Fed Opens The Door A Crack To Faster Growth

The US Federal Reserve, yesterday announced that, from next month, it will begin reducing the size of its $4.5 trillion balance sheet, by not replacing the government bonds and mortgage bonds it holds when they come to maturity. That is on top of the fact that, last year, it ended its QE programme of buying tens of billions of dollars of bonds each month. The additional measure amounts to a reduction in demand for bonds, of around $40 billion per month. In addition, the Federal Reserve also made clear that it will raise its official interest rates by another 0.25% points at its December meeting, and that it will raise rates by another 0.75 to 1.00% points during next year. Normally, economic theory would predict that such monetary tightening would lead to a slowdown in economic growth, and reduction in inflation. However, the policy of QE, implemented over the last 8 years, together with the increase in liquidity that central banks have created over the last thirty years, has created an Alice In Wonderland economy, where these economic truisms have been stood on their head. The Fed's actions actually open the door, a crack, to the potential for higher economic growth, and a rise in inflation.

As I have set out before, the policy of QE never was intended to stimulate economic growth. After the financial crash of 2008, at least as soon as the general economic conditions had been stabilised, the last thing that the state and the monetary authorities wanted was for the increasing economic activity that characterised the period up to 2008, to resume. In 2007, the global economy was booming. For the first time since the 1960's, not one single economy in the world was in recession; the global workforce had increased by around 30%, just in 8 years; the rapid increase in economic activity had caused shortages of primary products, such as oil, copper and so on, whose prices had soared, and the same was true of food prices, with food riots occurring in a number of places, as demand rose faster than could be met by supply. It meant that inflation had started to spike higher, and workers were responding to the higher inflation, by demanding compensating rises in wages. Sharply rising wages would have soon led to a squeeze on profits. And, when interest rates began to rise, it provided the spark that led to the credit crunch of 2007, with the collapse of Northern Rock, and several other banks around the world, and created the conditions that led to the financial meltdown of 2008.

The last thing the authorities have wanted, over the last eight years, has been for the rapid economic growth to continue, which would have quickly restored all of those conditions that led to rising interest rates, and a collapse in asset prices. It is why, alongside the policy of QE, which the authorities openly admitted was intended to reflate asset prices, we saw the policy of austerity, which took aggregate demand out of the economy, and slowed growth. Slowed growth, together with the potential for capital gains from inflating asset prices, guaranteed by the state, was a recipe to suck money out of investment in real capital, and out of the real economy, and into financial, property and other forms of speculation. The DOW Jones stands at around 3 times the level it was at in 2009, and, as one asset after another has been blown up into astronomical bubbles, speculation has been driven into finding yet more assets to blow up into bubbles, the most recent examples being Bitcoin, and other crypto-currencies. According to Robert Schiller, on the basis of his cyclically adjusted price-earnings ratio, stock markets today are overpriced to a level only previously seen on the verge of the Stock Market crash of 1929. It really is only a matter of time before all of these bubbles burst, now with even greater ferocity than in 2008, and given that this fictitious capital is now the form in which the bourgeoisie holds its private wealth, it is why the authorities have been doing all they can to hold back economic growth, and to keep those bubbles inflated.

The authorities, of course, do not want to drive the economy into recession, which would directly reduce profits, which would also, thereby hurt the potential to pay dividends, and other interest, which would then cause asset prices to fall, but they do not want economic growth to rise by more than a modest amount, so that wages remain constrained, inflation is constrained, and interest rates remain low. It is rises in interest rates that are the death of asset price bubbles, because asset prices are merely the capitalised value of the revenues those assets produce. The Fed is hoping that its policy of very slow rises in official interest rates, and very slow offloading of all of the bonds it holds on its balance sheet, will not have a symmetrical effect to its policy of QE, which built up that vast amount of those bonds on its balance sheet. It will be disappointed.

The extent to which economic truisms have been stood on their head as a result of QE, is shown by the fact that, over the last year, whilst the US has been raising official interest rates, the Dollar has been falling in value, certainly in the last few months. Normally, a rise in interest rates would cause the currency to strengthen as it leads to capital flows into the country, as foreigners seek to buy US bonds to obtain the higher rate of interest. After the Brexit vote, the Dollar certainly did strengthen against the Pound, but that was due to the Pound weakening. It fell to around $1.20, from being at one point as high as $1.70. Today, the Pound stands at around $1.35, but that is not due to Pound strength. The Pound has continued to fall against the Euro. The change is due to the weakness of the Dollar, with the Euro, which looked like it might have fallen to parity with the Dollar, now standing at $1.20.

So, why has the rise in official interest rates, and the ending of QE led to the Dollar weakening rather than strengthening? My guess, as I suggested last year, would be the case, is that because speculators have been buying financial assets to obtain capital gains rather than to obtain yield (which have fallen to near, and sometimes below zero, for many government bonds) as soon as a central bank announces that it is no longer acting as the buyer of first resort of these assets, and thereby ensuring that their price is goosed, the certain capital gains that speculators previously knew they could obtain, disappear, and the potential for those asset prices falling, and the speculators losing a lot of money arises. There is an incentive, therefore, for the speculators to take their funds out of those assets, and to put that money into the assets of some other country, where the central bank is standing behind those bonds, for example, as with the ECB, and European bonds.

US government bonds have not fallen as much as they might have done, but then, over the last year, the Federal Reserve has still been buying around $40 billion of bonds per month, to replace those bonds that mature. In addition, US banks have to maintain a level of bonds on their own balance sheets to comply with capital adequacy ratios, and US pension funds also have to buy bonds etc. Moreover, contrary to what I thought might happen as Trump was inaugurated, the Chinese have been buying US bonds, and are now the largest foreign holders of US government bonds, having replaced Japan, in that role. Why the Chinese have been doing that can only be guessed. Presumably, given the vast amount of US debt China holds, it didn't want to see US bonds fall sharply, as that would have caused it to lose a lot of the money it has tied up in US debt. Also, they may feel that holding this debt, gives them a weapon to hold over Trump, in the case that frictions arise between the two. Moreover, selling a large part of their US bonds, would have caused the Dollar to depreciate much faster, and made Chinese exports to the US much less competitive.

But, despite all of the central bank policies designed to divert potential money-capital into financial speculation, and away from real capital accumulation, despite the policies of austerity implemented in the UK, and EU etc. the global economy has continued to grow; and even stripping out all of the fake self-employment, the under-employment on zero hours contracts etc., the fact remains that employment levels have continued to rise. Rises in wages appear to be lagging surprisingly behind the rise in employment, but that can be explained by the fact that workers in that fake self-employment and so on can be drawn into the labour market, and as young workers increasingly replace retiring older workers, the lower wages of the former, distort the true picture. Surveys suggest, for example, that younger workers, in the UK, are obtaining wage rises closer to 4% p.a.

A look at the developments in the global economy also shows an increasing number of examples that confirms what Marx said a long time ago. With share prices at very high levels, it means that anyone with money-capital who uses it to buy shares, currently faces obtaining only a very low level of interest on it. However, if they use that money-capital themselves, directly to set up a business, to employ productive-capital, the rate of profit they can obtain by doing so will be many times the rate of interest they would have received. An increasing number, particularly of the very richest, of these capitalists have then been using their capital to establish businesses, such as Richard Branson's Virgin Galactic, or Elon Musk's Spacex, and so on, which are designed to key into the very high potential rates of profit from space technology.

At the other extreme, increases in productivity, and developments in technology mean that a lot of productive-capital has become very cheap, which means that other small entrepreneurs are able to utilise their money-capital to establish businesses, in other areas of new technology, whether it is in development of computer games, of mobile phone apps, of health-science technologies and so on. All of these represent real accumulations of capital, although they typically require little in the way of large scale fixed capital expenditure, and often next to nothing in terms of circulating constant capital, which also explains why the continued rise in economic activity has not witnessed any large scale increases in capital spending. That represented the old economic model.

One main reason that the investment in real productive-capital has not been greater than it has, is that for the majority of the available money-capital, at the disposal of shareholders, it has been a far safer bet to simply use that money-capital to speculate in the purchase of existing shares and bonds. It has been safer, given the backstop of the central banks for companies and their executives to further goose share prices, by using profits to buy back shares, or to buy the shares of competitors, or potential acquisitions, than to use those profits to expand the company. Once interest rates start to rise, that certainty disappears. Bond and share prices, along with property prices, crypto-currency prices, gold prices, vintage wine prices and so on, all start to fall, and the mindset sets in that actually investing in production, and making profits is a safer bet. That is why the action of the Fed, in reducing its balance sheet, and withdrawing its support for those financial asset prices, if only marginally, sends a signal to the speculators, that the party is over.  Its why those speculators, and the financial pundits who represent their interests on all of the business programmes, and financial press have been insisting that the Federal Reserve and other central banks will not be able (in other words, they are praying that they will not) to continue raising interest rates.

But, the fact is that the rise in economic activity is driving actual market rates of interest higher anyway.  As economic activity increases further, which is inevitable as more people are employed, and wages rise, and profits get squeezed by rising wages, the demand for money-capital will rise faster than its supply pushing interest rates higher still.  The days of the speculators are numbered, and as that vast sea of liquidity tied up in these financial asset bubbles floods out of them and into the real economy, inflation itself will rise mush faster than anyone currently thinks possible.  It will be the end of Alice in Wonderland economies, and economic laws being set back on their feet once more.