A Number of Inflexion Points Are Reached
Over the last few years, I have pointed out that the effect of QE has been to stand some economic dicta on their heads. For example, when yields approach zero, speculators become more concerned to obtain capital gain/avoid capital losses, than to maximise revenue. That means that wherever a central bank stands firmly behind the bonds and other revenue producing assets of a country, speculators will feel comfortable to put their money there, in the expectation that they might enjoy such capital gains, or avoid capital losses, because the central bank will have their back whenever asset prices falter.
At near zero yields, the absolute amounts of revenue are low. For example, if I have £100,000 in the bank, and get 0.25% interest on it, the revenue is £250. If the interest rate doubles to 0.50%, I get £500, but the absolute amount of interest is still small. If interest rates are say 3%, and double to 6%, the difference in absolute terms is from £3000 to £6000. At very low levels of interest, the incentive to move money from one place to another is, thereby minimal, purely to obtain these low absolute amounts of yield. It is one reason that high frequency trading has become important, because it is only when you are moving astronomical amounts of money from one place to another, in very short periods of time, that sizeable absolute returns can be obtained from such minute marginal differences in yield.
By contrast, if I have £100,000 in a bond, bought at par, which pays the same £250 of interest as coupon, it too provides a yield of 0.25%. If interest rates rise to 0.50%, so that new £100,000 bonds, bought at par, pay a coupon of £500, a yield of 0.50%, then the value of my original bond falls to £50,000, because it continues to pay me only a coupon of £250, and the capitalised value of £250 p.a., is now only £50,000. If I came to sell my original bond, I would only be able to get £50,000 for it, suffering a £50,000 capital loss. So, whilst the absolute benefit from a rise in interest rates is marginal in terms of revenue, the effect in terms of the capital loss that results from the rise in rates is sizeable. Given that private capitalists hold nearly all of their wealth, now, in the form of these revenue producing assets – shares, bonds, property – its obvious, therefore, why they have been so desperate over the last 30 years, and more specifically over the last 10 years, to ensure that they do not suffer such capital losses, in the value of those assets, as a result of rising interest rates, and why they have used their political power and influence to ensure that central banks, and the state have done whatever is necessary, including QE, to keep the prices of those assets inflated, even at the cost of undermining the real economy and real capital accumulation.
But, this fact has other consequences. For example, the traditional economic dictum is that when a country raises its official interest rates it strengthens its currency, because speculators, in search of higher yields, move their money to that country, in the form of bank deposits, or the purchase of the country's financial assets. But, for the reason described above, at these very low yields, the opposite becomes the case. If speculators allocate their money no longer on the basis of a search for yield, but rather on the basis of a search for potential capital gains, or absence of capital losses, then the countries that are seen to be raising official interest rates, or abandoning QE, will be seen by those speculators as places that are no longer standing behind the financial asset prices of the country, and where, therefore, they will be exposing themselves to large potential capital losses, in return for only tiny absolute higher amounts of revenue.
Rather than a rise in official interest rates, or a withdrawal from QE causing the currency to strengthen, therefore, it will cause it to weaken, as speculative money flows out of the country, and into those economies where the central bank continues to provide support for the paper wealth of speculators. Over the last year, that has been seen with both the Dollar and the Pound. The US Federal Reserve stopped its QE policy over a year ago, and more recently its has also stopped replacing those bonds it held that matured. It has also begun to raise its official interest rates, which have risen from a low of 0-0.25%, to its current level of 1.50%. Yet, the value of the Dollar has been falling, against a basket of other currencies, including the Euro, where the ECB continues to hold its official interest rates near zero, and continues to pump billions of Euros into the purchase of financial assets, which it has declared will continue until at least the Autumn of this year.
The Pound, which weakened significantly as a result of the Brexit vote, has since strengthened against the Dollar, rising from a low of around $1.20, to its current level around $1.36. But, the Bank of England also stopped its smaller QE programme, whilst not yet starting to reduce the size of its balance sheet, and has started to raise its own official interest rates. Like the Dollar, therefore, it has continued to weaken against the Euro, where QE and low official interest rates continue to be pursued by the ECB.
A look at US bond prices shows a marked curve flattening. In other words, the yields on shorter dated bonds such as 2 Year Bonds, as against the yields on 10 and 30 Year bonds, has become narrower. Meanwhile, the spread between the yield on German Bunds, and US Bonds, has been growing wider and wider, as QE, and ECB policy leads to German Bunds being bought up, by the ECB, and thereby creates an incentive for speculators also to buy these German Bunds, in order to obtain the capital gain, or avoid capital losses. Many European short dated bonds actually have negative yields. The German 2 Year Bund, currently has a yield of -0.60%, and its 5 year Bund also has a negative yield. The ECB is now having difficulty in finding bonds that it can buy, as part of its QE programme, that meet its criteria.
The lower the yield on bonds, the more difficult it is for the central bank to keep that price inflated, because speculators will always begin to see the probability of the bonds selling off as higher, than for bonds that have lower prices. As the Federal Reserve continues to withdraw from QE, and continues to raise its official interest rates, an inflexion point will be reached, where speculators begin to see the probability of further US interest rate rises as less than a rise in Eurozone interest rates. At that point, where the spread between US and Eurozone bond yields have widened sufficiently, speculative money flows will move out of Euros, and other currencies, and into the Dollar. At that point the Dollar will appreciate considerably.
This is one inflexion point I expect to be reached during 2018. The Federal Reserve has intimated in its dot plots that it is likely to raise interest rates 3 – 4 times in 2018. That would take the Fed Funds Rate to 2.25-2.50%. That is still historically low, but it begins to enter the territory where money-lenders begin to be attracted to the potential yield, once more as opposed to simply a search for speculative capital gains. But, for the reasons set out in Part 2, I expect the Federal Reserve to be led to raise its interest rates further and faster than the dot plots indicate. Trumps tax giveaway to the rich, will hit government revenues, which will have to be compensated by larger borrowing; the infrastructure plan will increase capital spending, causing borrowing to rise further; global growth will cause global borrowing to rise, causing global rates to rise; the US, already at levels of near full employment, will see wages rise, which will be passed into higher consumer price inflation, as the vast sea of liquidity washes into the economy, and as the demand for wage goods rises, as higher wages simultaneously squeeze profits, the consequence will be a higher demand for money-capital relative to supply, pushing interest rates higher. I expect the Fed Funds Rate to be around 2.25% by the middle of the year, and the Fed may start to raise rates in half point moves, after that, as it tries to get from behind the curve.
The US, therefore, also experiences a further inflexion point here. It is that as US interest rates rise to these levels, the message starts to filter through to speculators that the thirty year period of annual rises in capital gains are over. There is then a change of mindset. If speculators are no longer expecting 10-20% p.a. capital gains, but instead are looking at year on year capital losses, they will also not be happy to simply accept 2-3% yields on their money-capital. They will instead look to the potential annual rate of profit that they might enjoy from using their money-capital productively, by actually investing in productive capacity, rather than simply speculating in financial assets. The fact that a growing workforce, and rising wages, as the economy expands, creates significant demand for wage goods, and an expanding range of wage goods, as the technologies developed over the last 30 years, begins to be rolled out into a huge range of new commodities, will provide a further incentive for such productive investment, which will in turn strengthen economic growth, and creating additional aggregate demand. It reverses the process of the last thirty years, whereby money-capital was drained from productive investment, and channelled into financial speculation.
The flip-side of a rise in the value of the Dollar is a fall in the value of other currencies. As primary products such as oil, are traded in Dollars on the global market, a rise in the Dollar means that the prices of these primary products rise in other currencies whose value have fallen against the Dollar. As the Brexit effect again begins to hit the Pound, the rise in the Dollar will also again start to impact UK imported inflation, putting renewed pressure on the Bank of England to raise its own interest rates. Even the withdrawal of the quarter point rate cut introduced in 2016, after the Brexit vote, was enough to send the London house prices down, and that is likely to intensify in the current year, as UK wages get squeezed, and interest rates continue to rise. According to the BBC analysis done recently, despite the near zero official interest rates, and all of the government scams to push house prices higher, house prices in the majority of Britain are around 20-25% lower today than they were in 2007. Yet, those prices are still astronomically high compared to their historic averages. As interest rates continue to rise, the likelihood of a UK house price crash gets stronger by the week.
But, the EU will also see its import costs rise for energy, and other primary products, as the Dollar rises against the Euro. With growth expanding at around 2 – 2.5%, on current projections, and at more than 3% in some EU countries, these rising input costs are likely to cause consumer price inflation in the EU, to pick up faster than currently expected, leaving the ECB, like the Federal Reserve behind the curve. Even if the ECB does not stop its QE programme before its intended date of Autumn 2018, or start raising official rates, bond markets will begin to sell off, and cause EU bond yields to rise.
As in the US, this will then lead to a further inflexion point, whereby European financial assets, and property begins to suffer capital losses, whilst rising aggregate demand leads to a demand for capital, as the rate of profit on productive investment significantly exceeds the rate of interest. Across the globe, therefore, speculative financial assets sell-off, as money flows into productive-investment, creating a self-reinforcing cycle, of investment, revenue, consumption, investment that will ultimately, as all such cycles do, result in a crisis of overproduction. Before that point is reached, this same cycle will cause the astronomical inflation of asset prices, and property to cease, and the current sequential speculative bubbles, as referred to in Part 3, to burst spectacularly. The chances that this burst occurs in 2018, have grown considerably.
No comments:
Post a Comment