Wednesday, 31 July 2013

The Rates Of Profit, Interest and Inflation - Part 12

Inflation (4)

For some time, Marc Faber, who publishes The Gloom, Boom and Doom Report has been arguing that the Federal Reserve, and other central banks have become so committed to printing money, to keep asset prices inflated, that they cannot now withdraw from the policy. Every previous attempt to do so has resulted in markets crashing, and the reintroduction of the policy. They are hoping against hope that things will change that will allow them to withdraw at some point, but in reality they will just have to keep printing money to infinity, or more accurately until the entire system collapses. Its a similar view to that put out by Moneyweek in their End Of Britain video - The End Of Britain . Its possible, but unlikely.

There is a difference between money and other commodities. Marx in Volume II describes how money becomes available within the economy. Its not a question many economists consider, even Marxist economists, because its taken for granted that money is just there available to perform its function. But, of course it doesn't just appear from nowhere. Gold had to be mined, and converted from being just gold into being coins etc. But, the interesting thing about money, including gold, is that once it has been put into circulation, it basically stays there. Money as a commodity – the universal equivalent form of value – is different from every other commodity in that respect. Every other commodity, goes into circulation to be sold by its owner and consumed by its buyer. Even commodities that form fixed capital are consumed eventually, even if it takes a long time. But, money goes into circulation, not to be consumed, but just to circulate!

A has a commodity worth £10, which they sell to B, who consumes it. With the £10, A buys a commodity worth £10 from C, which they then consume. The £20 of commodities that went into circulation have now completely disappeared, consumed. But, the £10, which was used to buy them is still performing its function, still circulating, and will continue to do so, for many years possibly, until it is worn out. As seen previously, with gold and other precious metals, if too much of them is in circulation for the needs of circulating commodities, the value of the coins falls relative to their commodity value, and so they are withdrawn. But, that does not happen with money tokens or credit, in the form of bank deposits. Once created it remains in existence, available to circulate, so when more is created, it simply adds to the existing mass of money already in existence. The only way it can be reduced is essentially by the central bank taking the money out of the economy.

In general, this is not a problem. Capitalism continually, if unevenly, reduces the value of commodities, and generally speaking, because capital expands, more commodities are put into circulation. In order to prevent the fall in the value of commodities causing deflation, the value of money needs to fall, so a gradual increase in its supply achieves that. And, with more commodities to circulate, again more money is required. But, over the last 30 years, the amount of additional money put into circulation, mostly via credit creation, has been vast. It was needed to match the huge reduction in the value of commodities, and equally huge increase in the number put into circulation, but all of that money remains in circulation, and in the last few years an even larger amount has been added to it, to prevent the collapse of the asset bubbles blown up on the back of low interest rates and speculation.

The problem is, as stated in the last part, the conditions that caused the massive drop in the value of commodities is ending. Although, the prices of raw materials are likely to fall from here, as new supplies begin to match global demand, the productivity gains in the way those materials are used, is also coming to an end, so the effect on manufactured goods prices will generally be in an upwards direction. In fact, with some raw materials like oil, although new technologies like “fracking” are making additional supplies available, which will last for maybe 50-100 years, the costs of investment in this new production will mean that the price of oil is unlikely to fall much from here, even though oil will continue to be available to meet energy needs. China, and other previously low cost producers of manufactured goods are facing inflation, and that means the buyers of those goods will face higher prices too, which will pass through into higher prices of capital goods, and of workers consumption goods putting upward pressure on wages, and downward pressure on profits.

Where in the past, the mechanism was rapidly falling commodity values, leaving money available in large masses to flow into speculation, now the process will be the exact opposite. The huge pools of liquidity will begin to be soaked up in the circulation of increasingly higher priced commodities, including labour-power, i.e. inflation. Where there has been a real terms deflation of consumer goods prices for 30 years, and inflation of asset prices, we will now see an inflation of consumer goods prices, and deflation of asset prices, but in the nature of things, where consumer goods prices only deflate gradually, asset price bubbles deflate in the same way that a balloon does when its pricked with a pin!

On current evidence, there is a lot to support Faber's argument. The attempts to withdraw liquidity from the system goes back to the 1980's. But, when markets crashed in 1987, Alan Greenspan, a former devotee of Ayn Rand, and sound money, stepped in to goose the markets with lots of liquidity. On several occasions in the 1990's he repeated the same manoeuvre, and that policy has been followed by Ben Bernanke too. If we look at the policy of the UK Government, despite all their talk about debt, it has been exactly the same, print money, encourage more debt, particularly to try to prevent a collapse of the property market. And, of course, Governments have another good reason for adopting such a policy.

I pointed out several years ago, Paying For The Crisis – governments always look to inflation as a means of paying off their debts. In the last 5 years, inflation has reduced the real value of UK debt by around 30%. In other words, inflation has reduced UK debt, by far more than any of the Government's misplaced austerity measures!

But, the problem is that whilst Government's may welcome real inflation of around 6% in current conditions, they tend to fear it, as the Germans do, because it can get easily out of hand, precisely because of all that money sloshing around inside the system. Trillions of dollars is tied up in fictitious capital, in bubbles in property shares, and bonds, and even then, there is in the US alone about a trillion dollars sitting in cash waiting to find a home. As the prices of commodities rise, that cash will begin to move in that direction. The existing trend to higher interest rates caused by the shift in the supply and demand for money-capital, will then be compounded by the fear of inflation, causing the bond vigilantes to ditch their bonds over night. Bond prices will collapse, interest rates will rise, property prices will collapse, as will stock markets, the latter in part because of a collapse of the banks whose insolvency will become apparent, as this fictitious capital is destroyed.

So, Faber and Moneyweek's view is unlikely, because at this point more money printing would be pointless. All money printing can do from here is increase inflation, and thereby provide the spark for the above. At this point the only thing the State could do would be to fully nationalise what was left of the banks, so that the real economy could continue to function. Consequently, although we will see a huge deflation of asset prices, we are unlikely to see a hyper inflation of consumer goods prices. As I suggested a few years ago - A Momentous Change – this financial crisis, which should probably be seen as a continuation of 2008, will necessarily have serious knock-on effects to the real economy mostly in the US and Europe where the financial crisis will be centred, which could last 3 or 4 years, but the longer-term consequence would likely be positive for capital, because similar to the conditions Engels describes following the collapse of the Railway Mania, it would mean money-capital flowed into real productive capital, creating a better framework for a continuation of economic growth, and a rebalancing of the global economy.

The extent to which the banks and property remain pivotal to this has again been shown in the last few days. In the US, Detroit has declared bankruptcy, weighed down by its own accumulated debts. But, a side effect is that UK and European banks are set to lose $1 billion of the loans they had made to the city. Detroit is likely not to be the last US city to declare bankruptcy. Chicago looks to be in a similar situation. But, it is also being revealed that Greece remains mired in economic chaos, its debt continues to rise, and it looks likely that more of its debt will have to be written off. It was the writing off of large amounts of Greek debt that led to the collapse of the banks in Cyprus. With European banks all bankrupt, and only managing to hide it via large scale use of derivatives, further losses on their Greek debt is likely to see several more European banks go to the wall.

Given the use of all these derivatives, how that may play out with a series of unforeseen consequences is anybody's guess. But, Germany appears to believe that the various policies adopted by the ECB to buy up peripheral government bonds, has simply allowed the governments in those countries to continue without making the necessary adjustments to their economies to make them more competitive. As the German elections approach a tougher stance from Germany seems likely. Consequently, its unlikely that the ECB is going to engage in the kind of massive money printing that would be required to lead to hyper inflation.

To summarise, the global economy remains in the most powerful long wave boom of its history. It is a boom that has already led to the development of huge new economies in China and elsewhere, and a spread of the rule of exchange value across a wider area of the globe than ever before, with new capitalist economies, and with them working classes being established across Asia and Africa, and existing economies in Latin America taking on a new life. The Spring Phase of that boom has ended, and the Summer Phase has begun where continued strong growth continues, but where the productivity gains of the previous period slow down, and with it the rate of profit. The imbalances that arose in the global economy over the last 30 years, which are once again an example of the operation of the law of combined and uneven development, led to the build up of huge amounts of debt on one side, and huge cash hoards on the other. It led to the development of speculation, and the creation of astronomical levels of fictitious capital.

The Summer Phase will bring about a financial crisis that will resolved that contradiction. Inflation and interest rates will rise, asset prices will be massively deflated, creating a “reversion to the mean”, that will put the system on a more sustainable footing. The boom will continue until around 2025. Socialists should utilise the intervening period, to build up their economic and social weight, develop their organisations, and begin to create their own workers owned and controlled sector of the economy, ready for when the next conjuncture arrives.

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