Bank of England Doubles Its Rates

The Bank of England has doubled its interest rates from 0.25% to 0.50%. It's a move in the right direction, but it has much more to do. As I predicted, because QE and years of central bank support for asset prices has turned the normal economic mantras on their head, rather than the rise in official interest rates causing the Pound to rise against other currencies, it caused it to fall. The same has been seen with the falling Dollar, as the Federal Reserve has removed its QE, and gradually raised rates, whilst the Euro has strengthened, at a time when the ECB has been continuing and extending its policy of QE, to buy up and backstop European bonds, and financial assets. The models and predictions of the financial pundits, who continue to operate on the basis of those now out of date mantras, are necessarily wrong.

A good example of that was given by, former MPC member, David Blanchflower, in the week, on Newsnight, in a discussion with the FT's Gillian Tett. Blanchflower's argument that the decision to raise rates was a mistake, made no sense. His argument was that the economy is weak, and is dependent upon consumer spending by workers, whose stagnant or falling wages, already threaten to reduce that component of aggregate demand, without those workers then also facing higher borrowing costs, which would limit their spending further. Tett correctly pointed out that what this amounted to was arguing that the economy could only be saved by trying to perpetuate an already over inflated consumer credit bubble, which itself threatens the economy when, ultimately, it must burst, whilst doing nothing to actually provide a sustainable solution for the economy's problems, which requires an increase in capital investment, which is the basis of a rise in productivity, as a means of facilitating higher wages and other incomes. Blanchflower's only response to that argument was to say that other credit measures could be used to prevent the existing credit bubble inflating further, rather than using interest rates. But, he failed to recognise that, in that case, the basis of his initial argument that it was necessary to sustain consumer spending to maintain aggregate demand, would equally fail! His argument comes down to the same Friedmanite, monetarist argument of increasing liquidity to reduce interest rates to stimulate asset prices.

He may want to argue that his aim is to sustain aggregate demand, and that is the line that the central banks have pushed, but it is nonsense. As Keynes argued, in conditions such as those we have, printing money, and relaxing credit conditions is just like pushing on a string, as far as the real economy is concerned. In other words, you cannot get businesses to borrow money to invest, if they do not feel that there will be sufficient additional demand for the additional output resulting from that investment, to make it worthwhile. But, the reality is even worse than that. As Marx points out, in A Contribution to the Critique of Political Economy, central banks can put additional liquidity into circulation, but, having done so, they have no control over where that liquidity goes.

In the case of Keynes' argument it goes nowhere, and instead bunches up as the velocity of circulation slows down. But, it is not necessary that capitalists see no profitable outlet for investment to lead them not to borrow to invest. All that is required is that those who have control over these decisions see a more lucrative use for that money than its productive investment. In the last thirty years, the owners of loanable money-capital – that top 0.001% who own the majority of shares, bonds and so on – have seen that even if the yield they obtain on these assets has declined year after year, the price of those assets has grown like topsy, and whenever those prices have fallen back, the central banks have stepped in to push them back up again. The owners of that loanable money-capital have, therefore, seen that it is far more lucrative to use their own money-capital, and to borrow cheap money, so as to speculate even further in the purchase of shares, bonds, property, derivatives, bitcoin, wine, art and so on. And, that has been a self-fulfilling prophesy, because the more they have speculated in all these things that are in limited supply, the more the prices of all these assets have skyrocketed.

But, Blanchflower's argument is ludicrous for other reasons. More than 1 million people in the UK are reliant on payday loans in order to get from one pay day to another. These loans charge interest rates up to 4000% p.a. It is ludicrous to believe that a 0.25% point rise is going to make any noticeable difference to anyone already paying such astronomical market rates of interest. But, millions more rely on credit cards to get from one pay day to the next. Again, the rate of interest on this debt is around 20-30% p.a., and so a quarter point rise, is again negligible in proportional terms. If the argument then is that a rise in the base rate will reduce consumer spending, by making this debt more expensive, it looks hardly sustainable.

The other component of aggregate demand is investment. A few years ago, Michael Roberts provided the following information.

“as of August 2013, loans outstanding to UK residents from banks were £2.4tn (160% of GDP). Of this, 34% went to financial institutions, 42.7% went to households, secured on dwellings, and another 10.1% went to real estate and construction. Manufacturing received just 1.4% of the total! UK banking’s principal activity is just leveraging up existing property assets. I identified the same point in work done for the pamphlet for the Fire Brigades Union on the need for public ownership of the banks and found that the big five banks in the UK hold £6trn in assets. This is equivalent to the amount that more than 60 million British people produce in four years. Yet the banks have earmarked just £200bn of this to investment in industry in the UK, a measly 3% of the total.” 

The picture is a familiar one. For the very big companies, who have lots of cash, they have no problem issuing commercial bonds, with low yields so as to raise even more cash. That has been seen in the case of Microsoft, Apple and so on, whose bonds are also the ones that central banks buy as part of their QE programmes. Often, these huge corporations, whose executives operate in the interests of shareholders, not of the company itself, have then used this cash not to invest in production, but to buy back shares, thereby inflating the share price further, and so handing the shareholders a large capital gain on their shareholding. And, they have done the same thing with company profits, where these have also been given away to shareholders in the form of capital transfers, or increased dividends, not to mention to the executives themselves in the form of hugely inflated salaries, and share options. But, smaller and even medium sized companies have been in a completely different position, as Roberts' quote indicates.

They have found it increasingly difficult to obtain loans from banks, as those funds have gone to fund speculation in financial assets and property. For some of the smaller companies the reluctance of banks to lend is understandable. They form part of that 160,000 UK zombie companies barely able to cover interest repayments, let alone to repay the capital sum borrowed. But, that is not the case with all. It is simply safer and more lucrative for the banks to lend money to finance speculation, particularly speculation in property, that is backed by the state, and which they can repossess should they need to. Its not surprising that the one area of household credit where interest rates are low, compared to that for payday loans or credit cards, is for mortgages. With a 10% deposit, you would expect to pay only around 4% p.a.  It has encouraged even workers with small sums of savings to speculate in property, by becoming "Buy to Let" landlords.

But, a small firm that is unable to obtain a loan from a bank, might have to rely on a personal credit card to provide the funds they require for productive investment. Alternatively, they might be able to obtain funds from one of the growing number of peer to peer lenders that have grown up as, on the one hand, borrowing has become more difficult, whilst interest on savings has fallen to near zero, but, these rates are typically around 10% p.a. Although, a quarter point rise to 10.25% represents a significantly greater proportional rise than a quarter point on a payday loan, or a credit card debt, it is still only a 2.5% increase in the cost of servicing the debt, and consequently unlikely to have any significant effect on the demand for such credit, and consequently upon investment spending.

What it does do is to begin to send a message to the speculators that the long period during which central banks had their backs is coming to an end. That is why, as I pointed out previously, contrary to the traditional economic mantra, the rise in interest rates has led to a fall in the value of the Pound, rather than a rise. The traditional mantra is that a rise in interest rates causes the currency to rise, because speculators, seeking yield, have an incentive to move their money to those currencies that provide this higher yield. But, the reality is that speculators stopped searching out yield long ago, in order, instead, to concentrate on searching out the potential for capital gain, or to be able to minimise the potential for capital losses. So, because yield and the price of assets is inversely related, whenever interest rates are raised, and so asset prices fall, speculators are more concerned to avoid the capital loss this entails, than to be able to obtain a marginally higher – in absolute terms – yield on those assets. As the Federal Reserve and Bank of England raise their rates and stop QE, so the hot money moves out, and moves into Euros and Euro denominated assets, because the ECB has continued to keep its rates low, and to use QE to buy up Eurozone bonds, thereby underpinning their prices.

The prices of bonds and other such assets is based upon the capitalised revenue.  A £1,000 bond that pays £5 of coupon interest p.a., has a yield of 0.5%.  If interest rates rise, so that all such new bonds pay £10 of coupon, representing an interest rate of 1%, then the capitalised value of all the existing bonds, is halved from £1,000 to £500, so that they too produce a yield of 1%.  The owners of those bonds, thereby suffer a significant capital loss, as a result of this very small absolute rise in interest rates.  This applies to the prices of all other such revenue producing assets, such as shares, land, and so on.

For someone with a mortgage, paying 4% in interest, a quarter point rise to 4.25%, represents a 6% rise in their mortgage payments. This again is referenced by those like Blanchflower, who argue that the rate rise thereby increases living costs, and acts to reduce aggregate demand. That is wrong for several reasons. Firstly, the additional money paid in interest does not just disappear. It goes either into the profit of the bank/building society, and thereby into dividends/capital accumulation, or else it goes out again to savers in those institutions, whose deposits thereby attract higher rates of interest. Some of those savers are themselves people who are trying to save money as deposits on houses, or to buy other large consumer durables such as cars etc.

Secondly, the higher mortgage payments do not affect everyone. A large proportion of the population have either already bought their home, and have no mortgage, or else are tenants. Another substantial proportion have fixed rate mortgages, which will not change. To the extent that any of these categories are also savers, they will benefit from the additional income that higher savings rates will give them on their deposits. That means they will have additional money to spend.

But, in terms of house buying, it also misses out a further important point. For anyone buying a house with a mortgage, the cost comprises two different components. One is the rate of interest on the mortgage, the other is the actual price of the house. These two components are not unrelated. The lower interest rates are, the more debt buyers can take on, and thereby the more they can push up house prices, especially in conditions where the supply of houses does not rise proportionally to this increased monetary demand. Mortgage payers may face a 6% rise in their monthly payments, as a result of this quarter point rise in rates, but it would then result in a fall in monetary demand for houses, which will then lead to a fall in house prices. The rise in the cost of house purchase due to higher borrowing costs, would then be offset by a fall in house prices, and everyone looking to buy a house (including those looking to move up the housing ladder) would then benefit from these lower house prices, as their money would go further.

I heard one financial advisor on the TV the other day, talking about the fact that real interest rates are negative, i.e. the interest you get on your savings is outweighed by the reduction in the value of your savings as a result of inflation. Again this is a fallacy that derives from operating with mantras rather than understanding the underlying realities. Inflation is a measure of the change in money prices of consumer goods and services. But, as such, it hides a myriad of different relations. Money is simply the universal equivalent form of value. However, the reality is that every commodity has a plethora of different prices/exchange values, where it is measured against some other commodity, rather than money.

As Marx sets out in Theories of Surplus Value, if you measure the price of, say, corn in cotton, rather than gold, you will get a different price, and the movement in the price of corn may then also be completely different to the movement in its price, as measured in gold. Suppose the value of 1 kilo of corn is 10 hours of labour, and the value of 1 gram of gold is also equal to 10 hours of labour, whereas 10 kilos of cotton has a value of 10 hours of labour. In that case the gold price of a kilo of corn is equal to 1 gram, whilst its cotton price is equal to 10 kilos. In other words, the price of the corn is a function of its own value, and the value of the commodity that is being used as its measure. The price of the corn, therefore, can change as a result of either a change in its own value, or a change in the value of the commodity in which its value is being measured.

Suppose the value of corn rises to 20 hours per kilo. If the value of gold remains the same, at 10 hours per gram, then the gold price of a kilo of corn rises to 2 grams. But, suppose the value of cotton rises to 40 hours for 10 kilos. The cotton price of corn will now have fallen to 5 kilos. So, although the value of gold has remained constant, the gold price of corn has risen, whilst the cotton price of corn has fallen. So, it can then be seen why talking about the fall in the value of money (savings) makes no sense, when viewed concretely, because it depends what this money is to be exchanged for, as to whether its relative value has risen or fallen.

Suppose I have £100,000 in the bank, and the rate of interest is 1%, whilst the CPI rate of inflation is 3%. If I only ever intend to use this £100,000 to buy consumer goods as reflected in the CPI, then I will indeed effectively lose 2%, or around £2,000 p.a. of the real value of my savings. If I could be sure that this situation was going to continue, I would be well advised to take the money out of the bank, and buy stacks of tins of baked beans etc. However, suppose that I have accumulated the money in the bank, because I have had my eye on an expensive sports car. In that case, what happens to the general level of prices is irrelevant, because it is only what happens to the price of the sports car that is relevant in determining whether the relative value of my money will have depreciated or appreciated.

If the sports car was just out of reach, at a price of £101,000, then leaving my money in the bank, so that with the £1,000 of interest, I have the required funds the following year, represents not a depreciation of its value, but an appreciation, so long as the price of the car remains the same. Moreover, if the value of the car falls, for whatever reason, say to £90,000, then my £100,000 will have had a relative appreciation of more than 10%, as against the car, even though it may have depreciated by 2% as against general inflation. 

If house prices, fall by 6% as a result of a reduction in demand, consequent upon a rise in interest rates, then anyone with money in the bank, who has been saving to buy a house, will immediately benefit from a 6% appreciation in the real value of their savings, irrespective of whether general inflation means that real interest rates are positive or negative. And, this is simply a reversal of the situation that has existed for the last 25-30 years, whereby the constant rise of asset prices for things such as property, shares, bonds and so on, each year, underpinned by central banks, consequently gave an irresistible incentive for everyone to throw whatever money they had into the purchase of those assets, so as to obtain a capital gain. 

The money that was diverted into this speculation in property and financial assets, and consequently away from investment in real productive-capital, added not one jot to the creation of any additional value. But, this speculation meant that those who bought bonds, or shares thereby also bought a claim on future value creation, just as those who bought property to rent out bought themselves a claim on future value creation. Necessarily as this speculation added nothing to value creation itself, whilst creating these claims to future value, it forced down yields on these assets, because the speculation pushed up the price of the assets. The only way that could be mitigated was by increasing the proportion of value creation that went to finance these revenues – interest and rent – at the expense of retained profits, which thereby undermined the potential for capital accumulation, and so of the potential for creating additional profits. In the words of Bank of England Chief Economist, Andy Haldane, it meant that capital was eating itself.  And, just like farmers, who at times had part of their actual profits appropriated as rents, sought to compensate by reducing wages below the value of labour-power, so industrial profit of enterprise appropriated as rents and interest, led to industrial wages being reduced below the value of labour-power, with workers thereby forced to maintain their living standards by ever increasing levels of borrowing.  

Gillian Tett, therefore, was absolutely correct as against the nonsense purveyed by David Blanchflower, that this situation could not simply go on, and central banks around the globe seem to have been forced to accept it. Across the globe, yields on many shorter dated government bonds are negative, and on longer dated bonds, and even many high-risk, junk bonds yields are barely more than 2-3%. There is very little incentive to move money into these bonds in search of yield. The only reason to hold these assets has become to obtain capital gain, or to avoid large capital losses. But, the more the situation has reached a stage that is no longer sustainable, the more even this latter incentive disappears. Speculators have felt safe that where they have had their fingers burned, as happened with the Eurozone debt crisis, central banks would step in to bail them out, by buying up those overpriced bonds. If now central banks start to sell those bonds, and there is a rush for the exit by other bondholders, then bond prices will fall precipitously, and that will cause the prices of all other assets to crash along with them.

Keeping your savings in the bank at 1% rates of interest might mean that, theoretically your money loses 2% p.a. of its value as against the CPI basket of consumer goods, but it would still represent a significant appreciation of the value of your savings, if bond prices fall by 50% or more, and if share prices drop by similar amounts, and if land and house prices drop by 60% or more.

What is more, if the long period during which money was sucked into this speculation in property and financial assets comes to an end, then that money will be available to be used as real money-capital, to be invested in real productive activity. Contrary to the predictions of the catastrophists who have tediously warned that the global economy has been in some kind of long depression or secular stagnation, and have year in year out warned of the next recession being imminently upon us, the fact is that even with the effect of the worst financial crisis in history, in 2008, the global economy has continued to grow, and is now growing at an accelerating pace. In fact, the actions of central banks in the last ten years, along with the policies of fiscal austerity, implemented by conservative governments, has been to try to limit the pace of that growth, so as to hold back wages and inflation, and to limit the rise in interest rates, so as to keep asset prices inflated.

The contradiction facing the owners of fictitious capital, and of the central bankers trying to keep those asset prices inflated is that it has now become almost impossible to inflate asset prices furtheror even to prevent them from falling, without even more massive injections of liquidity, and yet, the continued growth of the global economy, and of the potential for productive investment means that the balance between the risk-adjusted returns from speculation, as against the rate of profit on productive-capital has shifted. It is why capitalists like Elon Musk, or Jeff Bezos have been increasingly using their money-capital to establish new high tech businesses, such as Spacex.  It is a manifestation of the point made by Marx.

“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, p 378) 

That is also why, contrary to the argument put by Blanchflower and others, the rate increase is a step in the right direction. It means that an additional incentive is given for money to be invested productively, rather than for speculation. And, as this money is invested productively, it results in higher levels of employment, which in turn creates the potential for more highly skilled, better paid labour, which in turn creates a real sustainable basis for the growth of aggregate demand, as opposed to the credit fuelled bubble in consumer spending of the last thirty years.