Wednesday, 16 March 2016

Capital III, Chapter 29 - Part 3

Marx sets out the basis of this fictitious capital, as it develops in the concept of “capitalisation”, which arises from interest bearing capital. It appears that the interest that accrues to money-capital does so simply because this is inherent to the nature of money-capital. In other words, the fact that this interest is only a portion of the surplus value, and the surplus value only arises in production is lost.

If interest is then a return to money-capital, the returns to other factors of production can then be considered in similar terms. Wages can be viewed as a return to human capital, rent a return to landed capital, and profits, as seen earlier, are viewed as only a specific type of wage paid to the entrepreneur.

“The matter is simple. Let the average rate of interest be 5% annually. A sum of £500 would then yield £25 annually if converted into interest-bearing capital. Every fixed annual income of £25 may then be considered as interest on a capital of £500. This, however, is and remains a purely illusory conception, except in the case where the source of the £25, whether it be a mere title of ownership or claim, or an actual element of production such as real estate, is directly transferable or assumes a form in which it becomes transferable.” (p 464)

Marx gives two examples of this, one relating to the national debt, and the other relating to wages. The state requires funds to cover its activities. This arises in different ways. For example, in the same way that someone may need to borrow money to make a large purchase, such as a house, the state may need to engage in large-scale purchases, such as the construction of dams and so on, which would impose too large a burden if they were to be financed out of current income (taxation). In other words, it needs to borrow for this kind of “capital” expenditure. 

But, also, at times, the state may need also to borrow to finance current expenditure, where this is greater than its income from taxation. For example, if it is engaged in a war, and needs finance to cover the wages of troops, purchase of munitions and so on.

In order to borrow this money, the state issues bonds of varying durations, from a matter of months, up to thirty years. In general, the shorter duration bonds will be intended to act like a firm's working-capital, to smooth out the monthly variations in the money taken in from tax, and the money spent as revenue. The longer dated bonds will finance the bigger capital projects, thereby spreading out the cost over a large number of years, and so smoothing the average annual cost. However, the state will often prefer to have more debt in longer dated bonds because, although it pays a higher absolute rate of interest on them, it often averages out over the lifetime of the bond, to a lower rate; its real value is always depreciated by inflation, but also it only has to pay the interest on the bond for long periods, rather than having to find the large amounts required for its redemption.

When the state issues such a bond – and the same applies to corporate bonds issued by companies – it has a coupon. This coupon is the amount of interest to be paid to the bondholder. If the rate of interest is 5%, then a £1,000 bond will have a £50 coupon – 5% of £1,000. The bondholder now possesses a bond, which acts like capital, in so far as it pays the bondholder £50 in interest each year. At the same time, the £1,000 that the bondholder paid for this bond has now been transferred into the hands of the state, and been used to cover its purchases and activities. But, all of this capital is fictitious.

The money provided to the state has been spent. The bondholder cannot claim it back. Even if it is in the form of physical assets, such as dams, the bondholder cannot obtain a piece of the dam. Bondholder A must either wait until the bond matures, in order to receive their principal back, or they can try to sell this bond to B. If the state's credit is good, B may be prepared to buy this bond from A, for the same reason that A bought it originally. That is that each year the coupon on the bond pays them £50. But, the question then is, how much they will be prepared to pay for it.

If the bond is say a 10 Year Gilt, and A has already owned it for five years, then, on the one hand, B may be prepared to pay more for it, because they only have to risk their capital for five years, as opposed to the ten years when A originally bought it. There is likely to be less depreciation of the bond in five years than there would be in ten years, for example, and less risk that some catastrophe might befall the state, leading it to default on repayment.

At the same time, economic conditions may have improved. The state may be seen as more creditworthy than it was, a steady supply of profits may have caused interest rates to fall. In that case, B may be prepared to pay more than the £1,000 face value of the bond, which was paid by A. If B buys the bond from A for £1,250, they will still get £50 per year on the coupon, but this £50 will now represent a rate of interest or yield, on the capital, they have advanced of 4%, not the 5% previously obtained by A.

On the other hand, if economic conditions have worsened, and the risk of the state defaulting on its bonds has risen, or if interest rates or inflation has risen, then B will offer less than the £1,000 face value of the bond. Suppose they offer A only £500 for it. In that case, the £50 a year in the coupon they receive will be the equivalent of a 10% interest on the capital they advance for its purchase.

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