve has continued to buy bonds on a massive scale. But, Alan Greenspan, who started this process in the US more than 20 years ago, said the other day on CNBC that it has now reached a dangerous level, where if bond investors begin to sell, the Federal Reserve will not have enough fire power to stop it.

Well it could, in theory. It could simply print enough money to buy up every single bond, but in that process it might have to start buying foreign bonds with that money too. In practice, that can't happen because it would completely destroy the dollar and lead to hyper inflation. Greenspan is right, the situation is now very dangerous. Interest rates are rising, productivity is slowing, the sell off in the bond markets is so far manageable, but it could, and probably will turn into a panic. There seems little the Federal Reserve or any other central bank can now do to stop it.

But, the reality is that the policy of money printing has been a mistake from the beginning. Money printing works by the central bank, buying up government and other bonds from the banks. The banks then receive money from the central bank, which they can use to lend. This is the opposite of what usually happens, when the state issues bonds to finance its spending, and those bonds are bought by the banks who give it money in exchange, thereby reducing the money they have to make loans, and create credit.

Rather than using the conditions that led to low interest rates to print money and blow up asset bubbles, what was really required was for the state to have absorbed some of the excess supply of capital, and use it to invest in things like infrastructure that would have provided the basis for future economic growth. That is what happened under similar circumstances when the Industrial Revolution began, or after WWII, when huge sums were spent by the state out of surplus value to restructure industry and create the Welfare State.  Central to future economic growth in the West is the development of highly educated and skilled workers. The policies that have been adopted of increasing the costs of education, have been crazy. Western governments should have used low interest rates to borrow money to invest in education by providing free further and higher education.

Governments and central banks cannot lower real interest rates when the demand for capital exceeds the supply. Printing money under those conditions only creates inflation, so that interest rates are forced up, as the demand for capital in nominal terms rises along with the inflation. But Government's can prevent interest rates from falling too low where the supply of capital considerably exceeds demand. They can do that by fiscal policy, taxing the excess surplus value produced, so it does not hang over the system. The Government can either run a budget surplus by such means, thereby paying down the National Debt, or it can use those funds, in the way described above, to provide the necessary infrastructure to ensure the efficiency of the economy in future years. That is what the state in the US, in the UK, and in Europe should have been doing over the last 30 years, and certainly the last 20 years.

Low interest rates are actually bad for the economy. Especially under conditions where those running businesses are not the providers of money-capital, but only bureaucrats acting on their behalf, cheap money, as Marx sets out, encourages those bureaucrats to make rash investment decisions. Businesses that are not really viable are encouraged to set up, or continue in business, when their capital would be more effectively used elsewhere. Moreover, where that cheap money leads to large speculative gains, it encourages money that would have become productive-capital, to instead be used for speculative purposes. Low interest rates, also encourage people to consume rather than save, so a greater proportion of the economy tends to be devoted to meeting the needs of consumption rather than investment, so the basis of expanding production is itself undermined.

The US has avoided the mistakes of the UK and Europe in that it has shunned austerity, but the fiscal expansion in the US has not been sufficient to soak up the surplus capital. Instead that has provided the basis of money printing, that has fuelled speculative bubbles that sooner or later will burst. Those bubbles are not just in the US, but because of the role of the dollar, have been inflated worldwide. The consequences of that were demonstrated by Cyprus, but Cyprus is small fry. The only question now is who will be next – Slovenia, Luxembourg, Malta – or what will spark the crisis that arises from bankruptcy of European Banks like Deutsche Bank, which holds €53 trillion in derivatives as a means of hiding its indebtedness. Its no wonder the UK government wants to sell Joe Public shares in UK banks, because they are even more bankrupt. Not only are they tied into this global debt, but they are massively exposed to hugely overvalued property portfolios in the UK itself.

The financial meltdown of 2008 was the result of 30 years of money printing to blow up these asset price bubbles. In the four years since 2008, a much greater amount of money has been printed, and the asset price bubbles have been inflated to an even more irrational degree. When they burst, the consequence must be an even bigger bust than happened in 2008. As I set out several years ago - A Momentous Change – I believe that central to that will be what happens to property. We have already seen that in part in the US, in Ireland, and partly in the rest of Europe. In fact, the measures taken to avoid that denouement, so far, have only made that situation worse, in the sense that the bubble has simply been inflated even more, and made thereby even more dangerous.

Central to that has been the policy of money printing pursued by Bernanke and adopted by other central bankers. The Federal Reserve is now caught in a Catch 22. It cannot keep printing money forever, and the more it does, the worse the consequence will be when it stops. But, it dare not stop because even the hint of slowing down the money printing, let alone stopping it, or god forbid reversing it, leads to a huge sell-off in the markets, and spike in interest rates. But, for the reasons previously set out, whether central banks continue printing money or not, the conditions now exist for interest rates to rise anyway. When that happens the serial bubbles that now characterise the economy will burst. That will be bad news for bankers, but it may well be very good news for the rest of us.

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