Monday, 25 August 2014


Everywhere you look there is some kind of flation. In Japan, for the last 20 years, there has been deflation. In China, by contrast, there is inflation. In Europe, including the UK, there is disinflation, and it may be heading for stagflation, in the near future. In the US, inflation is on the rise. Everywhere, except Japan, there is massive asset price inflation.

Twenty years ago, Japan had gone through a massive asset price bubble, similar to, but actually smaller than, that which western economies have experienced, over the last few decades. When the Japanese bubble burst, in the early 1990's, the stock market fell 82%, from over 39,000 to less than 7,000. With Japanese banks highly geared to property and shares, the fall in the stock market also went along with a fall in Japanese property prices, of around 90%. The sharp fall in prices, also set in place the process of deflation that has affected Japan, for the last twenty years.

Consumers, who saw that there was an advantage in saving money, rather than spending it, because next week, the prices of things you want to buy will be cheaper than they are this week, caused Japanese consumption to fall, and its savings rise. Falling consumption itself plays into deflation, because it tends to mean that aggregate supply is always greater than aggregate demand. Pressure is constantly maintained, on prices, in a downward direction. But, also, as savers save rather than spend, producers seek markets elsewhere. At the same time, the savers provide the state with the money it requires to fund its expanding budget, as they buy its bonds.

The savers also buy the bonds of foreign state's and companies, and thereby provide them with the funds they require, to buy the commodities exported to them from Japan, China and other surplus economies. The income they receive, on these bonds, even as its squeezed by “financial repression”, still appears positive, for the Japanese saver, because even these low rates of return buy more, in an economy where prices are falling, than where they are rising. Prime Minister Abe, seeing the state deficit rising, whilst the Yen rises, thereby increasingly threatening the ability of the economy to finance itself, by high levels of exports, has attempted to reverse the deflation, by promising to double the money supply, thereby massively depreciating the value of the currency. Despite massive money printing, Japanese consumer prices have only moved up slowly, and whenever there is any global uncertainty, the Yen rises, as money rushes towards safe havens.

In China, without a welfare state or other means of social insurance, workers similarly save large amounts of their income to cover unforeseen eventualities. Yet, despite this high savings rate, China has seen inflation rather than the deflation that has affected Japan. Building its economy, on the basis of exporting large volumes of cheap commodities, China pegged its currency to the Dollar, as its main market for those commodities. In that way, whenever the US printed money, to pay for its debts, and thereby reduced the value of the dollar, the Remnimbi also fell, and the Chinese money supply increased, pushing up inflation.

As China, consumed ever more quantities of raw materials, to feed its rapidly growing industrial machine, the prices of those commodities rose, and was monetised by the increasing quantity of money circulating in the Chinese economy. From 1999 onwards, as the new global long wave boom swung into action, the prices of food and raw materials soared. That pushed up the end prices of commodities, produced in China, that was only offset by the massive rise in productivity that Chinese productivity brought about. As China sucked in increasing quantities of labour-power, from its countryside, Chinese wages themselves began to rise, by around 10% p.a., some of it simply covering the rise in prices, some reflecting an actual rise in Chinese real wages, as workers living standards rose sharply.

For twenty years, global commodity prices were kept low, because the new global long wave boom brought with it massive rises in productivity, and rises in the rate of turnover of capital, and in addition, because China pegged the value of its currency to the Dollar, although Chinese domestic inflation was pushed up, by the greater volume of money in circulation, Chinese export prices were kept low.

But, China has itself had to start sourcing production in lower wage economies, as wages have risen continually at home. In fact, its reported, in some industries, that Chinese wages have risen so much that production has been relocated to the US, because production costs are now cheaper there than in China! Whilst the rise in global food and raw material prices has more or less ceased, as new sources of cheaper supply have been brought on stream, the huge rise in productivity that occurred in the 1990's, and early 2000's, has also slowed, so that unit costs are rising. At the same time, China has allowed the RMB to rise, within limits. That helps to reduce its own import costs, but simultaneously causes its export prices to rise.

At the same time, the huge expansion of Chinese money supply, as elsewhere, has caused an increasing bubble in Chinese property prices. Chinese share markets have not bubbled up as they have elsewhere, because large amounts of money-capital has gone into actual productive investment, rather than simply bidding up existing share prices, but another feature has been that, particularly smaller companies, whose output is not encouraged within the objectives of the Five Year Plan, have had to seek out funding from a shadow banking system, that has also grown on the back of low interest rates, and a surplus of money in circulation. Instead, the surplus Chinese money-capital, has been converted into revenue, and invested in western bonds and shares, creating massive bubbles in such fictitious capital.

This massive rise in productivity, that went along with the new long wave boom, after 1999, as well as the fact that vast quantities of cheap commodities were thrown on to the global market, by China, during this period, has caused commodity price inflation, in Europe and the US, during that period, to be low. Had there not been massive money printing, during that period, there would have been actual deflation. That is market prices would have been falling significantly rather than rising. This is one reason that the real rate of profit is much higher than it appears, on the basis of nominal prices. At the same time, the massive rise in money supply, that started back in the late 1980's, caused a huge rise in asset prices. The real rise in those prices, whether for property or shares, occurred in the 1980's and 90's; the bubbles blown up at that time have only been kept inflated in the last 15 years. The Dow Jones, for example, rose by 1,000% between 1982 and 2000, but has risen by only 70% since 2000.

But, as productivity slows, and Chinese production costs rise, the potential for the value of commodities to fall further becomes limited. Meanwhile, the huge volume of currency thrown into circulation, and the inflation of banks balance sheets, on the back of this fictitious capital, provides the potential for money prices, of these commodities, to rise sharply, with only a small rise in the velocity of circulation. That is being witnessed now in the US, as both Producer Price and Consumer Price indices have begun to rise sharply. This poses a severe problem for the Federal Reserve. It has been “tapering” its money printing for several months, and yet is still engaging in quantitative easing to the extent of $15 billion a month.

Many are already saying that the Federal Reserve, and other central banks, are way behind the curve, in relation to inflation. It takes around two years before changes in money supply feed through into the economy, to be shown up in prices. Having previously targeted the unemployment rate, as a point when they would cease money printing, and begin to raise official interest rates, the Federal Reserve and the Bank of England, have both abandoned that criteria, after it was met, to justify continued money printing and low official rates. Now, they are targeting wage inflation. But wage inflation always arises – if it arises at all – after price inflation, not before.

The process is, as occurred in China, that commodity prices rise, and cause profits to rise. If the rise is sustained for long enough, so that firms believe that it is a permanent state of affairs, they begin to take on additional workers. Eventually, the number of workers available begins to fall, relative to this demand, so firms have to begin to bid up wages, to attract them. There are indications this is already happening in the US, and, in the UK, there are shortages of workers, with the necessary skills, for a number of industries, which has been exacerbated by the Liberal-Tory immigration controls.

If the Fed and the Bank of England wait until they see actual wage inflation, they will be two years too late. An inflationary spiral will already be under way, and any action they take will require two years to have any effect. It will have to be that much more drastic as a consequence. That is why there are increasing voices being raised, at the Fed, for the pace of action to be speeded up, why its more recent announcements have sounded more hawkish, and also why the minutes of the last Bank of England MPC meeting showed that two members –  Martin Weale and Ian McCafferty – voted to increase rates immediately to 0.75%.

But, both the Fed and Bank of England are reluctant to stop the money printing or raise official interest rates, because as soon as they do so, the massive asset price bubbles will collapse, and that means that the banks, whose insolvency is only hidden, by their fictitious balance sheets, will start to go bust on a large scale. The ECB has already enlisted the help of a US firm that dealt with bank failures in the US, in preparation for the expected failure of many European banks.

In the US, Robert Shiller has pointed out that, on his Cyclically Adjusted P/E ratio, shares are at levels only previously seen ahead of major market crashes, in 1929, 1987, 2000 and 2008. He also believes that property prices are once again in a similar bubble. Following a 30 year secular bull market, in bonds, that has raised their prices to levels not seen in centuries, this is another asset class that is in bubble territory. Almost everywhere you look, asset prices have been bubbled up, as investors seek places to put their money that might provide some modicum of return. Worryingly, one of those has been in the so called “Junk Bond” market.

Junk Bonds, are bonds issued by countries or companies with poor credit ratings. They tend to pay a bit higher yield because lenders are reluctant to lend to them for fear that they will not get their money back. But, there is another problem with Junk Bonds, especially as they have begun to be bought via exchange traded funds. That is that they are illiquid. Fewer people invest in them than other, safer assets. That means that if investors run for the doors, there is no potential buyer of these bonds, at almost any price, so they fall through the floor, taking investors with them, and that causes the kind of financial panic and credit crunch that was seen in 1929, and 2008.

For years, UK inflation was way above the Bank of England target of 2%. The reason was that the value of the pound was falling, and that pushed up UK import costs, for things like food and energy. When the US began QE III, whilst the Bank of England stopped its policy of money printing, the pound rose against the dollar by about 15%, going from $1.50, to over $1.70. That reduced UK import costs, and inflation fell. A similar cause lies behind the fall in Eurozone prices, as the Euro rose from around $1.20 up to $1.40. The other factor was that recession and austerity in the Eurozone depressed prices. As Marx demonstrated, lower wages do not cause lower prices. They bring about higher profits. However, in a global economy, prices and wages are determined at this global not national level. Within this context, lower wages can only result in higher profits, if the firm's involved are globally competitive, so that their prices remain the same. In much of peripheral Europe, the industry is not even competitive within the EU, let alone the global economy. Under these conditions, lower wages do not translate into higher profits, but into lower market prices, in order to enable the company not to go bust.

But, with global productivity gains slowing, global commodity prices rising, as the cheap prices offered by Chinese producers disappear, and are replaced by rising prices of Chinese commodities, the consequence is an overall squeeze on profits, whilst the demand for labour-power rises, and causes wages to rise. Moreover, the consequence of austerity measures is to constrain demand, and reduce the level of output to meet it. As was seen in the 1970's, the consequence of this is not to put downward pressure on prices, but to put upward pressure on unit production costs. The result is stagflation, low levels of economic activity, combined with steadily rising prices.

It creates the worst of all possible conditions, for asset prices. Share prices fall sharply, as the rate of profit declines, and available money-capital is required for productive-investment, rather than speculation. Workers have less money available, despite rising nominal wages, as inflation rises. Low levels of economic activity, mean they are less likely to spend on things like property. But, also as inflation rises, interest rates rise sharply, as bond investors seek compensation for the constantly falling value of the money they are paid in. The rise in interest rates causes share prices to fall further, and collapses the property market, especially where it has been in the kind of massive bubble that has built up over the last 40 years.

That is why the central banks have continually changed their message as to when they will stop money printing and begin to raise rates, because the end of this story is coming closer by the minute.

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