QE Chickens Start Roosting

Unless you watch the business channels, or read the financial press, you might not have been aware that over the last week there has been some panic in global markets. Not only have the US stock markets fallen every day for a week, sometimes by more than 1% per day, with other stock markets following suit, but there has been increasing fear that the emerging economies might go into a crisis. The currencies of many of the latter have fallen sharply, reminiscent of the Asian currency crisis of the late 1990's, and their central banks have held emergency meetings at midnight to sharply raise interest rates to protect those currencies, and guard against rising inflation fears. The cause of these panics is cited as being the introduction of “tapering” of QE by the US Federal Reserve. The real cause is not the tapering, but the QE itself, together with the changes in the Long Wave conjuncture I have set out elsewhere - Rates of Profit, Interest and Inflation. 

The effect of QE, is not to have reduced interest rates as generally proposed. Global interest rates have fallen since 1982, for the reason Marx sets out. High and rising rates and volumes of profit, produced a greater supply of potential money-capital, relative to the demand for money-capital. This greater relative supply then pushes down on money markets causing interest rates to fall. Money printing cannot have this effect, because it simply reduces the value of the money tokens printed, causing a relative rise in prices, which, in fact causes potential lenders to seek to protect themselves against such inflation by demanding higher not lower interest rates. QE, can increase the price of the bonds bought by the central bank, thereby reducing their yield, but this only causes yields to be higher than they would have been elsewhere, because money flows away from them towards where the state has provided a safe bet. The state cannot buy every bond, be the provider of printed money for every borrower without causing hyper-inflation. As Marx put it,

“The entire artificial system of forced expansion of the reproduction process cannot, of course, be remedied by having some bank, like the Bank of England, give to all the swindlers the deficient capital by means of its paper and having it buy up all the depreciated commodities at their old nominal values.”

“Incidentally, everything here appears distorted, since in this paper world, the real price and its real basis appear nowhere, but only bullion, metal coin, notes, bills of exchange, securities. Particularly in centres where the entire money business of the country is concentrated, like London, does this distortion become apparent; the entire process becomes incomprehensible; it is less so in centres of production.”

Capital III, Chapter 30

The difference here is that QE was not intended as a means of forced expansion of the reproduction process of productive-capital, but only as a means of bailing out the swindlers of financial capital. It was not intended to buy up depreciated commodities, but to buy up highly inflated financial assets, each time they began to be depreciated! In fact, the huge capital gains which were to be made from such speculation during this 30 year period, acted in many economies to divert potential money-capital away from productive use, where it could have been profitably employed. As a money-capitalist – and as Marx points out from the end of the 19^th century nearly all the big capitalists were really just money-capitalists who simply made their money available to the professional managers of their businesses - why, even if you could make 30% plus p.a. profit and rising from investing your money in productive-capital, would you do so, if you could buy technology shares in the 1990's, whose price was rising often by 70% p.a.???

During that same period, a lot of money-capital was invested in productive capacity in the Asian Tigers, but likewise, for the above reason, a lot also went into speculation in rapidly inflating property, until that crashed. The same thing happened when entry into the Eurozone made available large amounts of money, at lower interest rates than would otherwise have been the case, to countries like Greece, Spain, Portugal, Italy, Ireland and so on.

What QE did was not to reduce interest rates, but to devalue money, and thereby to prevent the nominal deflation of commodity prices, whose value was falling because massive rises in productivity reduced the labour-time required for their production, in addition to which vast new reserves of labour-power in China and other parts of the globe, where the value of labour-power was much lower, became employed to produce manufactured commodities using these same highly productive methods. In the process, this hugely increased volume of money tokens, together with the huge relative increase in the supply of money, itself resulting from the increased volume of surplus value, flooded in to buy up a restricted supply of fictional capital, fuelling massive bubbles in stocks, bonds, and property. Because, these financial assets provide the backbone of financial capital – the balance sheets of the banks, building societies, insurance companies etc. - and because this financial capital sits at the heart of capital markets, and therefore of the capitalist system, any bursting of those bubbles threatens the existence of those financial institutions and the functioning of the capitalist system, at least in the short run.

A look at what happened in Japan in the 1990's indicates that. As the financial bubble burst, the value of property and shares on the books of Japanese Banks collapsed by up to 90%. That undermined the capital base of those banks restricting their ability to lend, which in itself then has economic rather than purely financial consequences. It set in place the conditions for Japan to remain in deflation and the doldrums for more than 20 years.

For those economies that did not engage in the same kind of money printing that the US and UK did, the consequence, provided their economy had the potential for earnings, was that their currency appreciated. For two reasons this is anti-inflationary. Firstly, most globally traded commodities are denominated in dollars. So, if say the price of oil is $100 a barrel, and your currency appreciates against the dollar by 20%, then the price of a barrel of oil to you falls by 20%. So countries that needed to buy things like food, energy or even things such as capital equipment saw their prices fall often by significant amounts. By the same token, if you are a supplier of some strategic raw material, then the price you obtain for it in your own currency rises by 20%. That helps strengthen your currency further. In a period when the Spring Phase of the Long Wave cycle was causing primary product prices to rise sharply, this is significant for many emerging economies, a large part of whose income came from such commodities. But, the second anti-inflationary aspect of this is that as your currency rises in value, so the exchange value of other commodities denominated in it (their price) falls. It puts pressure on domestic producers to lower prices. In other words, a rising value of money acts as a monetary contraction, just as a monetary expansion acts to create a devaluation of money. In fact, the recent falls in inflation in the UK and EU, are a result of sharp rises in the value of the £ and € against the dollar. Both have risen by more than 10% in recent months. This will be reversed in coming months, as the underlying increases in commodity values, referred to in the post above, together with a strengthening of the dollar, as the US economy rebounds, will reverse those trends. A look at the rash of strikes in South African mines, the sharp rises in wages for workers in China and elsewhere indicate that the analysis I gave 7 years ago - Prepare To Dust Off The Sliding Scale – is correct.

But, as I pointed out a while ago - QE etc., whilst QE could act to resolve a credit crunch, it could not change the underlying insolvency of the banks and financial institutions, nor could it act to stimulate economic activity, because without sufficient demand, it was merely pushing on a string. The continuation of QE proved not only that point, but showed that continuing that policy was causing other contradictions to arise and intensify. That was containable so long as the economy was in the Spring Phase of the Long Wave boom, but as that conjuncture changes to the Summer Phase, it is not. Productivity gains begin to erode, innovation in new products also slows (the latest results from Apple shows this trend I have highlighted previously – Apple Also Confirms The Conjuncture.

Global interest rates have been rising for the last year, for the reasons set out in these previous analyses. The danger for the US Federal Reserve was that it would be behind the curve, and the markets would take matters into their own hands, causing the bond bubble to burst. Tapering is not the cause of rising interest rates, but a response to it. Just as QE did not reduce interest rates but reduced the value of the dollar, so tapering is not causing rising interest rates, but is causing the dollar to rise in value against all those emerging market currencies that benefited from it. Turkey's economy has grown spectacularly in the last few years, but its currency has now started to drop sharply against the dollar, forcing the central bank to hold an emergency meeting to raise official interest rates by more than 2.25 percentage points, to around 10%, a rise of more than 25%. Similar rises in official rates are likely across emerging markets.

The consequence of these higher official rates as well as of rising market rates will be that it will attract hot money flows as a means of defending the currency, but it will burst the asset bubbles that have developed in many of these economies. As well as the risk of contagion in global financial markets that entails, there are other risks to inflated asset prices in developed economies. That was highlighted in the recent heated debate between the Singapore Monetary Authorities and the business magazine Forbes as I pointed out recently – Is Singapore The Next Iceland?. Many of these Asian economies like Singapore and Hong Kong have highly inflated property markets reminiscent of the 1990's. A sharp rise in interest rates, and falling currencies are likely to burst it. But speculators from many of these countries have also been heavily involved in speculating in property in London and elsewhere. When they get their fingers burned its likely to have a similar effect on speculation in London property, as well as in property in parts of Europe, like Spain where the property bubble has not yet fully been deflated. According to the biggest estate agent in Spain, Idealista, prices there still have another 15% to fall. Some analysts believe that could be more like 50%. In the event of a renewed global financial crisis, the latter may still be an underestimate. That in turn will have huge consequences for the European banks that are essentially bust, but are given the semblance of life only by listing such property on their books at these inflated prices.

More worrying is the situation in China. The same processes that created this huge sea of liquidity have sent large amounts of money via the shadow banking system into a range of investments that are unsound. In fact, it was one of these - China Trust – that was partly the spark for the sell off in global markets in the last week. The immediate problem was addressed by a bail-out, but as Marx's quote above demonstrates, you cannot simply keep bailing out every bank, or every company that has such problems. In China there are many more instances of this kind of problem. Because China pegged its currency to the dollar, whenever the US printed money to lower the value of its currency, China had to do likewise. That is on top of a huge amount of actual money being created in its economy as a result of the growth of surplus value. With the US now tapering QE, the consequences of that are manifesting themselves via all the contradictions that money printing created.

The problems highlighted by the financial crisis of 2008 have not been addressed, QE has simply multiplied and magnified them. In store is a much bigger financial crisis than 2008. Whether it comes this week, this month, or this year, no once can say. The longer it is delayed, the worse it is likely to be.