Sunday, 15 May 2016

The Rate of Interest - Part 4 of 4

The supply of money-capital, however, should not be confused with the supply of money, and still less with the supply of money tokens. The supply of money is determined by the value of money, the value of commodities to be circulated, and requirements for payments, and the velocity of circulation. If more money is thrown into circulation than is required, the velocity of circulation will slow down, money will be hoarded, and taken out of circulation. So an increased demand for money-capital cannot be met by an increased supply of money, other than to the extent that this increased demand is also an increased demand for money to circulate an increased value of commodities.

But, the supply of money-capital is a supply by money-lending capitalists, who expect to receive interest on it. That supply is only increased because they have an increased quantity of such available capital. That may be as stated above, because commodity prices have fallen, and so they require less to cover their living expenses, leaving more as potential savings. It may be because profits have risen, and so firms have more money profits available for reinvestment, or else pay out higher dividends, interest, and rents so that the recipients of these revenues have more money to be able to throw back into the money market. Or it may be because, existing money hoards are mobilised.

All of the above might cause the supply of money-capital to rise, and thereby reduce interest rates, if the demand for money-capital remained the same. But, if the demand for money-capital rises, then interest rates may rise, and it may then be the rise in interest rates that encourages a rise in the supply of money-capital, which pushes down interest rates, but not to their previous levels.

In other words, the supply of money-capital here can be thought of as a change in the proportion of money revenues allocated to saving as opposed to consumption. If revenues rise, consumption may rise in absolute terms, but fall in relative terms, so that there is greater saving, and so more potential money-capital thrown into money markets.

Its then clear that more money-capital cannot be created simply by increasing the money supply. If the supply of money is raised above what is required for the circulation of commodities, the velocity of circulation will slow down, and the money will be thrown out of circulation. But, in modern fiat money economies, where it is not money that is circulated, but money tokens, and credit money, an increase in the supply of these tokens and credit money above what is required simply results in a depreciation of those tokens, and thereby creates inflation. It can then be seen why such a policy, such as QE, cannot reduce the rate of interest – though it can reduce the yield on specific financial instruments. 

If the rate of interest is determined by the demand and supply of money-capital then this is expressed in money terms. If the demand for money-capital is £100 million, at a rate of 6%, and at this rate of interest, a supply of £100 million of money-capital is forthcoming, then demand and supply will be in balance, and the market rate of interest will be in equilibrium at 6%. If, more money tokens are thrown into circulation, however, then the value of these tokens will be devalued. Suppose the quantity of these money tokens is doubled, as has been the proposal of the Bank of Japan, recently, a value of £100 million then becomes a value of £200 million. It is not that there has actually been any change in the values of these commodities, merely that the monetary unit of measurement of that value, their price, has changed. In that case, what was previously expressed as a demand for money-capital of £100 million becomes a demand for £200 million, so that although the supply of money-capital might then also be represented by £200 million, the rate of interest remains 6%.

Marx makes this clear in Theories of Surplus Value where he quotes, David Hume and Joseph Massie to this effect.

“Hume attacks Locke, Massie attacks both Petty and Locke, both of whom still held the view that the level of interest depends on the quantity of money, and that in fact the real object of the loan is money (not capital). 

Massie laid down more categorically than did Hume, that interest is merely a part of profit. Hume is mainly concerned to show that the value of money makes no difference to the rate of interest, since, given the proportion between interest and money-capital—6 per cent for example, that is, £6, rises or falls in value at the same time as the value of the £100 (and. therefore, of one pound sterling) rises or falls, but the proportion 6 is not affected by this.”

The rate of interest is the market price for money-capital, but the money-capital may be loaned by a variety of means, represented by different types of financial instrument. A bank may lend money-capital, for example, in the simple form of a loan. Money-capital may be loaned by the purchase of a bond, with a given duration, and a fixed or indexed coupon, or capital may be loaned to a company in exchange for a share certificate, which provides for a variable amount of interest in the form of dividends.

As each of these offer varying amounts of security, or limitations on the lender, they each tend to offer different rates of interest, because these different risks and limitations will make owners of money-capital more likely to lend it in one form rather than another. A bondholder, for example, is entitled to the face value of the bond at the expiration date for the bond. Their coupon is a guaranteed amount paid at regular intervals. A shareholder by contrast, lends their money-capital effectively in perpetuity. They would only recover it in the event of the company being liquidated, and usually under such circumstances, the asset value of the company's capital would not be sufficient to cover the repayment of such funds. Moreover, the shareholder only obtains dividends if the company produces profits to cover them. Shares would, therefore, tend to provide a higher yield than bonds.

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