In Part 1,
it was indicated that one place that the money could go to from
selling bonds, is into buying means of production, and labour-power,
in other words buying commodities that comprise constant and variable capital. In fact, it will also be shown that this may also involve
selling bonds, in order to buy bonds!
Companies
make profits. A portion of these profits is paid out in interest
(dividends, bond interest, loan interest) to the money lending capitalists
(shareholders, bondholders, banks) who lend money-capital to
businesses, in return for shares and bonds (fictitious capital).
Another portion of these profits is used by the company to internally
finance capital accumulation. The more a company can finance its own
expansion by these internal resources, the less it needs to borrow
money-capital, for that purpose.
In other
words, the higher the mass of profits that a company produces, the
more it can use these profits to expand. There are clearly two
factors at work here. Firstly, the mass of profits the company has
to use for such expansion, and secondly the mass of capital it
requires for this expansion. If the prices of things like machines,
materials and labour-power are high, it will require relatively more
capital to expand. Similarly, the amount of expansion required for a
company to be competitive may be large or small dependent upon the
industry, and the amount of competition it faces. As Marx states, in
Capital I, this depends upon various technical factors, which
govern the proportions in which capital can be expanded. For
example, a glass furnace that has six openings, requires six teams of
workers to be employed, one for each opening, as well as the
materials required by each team. It is not efficient, to employ only
five teams. Similarly, if additional capacity is required, it can
only be achieved by investing in an additional furnace, and a further
six teams.
So, at times
when relatively more productive-capital is required, the demand for
money-capital to buy this productive-capital will increase. It may
or may not coincide with relatively higher profits to finance it. At
times, it may be necessary to buy more productive-capital for the
reasons described above, but the mass of profit available for this
purpose may not be expanding as quickly as this demand, so the demand
for money-capital rises relative to its supply. As Marx explains, it
is this relation, which causes interest rates to rise.
This
situation is not the same as that which applies with the Law of The Tendency For The Rate of Profit To Fall. In fact the two situations
are diametrically opposed. With the LTFRP, there is rapidly rising
productivity. This causes the relative value of fixed capital and
labour to fall, and the value of the material processed to rise, as a
proportion of the commodity product. The unit price of the material
may fall, for example, cotton prices may fall per kg., as a result of
the rise in productivity, but the total value of cotton used rises,
because the quantity processed rises by more than the unit price
falls. The organic composition of capital rises, here because of
this rise in the mass of processed material, relative to labour. It
goes along with a rise in the rate of surplus value.
But, the
situation being described here is one where productivity growth is
slowing. Profits are squeezed because the price of materials rises
(rather than higher productivity causing relatively more of them to
be processed), whilst low productivity growth means this cannot be
offset by their more efficient use, so unit costs rise. In other words, it is not the organic composition of capital that rises here, but only the value composition of capital. Similarly,
this slower productivity growth means that relatively more labour is
used for any increase in output, so labour supplies get used up, and
this puts upward pressure on wages. The consequence is that profits
get squeezed as a result of these rising costs, and because higher
wages reduce the rate of surplus value. This is the opposite of the
conditions that exist to bring about the tendency for the rate of
profit to fall.
Moreover, these higher wages, bring about higher living standards, so, as workers begin to satisfy their needs for a range of commodities, the price elasticity of demand for these commodities rises. That means that to bring about any rise in demand for them, prices have to fall by larger and larger amounts. As Marx puts it,
“The same value can be embodied in very different quantities [of commodities]. But the use-value—consumption—depends not on value, but on the quantity. It is quite unintelligible why I should buy six knives because I can get them for the same price that I previously paid for one.”
(TOSV 3 Chapter 20, p 119)
The consequence is that the rate of surplus value falls as wages rise, and the cost of materials rises at a time when this increased cost cannot be passed on in prices. The first directly reduces the mass of surplus value, and the second reduces the mass of surplus value that can be realised, as firms have to absorb some of the cost increases out of the surplus value. So, more capital is required to finance even reproduction on the same scale, and more still to finance expansion, at a time when profits are being squeezed. But, competition, and the need to operate at minimum technical limits, forces firms to make the necessary investment in productive-capital.
As I wrote some time ago, we entered such a period in 2012. It means that firms need relatively more money-capital in order to buy this additional productive-capital. As stated above, there are two ways the firm can achieve this. Either, it can devote a greater portion of its profits for this purpose, or else it can borrow this money-capital in the money market.
Suppose the firm does the former. It uses a greater portion of its profits to buy productive capital. But, the consequence of that is that there is a smaller portion of profits available to pay out as dividends. Suppose, a firm makes £1 million of profits, and out of this it uses 80% for accumulation, and 20% are paid out as interest to shareholders, as dividends. If the value of the shares owned by the shareholders is also £1 million, then the dividend yield they obtain is 20%.
Now, if the firm needs to invest more in productive-capital, it may need to allocate 90% to that purpose, but would then have only £100,000 left to pay out as dividends. This would now represent just 10% dividend yield. Assuming that shareholders could obtain a 20% yield on their money by investing in bonds, or land or some other asset, they will then sell their shares. Share prices will then fall, until such time as the yield on shares is equal to the yield on bonds. This fall in share prices does not affect the capital already invested in businesses. It is the owners of shares who lose money, not the businesses they have lent to. The business itself still has the buildings, machines, material and labour-power it bought with that borrowed money, and those commodities still have their original value.
But, the other consequence here is that £100,000 that was previously paid out as dividends, and could be used by money-capitalists to lend out in the money-market, is not in their hands. It has been used directly to finance capital accumulation. That means the supply of loanable money-capital is reduced, and this acts to push interest rates higher. The means by which this occurs, can be seen easily if instead of assuming that the firm provides the necessary money-capital itself, it instead borrows this money, by issuing shares or bonds.
The firm needs to raise an additional £100,000. It does this by issuing a bond for £100,000. This is where the situation of selling bonds to buy bonds arises. Assume there are £1 million of bonds already in issue. When these additional £100,000 of bonds come on sale, buyers of them sell some of their existing bonds, and use the proceeds to buy these newly issued bonds. So, in reality, only £1 million is in circulation, but now there are 1.1 million bond units circulating. That means that the price of each bond has been devalued by 9%. Each bond now has a value of £0.91, rather than £1.
Suppose, that the coupon on each bond is equal to £0.10, which previously amounted to £100,000 on the total bond value of £1 million, or 10%. Now, the yield on each bond is equal to 11%. The total amount paid out in interest is equal to £110,000, but the total value of bonds is still only £1 million, which again is equal to a bond yield of 11%. So, in this way, one place that the money goes to from the sale of bonds, is to buy bonds!
The question then seem to be, why would anyone sell some of their existing bonds just to buy other bonds? The answer is simple, when the new bonds are issued, the issuer, must offer a higher coupon on those bonds to begin with. So, in order to persuade people to buy this additional £100,000 of bonds, the issuer – which may be a company, a country or a local government – has to offer a coupon rate of interest of 11%. So, someone who buys such a £100,000 bond, for its face value, would expect to receive a coupon interest of £11,000. Alternatively, when the bonds are auctioned, although they may have a face value of £100,000, they may only sell for £91,000.
In the final part, I will look at how this relates to the current spike in interest rates.
Back To Part 1
Moreover, these higher wages, bring about higher living standards, so, as workers begin to satisfy their needs for a range of commodities, the price elasticity of demand for these commodities rises. That means that to bring about any rise in demand for them, prices have to fall by larger and larger amounts. As Marx puts it,
“The same value can be embodied in very different quantities [of commodities]. But the use-value—consumption—depends not on value, but on the quantity. It is quite unintelligible why I should buy six knives because I can get them for the same price that I previously paid for one.”
(TOSV 3 Chapter 20, p 119)
The consequence is that the rate of surplus value falls as wages rise, and the cost of materials rises at a time when this increased cost cannot be passed on in prices. The first directly reduces the mass of surplus value, and the second reduces the mass of surplus value that can be realised, as firms have to absorb some of the cost increases out of the surplus value. So, more capital is required to finance even reproduction on the same scale, and more still to finance expansion, at a time when profits are being squeezed. But, competition, and the need to operate at minimum technical limits, forces firms to make the necessary investment in productive-capital.
As I wrote some time ago, we entered such a period in 2012. It means that firms need relatively more money-capital in order to buy this additional productive-capital. As stated above, there are two ways the firm can achieve this. Either, it can devote a greater portion of its profits for this purpose, or else it can borrow this money-capital in the money market.
Suppose the firm does the former. It uses a greater portion of its profits to buy productive capital. But, the consequence of that is that there is a smaller portion of profits available to pay out as dividends. Suppose, a firm makes £1 million of profits, and out of this it uses 80% for accumulation, and 20% are paid out as interest to shareholders, as dividends. If the value of the shares owned by the shareholders is also £1 million, then the dividend yield they obtain is 20%.
Now, if the firm needs to invest more in productive-capital, it may need to allocate 90% to that purpose, but would then have only £100,000 left to pay out as dividends. This would now represent just 10% dividend yield. Assuming that shareholders could obtain a 20% yield on their money by investing in bonds, or land or some other asset, they will then sell their shares. Share prices will then fall, until such time as the yield on shares is equal to the yield on bonds. This fall in share prices does not affect the capital already invested in businesses. It is the owners of shares who lose money, not the businesses they have lent to. The business itself still has the buildings, machines, material and labour-power it bought with that borrowed money, and those commodities still have their original value.
But, the other consequence here is that £100,000 that was previously paid out as dividends, and could be used by money-capitalists to lend out in the money-market, is not in their hands. It has been used directly to finance capital accumulation. That means the supply of loanable money-capital is reduced, and this acts to push interest rates higher. The means by which this occurs, can be seen easily if instead of assuming that the firm provides the necessary money-capital itself, it instead borrows this money, by issuing shares or bonds.
The firm needs to raise an additional £100,000. It does this by issuing a bond for £100,000. This is where the situation of selling bonds to buy bonds arises. Assume there are £1 million of bonds already in issue. When these additional £100,000 of bonds come on sale, buyers of them sell some of their existing bonds, and use the proceeds to buy these newly issued bonds. So, in reality, only £1 million is in circulation, but now there are 1.1 million bond units circulating. That means that the price of each bond has been devalued by 9%. Each bond now has a value of £0.91, rather than £1.
Suppose, that the coupon on each bond is equal to £0.10, which previously amounted to £100,000 on the total bond value of £1 million, or 10%. Now, the yield on each bond is equal to 11%. The total amount paid out in interest is equal to £110,000, but the total value of bonds is still only £1 million, which again is equal to a bond yield of 11%. So, in this way, one place that the money goes to from the sale of bonds, is to buy bonds!
The question then seem to be, why would anyone sell some of their existing bonds just to buy other bonds? The answer is simple, when the new bonds are issued, the issuer, must offer a higher coupon on those bonds to begin with. So, in order to persuade people to buy this additional £100,000 of bonds, the issuer – which may be a company, a country or a local government – has to offer a coupon rate of interest of 11%. So, someone who buys such a £100,000 bond, for its face value, would expect to receive a coupon interest of £11,000. Alternatively, when the bonds are auctioned, although they may have a face value of £100,000, they may only sell for £91,000.
In the final part, I will look at how this relates to the current spike in interest rates.
Back To Part 1
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