Monday, 3 March 2014

Just Another Financial Volley For Now

The crisis is Ukraine is in some ways another manifestation of the volley firing I've described previously. Huge amounts of QE by the US over the last 20 years have devalued the dollar, and thereby increased the value of other currencies, like those of emerging economies, beyond what the strength of their economies justified. The high values of their currencies, reduced their import prices reducing their inflation rates, and thereby causing them to adopt lower interest rates than would otherwise have been the case. As QE is withdrawn this process unwinds, and it does not unwind smoothly. The currencies of countries like Turkey have been attacked, causing them to have to raise interest rates sharply.

Ukraine saw the value of its currency fall sharply against the dollar long before this crisis broke out. That was causing inflation to rise, despite the fact that one of its most important imports – energy – was being provided on the cheap by Russia. As with other emerging economies in this situation, the sharp fall in its currency caused import prices to rise, sending inflation up sharply. Turkey has just seen its CPI inflation go to nearly 9%, whilst its Producer Price Index, which is the first to be hit by imported input costs, has already gone over 12%. The reason Yanukovich, in Ukraine needed to do a deal with either Russia or the EU, was precisely this economic vice it was being forced into.

So, far this is just another volley in this series of volley firing, as one economy after another gets hit by sharp falls in its currency, sharp rises in inflation, requiring big rises in interest rates, which then sends its financial markets into turmoil, and brings to a halt the forward movement in its real economy. Lying behind that is the process of global rises in interest rates, which arises, as I've set out previously from the fact that the Spring Phase of the Long Wave cycle has ended. It is always the case that in this Summer Phase, global growth continues overall to be robust, but the factors that caused higher profit rates and lower values in the Spring Phase, are reduced and reversed. More productive-capital has to be invested to maintain growth of the economy and of profits. That means the rate of profit – though not the volume of profit – falls, the demand for money-capital rises relative to the supply pushing global interest rates higher. That is what we are seeing. It is the real reason behind the tapering of QE, whose continuation could now only be counter-productive, causing consumer price inflation to rise, and thereby pushing up interest rates even further.

That process like all others under capitalism does not unwind smoothly because capitalism is not a planned system. The resolution of these contradiction is always achieved via sharp breaks and crises. In fact, an example of that is to look at what has happened to interest rates. Whilst interest rates have risen sharply across emerging economies - today Russia raised its interest rates from 5.5 to 7%, as its stock market fell by 13% - in the developed economies they have fallen. The US and UK 10 Year Bonds having risen to over 3%, a few months ago, have fallen back now to around 2.6%. 

But, this is rather like what happens with a tsunami. The first sign of a tsunami hitting is that the sea level drops sharply, as its drawn back. Interest rates here have fallen because money that poured out of the emerging markets sought a relatively safe home. Today's sharp drops in stock markets have caused bond markets to rise for the same reason. But, once the sea has been drawn back into the mass of the oncoming tsunami, it floods back with devastating consequences. That is what lies ahead for the bond markets of developed economies.

So far, there has been no volley-firing of actual munitions in Ukraine, fortunately, but as Paul Mason recently pointed out it could be the economic consequences that are the more devastating. I think he is wrong about the end of globalisation, but this is just a current manifestation of underlying contradictions stored up by QE that are now in the process of being resolved across global financial markets.

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