Yesterday, the Bank of England increased its base rate by 50%, from 0.50% to 0.75%. It is only the second rise since 2009, and is the first time rates have risen above where they were in the aftermath of the Financial Meltdown, the Bank having cut rates in 2016, to head off panic following the Brexit vote. As when the US Federal Reserve began raising its official rate over a year ago, the speculators and their representatives have complained that the rise is unjustified, warning, as they did in relation to the Fed, that the rise will have to be reversed before long. This is the whining of speculators who know that these rising rates spell the end of the goosing of asset prices they have enjoyed for so long, and signifies that the completion of the cleansing process, started by the 2008 crash, is imminent. Far from having to reverse its rate rises of over a year ago, the Federal Reserve has continued raising rates, and reducing the size of its balance sheet. The same will be true in the case of the Bank of England, soon to be followed by the ECB, and Bank of Japan.
The Governor of the Bank of England, Mark Carney, yesterday, suggested that the market perception of one such rate rise every year, is likely to be about right, as the UK economy is hitting capacity constraints, and inflation pressures are mounting. In fact, its likely that the Bank will have to quicken the pace of rate hikes before long. When the Federal Reserve began raising interest rates, over a year ago, the initial response was for the Dollar to fall. I had predicted it would. For years, financial asset prices have been sustained at astronomical levels by central bank money printing, and the use of that money to buy financial assets. That encouraged other speculators to buy financial assets too, knowing that rising prices for those assets was a one way bet. As soon as the Fed stopped its QE programme, and then began raising rates, it was a sign that underpinning of assets was coming to an end, so private speculators had reason to sell those assets, and buy the financial assets, say, in the Eurozone, where the ECB continues to print billions of Euros to be used in its own QE programme of buying Eurozone bonds. Money coming out of US financial assets and heading for Eurozone assets caused the Dollar to fall, and the Euro to rise. The Pound benefited from that process too, reversing some of the big drop in the Pound that happened after the Brexit vote.
But, as I wrote at the start of the year, US rates were starting to reach an inflexion point, whereby, as rates rose, they began to attract additional speculative money, searching out higher yields. We have reached that point. As the Fed continues to raise rates, another quarter point hike expected next month, the Dollar is likely to strengthen further, and conversely the Pound, Yen, Euro will weaken against it. In the UK, official rates are still near zero, even after this quarter point hike. The Bank is still sitting on all of the QE it has previously undertaken. Any indication that the Bank will start to unwind some of that QE from its balance sheet, or will start to raise rates more quickly, will cause a flight out of all those UK financial assets whose high prices depend on low, indeed near zero interest rates. That will again cause the Pound to fall, as that hot money leaves the country. As happened in 2016, when the Pound dropped as a result of the Brexit vote, that lower Pound will result in a resumption of the inflation seen over the last year or so. With UK unemployment at low levels, labour shortages beginning to emerge, and inevitably worsen as EU workers return home, and new EU workers shun Britain, wages are likely to begin to rise, in response both to these shortages, and in response to the higher inflation levels caused by the falling Pound. After the Bank raised rates, yesterday, therefore, the Pound fell both against the Dollar and the Euro.
UK rates will need to rise quite a bit further, before they reach levels, as with US rates, where they begin to attract rather than repel speculative money flows. In the meantime, a falling Pound, relative to the Dollar, as the Fed continues to hike, and against the Euro, as the effect of Brexit continues to be felt, will push UK inflation higher, once more, following the temporary respite of the last few months. The stagflation that began to occur a couple of years ago, will, therefore intensify. The financial pundits interviewed on TV yesterday, fail to understand this point. They see the pressure for higher rates arising from growing gross output, and rising inflation. Rising inflation certainly leads speculators to demand higher nominal yields, because they are aware of the effect of inflation on the future value, both of their revenue, and of their capital. But, it is not inflation that is actually driving market rates of interest higher. And, it is not gross output that is significant here, but net output, i.e. the growth of surplus value, in the economy, as Ricardo and Ramsay correctly argued, as against Adam Smith.
The rate of interest is a function of the demand and supply of money-capital. The demand for money-capital comes from the demand of businesses so as to be able to accumulate productive-capital. At times of crisis, as Marx describes, those businesses demand this money-capital, not as money-capital, but as currency, because they need money to pay their bills and stay afloat. That is the time when interest rates hit their highest level. In a modern economy, there is also a demand for money-capital from consumers, again not to be used as money-capital, but to be used as currency, to enable them to be able to buy the consumption goods they need, but which their wages do not immediately cover. In the end, this demand for money-capital, is a demand by capital too, that is simply deferred. Capital pays wages, now, at levels below the value of labour-power, the difference being made up by borrowing, but then has to pay higher wages later, so that workers can cover not only the cost of the wage goods they buy then, but also the accumulated debts and interest accumulated in the previous period.
The supply of money-capital consists of a stock of savings, plus a flow of new money-capital from realised profits, plus short-term savings by workers out of their wages, which are pooled by the banking system. As Marx and Ramsay noted, in older societies, where the ruling class has accumulated wealth, the stock of savings tends to be higher, and former active capitalists retire from business, living as rentiers from the interest on their money-capital, which is thrown into the money market. This higher stock of savings then tends to mean that interest rates in these societies tend to be lower, due to this greater supply of loanable money-capital. Yesterday, it was being suggested that the existence of a growing older portion of the population in Britain, similarly, results in them having a greater stock of such savings pressing down on interest rates. However, in Britain, a large part of the population has no savings, and rather has massive household debt. The older sections of the population, have a lot of their wealth in the form of the house they live in, and over recent decades they have themselves been encouraged to go into debt, by various equity release scams, suggesting they borrow against the value of their home, in order to spend the money, or lend to their children to buy overpriced houses.
Although, this stock of saving can be influential in determining interest rates over the longer term, it is not so influential in the short-term. The main determinant in the short term, is the new supply of realised profits. If the mass of realised profits rises, then these profits become immediately available for businesses to use, either directly for accumulation in their own business, or else those profits are thrown into the money market, creating an increased supply of money-capital, available for other businesses to use. If the demand for money-capital remains constant, this increased supply causes interest rates to fall. That is what happened from the 1980's onwards.
But, what determines this supply of realised profits, is not gross output, but net output. The gross output in an economy can be growing strongly (which tends to increase the demand for money-capital to finance accumulation), and with it the mass of profit, but if the net output grows at a slower pace than the gross output, this growth in realised profit, will fail to keep pace with the demand for money-capital to be used for accumulation. If more workers are employed, and/or wages rise, as the supply of labour starts to get used up, this will lead to an increasing demand for wage goods, at the same time that profits begin to get relatively squeezed – even though the mass of profit continues to rise. The increased demand for wage goods, itself causes business to respond by expanding production. Competition forces them to do so, so as not to lose market share. So, their demand for money-capital to finance this expansion increases. But, the same rising wages, not to mention rising costs of other inputs, squeezes their profits. The profit for each firm, and for firms in general rises, but not by as much as its demand for money-capital to finance accumulation rises. So interest rates rise.
That is what central banks and conservative governments have been trying to constrain since 2008. It is why they used QE to encourage money to go into speculation in asset prices rather than productive investment; it is why they imposed large doses of austerity to reduce aggregate demand growth in the economy. They did that, because any rise in market rates of interest, which is what was happening in 2007/8, will cause those astronomically inflated asset prices to crash, as they did in 2008, when that happened, and as has happened repeatedly with asset prices repeatedly since 1987. Today, those asset prices are even more astronomically inflated than they were in 2008. But, despite their best endeavours to constrain economic growth, and capital accumulation, the strength of the fifth long wave boom that began in 1999, has forced its way back through. Global growth has resumed apace. Employment has risen, wages are rising and now market rates of interest are rising across the globe too. Central banks are being forced to raise their rates, and to end QE, in order not to get left way behind the curve, and to be left with absolutely no ammunition to fire, when the imminent financial collapse rushes towards them.
The more central banks are led to have to withdraw from QE, and begin to raise rates, the more the vast quantities of potential money-capital that have formed speculative flows into asset markets will begin to migrate to real productive investment. Those funds are not flooding panic stricken from asset markets yet, because the central banks are attempting to hold the ring, to convey the idea, as Carney did yesterday, that their withdrawal will be glacial, and the speculators still have deluded themselves into the idea that central bankers can control interest rates, quite at variance with their free market ideology, and hostility to the idea that market prices can be dictated by central planners. In absolute terms, yields on financial assets and property remain minimal, whilst even as the rate of profit starts to get squeezed, it is still at historically high levels. As the prospect of guaranteed capital gains is replaced with the prospect of near certain capital losses on financial assets and property, there is then a growing incentive for capital to desert fictitious assets, and move to real productive investment. That of itself promotes further economic growth, further increases the demand for labour, further causes upward pressure on wages, which causes increased demand for wage goods, increased need for capital investment to meet that demand, and causes interest rates to rise further.
The quarter point rise yesterday, means that the interest on a £100,000 loan/mortgage rises by £250 per year. On the average £150,000 mortgage that is a rise of £375 a year, or £31 a month. Put another way, the average variable rate mortgage stands at around 4%, p.a. A quarter point rise is equal to a rise of 1/16, or 6.25%. So, if the interest on the mortgage is £1,000 per month, that is equal to a rise of £62.50 per month. A large proportion of mortgages are now fixed rate mortgages, so existing fixed rate mortgages will not be affected. However, any new fixed rate mortgages being offered are likely to be at a rate higher than the additional quarter point, because, with banks and building societies knowing that the Bank of England is going to continue raising rates, they have to protect themselves against those higher rates over the lifetime of say a five year fixed rate mortgage. And, although a large proportion of existing mortgages are fixed rate, there are always some of those, particularly the shorter term fixed rate mortgages that come up for renewal, and these renewals will again be set at this new higher level.
But,as I have set out in the past, it's not this effect of rising interest rates on mortgages that is the main effect. The main effect of rising interest rates is on asset prices themselves as capitalised revenue. A UK 2 Year Gilt currently yields around 0.79%. The lower yields, the greater the proportionate effect of any rise in rates. The price of such assets moves inversely to the change in interest rates. If the revenue of the asset remains constant, the price of the asset halves, if interest rates double. Because all of these assets, including property are substitutes for each other, a fall in the price of one feeds through into a fall in the price of them all. This is not immediately apparent. If interest rates rise, for example, so that bond prices fall, that fall in the bond price arises, as speculators sell bonds. They then use this money to buy shares, or property. But, the yield on these assets then falls, as their price rises. This yield is then lower than for newly issued bonds, that reflect the higher rate of interest. So, money flows out of these lower yielding assets and into the higher yielding bonds. Adjusting for different degrees of risk, the process averages out the yields across these assets over a period of time. Its this effect of reducing capitalised asset prices, and so of land and property prices, that the rise in interest rates mostly affects, not the rise in mortgage rates. And, by reducing land prices, it also thereby reduces the cost of building new houses, making house building more profitable at lower prices. Those lower house prices stimulate additional demand, which encourages more building to meet the demand, which then increases the supply, which acts to push down on house prices further.
The US economy, despite all of the predictions that the Fed's rate hikes would crater the economy, and have to be reversed, has continued to strengthen over the last year. Trump is trying to take credit for that, but if anything growth was even stronger under Obama. The UK economy will not match the US performance, because of the depressing effect of Brexit. But, the UK's abysmal productivity, means that as the UK economy is dragged along by renewed growth in the global economy, if anything, demand for labour will rise faster, exacerbating some of the conditions described above. Carney, yesterday, pointed out that the average Bank Rate over the Bank's entire history, as well as the average since the Bank was given independence, in 1997, has been 5%. Yet, Carney argued that its likely that the rate will not exceed an average of around 2.5% in the foreseeable future. That sounds like incredible hubris set against those long term averages. Such hubris almost invariably precedes events that undermine those guilty of it. The very fact, of UK low productivity growth, and so of a more rapid squeeze on net output/surplus value is likely to cause interest rates to rise more sharply than elsewhere.
The Bank may not raise its rates again before the end of this year, though events might force that upon it. But, for all the reasons set out above, it will find itself having to raise rates at a much faster pace than it is currently suggesting.
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