Another Volley Resounds

On Monday, I wrote – Volley-Firing – that the crisis in some emerging markets was a manifestation of a process of financial crisis, whose cause is the blowing up of asset price bubbles, during 30 years of money printing and credit creation. The contradictions which that caused would ultimately have to be resolved by a crisis, in which those bubbles burst, as interest rates rise. The tapering of QE is not the cause of rising interest rates, but a response to the fact that market rates were already rising. Tapering is not the cause of the crisis, but is only the spark, as it leads to a rise in the dollar, and a corresponding fall in other currencies. Because, in such circumstances, contradictions never unwind smoothly and gradually, the response has been the sharp sell off of various currencies such as the Turkish Lira, Argentinian Peso, Indian Rupee, South African Rand etc., sparking equally large rises in their official interest rates in an attempt to defend the currency. The response, in global stock and bond markets, shows that this initial volley, is already sparking further volleys in the process that Marx described as “volley-firing” as the crisis moves from one country to another in turn, as its turn to pay is encountered.

In my series - How High Can Stocks Go? – I have been pointing out that these asset prices, in stocks, bonds, and property, have been inflated over the last 30 years, as a result of this money printing, and stand in no relation to the actual economic development that has taken place during that period. I have also pointed out previously - The Bust Without A Boom – that there is a 13 year cycle of stock market crashes, of which 2013 was the next year when one was due. The crash in global stock markets began at the end of last year, continued through January, and appears to be intensifying in February. Does this mean the answer to the question, “How high Can Stocks Go?”, has been answered? Possibly, but maybe not. US stock markets have fallen by around 5%, but are still way above the level they began last year, because last year they rose by around 30%. Asian stock markets have fallen by more than 10%, meaning that they are in a technical correction. The Japanese Stock Market fell more than 4% on Tuesday alone. Yet, the Nikkei rose by a whopping 60% last year.  These oversized increases in markets are themselves a reflection of the fact that markets are being distorted by this huge volume of money printing, and the massive upward moves will also result in at least equally massive crashes.  But, as I pointed out recently, in relation to the massively inflated UK property market - When Falling Prices Still Signify A Bubble – in conditions, where the capitalist state continues to print massive amounts of money, and uses it to directly intervene in the market, as George Osborne is doing in the property market, with “Help To Buy”, the bursting of bubbles can be repeatedly delayed, but with the consequence that when it does burst, the explosion is even more cataclysmic. The current stock market crash could be the one that signifies that point has been reached, but it may not.

To put it in context, a reasonable level for the Dow Jones 30 Index is around 6,000 compared to its current level over 15,000. That implies a drop of around 60%. That would be huge, but it is less than the fall that occurred in the NASDAQ in 2000, which fell 75%. It is less than the fall that occurred in Japan's Nikkei in the 1990's, which fell from 39,000 to 7,000. It is, in fact, only around the same kind of drop as the 60% fall in US property prices, when that bubble was burst in 2008/9, or the similar falls in the property markets in Ireland and Spain. But, when markets correct, they never simply revert to the mean. By definition a reversion to the mean requires that when prices have been above it, they must also correct by dropping below it. It would not at all be surprising for the Dow to have to pass through 3000, or 4000 on its way back from 16,000 to 6,000. But, those kinds of correction are also required in other global stock markets, as well as in those property markets such as the UK, which have not yet passed through the corrections seen in the US, Ireland, Spain etc. where similar bubbles were inflated.

Rising interest rates are one means by which the bursting of such bubbles will be effected. In that context, the fall in recent days in UK and US interest rates might seem contradictory, but it is simply another manifestation of this process of volley-firing described by Marx. The process we are seeing goes something like this. Global interest rates rise, because all of the conditions that led to a rising rate and volume of profit over the last 30 years have started to reverse. The rise in the global rate of profit at least slows down, and has probably started to fall. The demand for money-capital rises – because firms need to invest more in productive-capital to ensure they retain market share, and capitalist states need to drain surplus value, to use it to spend on decaying infrastructure, to maintain the competitiveness of their economies – at a time when the falling rate of profit means the supply of money-capital relatively declines. This rise in interest rates has been witnessed in rising yields on sovereign and corporate bonds around the globe. The tapering of QE was an attempt not to be left too far behind the curve by the Federal Reserve, which might have resulted in a sudden bursting of the bond bubble. (The UK stopped its QE programme last year, as UK inflation continued to be massively above the target 2% rate.  It caused the £ to rise, which is part of the reason UK inflation has temporarily fallen.)  Tapering causes the value of the dollar to rise relative to other currencies, and particularly those emerging market currencies that have benefited from attempts to weaken the dollar. The weakening of those currencies arises as money flows out of their bonds and other assets. It has to go somewhere, so the first place it goes is to the relative safety of the bonds of the US, UK, Germany, Japan etc. Even some of the peripheral Eurozone economies are seen as safer bets, so long as the ECB stands behind their debt, with its own printing press ready to be sent into action, and so long as the assumption holds that German fiscal power stands behind the ECB.

The fall in the yields on the US and UK Bonds, is merely the other side of this trade. Another part of it is the fall in stock markets. That fall is being presented as due to the potential for reduced global growth as a result of the emerging market crisis. But, that view is false. Any slow down in global growth is marginal. Slower growth in some economies is being compensated by higher growth in others, for example, the continued industrialisation of a series of developing sub-Saharan African economies.  However, stock markets frequently move in the opposite direction to the real economy for the reasons I have set out previously, for example in the posts above - “How High Can Stocks Go?”. It is why market commentators frequently talk about bad news being good news. Stock prices are not determined by growth, by how much the economy is expanding, but by how much profits are expanding.  It is not slowing growth that threatens asset prices, but rising growth in current conditions, because rising growth, means rising demand for money-capital, which means rising interest rates.  Under current conditions, higher growth will be the assassin of the stock, bond and property markets.

Economies frequently experience conditions of boom, whilst the rate of profit within them falls. In fact, as Marx sets out, particularly in Capital III, Chapter 6, it is precisely the boom which causes the rate of profit to be falling, in such cases, because it pushes up the price of inputs such as materials, which cannot be passed on to end product prices, squeezing realised profit, and it pushes up wages, which directly reduces surplus value. Similarly, it is frequently the case that a period of stagnation and low growth coincides with a period of rising rates of profit, as happened in the 1930's and 1980's. Moreover, the lower the rate of profit, the greater the percentage of that profit, firms have to devote to investment in productive-capital so as to remain competitive, and to retain market share. The less of it, they have to be given away as dividends, or to be used for speculation by buying back their own shares and so on. In fact, they may have to issue additional shares and bonds, in order to obtain the money-capital they require for such productive investment. That means the demand for shares and bonds drops as the supply of them rises, sending share and bond prices lower.  As the potential for speculative capital gains disappears, so money-capital has more incentive to be used for real productive activity.

Over recent months, the falls in global bond prices have prompted talk of a “Great Rotation” from bonds to stocks, as money sought to obtain higher returns. But, with global stock markets themselves already in massively inflated territory that failed to happen. In fact, with the current sell-off in stock markets, money has flowed the other way, into the relative safety of those bonds, again causing the fall in yields witnessed over the last few weeks. But, as the process of “volley-firing” proceeds, that is not likely to last. In the first exchange of volleys, the participants will be the emerging markets themselves. Turkey has raised its official interest rates by huge amounts, but its currency has continued to slide against the dollar. Yet further interest rate hikes are likely to be necessary. But, at a certain point, its currency will have fallen to such a level and its interest rate will be at such a height, that further attacks on it will not be profitable for the currency speculators. Their attention will turn to the next victim. It is a target rich environment. The speculators may turn their attention to some other emerging economy whose currency has risen significantly, for example Singapore. It will then be Singapore's turn to increase its interest rates sharply, to defend its currency. As stated recently, Is Singapore The Next Iceland? such an event would be highly damaging for Singapore or for Hong Kong, both of whom have seen astronomical rises in their property markets as part of this process of asset price inflation and speculation. A sharp rise in interest rates, and a fall in their currency, possibly accompanied by sharp rises in inflation, would send their property markets crashing around their ears, taking a large chunk of their banking system, that has lent into this rising property market, with it.

As money streamed then out of Singapore, it might even flow back into Turkey, as the next exchange of volleys. When the Singapore Dollar falls to a much lower level, and its interest rates rise to a much higher level, attention will then pass to the next target and so on. At some point, and possibly one not too distant, dependent upon the pace of the “volley-firing”, attention will then turn to the next economies in line in Europe. To the extent that these weaker European economies use the Euro, any attack on their currency is at the same time an attack on the currency of Germany! The attack is then not manifest as an attack on the currency itself, but on the sovereign bonds of the country, as happened with the last Eurozone crisis. As money streams out of Luxemburg, Malta, Slovenia, and so on, causing an even bigger banking crisis than happened with Cyprus, because the banks in these countries comprise an even bigger proportion of GDP than they did in Cyprus, and because in the case of Luxembourg, it represents a much bigger proportion of EU GDP - After Cyprus, Who's next? - so it becomes necessary for the ECB to put its money where its mouth is, and to begin printing money to buy up these bonds. So far, Mario Monti has not had to act on his promise to “do whatever is necessary”, but that moment is approaching. The questions then will be, “Can the political paralysis in Europe be overcome to take the necessary measures to establish fiscal and political union, and can the ECB do enough to prevent a crash of European Bonds, and simultaneously, the value of the Euro."  I doubt it.