Tuesday, 20 February 2018

Its Not Inflation Driving Interest Rates Higher (3/10) - Inflation and Interest Rates

Inflation and Interest Rates 

On the one hand, therefore, orthodox theory claims that interest rates are reduced by the central bank printing money, and thereby increasing its supply, whilst, on the other hand, it says that interest rates are rising because of rising inflation, and what causes inflation? Printing money! The reality is, of course, that printing money, increasing liquidity, can neither raise nor lower interest rates. The rate of interest is determined by the demand and supply of money-capital. If more money tokens are printed, so that the value of each token is reduced, it simply changes the nominal amount of demand and supply on each side of the equation. As the currency is depreciated, the nominal amount of capital, required to reproduce the constant and variable capital may rise from £1 million to £1.2 million, but the nominal value of the output will also rise from say £1.5 million to £1.8 million, with the profit rising in nominal terms from £0.5 million to £0.6 million. The supply of potential money capital from these profits has then risen nominally from £0.5 million to £0.6 million, but in real terms it has not changed, because this £0.6 million will now buy only the same quantity of productive-capital as previously could be bought for £0.5 million. 

The main effect of any such change in prices would be in relation to the existing stock of money-capital, i.e. in relation to all of the existing money savings, whose real value would have fallen. Anyone with a stock of savings then faces a number of possibilities. If as in the Weimar Republic there is a hyperinflation of commodity prices, it makes sense to use those savings to buy in as many of those commodities as you can, because otherwise your stock of savings may buy only half as many of them tomorrow as it will buy today; if commodity prices are not rising rapidly, but asset prices are, for things such as shares, bonds, property, you will use your stock of savings to speculate in those assets, not because they will provide you with a decent yield in the form of interest or rent, but because again tomorrow, your savings will buy only a fraction of what it buys today, whilst by speculating in these assets, the rise in price provides you with a sizeable capital gain; if the prices of assets starts to fall, creating the potential of capital losses, whilst commodity prices start to rise even modestly, you will want to get rid of all those shares, bonds and property quickly, so as to avoid suffering those losses; instead of such speculation, you might want to use the money-capital for real investment, to accumulate real capital that produces profits that rise along with the rise in general inflation; you may want to lend money-capital, rather than engaging in real investment, but you will demand a higher rate of interest for doing so, because the longer you lend the money-capital for, the less the capital sum, and the interest on it, will be worth, in real terms, at the end of the period for which it is lent, and the more capitalists turn to real investment, as nominal profits rise, in line with nominal commodity prices, the higher the demand for money-capital becomes, which means that interest rates will rise along with it. 

This latter fact, is indeed the reason that longer term loans attract higher rates of interest than shorter term loans. It is also the basis of the orthodox theory that it is inflation that drives interest rates higher. So, if we examine the effect of QE, it has been, in conjunction with measures of austerity, to cause a hyperinflation of asset prices – the Dow Jones has trebled since 2009, and between 1980 and 2000, it had already risen by 2300%, house prices in Britain quadrupled in the 1980's, and again between 1997-2007, and similar rises have occurred in North America, Europe, and Asia – whilst creating disinflation, and the threat of deflation in commodity prices; it led to a dearth of funds for small and medium sized businesses causing the interest rates they faced to rise. 

No comments: