Sunday, 12 March 2017

The Fed's Forthcoming Rate Hike - Part 2 of 4

What the Eurozone crisis did show, however, and what also applied to the ERM crisis, is that it is not sufficient to simply have a single currency, and single monetary policy. If financial markets cannot attack a country's currency, because it is part of a currency union, like the Eurozone, they can instead attack the individual country's bonds, i.e. to force it to pay much higher rates of interest on its borrowing. The same is true in reverse, for countries, like Germany, where speculators are prepared to bid up the prices of its bonds to higher and higher levels, even to the extent of creating negative yields. I will return to this point later.

But, what the Eurozone crisis, thereby, illustrated was not that individual countries, like Britain, or Greece, are better off outside such a single currency, but that single currencies also require single fiscal and debt management systems. If it were the case that all borrowing on international capital markets, was conducted by a single EU Debt Management Office, on behalf of Eurozone members, it would be as impossible for those capital markets to attack the borrowing costs of Greece compared to Germany, as it was to attack the Greek currency compared to the German currency.

A single Eurozone debt Management Office would issue EU bonds to raise the funds required by all Eurozone member states, and these bonds would then be homogeneous, and backed by the whole Eurozone economy, and its total tax raising capacity. Moreover, because the Eurozone is dominated by the large economies such as Germany, the rates of interest required on these bonds would tend to be closer to those on German bonds rather than on Greek bonds. It would thereby lower borrowing costs for the whole Eurozone. It is an argument for a larger, more integrated Eurozone, not against it.

And that, of course, is what happens in the US. The US Treasury, through its debt management office, issues US government bonds, which finance the borrowing of the US Federal state, which it uses to finance the federal spending across the whole of the United States, including projects undertaken in individual states. The individual states themselves can borrow money, in the same way that, in Britain, local councils can borrow money to cover their activities not accounted for by their central government grant, Council Tax, or other revenues. But, the more this additional borrowing is reduced in proportion to that raised centrally, the less the possibility of widely different borrowing costs being established. Instead this becomes a powerful economic tool to encourage economic development and capital accumulation in those areas, where it is lagging.

The point here is that although central banks can exert significant influence, and the larger the economy they represent the more influence they can exert, in the end, they cannot outweigh the power of global financial markets, or the laws of economics. The Bank of Japan has been trying, for the last twenty-five years, to keep the value of the Yen depressed, but it repeatedly sees its efforts thwarted, even if for short periods it is able to bring about such a devaluation. It is more difficult for a country to raise the value of its currency, in the face of hostile markets.

So, in a sense, the action of the Federal Reserve, on Wednesday, should be irrelevant, because it is these astronomically large, global financial markets that determine actual market rates of interest, and not central banks. If the state, via the central bank could dictate the price of capital, i.e. the interest rate, then, by the same token, it could dictate the price of any other commodity. Stalin believed that his planners could achieve that, in the 1920's, and the means of doing so, they thought, was through their control of the money supply, much as the Federal Reserve used quantitative easing. However, Trotsky and the economists of the Left Opposition, such as Preobrazhensky, showed why that was not possible.

Simply exercising political control over the state, even in a planned economy, does not abolish the objective laws of economics, and of the Law of Value. In fact, as Marx describes in Capital III, in such a society measurement of value becomes even more significant.

“... after the abolition of the capitalist mode of production, but still retaining social production, the determination of value continues to prevail in the sense that the regulation of labour-time and the distribution of social labour among the various production groups, ultimately the book-keeping encompassing all this, become more essential than ever.”

(Chapter 49)

And, so long as the measurement of value is undertaken in some monetary unit, then as Trotsky says, in order for such a planned economy to be able to undertake measurements confidently, the need for a stable currency is even greater in a planned economy than in a market economy.

“The question of the fate of the chervonetz has occupied a prominent place in the struggle of factions in the Communist party. The platform of factions in the Communist party. The platform of the Opposition (1927) demanded “a guarantee of the unconditional stability of the money unit.” This demand became a leitmotif during the subsequent years. “Stop the process of inflation with an iron hand,” wrote the émigré organ of the Opposition in 1932, “and restore a stable unit of currency,” even at the price of “a bold cutting down of capital investments.” The defenders of the “tortoise tempo” and the superindustrializers had, it seemed, temporarily changed places. In answer to the boast that they would send the market “to the devil”, the Opposition recommended that the State Planning Commission hang up the motto: “Inflation is the syphilis of a planned economy.””

Marx, in Theories of Surplus Value, describes why the rate of interest cannot be determined by these changes in the supply of money, or money tokens, into circulation. To begin with, as he says, it is necessary to distinguish the actual market rates of interest, as opposed to the official rates of interest set by central banks.

Marx quotes Massie.

““All Reasoning about natural Interest from the Rate which the Government pays for Money, is, and unavoidably must be fallacious; Experience has shown us, they neither have a agreed nor preserved a Correspondence with each other; and Reason tells us never can; for the one has its Foundation in Profit, and the other in Necessity; the former of which has Bounds, but the latter none: The Gentleman who borrows Money to improve his Land, and the Merchant or Tradesman who borrow to carry on Trade, have Limits, beyond which they will not go; if they can get 10 per cent by Money, they may give 5 per cent for it; but they will not give 10; whereas he who borrows through Necessity, has nothing else to determine by, and this admits of no Rule at all” (pp. 31-32).”

(Theories of Surplus Value, Chapter 7)

And Marx makes a similar point in Capital III. If we want to compare the market rate of interest in Britain with that in say India, Marx says, we would not look at the yields on government bonds, but on the rate of interest that companies charge for the loan of machinery etc. As Marx and Engels describe, the rates of interest that the Bank of England set often bore no relation to those actually charged in the market. A central bank can often intervene to raise market rates of interest more easily than it can reduce them. That is because the market rate of interest is determined by the demand and supply for money-capital. Because money-capital takes the form of money, a withdrawal of money itself from circulation necessarily reduces the supply of money-capital in circulation. 

Not only does this reduce the supply of money-capital, but by reducing the amount of currency itself in circulation, it encourages money hoarding, limitation of credit and so on. The consequence is then that the demand for money-capital itself rises, even if those who demand it only want to use it as currency, and not as money-capital.

If I am a small business, for example, that sees cash-flow dry up, because my customers seek to pay by cheque rather than cash, whilst my suppliers want me to pay by cash rather than commercial credit, or who reduce the payment terms from 90 days to 30 days, I may go to the bank for a loan not to use as money-capital, but simply to use as currency, i.e. to be able to make payments to suppliers and creditors.

But, for the bank, it makes no difference that I demand this loan to use simply as currency, because to them it is loanable money-capital, able to be used as capital, and to produce the average rate of profit. They are giving up that use value of capital, to produce the average rate of profit, and so demand the market price from me for it, whatever I use it for.

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