Saturday, 4 April 2015

Liberal-Tory Lies – Interest Rates

I have previously examined the Liberal-Tory lies that Labour profligacy caused the financial meltdown, which then caused the recession, and that the Liberal-Tories had restored growth. In fact, the deficit to GDP ratio, under Blair and Brown, between 1997-2007, was only half what it had been under Thatcher and Major, between 1979-1997, and even taking into consideration the period after 2008, the average deficit to GDP ratio was lower, under Labour, than it had been under the Tories.

Moreover, the policies that were pursued by Labour, after 2008, of fiscal stimulus, policies that were also being pursued in the US, and elsewhere, quickly stopped the further contraction of the economy, and restored growth. In fact, in the second quarter of 2010, the last quarter when Labour was in government, the economy grew at 1%, a faster rate than the Liberal-Tories have been able to achieve in any subsequent quarter!

The other lie that the Liberal-Tories have told is that, as a consequence of this supposed Labour profligacy, running up massive amounts of debt, the financial markets were in such a panic, over the UK economy, that they were pushing up the interest rate charged for lending to it, and in danger of cutting off any future lending. It is only the actions of the Liberal-Tories, in calming the fears of the financial markets, that rescued the economy, we are told. But, again it is a lie. It is a lie for a number of reasons.

Firstly, as shown, there was no Labour profligacy. The deficit to GDP ratio under Labour was, for most of the period, half what it had been under Thatcher. It was also less than it has subsequently been, under the Liberal-Tories. The average deficit to GDP figure, for the whole Labour period, was just 2.85%, whereas the average for 2010-12, under the Liberal-Tories, was 7.11%, or more than twice the rate!

The real debt, in the economy, that posed a problem, was not government debt, but the mass of private debt, which the Tories themselves had encouraged, from the late 1980's onwards, as a means of sustaining aggregate demand, whilst reducing wages. It was this mountain of private debt, which was more than double the amount of government debt, which was behind the blowing up of the share, bond and property bubbles. It was that which fed into the sub-prime crisis, which gave the spark to the 2008 financial crisis. What is more, rather than dealing with that mountain of private debt, as a means of rebalancing the economy, the Liberal-Tories have encouraged it to grow even larger. They have acted to encourage further speculation, and debt, in the property market, with their “Help to Buy” scam, for example, as well as landing students with an average of £40,000 of debt, from the moment they leave university!

It is that private debt, which the Tories have encouraged, since the late 1980's, and which the Liberal-Tories have further stimulated, in the last five years, that poses the real threat to the economy, because governments can always print money to pay their debts, whereas private citizens cannot. If interest rates rise, private citizens find they simply cannot pay their debts. They default on their mortgages, and other loans, and so on. The price of the property, and other assets, against which those loans are secured, collapses, and the banks and other financial institutions, who have lent the money, become insolvent, as their loans go bad, and the value of bank capital, in the form of the collateral they hold, gets decimated.

Secondly, the fact is that there never was a problem with the UK paying its debt, and the financial markets knew that, so there was never any danger that they would stop lending to the UK, or that they would demand much higher rates of interest, as happened with Greece, for example. As stated above, a government, with control over its own currency, can always pay its debts by simply printing money. That may have other consequences, such as depreciating the currency, and so raising inflation rates, which in turn raises the interest rates that lenders demand in future, but unless the amount to be printed is extremely large, this is usually manageable. In fact, the economies that have the largest debts, such as the US and Japan, have very low interest rates, and no problem borrowing on financial markets, because no one doubts that they will get repaid, even if the value of the currency they get repaid in, may have been depreciated.

Thirdly, and for the reasons set out above, the UK, in 2010, was having no problem in borrowing on financial markets, and the interest rates it was paying were some of the lowest it had paid in around 200 years! Where interest rates were rising, it was a consequence, not of government debt, but of a credit crunch in financial markets caused by uncertainty, largely in relation to that mountain of private debt, and in relation to the Eurozone debt crisis. The problem was not a fear that government may not repay the debt, but that if some countries like Greece went bust, if the crash in property markets, in Spain, Ireland and so on continued, then banks would go bust again. Once the Bank of England, began quantitative easing, and the ECB announced that it was standing behind European banks, that immediate problem was resolved.

Fourthly, a look at the figures for 10 year bond yields, shows that, once again, the Liberal-Tories claims simply do not stack up against the truth. At the start of 2010, those bond yields were falling not rising, and, in fact, they rose for a period after the Liberal-Tories took office!

A look at the actual bond yields for the UK 10 Year gilt demonstrates this. The graph at the site linked to above shows that the yield peaked at 16.34% in the early 1980's (click the max tab at the bottom of the graph), and then steadily fell, over the next 30 years. (This is consistent with the explanation of this phase of the long wave, I have described elsewhere). But, a look at the period from just before the financial crisis to 2012 (click the 4Y tab), is also illustrative. It shows that, in fact, in the period immediately during and after the financial meltdown, the period when the Labour government was borrowing most to bail out the banks, and to cover a loss of revenue, and increased benefits, as a result of the recession caused by the financial crisis, far from the interest rate, it faced, rising, it was actually falling sharply.

From about 5.25% in 2008, the yield fell to around 3.25% at the start of 2009, as the fiscal stimulus began to bring economic recovery. Although the rate rises, during the year, to around 4%, it peaks at that level, before starting to fall again. In fact, during this latter part of the Labour government, it falls, by May of 2010, to around 3.5%. In other words, at the time the Liberal-Tories came to office in May 2010, the UK was facing falling not rising interest rates. Moreover, by August of that year (and so before the Liberal-Tories could claim any real responsibility for what was happening in the economy) the interest rate had fallen to below 3%!

From that point on, interest rates actually began to rise not fall, reaching 3.75% by 2011. Its true that after that point, interest rates did begin to fall once more, but none of that can be claimed to be a consequence of the Liberal-Tories policy of austerity, began in mid 2010. Rather that fall, as with the even greater fall in the US, which applied a policy of fiscal expansion, is due to the role of the central bank in starting a policy of sizeable money printing.

Let's be clear about how this money printing works. Elsewhere, I have pointed out that money printing (in reality the printing of additional money tokens, creation of additional credit money etc.) cannot reduce interest rates. Interest rates, as Marx explains, are determined by the interaction of the demand for and supply of money-capital. The supply of money-capital depends on two things. Firstly, as the mass of realised profits rises this produces an increased mass of potential money capital that can be used for expansion, i.e. it increases the supply of money-capital. But, secondly, in addition to this increased flow of potential money-capital, the supply can be increased from the existing stock of potential money-capital.

So, where an economy has a mass of savings, this can always be mobilised as money-capital. Its why Marx says, older economies, where such stocks have had time to build up, have a greater potential for their mobilisation, and so lower interest rates.

The demand for this money-capital, however is also increased when the rate of profit rises, and because more is required, for investment, by productive-capitals seeking to obtain this higher rate of profit. But, it can also rise when these capitals simply need to invest more, in order to obtain greater market share, or to invest in research and development. During these periods, the demand for money-capital rises, whilst the lower rate of profit tends to decrease its supply, so interest rates rise faster. They rise even faster still, during periods of economic crisis, when profits collapse, but firms demand money-capital simply to stay afloat!

So, interest rates depend on this interaction of demand and supply, and so simply printing more money tokens, or issuing more credit money, does not affect this, because it merely depreciates the value of each token, and thereby leaves the balance of demand and supply for this money-capital unchanged in real terms.

This seems then to contradict the idea that quantitative easing, money printing, could have caused these bond yields to have fallen. But, the answer is that the money printing can affect the price of the bonds bought with the printed money tokens, and thereby reduce the yield on these particular bonds, but only at the expense of the yields on other bonds, or financial assets, or other market rates of interest. So, we have the situation where this money printing causes an artificial hyper inflation of share, bond and property prices, which reduces the yields on these assets, whilst, elsewhere in the global economy, we have yields rising to 20-30%, and beyond. In certain parts of the global economy, including in the developed markets, there is difficulty in even obtaining loans for small businesses, and there is the phenomenon of private debt, where borrowers face interest rates of up to 4000% p.a.!

The reason is quite simple, if you have money available to lend, and you are concerned with making a capital gain, or even just not making a large capital loss, rather than being particularly concerned about obtaining yield, why would you lend your money to a risky country, or small company, or someone with inadequate income, rather than lending your money to a large state, which is committed to underpinning and boosting the value of its bonds by printing money, and buying them with it?

That is what happened in the UK, as the Bank of England did quantitative easing. During the financial crisis, the Bank undertook £200 billion of money printing by the end of 2009. But, even after the crisis had been resolved, it undertook a further £175 billion of money printing in the next two and a half years (£75 billion October 2011, £50 billion February 2012, £50 billion July 2012).

The fact that the UK economy hardly grew at all during this period is an indication of the extent to which the policy did very little to boost economic activity. What it did do, was to suppress the interest the government was paying, to depreciate the currency, and thereby to cause inflation. During this period, as the pound fell against other currencies, inflation remained well above the Bank of England's 2% inflation target – more than double that target for much of the time. At a time when wages were stagnant or falling this policy was, therefore, a significant means of cutting real wages, and transferring income away from workers.

What the policy also did was to fuel the hyperinflation of property prices, putting them even further out of the reach of ordinary workers, and causing rents to rise, which in turn caused welfare payments for Housing Benefit and so on to rise. Similarly, it caused the prices of shares and bonds to rise even higher, as the bubble was further inflated. At a time when workers' pension contributions from employers were being reduced, and when workers' wages were being held down, so preventing them from making the necessary higher contributions themselves, this meant that fewer bonds and shares were purchased by pension funds, at exactly the point when the yields on the underlying assets in those funds was being squeezed. Once again, it meant that the interests of financial capital were being catered for, whilst workers wages were being squeezed, and a black hole in their pension funds created, as a direct result of Liberal-Tory policy.

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