Monday, 22 July 2013

The Rates Of Profit, Interest, and Inflation - Part 8

The Rate Of Interest (2)

In Part 7, I described how the huge rise in the rate and mass of profit causes interest rates to fall, which in turn leads to the kind of speculation we have seen in shares, bonds and property, even as increased accumulation takes place. In the Summer phase, we have now entered, as Marx and Gilbart then relate, the demand for capital begins to outstrip the supply of new capital. I have set out in the previous post how it is that during the Summer Phase, the rate of profit, though not the volume of profit, begins to fall. More surplus value has to be invested to maintain growth, as productivity gains slacken. Capacity constraints begin to raise unit costs, particularly for labour-power. More surplus value has to be used for actual productive investment, and less can simply be used as money-revenue, circulating within the circuit of money, blowing up those asset bubbles.

In the previous period as this fictitious capital increases, the belief can develop that money simply creates money, without any need for surplus value to be created by productive activity. In fact, Marx and Engels cite the lunacy of those writers from their day who thought that the nation's problems could be resolved simply via the magic of compound interest. But, without any demand for capital for productive activity the money-capital can make no return, without the production of surplus value, there is no fund from which the interest can be paid. With interest rates at record low levels the rentier capitalists have to find a productive use for their capital. This tendency is increased the more the various bubbles are shown to be swindles of one sort or another. For example, in the context of the Railway Mania, Engels notes,

“The period of prosperity in England from 1844 to 1847, was, as described above, connected with the first great railway swindle. The above-named report makes the following reference to the effect of this swindle on business in general:

In April 1847 "almost all mercantile houses had begun to starve their business more or less ... by taking part of their commercial capital for railways"”

Capital – Vol III Chapter 25

The Railway Mania had many similarities to the bubbles we have seen over the last 20 years or so. Its essential basis was the availability of cheap credit made possible by this huge increase in the rate and volume of profit. But, it was also made possible because a middle-class had arisen that had available money-revenue that could be invested in shares, even though most of these investors did not really understand what they were getting into. When money is easy to come by, and the bubble lifts all boats, every amateur investor thinks they are a genius, whether they are buying shares in railways, tech companies, or buying property. Just as Thatcher made possible the present bubbles by the deregulation of financial services via The Big Bang, so the Railway Mania was made possible by the repeal of the Bubble Act, brought in after the previous swindle, the South Sea Bubble, and by the creation of the Stock Market.

Moreover, as Engels describes, many banks and commercial ventures, seeing the possibility of quick capital gains from this speculation, even diverted resources that would more profitably have been used for productive investment. Today, the Government actively encourages banks to divert resources into the property bubble, and encourages individuals to risk their savings in the same way.

The rise in global interest rates that is now occurring is being put down to the threat to withdraw QE by the Federal Reserve. That is no more tenable than that interest rates have been falling for the last 30 years due to money printing. Interest rates are driven by the demand and supply of money-capital. The fact is that the Federal Reserve is still printing money; the Bank of England has maintained its QE; the ECB is standing behind European banks promising to provide whatever liquidity they may require; the Bank of Japan has committed itself to doubling the size of its already sizeable money supply. In fact, when Japan announced this policy a month ago, the yield on Japanese JGB's trebled, rather than falling. The reason for that was simple. There was a concern that the aim of that policy, to create 2% p.a. inflation, might be achieved. Why would Mrs. Watanabe want to hold her 10 Year JGB, paying 0.2% interest, if inflation was reducing the value of that bond by 2% per year?

Global interest rates are rising for the reasons previously set out. The rate of profit globally is set to fall. That will not be a straight line process, and profit rates will be higher in some places than others, for some industries compared to others. But overall, the rate of profit will be falling, and the demand for capital will be rising, as firms and economies have to accumulate additional capital in order to maintain market share, and to remain competitive.

National economies have to attempt to be competitive in the sense that the cost of doing business within them is lower than elsewhere. That is not just, or even mainly a matter of taxes. Far more important is does the economy have the necessary levels of educated and skilled workers, does it have a sufficient infrastructure that enables goods and services to be distributed cheaply and effectively, thereby reducing costs, and raising the rate of turnover of capital. In fact, many of these things, and attendant requirements such as a relatively stable polity and social environment require higher levels of taxation and government spending.

Companies, on the other hand have to retain competitiveness, by having invested sufficiently in research and development to have a range of new products that can attract consumers, that provide better levels of quality of those commodities compared to their competitors, that they have developed distribution channels and so on. And they have to invest in the latest productive technology to reduce their costs. Both investments at the level of the state and the firm require the accumulation of additional capital. In fact, as a consequence of the financial meltdown in 2008, there is clear evidence that capital expenditure was deferred. In the next few years, that will have to be made up for. Moreover, even as China deliberately slows its growth rate, and as North Atlantic economies are experiencing lower growth, new developing economies in Africa, are building up their infrastructure, and productive capacity.

The ability of the state to meet the need for this additional capital is limited. The state can print money, but it cannot print capital. Capital has to be created as a consequence of the production of surplus value. As in the case of the crisis of 1847, where the issue is actually financial rather than economic, the simple answer is to print money to put into circulation. If A and B have both produced commodities they are prepared to exchange with each other, but are prevented from doing so, in a money economy only because there is insufficient means of circulation, the obvious thing to do is to increase the means of circulation so they can! If the problem is that B does not want to buy A's commodity, printing money is not the answer. It may produce a buyer for A's commodity, but only at the expense of inflating other prices.

Central Banks may be able to reduce short term interest rates by printing money, but only at the expense of causing inflation to rise, and with it longer-term interest rates. In this new conjuncture, Central Banks will not be able to prevent interest rates from rising as the demand for money-capital rises relative to supply. In a number of places, inflation is already increasing, and the previous forces that reduced the value of commodities have run their course. In places like the UK, inflation has run way above the Bank of England target for more than 5 years. Further attempts to protect the banks by printing more money will only push up inflation, leading to the potential for a sharp sell off in Bonds causing a new monetary crisis.

In either case rising interest rates pose a significant threat once more to the banks. Once again, the real basis of that is that the banks require huge amounts of additional capital. The reason states have been engaging in QE for the last 4 years has nothing to do with stimulating the economy. It has not. It is there, purely and simply to try to buy time for the banks. Banks internationally, for the reasons set out previously have used their resources for speculation. The extent of that was only partly exposed with the financial meltdown of 2008. It was only partly exposed, because throughout the globe central banks stepped in to provide liquidity. But, the real problem is one of solvency not liquidity.

The banks have on their balance sheet grossly inflated assets. They are grossly inflated for all the reasons previously described. If those assets were actually priced at a realistic market price, it would show that the banks were massively under capitalised. What happened with Anglo-Irish Bank, and has been revealed in the secret recordings is an illustration of that. Given that modern capitalism cannot function without a large advanced banking system, that in itself indicates the degree to which the demand for capital is likely to rise. However, that situation is not likely to be resolved without large amounts of fictitious capital being destroyed, and many organisations and individuals who believe they have become rich on the basis of it, are likely to see that fictitious wealth rapidly disappear.

That has already happened in the US and Ireland, and in part in Spain where property prices have collapsed. The same kind of collapse or worse is inevitable in Britain and elsewhere. But, the bubbles in share prices and bonds will inevitably collapse too. At the centre of the web will sit the banks once more. The extent of the web they have weaved is immense. As I described recently - The Great Property Market Conspiracy - Deutsche Bank is reported to have exposure to derivatives amounting to €55 trillion, or equivalent to the entire global GDP! Those derivatives are being used to disguise the extent to which its balance sheet is exposed to all of this debt. As interest rates rise, and more people default on their loans, and the property market collapse continues, these chickens will once more come home to roost.

The consequence will be a significant deflation of these asset prices, and possibly a general deflation similar to that experienced by Japan. On the other hand, it may prompt in response an even greater amount of money printing that will lead to the kind of hyper inflation witnessed in Weimar. I will explore the rate of inflation next.

No comments: