Company profits are disappearing as governments close down the economy. Just to stay afloat, firms need to borrow money to pay their bills, and workers' wages. Government tax revenues are collapsing because governments have shut down their economies, and so shut down the production of value and surplus value. At the same time, governments are not only, thereby, paying out more in welfare benefits, but they are also paying the wages of workers and the self-employed. So, governments too, are needing to borrow much, much more. On top of that, governments are introducing fiscal stimulus packages in a desperate, but inevitably futile, attempt to counterbalance the economic disaster they have created by shutting down their economies. That means that they are again borrowing much, much more money. Interest rates are determined by the interaction of the demand for, and supply of money-capital. The main supply of additional money-capital is realised money profits, but all of those realised money profits are not only being cratered, but completely disappearing, as economies are closed down. As the supply of additional money-capital disappears, and the supply of money-capital itself contracts, whilst the demand for money-capital, not to act even as money-capital, but simply to act as currency, to pay bills, goes through the roof, interest rates are set to soar. What is different now, compared to the last thirty years, is that this will also cause bond yields to soar too.
Marx in Capital III, describes this situation.
“It (the rate of interest, AB) reaches its maximum again as soon as the new crisis sets in. Credit suddenly stops then, payments are suspended, the reproduction process is paralysed, and with the previously mentioned exceptions, a superabundance of idle industrial capital appears side by side with an almost absolute absence of loan capital.”
(Capital III, Chapter 30)
“In times of crisis, the demand for loan capital, and therefore the rate of interest, reaches its maximum; the rate of profit, and with it the demand for industrial capital, has to all intents and purposes disappeared. During such times, everyone borrows only for the purpose of paying, in order to settle previously contracted obligations. On the other hand, in times of renewed activity after a crisis, loan capital is demanded for the purpose of buying and for the purpose of transforming money-capital into productive or commercial capital. And then it is demanded either by the industrial capitalist or the merchant. The industrial capitalist invests it in means of production and in labour-power.”
(Capital III, Chapter 32)
The advocates of the Magic Money Tree (MMT) put forward, as an alternative to this reality, described by Marx, the dangerous delusion purveyed 200 years ago by John Law, and the Pereire Brothers. They say, in order to finance the borrowing by the government, or by businesses, simply print more money tokens, and have the central bank buy up all of the government bonds, commercial bonds, and, as is now appearing, buy up all of the company shares, as their prices collapse. In the latter case, the company shares are collapsing in price for two reasons. Firstly, as interest rates rise, the capitalised value of all revenue producing assets falls. Secondly, the revenue produced by companies, profits, is the basis of the revenue paid out to shareholders, dividends, and, as profits disappear, so the ability to pay dividends also disappears. The share of dividends in profits has already gone from 10% in the 1970's to 70% today, so a collapse of profits, as the economy is closed down, equates to a collapse of dividends too. So, share prices collapse accordingly.
Over the last thirty years, this MMT has appeared to work, for the same reason that, for a time, it seemed to work for John Laws' Mississippi Scheme, and for the Pereire Brothers Credit Mobiler. It is the same reason that it appears to work for a time for all such Ponzi Schemes, which blow up asset price bubbles, like the South Sea Bubble, Tulipmania, the Railwaymania, The Tech Bubble, and the property bubble. If the money demand for these assets increases faster than the supply of the assets themselves, then the price of the assets continues to inflate. The reason people buy the assets, during such manias, is never to obtain the revenues produced by the assets, but is only to be able to benefit from the speculative capital gains produced by the rising asset price. The speculative capital gains continue for as long as the asset prices continue to rise, and the asset prices continue to rise, until suddenly, one day, they don't. Then the Ponzi Scheme is exposed, people want to sell, but find all of the doors to the escape route are clogged by other sellers, like desperate people trying to escape a burning building.
Over the last thirty years, central banks have printed money tokens (banknotes and coins, credit, electronic deposits) and used it to buy up government and corporate bonds, as well as mortgage bonds, and in some countries, shares). So, this additional money printing, QE, created an additional, artificial demand for these assets. Every time the prices of these assets fell, central banks stepped in to buy more of them to push the prices higher. Given that the underlying revenues for these assets was not increasing proportionally, despite a larger and larger proportion of profits being diverted into paying dividends rather than being invested productively, the yields on all of these assets more or less continuously fell. But, the speculators who buy these assets are not bothered about the yield, only in the large speculative capital gains, and the degree of speculation itself disappears, when central banks make it a one way bet by always buying up assets when their prices fall – The Greenspan Put.
The prices of the assets were bound to rise, not just because of this central bank put, but also because the supply of these assets was itself deliberately constrained. Shareholders had their representatives on company boards use profits to buy back shares, rather than invest in additional productive capacity. That meant that the supply of shares, rather than expanding, was being contracted, at a time when the monetary demand for those shares was being inflated, inevitably causing the share prices themselves to be inflated, and the yield on those shares to contract, only offset by a continuously growing proportion of profits being diverted into dividends and away from capital accumulation.
But, the same thing was happening with bonds too. Whilst companies issued additional bonds, they used the money raised from these bonds to further buy back shares, so the increased supply of bonds was offset by a reduced supply of shares. And, it was used to simply transfer capital to shareholders, who were then also able to use this money to buy up shares, so increasing the demand for shares and inflating their prices further. Meanwhile, as central banks printed money, and bought up government bonds at a rapid rate, governments themselves imposed measures of austerity, particularly in the period after 2010. The issue of additional government bonds (supply) was always less than the monetary demand for those bonds, which meant that their price always continued in an upward direction, causing the yields on those bonds to move in the opposite direction. The reason was that, in an era of conservative social-democracy, the state was increasingly removed from the provision of goods and services, as this function was transferred to the private sector, or simply ceased.
So, it appeared that interest rates could always be reduced simply by having the central bank print more money tokens. But, this was the same delusion as that purveyed by Law and the Pereire Brothers. Printing more money tokens was not reducing interest rates, it was simply inflating asset price bubbles, and the concomitant of higher asset prices is lower yields. As Marx points out,
“Those who say that there is merely a lack of means of payment, either have only the owners of bona fide securities in mind, or they are fools who believe that it is the duty and power of banks to transform all bankrupt swindlers into solvent and respectable capitalists by means of pieces of paper.”
(ibid)
But, as Marx describes, the yields on these assets should not at all be confused with the market rate of interest. That is precisely, because this yield is a function of this manipulated monetary demand for the bonds. Marx notes that a comparison of the market rates of interest between, say, Britain and India, should be based on the rates of interest that capitalists charge each other in their actual dealings with each other. If we look at the rates of interest that small and medium sized capitalists pay to borrow money-capital to finance their activities, therefore, we see that, even where they can obtain such loans from banks, the rate of interest bears no resemblance to the yields on government and corporate bonds. Many cannot get bank loans at all. They rely on borrowing against personal credit cards, which levy interest rates of up to 30% p.a. Some are able to borrow from peer to peer lenders, at rates of interest of around 10% p.a. And, of course, the official rates of interest bear no resemblance, whatsoever, to the rates of interest paid by workers, and those that need to borrow from pay day lenders that charge up to 4000% rates of interest. Again, this demonstrates Marx's point that the highest rates of interest arise as a result of crises, when people need money not to use for productive purposes, but simply to survive, to pay bills, and will pay almost any rate in order to do so.
Printing money only worked to reduce yields, because the money was diverted solely into buying bonds, and by extension other assets, whilst the supply of those assets was deliberately constrained, thereby causing their prices to rise. But, what is being seen, and proposed, now, is wholly different. Rather than constraining the supply of assets, governments are about to unleash a tsunami of supply of bonds on to the market, in order to finance their spending! The effect is also two-fold. First, this huge increase in supply of bonds, means that their prices will necessarily fall, which means that yields will rise. The cost of government borrowing will rise sharply. As yields rise, the prices of other assets will also fall. Share prices will inevitably fall much further, as shares appear expensive as against bonds, even setting aside the disappearance of profits and dividends. Land prices will also fall, as the capitalised value of rents falls sharply with rising yields on financial assets. It has been inflated and inflating land prices that has been the foundation of high property prices that fuelled property speculation, and as land prices crater, so property prices will also collapse.
The advocates of the Magic Money Tree say that there is no problem, because all of these additional bonds can simply be bought by central banks who print more money tokens for that purpose, and so demand would rise to match the supply causing interest rates to remain constant. It is the same dangerous delusion as proposed by Law and the Pereire Brothers that led to financial disaster. The question, here is, what does the government now want to borrow this additional money for. Well, in part, it wants to throw this money into the real economy, in a way it has not done for thirty years, and particularly for the last ten years, when it has implemented policies of austerity. If more money is printed, the value of each individual money token is depreciated. When all of those money tokens were used only to buy bonds and other financial assets the scale of that depreciation was manifest in the hyper inflation of asset prices. If, instead, the money is used to buy actual commodities, then, now, it will be manifest in a hyperinflation of commodity prices.
Take one commodity, gold. As is usual, in times of panic, the demand for gold rises. Given that central banks are turning currencies into confetti by money printing, this leads even more to a demand for something that has real value, such as gold. But, currently, its virtually impossible to buy gold. That is not just because of the scale of demand. It is also because, as the economy is closed down, across the globe, gold production is also closed down. The same is applying to all other commodities be it baked beans or Rolls Royce cars, because unless workers produce them, they do not appear as supply in the market. Gold dealers report a 718% increase in gold demand over the last 5 weeks, but gold refineries have shut down. The main refineries in Switzerland – Valcambi, Argor-Heraeus and PAMP – process around 1,500 tonnes of gold – over a third of global demand – every year, but they are close to the border with northern Italy. The closure is at present for two weeks, but is likely to last longer. The Rand refinery in South Africa has done the same, and many mining companies, like Newmont, New Gold, Alamos and B2, for example, have suspended operations. The global supply of one-ounce gold and silver bullion coins and bars has quickly evaporated. Gold bars are still available, but a kilo bar costs around $50,000. The consequence is also that the spread in futures markets for gold has ballooned. It is normally about 0.6%, but has expanded to over 6%, with spreads of over $100. The last time the New York-London spread was as big as this was in the 1980's when gold futures went to a record high of $850/oz.
What is true for gold applies to all other commodities that are produced by labour, and demanded for final consumption. On the one hand, production of these commodities has come to a stop, because economies have been closed down. That is also why the prices of the inputs of those commodities has collapsed. If cars are not being produced, there is no demand for steel, and so all of the steel stockpiles become worthless, causing steel prices, and thereby iron prices to fall through the floor. But everyone still needs to eat, and so baked beans, bread and so on still needs to be produced. If they aren't, whilst the government hands out depreciated money token to buy them, the only consequence can be that the price of baked beans, bread and so on goes up. And, as the prices of all these things goes up, both because constant money demand faces reduced supply, and because the money tokens themselves become depreciated, so wages must also rise, and the money that the government must pay out in benefits to compensate for these rising prices must also rise, and so the amount of money the government must borrow to pay for this additional expenditure due to rising inflation also rises.
And, this is the point that Marx, following Massie and Hume set out long ago as to why interest rates cannot be lowered by simply printing more money tokens. If say 1 billion £1 notes are put into circulation, and the velocity of circulation is equal to 1, it will buy 1 billion standard commodity units, with an exchange value of £1, equal to the production and supply of those units. If, however, the government now prints 2 billion of these notes, whilst the amount of production and supply of standard commodity units remains at just 1 billion, the result will be that each note becomes reduced in value by 50%. The price of each commodity unit will rise to £2. So, if the government starts from a position where it needs to borrow £1 billion to buy 1 billion standard commodity units, and the rate of interest is 6%, (determined by the interaction of the demand for and supply of this £1 billion of money-capital) it does no good whatsoever to simply print an additional 1 billion notes. That would simply result in the price of the standard commodity unit doubling so that, now the government has to borrow £2 billion instead of £1 billion, and so the rate of interest would remain 6%, the price of this £2 billion of money-capital. As Marx says,
“Hume is mainly concerned to show that the value of money makes no difference to the rate of interest, since, given the proportion between interest and money-capital—6 per cent for example, that is, £6, rises or falls in value at the same time as the value of the £100 (and. therefore, of one pound sterling) rises or falls, but the proportion 6 is not affected by this.”
(Theories of Surplus Value, Part One, p 373)
But, the situation is worse than this. The rate of interest would remain constant even after printing more money tokens, only if government borrowing were not increased. But government borrowing is being increased massively! So, the rate of interest must rise. But, its not just the government that is borrowing more. Firms are borrowing more in order to pay their bills, and the wages of their workers, because they have no income to make those payments, as their production is closed down. The self employed have to borrow to live, as their income disappears. In addition, the other source of the supply of money-capital besides realised profits, is savings, but not only are profits disappearing, so are savings. Anyone with savings is using them in order to pay their bills and survive. So the supply of money-capital is, thereby further contracted causing the rate of interest to rise further.
If governments attempt to resolve this by printing more money tokens as the proponents of the Magic Money Tree suggest, they will simply find, as did the government in Weimar, and many other since that they simply cannot print enough money to keep pace with their additional borrowing requirements due to the rising inflation that the money printing causes. In Weimar, a loaf of bread that cost 1 Mark in 1919, had risen in price to 100 billion Marks by 1923! But, things are even worse than that. Inflation would rise, simply as a result of depreciating the currency by printing more money tokens, and this increased inflation would mean that households, businesses, and government would have to borrow even more money to finance their spending. But, on top of that, this increased monetary demand is facing reduced supply of commodities, because production is being closed down, as seen in relation to gold. Fortunately, for governments around the world, people are not observing their demand for everyone to stop work and stay at home. If they were, a real catastrophe would already have unfolded, as electricity supply would stop, food supplies would already have run out, water supplies would begin to break down and so on. But, production is being seriously constrained, and so this rising monetary demand, caused by depreciated currencies, is meeting this reduced supply causing market prices to rise even further.
Moreover, because production is being constrained, the economies of scale, and falling marginal costs that derive from production on a larger scale are being lost. The price of a commodity is determined by two factors, firstly the actual value of the commodity itself, i.e. how much labour-time is required for its production, and secondly the value of the money-commodity, or nowadays money token standing in the place of that money commodity. Even if the value of money tokens remained constant, the value of commodities is rising, because the scale of production is being scaled back. Productivity drops, economies of scale are lost, each commodity represents an increased quantity of labour-time, so that its price rises for this further reason. In addition, global trade, already suffering from the effects of Trump's idiotic global trade war, and Brexit, was already creating frictions, and increasing the costs of distribution. The further constraints now being imposed, as borders are closed, means that the massive benefits brought by globalisation and world trade are being eroded, causing commodity prices to rise further. As prices rise, so the amount of borrowing to finance consumption will also rise, causing interest rates to rise much higher.
Financial markets had a dead cat bounce as a result of announcements of additional money printing, and purchase of financial assets by central banks, alongside the announcement of massive fiscal stimulus programmes announced by governments. But, the amount of additional borrowing, and the nature of this borrowing, now to finance consumption, and so money going directly into the real economy, and causing a spike in inflation, thereby creating a need for even more borrowing, is going to push interest rates, and yields on assets to rise much higher. Given that the revenues on those assets is simultaneously going to more or less disappear, as profits disappear, the only way that yields can rise, is for asset prices to fall massively. Financial markets are looking into a bottomless pit.
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