Monday, 13 March 2017

The Fed's Forthcoming Rate Hike - Part 3 of 4

The restrictions on the influence of the central bank here depends on the underlying strength of the economy, and the willingness of businesses to extend commercial credit, as well as upon the potential for a rise in the velocity of circulation. If economic activity is robust, the mass of realised profits will rise so that the potential supply of loanable money-capital thereby rises. But, robust economic activity will, in any case, lead firms to believe they will be paid for the commodities they sell, and may, therefore, compensate for the reduction in currency circulation via an increase in the supply of commercial credit.

As Marx notes from the discussions of the Bank Committee, businesses would simply replace Bank of England currency with their own notes. Moreover, in a modern, highly banked economy, currency itself may be largely replaced by electronic money. Firms do not require currency to pay wages, bills and so on, as these can now be paid directly by electronic transfer, and individual consumers can not only make many such payments in the same way, but individual small payments can be made by cash cards, mobile phones, and larger payments by debit and credit cards. As electronic payments are more or less instantaneous, the velocity of circulation thereby becomes highly correlated to the velocity of commodity circulation.

But, whilst a central bank can act to raise interest rates by restricting the supply of currency, that does not apply in reverse. Money-capital necessarily takes the form of money, but money does not necessarily take the form of money-capital. Money may simply act as currency. Moreover, as Marx describes in Theories of Surplus Value, Chapter 7, this increase in currency thereby reduces its value, so that the net result is only an inflation of money prices.

If previously £1,000 of money-capital was demanded and supplied at 6% rate of interest, to be used to buy a £1,000 machine, the consequence of doubling the currency in circulation is to cause a doubling of money prices. The machine then has a price of £2,000, and so £2,000 of money-capital is now demanded to buy it. So, the fact that the supply of money-capital now stands at £2,000, has no impact on the rate of interest, because the demand has also doubled in money prices. £1,000 of money-capital demanded and supplied at 6% interest is the same as £2,000 of money-capital demanded and supplied at 6% interest. The devaluation of the currency unit, by increasing the quantity of currency in circulation, simply changes the units in which both demand and supply are measured.

Marx describes this in Chapter 7, in his quotes from both Massie and Hume.

“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 hike, by the Fed, has other significance. Economics text books will tell you that a country that seeks to raise the exchange rate of its currency will raise its benchmark interest rates. Generally, that is the case. Its why, in the ERM crisis, Britain kept increasing its bank rate. The mechanism is that, by raising these interest rates, foreign owners of money-capital use it to put on deposit in British banks to obtain this higher rate of interest, or to buy UK bonds that then have a higher yield.

As this money-capital flows into the country, it is converted from Dollars, Euros, Yen etc. That means that these foreign currencies are sold, whilst the Pound is bought, causing the value of the Pound to rise in relation to them. In the 1960's these flows of money, in search of higher yields, were referred to as “hot money”, and they could be very destabilising, because it meant that huge amounts of money could move overnight from country A to country B, simply in search of this higher yield.

But, as I have discussed in the past, over the last 20 years, and last 10 years even more particularly, interest rates have fallen to lower and lower levels. In many cases, now, yields on bonds are actually negative. It is no longer obviously a search for yield that drives these money flows or else it would already have flowed out of these bonds into higher yielding bonds or other assets. Indeed, it would more logically have been used directly, by its owners, for productive purposes to produce a profit.

As Marx says, in Capital III,

“It would be still more absurd to presume that capital would yield interest on the basis of capitalist production without performing any productive function, i.e., without creating surplus-value, of which interest is just a part; that the capitalist mode of production would run its course without capitalist production. If an untowardly large section of capitalists were to convert their capital into money-capital, the result would be a frightful depreciation of money-capital and a frightful fall in the rate of interest; many would at once face the impossibility of living on their interest, and would hence be compelled to reconvert into industrial capitalists.”

(Capital III, Chapter 23)

And, he makes the same comment in Theories of Surplus Value, where he sets out against Ricardo that the owner of a farm may advance an additional £1,000 of capital on it, even if it does not produce the average rate of profit, because the alternative may be only to lend out this £1,000 at an even lower rate of interest.

“In practice matters do not always work out in the Ricardian manner. If the farmer possesses some spare capital or acquires some during the first years of a lease of 14 years, he does not demand the usual profit, unless he has borrowed additional capital. For what is he to do with the spare capital? Conclude a new lease for additional land? Agricultural production favours to a much higher degree more intensive capital investment, than a more extensive cultivation of land with a larger capital. Moreover, if no land could be leased in the immediate vicinity of the old land, two farms would split up the farmer’s work of super-intending them to a much greater extent, than six factories would split up the work of one capitalist in manufacture. Or should he invest the money with the bank, for interest, in government bonds, railway shares, etc.? Then, from the outset, he forgoes at least a half or a third of the usual profit. Hence, if he can invest it as additional capital on the old farm, even below the average rate of profit, say at 10 per cent, if his profit was 12, then, he will still be gaining 100 per cent if the rate of interest is 5 per cent. To invest the additional £1,000 in the old farm is, therefore, still a profitable speculation for him.

Hence it is quite wrong for Ricardo to identify this investment of additional capital with the application of additional capital to new soils. In the first case, the product does not have to yield the usual profit, even in capitalist production. It must only yield as much above the usual rate of interest as will make worth while the trouble and risk of the farmer to prefer the industrial employment of his spare capital to its employment as money capital.”

(Theories of Surplus Value, Chapter 13)

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