Thursday, 1 March 2018

Its Not Inflation Driving Interest Rates Higher (10/10) - Squeezed Profits, Rising Interest Rates and Asset Price Crashes

Squeezed Profits, Rising Interest Rates and Asset Price Crashes 

As described in Part 9, there is significant evidence of the rise in wages during the 1960's, and 70's, which led to a squeeze on profits via a fall in the rate of surplus value. In fact, the real rise in wages and squeeze on profits is greater than the raw data for wages and profits would suggest. The post-war period, particularly into the 1960's, was also the period when welfare states were established in all developed capitalist economies, including the US. The US differed from other developed capitalist economies in that it did not create a universal, socialised healthcare system, though it did produce socialised healthcare for the elderly and poor via Medicare and Medicaid, but the post-war period in the US, also saw the expansion, particularly in large unionised industries, of the expansion of company healthcare, and pension schemes provided to workers. Indeed, the extent of these systems provided to workers in the car industry, for example, were reported to have risen to such a level in recent years that the amounts being paid out in benefits exceeded the current wage bills of those companies. 

This was the period of Johnson's Great Society, and of the development of welfarism across Europe, which represented a shift in the proportion going to labour, as rising social productivity made this expansion of both wages and profits possible, and, indeed, necessary for capital accumulation. 

On the basis so far described, the post-war crisis that arises after 1974 is perfectly explainable. The profits squeeze of the 1960's conforms fully to the description provided by Marx, of a situation in which capital has expanded rapidly, leading to the demand for labour-power and means of production rising steadily, so that wages and input costs rise. That is the finding also of Glyn & Sutcliffe in “Workers and the Profits Squeeze”. At the same time, many of the commodities that were developed in the 1950's, had, by the late 1960's, become mature products. They were now produced on a much larger scale, with unskilled labour, and low profit margins. Again, that conforms with Marx's analysis that, as the supply of use values is increased without limit, so this increasing volume of use values comes up against the limitations of the growth of the market. Increased input costs have an even bigger effect, because productivity slows, as the inventions of the previous Innovation Cycle, cease to have such an impact. As these increased costs meet market resistance, so profits are squeezed further.  I have described these processes in my book "Marx and Engels' Theories of Crisis - Understanding The Coming Storm".

In Britain, families began to rent primitive black and white TV's, in the late 1950's, and by 1974, were owning colour TV's; in 1950, there were just 1.9 million cars on Britain's roads, by 1971 that had risen to 19 million. In 1951, nearly 90% of households had no car. By 1971 that had fallen to around 40%. By 1971, around 5% of households had two cars, and for the first time the number of households, even with 3 cars begins to appear in the statistics. 

We are not yet, in that crisis phase, and as I said previously, I expect that the hiatus in the conjunctural transition, means that the crisis phase has been put back to around 2030. But, the increase in wages that started to arise in 2007/8, and which we are seeing again now, along with the pick up in synchronised global growth, despite all of the attempts by austerity and QE, to limit that growth, shows that we are inevitably entering a period similar to the early 1960's, where the demand for labour-power starts to push up the wage share at the expense of profits, whilst the growth in wages leads to an increased demand for wage goods, which forces companies, on pain of extinction, to increase their output to meet that rising demand, which requires increasing capital accumulation, at a time when profits start to be squeezed, which means that the demand for money-capital starts to exceed the supply, causing interest rates to march sharply higher, and which thereby leads to crashes in stock, bond, and property markets. That likelihood has been seen in recent weeks, and is mirrored in the VIX Index

Moreover, as I pointed out in my predictions for 2018, Trump is sending the US into a repeat of the twin deficits crisis of the Reagan era, based on the implementation of the same Voodoo Economics. The huge tax cuts for the rich, gave the stock markets a short term sugar rush, that quickly led to a crash; it will not lead to increased real capital investment, but will increase demand, leading to increased imports, and a rising trade deficit, putting pressure on the Dollar. It will not result in increased tax revenues, as the snake oil salesmen pretend, but only a blowing out of the budget deficit even further, leading to the need for additional bond issuance, a fall in bond prices at a time when the Federal Reserve is reducing its balance sheet, and China are reducing their purchase of US bonds. It means that US bond prices are set to fall, and yields rise sharply, which has already happened with shorter dated US Treasuries, flattening the yield curve, and is now starting to occur with longer dated Treasuries, with the 10 Year, now set to break through 3%. 

And, as pointed out in that prediction, Trump, like the Democrats, is committed to a large scale project of infrastructure spending, that will require even more government borrowing, causing bond prices to fall further and yields to rise. After years of failing to spend adequately on infrastructure, such spending is now unavoidable, if the US is to be able to enable its businesses to compete with businesses elsewhere in the globe, such as in China, and increasingly developing Africa, where the process of combined and uneven development has seen economies able to leap over stages of development, and produce modern infrastructure, at least in selected regions, from scratch. The same requirement for such infrastructure spending applies to the UK and EU, along with a need to invest in education and skills training, if the most significant element of modern economies, intellectual, creative and skilled labour is to be developed in sufficient supplies. 

Over the last year, a series of US rises in official interest rates, and Quantitative Tightening by the Federal Reserve, has been accompanied by a steady fall in the Dollar against other currencies, particularly the Yen and the Euro, where central banks have continued to pump up asset prices via money printing. It illustrates the point I have made previously that hot money has been swilling around the globe not in search of yield, but in search of capital gains, and increasingly, just the avoidance of capital losses. But, as I pointed out at the start of the year, we are approaching a tipping point. Global growth is causing interest rates to rise across the globe, as the demand for money-capital begins to exceed the supply. Rising interest rates eventually overwhelm the capacity of central banks to manipulate bond prices, via QE, as has been seen in the past, and at that point there are widespread financial crashes along with a destruction of the credibility of central banks and other financial institutions. 

The continual rise in US official interest rates, and of US Treasury yields, is going along with that significant fall in the value of the Dollar. If you are an EU, or Japanese speculator, the price of US bonds, has not only fallen by around, 20%, in Dollar terms, but by perhaps a further 10% in Euro or Yen terms. The more US bond prices fall, and the more the Dollar falls against the Euro, the Yen etc., the cheaper US financial assets become to these foreign speculators. At the same time, the very fact of global economic growth, and rise in global interest rates starts to impact the psychology of those speculators. The reality is that as global interest rates continue to rise, under the impact of strengthening growth, the greater becomes the potential for a crash in EU and Japanese bonds, and the more the holders of those bonds, begin to see the risk-reward balance shift in favour of those cheaper US financial assets, that already provide a much higher yield. In short, we are likely to see increased capital flows from the EU and Japan, and into US financial assets, which will mean that the spread of yields between the two is narrowed, meaning that the EU and Japan will see the prices of their financial assets correct. The UK, increasingly sidelined, and facing economic catastrophe outside the EU, will be swept aside in the process. 

Its not inflation that is driving global interest rates higher. It is global economic growth, and more precisely the growth of the wage share relative to profits, which starts to reduce the rate of surplus value. It creates the conditions whereby rising wages leads to a rising demand for wage goods, which means that competition forces businesses to accumulate capital so as to meet that rising demand. They do so in conditions where the mass of profits expands absolutely, but because of the fall in the rate of surplus value, the profits decline relatively. It means the amount of money-capital they require to finance that capital accumulation expands relatively, which then causes the rise in interest rates. 

Whether firms increase their borrowing of money-capital, by actually borrowing in the money market, or whether they finance their expansion by using a larger proportion of their profits to finance that capital accumulation (reversing the trend of the last 40 years, whereby the share of dividends out of profits has risen) does not matter, the effect is the same. The supply of money-capital from realised profits falls relatively, whilst the demand for it rises. That is also why the argument that King and Regan made against Glyn and Sutcliffe, that whilst the profit share fell the share of property income fell by a smaller amount, is not so relevant in this instance. Whilst, some of the revenue received as rent or interest may find its way back into the money market, to be made available for real capital investment, a larger portion of it, will simply go into funding unproductive consumption. Landlords tend to spend rents to finance their consumption, or to buy additional properties to rent, which acts to push up property prices, not to produce additional properties. Money-lending capitalists do the same, using their dividends and other interest payments to finance their personal consumption, and to engage in further speculation, not to invest in productive-capital. The rate of profit relevant to capital accumulation, is thereby the rate of profit of enterprise, i.e. the rate of the profit of enterprise (profits less taxes, rent and interest) in relation to the advanced capital. The lower this rate, the more industrial capital has to borrow to finance capital accumulation, and so the higher this drives the rate of interest. 

Its not inflation that is driving interest rates higher, it is this increasing demand for money-capital relative to the supply of money-capital from realised profits. The rise in inflation is merely a symptom of that as liquidity pumped into the system acts to facilitate rising commodity prices, as firms seek to offset rising input costs, and the squeeze on their profits, by passing those costs on. The vast oceans of liquidity that central banks have pumped into the global economy in the last 40 years, means that as that liquidity flows into general circulation, there is considerable scope for a rapid increase in commodity price inflation. The flow of that liquidity into general circulation will reverse the trend of the last thirty years, whereby it flowed into financial and property speculation. It will lead to an almighty crash in stock, bond and property prices.


John said...

Hi, think I'm missing something here. Understand how the demand for money-capital is driving up interest rates. Understand how the flow of liquidity into circulation is inflationary. However, why isn't the demand for money-capital fed by the available liquidity thereby reducing pressure on interest rates and reducing commodity price inflation? Thanks.

Boffy said...

Hi John,

The answer to your question is set out in Part 1, as well as in the links to the definitions of interest rates and money-capital.

Liquidity is not money-capital. Increasing liquidity, therefore, does not increase the supply of money-capital. Only an increase in the supply of actual money-capital, for example by an increase in the amount of realised profits, or an increase in the stock of savings thrown into the money market can increase the supply of money-capital.

Increasing liquidity, to the extent the liquidity goes into general circulation, rather than lying dormant (Keynes argument about pushing on a string), and slowing the velocity of circulation, or going into financial and property speculation, does not increase the supply of money-capital, it only increases the supply of liquidity/money tokens/credit, which causes a depreciation of the money tokens, and thereby leads to inflation of commodity prices. To the extent the increased liquidity/inflation increases the amount of money (in nominal terms) available to be loaned, and increases the money prices of output, and so money profits, it increases the supply of money-capital in these nominal terms. However, the demand for money-capital is a demand for money-capital to buy the elements of productive-capital. The elements of productive are themselves commodities - raw materials, machines, buildings and labour-power.

All of these commodities that comprise the elements of the productive capital - including labour-power, whose value is determined by the value of the commodities required for its reproduction - have also thereby increased in price by the same proportion, as a result of this inflation. The inflation means that the demand and supply for money-capital only changes in nominal terms, so that the relation between the two is unchanged.

Marx also sets this out in Chapter 7 of Theories of Surplus Value, quoting Massey and Hume.

John said...

Thanks - will re-read part 1