Sunday, 18 February 2018

Its Not Inflation Driving Interest Rates Higher (1/10) - The Orthodox Theory of Money and Interest

The Orthodox Theory of Money and Interest 

Rising interest rates cause stock, bond and property market
For several months, global interest rates have been moving higher, most visibly in the form of higher yields on government bonds, though these are not a good measure, given that they are highly manipulated by central banks, especially in an era of QE. The rise in interest rates, and particularly the higher yields on bonds is causing some consternation amongst the financial pundits, as these higher yields are also a factor in the falls in stock markets seen over recent weeks. The explanations given for these rising interest rates expose the fallacy that underpins the orthodox bourgeois economic theory in relation to money and interest

The explanation for rising interest rates, we are told, by the various financial pundits, on all of the speculation news channels, is that inflation is rising. Indeed, one of the sparks for the near 10% sell-off in US stock markets just over a week ago, was a strong US payroll number that showed US wages rising at around 2.9%, and led to a spike in bond yields. But, a look at this explanation shows a fundamental contradiction within the orthodox theory. For several years these same orthodox economists, and financial pundits have told us that interest rates are dictated by central banks. That in itself is a hell of claim from people who usually tell us that prices cannot be determined by central planners! Yet, they console themselves with the idea that if economic conditions deteriorate, the central banks will ride to the rescue by reducing interest rates. The central banks dictate interest rates, we are told, by setting the official interest rates, the Bank Rate, or Fed Funds rate, or whatever is the relevant rate in each country, which determines the rate commercial banks can borrow from the central bank. The central bank can reinforce this official rate by other means, previously called Open Market Operations, and today called Quantitative Easing, or Tightening, by which the central bank can print money – nowadays actually just electronic deposits – which it uses to buy bonds from the commercial banks, so as to put additional liquidity into circulation, or else it sells bonds on its balance sheet to commercial banks, or requires them to hold additional reserves, which limits how much liquidity is put into circulation. 

Orthodox theory believes that the rate of interest is a price of money. As Marx demonstrated, that in itself is an absurdity. The price of £10 is £10, it makes no sense to say that the price of £10 is £11! As Marx demonstrates, the rate of interest is not a price of money, but of money-capital, in other words of the use value of that money-capital, its ability to produce the average profit. If £10 of capital can produce £3 of profit, with an average rate of profit of 30%, then productive capitalists may be prepared to borrow £10 of money-capital, and pay £1 of interest to the lender, in order to still be left with £2 of profit, after they have paid the interest. Similarly, the owner of £10 of money-capital may be prepared to lend it to a productive-capitalist, and accept only £1 of interest, guaranteed, rather than take the risk that they might not actually make the £3 of profit, if they were to use it productively themselves. The rate of interest, is then determined by a struggle of supply and demand, between the owners of money-capital who demand a price for lending it, and the productive-capitalists who seek to borrow it in order to produce profits, and who, therefore, seek to minimise the cost of doing so, in order to maximise their profits. 

Orthodox theory, therefore, believes that interest rates can be reduced by increasing the supply of money, liquidity, but Marx shows that this cannot be true, because an increase in the supply of money, is not the same thing as an increase in the supply of money-capital. Moreover, what the central bank does, when it prints more money – be it more notes and coins, more electronic deposits, or credit – is actually not to produce more money, but only to produce more money tokens. Money is actually a claim to a certain amount of value/social labour-time, it is the universal equivalent form of that value, and the amount of money in circulation is a function of the value of commodities to be circulated, and the velocity of circulation of the money. If money takes the form of 1 gram gold coins, each of which has a value equal to 10 hours of labour, and each coin circulates 10 times in a year, then if the total value of commodities to be circulated is 1,000 hours of labour, 10 such coins must be in circulation. 

If 20 such coins are thrown into circulation, then either the velocity of circulation of these coins must halve, or else half of the coins will fall out of circulation. Otherwise, these 20 coins will represent a claim to 2,000 hours of labour, where only 1,000 hours of value is available in the form of commodities. The result would be that the money price of those commodities would double. A commodity that previously sold for 1 gold coin would now rise in price to 2 gold coins. And, one of those commodities would be gold itself. It would mean that the price of a gram of gold would be equal to 2 1 gram gold coins! So, it would make sense for holders of coins to melt them down into bullion. That happened a few years ago, when the price of copper rose to such an extent that the value of the copper contained in some 2p coins was greater than 2p.

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