Yesterday, the US Federal Reserve hiked its official interest rates by 0.25% points, as predicted. Financial journalists, in discussing the consequences, continued to repeat the old orthodoxy that higher US rates would mean a higher dollar, and so problems for the US exporting its goods and services. In fact, as I had suggested previously, rather than the Dollar rising after the rate hike, it fell. The Dollar fell, yesterday, by around 1% against both the Pound and the Euro.
The reason, as I previously suggested, is that both the Bank of England and the ECB are seen to be standing behind the inflated financial asset prices, and particularly the government bonds. The ECB continues its huge QE programme that is buying up the bonds of European countries, banks, and companies, whilst the Bank of England is seen keeping its QE programme at its current level, and holding its official interest rates pinned to the floor for as long as it can.
But, in terms of Hemingway's description of how people go bankrupt, we are still in the stage of "slowly at first", rather than yet the "then all at once" stage. The US Federal Reserve is less reliable as a buyer of last resort of all these astronomically over priced financial assets, than are now the Bank of England or ECB, but it still has $4 trillion of those assets on its balance sheet. Not only is it not selling any of them, it is when they mature actually still using the proceeds to replace them. Janet Yellen has said that they will not start shrinking that balance sheet until the process of raising official interest rates has become more normalised. So, far they have only increased official rates three times since the process began in 2015.
But, bond king Jeff Gundlach has suggested that the Fed may now go old school in its rate hike strategy. That is, it may start to raise rates at each of its meetings, or at least the so called "live" meetings, where it holds a press conference following its meeting. That would mean there would be many more rate hikes this year than the 2-3 the markets are currently expecting.
Listening to Yellen at the press conference yesterday a number of things materialised. Two weeks ago, markets put only a 30% chance of a rate hike on the books. By the time the meeting happened that had risen to a near 100% certainty. The reason was a series of statements by Fed officials in the intervening period. The Fed clearly wanted to signal to markets that something had changed, and it was entering a more serious period of rate hikes.
Yet, the Fed, like other central banks and participants in the global financial system, is scared stiff of throwing markets into a panic that financial conditions are being tightened too quickly. The reason is, as I set out in the previous series of posts, that when speculators feel that the end of the road has been reached and that reality is imposing itself on interest rates, asset prices will crash. It will be the "all at once" stage. Central banks and financial institutions want to delay that for as long as possible, even if they cannot avoid it.
But, the fact is that they cannot any longer avoid it for much longer. Yesterday, financial pundits were still talking about equity markets rising because of the magical properties of compound interest. They seem to think, as Marx pointed out, that financial assets produce interest, like a magic money tree, in the same way that a pear tree produces pears. They never ask where this interest comes from, what is the fund that enables this interest to be paid?
The fact is that interest/dividends can only be paid, and can only then become compound interest, because real capital produces profits. If more interest/dividends are to be paid then more profit must be produced, as the fund out of which that interest is paid. There is only two ways that this profit fund can expand. Either more capital must be employed - extensive accumulation - which employs more labour-power, which produces more surplus value, and consequently more profit, or else the average rate of profit on existing capital must rise, which itself requires that the value of either constant or variable capital, or both is reduced, or the average rate of turnover of capital is increased, which in turn requires that social productivity rises, which means that the technological basis of production must be revolutionised. In other words, it requires an intensive accumulation of capital. Either way, it requires an accumulation of capital.
But, what we have seen is an increasing proportion of realised profits going not to real capital accumulation, but to speculation, which drives up the financial asset prices, and thereby drives down the yields on those assets. That is not to say that there has been no accumulation of real capital. Clearly there has been. But, all that this process requires for yields to fall, and the basis for remedying that to be undermined is that the proportional growth of real capital, and on the basis of it, profit, to be less than the proportional growth of financial asset prices, which in turn means the proportional growth of realised profits devoted to such speculation, rather than real capital accumulation.
That is what has happened, and has happened at a quickened pace in the last 9 years after the financial crash, as central banks underpinned financial asset prices with endless amounts of money printing. But, in the end, you can't get blood out of a stone. If real capital and so real profits do not grow fast enough, whilst asset prices based on the potential of interest/dividends paid out of those profits, grow astronomically, something eventually has to give. As Andy haldane has pointed out, in the 1970's only about 10% of company profits went to pay dividends, yet today that figure is around 70%, even though yields have continued to shrink.
The total global financial assets are estimated at around $1,000 trillion, or about 14 times global GDP. If that was to be put in the context of the price of stock markets it is the equivalent of a stock market being valued at 14 times the revenues of the companies listed on it. And, of course, revenues are not the same as earnings. Revenues are simply the total sales of the company, whilst its earnings are the profits it makes from those sales, i.e. sales minus costs.
If we assume a global rate of profit of say 10%, that would give profits of around $7 trillion, and would give a global p/e ratio of these financial assets to global profits of around 140. The average p/e ratio for stock markets is considered to be around 12-14, and ratios over 24 are associated with periods just ahead of financial bubbles bursting. Stock markets are considered cheap after such crashes when p/e ratios are around 8. Some technology companies with sky high p/e/ ratios do have ratios running into hundreds, and some even into thousands, but often either the company is expected to have extremely high rates of growth, or else the valuation is yet again simply an example of speculation that sooner or later results in a bust.
With the level of financial asset prices at such a high level compared to global profits, and with no prospect that profits are going to rise sharply to correct that situation, a bust of asset prices is inevitable, and as set out in the previous post, the very mechanisms of the capitalist system ensure that, as capital will be driven to accumulate, and to drive up interest rates, whatever central banks do, and thereby to cause the capitalised value of those assets to fall sharply.
So, it was interesting, given Gundlach's comments about the Fed going old school, that in her comments at the press conference, Yellen seemed to counter that suggestion. Asked about what normalisation might look like, she referred back to the period of rate hikes in 2004, when the Fed did begin to hike rates at each live meeting, and stated that she did not envisage a process as rapid as that. The period after 2004, of course, saw US official rates rise to around 6%, ahead of the bursting of the financial bubble at that time, which led to the 2008 global financial crash.
We will see, but my instinct is that, as with Fed speak earlier in the year, which led markets to originally place only a 30% chance of a rate hike in March, until two weeks before, when they signalled it was a certainty, Yellen here is just trying to shape the market to deter the feeling as long as possible, that as Gundlach has said, there is going to be a sustained period of rate hikes, and speculators had, therefore, better get used to the idea that their fictitious wealth is going to shrink substantially over a sustained period. Its obvious why Yellen and the central banks want to deter that message getting out to speculators for as long as possible, but its also clear why people like Gundlach, and Bill Gross, responsible for managing hundreds of billions of dollars of speculators money want to be able to get their clients out of such situations ahead of the crowd.
The period of "slowly at first" continues, but the period of "all at once", is fast approaching.