Nearly every economist now agrees that inflation is set to rise rapidly. The latest UK inflation data shows that it doubled in December, rising from 0.3% in November to 0.6%. As set out in previous posts, in fact, even that understates the real position, because the current index is not lockdown adjusted. It does not take into account that many of the items whose prices have fallen, or risen slightly, are heavily weighted, but cannot be currently bought, whilst those that have risen most are lightly weighted in the index, but a higher proportion of those are being bought in current conditions. The basic cause of the inflation is the same as that which has caused a hyperinflation of asset prices over the last thirty years, i.e. the printing of vast amounts of money tokens, thereby, devaluing each of those tokens. But, there is a further cause of the incipient commodity price inflation, and that is that costs have risen due to falling productivity caused by lockdowns, and secondly lockdowns have reduced supply, whilst boosting monetary demand, causing market prices to rise.
When economies are released from lockdowns, these factors are going to cause demand to exceed supply by a significant degree, causing prices and money profits to rise sharply. With rapidly rising demand, and money profits, firms driven by competition, will seek to increase their output to capture, or at least not lose, market share. This sudden increase in output will cause further dislocations and sharp rises in prices of some inputs, because supply of them will not be able to respond, adequately, in the very short term, either. The move to online activity is going to become entrenched, as the high street's decline is enhanced. That means that the types of labour that are in demand are likely to change. As Marx sets out in Theories of Surplus Value, there can be higher unemployment alongside higher wages, or living standards for the workers that actually are in employment. A demand for more skilled workers as web designers, network administrators and so on, will cause their wages to rise, even as unskilled, particularly older workers, find themselves continuing in low value, low paid employment or unemployment. But, the general tendency will be for employment to rise, and wages to rise, giving a further stimulus to demand for consumer goods, which will cause firms to seek to expand output further.
But, we know how states will respond to this rising inflation. They have told us, and we have seen it in the recent past. Central banks have said that, because inflation has been below their 2% target, they see no problem in it being above it for some time. In the period after 2008, the Bank of England continued to print money tokens, and to hold down its policy rates, despite inflation rising to over 5% for many months. The central bankers believe they are masters of the universe, able to determine the most important price, the price of capital, i.e. the rate of interest, simply by diktat, like some modern day King Canute. They cannot, and the laws of economics and of capital have not been abolished. Those laws, in relation to the rate of interest are simple. If the demand for money-capital rises relative to supply, then interest rates will rise, irrespective of how many money tokens central banks print, or what policy rates they dictate.
And, when economies are released from lockdowns, the demand for money-capital will necessarily rise relative to supply. In order to accumulate capital, to increase output, firms have either to use their retained profits – meaning those profits are not thrown into the money market, so reducing the supply of money-capital – or else they must go into the money market to borrow the money-capital required, meaning that demand increases relative to supply. They can do that by taking out bank loans, or lines of credit, or by issuing additional shares, or bonds. Small businesses, are restricted to taking out bank loans, or using personal credit, such as maxing out credit cards, or re-mortgaging their houses, and so on. Either way, the demand for money-capital rises relative to the supply.
That is particularly the case given that, over the last year, many businesses have seen their profits annihilated, because lock downs forced them to close down production or sales. They have had to draw down on their balance sheets to be able to stay in business during that period. So, these businesses now have to borrow money not only to finance expansion, as demand increases, but also to rebuild their balance sheets. Of course, the government can, and for the big companies, will do this for them, bailing them out with trillions of dollars of taxpayers money, but, in the short-term, governments too will have to finance that by additional borrowing rather than higher taxes. That is on top of the huge levels of borrowing that governments have undertaken to finance furlough schemes, and other programmes to provide revenues to people whose incomes have disappeared. So, not only inflation, but also interest rates are bound to rise sharply.
Higher interest rates, not those dictated by central banks that will become increasingly irrelevant, but the actual rates of interest determined in the market, i.e. the rate you will have to pay if you take out a bank loan, or on your credit card, or the yield that firms have to pay on their shares, if they want to attract buyers of those shares. It will first appear in terms of bonds, whose prices will fall, as the means by which these yields rise. But, because the central banks believe they can control these yields by simply printing more money, and buying more bonds, that is what they will do.
Last night, I watched “The Big Short” again on iPlayer. It shows just how corrupt the financial system was before the 2008 financial meltdown. It focused on the selling of mortgages, mortgage bonds, and CDO's, but the corruption and irrationality in the housing market was itself just a symptom of the same thing that existed across the entire financial sector, where the same ridiculous inflation of asset prices, of shares and bonds could be seen, based upon nothing, and only sustained as a result of central bank intervention and money printing. As they say at the end of the film, in the end, the state bailed out all of the banks and speculators that caused that crash, and they will try to do so again, now that the same irrationality, the same corruption has continued on an even larger scale after 2008, creating an even bigger, even more irrational bubble in financial and property markets.
The model will be what happened with Greek debt, following the Eurozone Debt Crisis of 2010. Then, all of the private holders of Greek debt were allowed to escape the reality that the bonds they held were worthless, by central banks buying them up. Some of those speculators took a haircut on the price they got for their bonds, but it was much better than getting nothing for them. In fact, central banks have done that with a host of government bonds. They now hold about a third of all government bonds in circulation.
As commodity price inflation increases sharply, and asset prices fall, the owners of fictitious capital, in particular, here, bonds, will seek to sell it, to avoid capital losses. They will seek to use the proceeds to buy real assets. In other words, they will want to buy actual factories, machines and so on, to invest in industrial capital, to be able to obtain real profits. Huge amounts of liquidity was created that inflated the asset price bubbles, and the release of that liquidity, from bursting bubbles, into the real economy, will cause asset price deflation alongside rapid commodity price inflation. But how?
If owners of fictitious capital sell, for example bonds, as their prices are falling, the money they get for those bonds can then be used by them, and put into the real economy. They can use it to invest in real capital, or they can use it to finance consumption. Either way, this money goes to fund demand for commodities, and, thereby, as additional liquidity, leads to rising commodity price inflation. However, for them to sell these bonds, requires that someone else buys them, and so this other person then reduces their own liquidity, making the net effect zero, in terms of available liquidity. But, that is not the case, if the buyer of these bonds is the central bank. If the central bank buys the bonds, which they are likely to do, as they see a new collapse of all these financial bubbles, they can simply print more tokens to do so. So, printing money tokens creates asset price bubbles to begin with, and then the collapse of those bubbles causes more money printing to occur, now, with that additional liquidity going into the real economy, as against the last thirty years, where it just went to reflate, and further inflate the asset price bubbles.
So, now, collapsing financial and property bubbles, will be a source of additional liquidity pumped into the real economy, thereby, exacerbating an already inflationary spiral. Central banks will not respond to rising inflation, and as asset bubbles pop, they will print more money tokens, saving many of the speculators from taking huge capital losses on their gambles. The liquidity will go into circulation, causing commodity price inflation to rise even faster. That will drive even greater rises in money profits, causing firms to seek to expand even more. Inflation will become embedded within the economy, and so too will rising interest rates. Firms that want to expand by issuing new shares or bonds, will have to price them accordingly, so as to provide a high yield to speculators. In other words, bond and share prices will fall significantly. Banks will also charge higher interest rates on loans. Speculators will not buy land or property to obtain yields that are significantly lower than those available on shares or bonds, or the profits available from simply using their money-capital themselves to start businesses, and obtain a high rate of profit. Especially as the speculative capital gains on assets of the last thirty years disappear that will be the case. So, as yields rise, land and property prices will also fall significantly.
This effect on asset prices of rising interest rates, however, does not affect the rate of profit, or mass of profit in the same way. The process of capitalisation means that, if interest rates double, then the price of the revenue producing asset is halved. But, suppose the result of increased money profits is that the demand for money-capital doubles. Let us say that the current rate of profit is 10%. A capital of £1,000 produces £100 of profit. If the rate of interest is 1%, then the firm will pay £10 of interest out of its profits, leaving £90 of profit that can be accumulated as additional capital. Now demand for capital doubles to £2,000, as a result of the economy growing. Even if the rate of profit remains 10%, it now produces £200 of profit. Suppose that interest rates now also double to 2%, meaning that £40 of interest are due. The remaining profit still now amounts to £160, or nearly double what it was, and so, accumulation can increase, even with these higher rates of interest.
Even in terms of the rate of profit, a doubling of the rate of interest does not halve the rate of profit of enterprise, because interest comprises only a fraction of the total profit. In the above case the rate of profit of enterprise fell from 9%, to 8% for example, despite a doubling in the rate of interest. Consequently, as rising economic activity causes interest rates to rise, and asset prices to crash, profits will continue to rise sharply, encouraging further economic growth as a result of investment in productive capacity. As asset prices crash as a result of rising interest rates, whilst profits rise, more of those that have engaged in asset price speculation, will seek to avoid further capital losses, and will seek higher yields by investing directly in productive activity. And, there is lots of higher profit areas for such investment to occur, for example in space technology, green energy technology, medical science technology and so on.
According to the latest ONS data, between 10-15 million people in Britain, in December had had COVID19, and had immunity. In actual fact, the data for those with antibodies has always significantly understated the real number, because the vast majority of people infected are asymptomatic and never tested, whilst the current tests fail to detect low levels of antibodies, which can occur when someone acquired immunity several months ago, and the tests do not detect other forms of cell immunity, and so on. The real level of previous infection, and of immunity is probably closer to 20 million, and we also have now 4 million people that have been vaccinated, giving around 25 million people with immunity, or about 40% of the population. But, with the current levels of infection, we are likely to have more than half the population with immunity within about a month. Its thought that 60% is required to create a required level of herd immunity, which is, then, likely to occur within the next three months. This is likely to be the case in many other countries.
By the middle of the year, therefore, we are likely to see that herd immunity has been achieved, meaning that the spread of the virus will be, at the least, heavily curtailed, and deaths and hospitalisations along with it. There will no longer be any possible foundation for continued lock downs. Experience so far suggests that we will see a strong surge of “revenge spending”, rapidly boosting aggregate demand. Profitability remains high, and profits themselves have only been squashed as a result of enforced close downs. With demand rising sharply, and vast amounts of liquidity already available, and more to come, monetary demand is going to push up inflation, and money profits, provoking yet more capital accumulation, and demand for money-capital, causing interest rates to rise, and asset prices to crash.
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