Paul, however, like the proponents of the Magic Money Tree thinks that this is not a problem because Britain can just print more coloured bits of paper and use them to pay the interest to its creditors. He points to the fact that, QE has enabled central banks to buy government debt, in the shape of bonds, and that the yield on these bonds has fallen. But, this totally misunderstands what has happened with that process of QE, and why those yields have fallen, and why this is irrelevant to the question of the rate of interest.
Every month, government bonds, issued at some time in the past, mature. That is, a 10 Year UK Gilt, issued on January 1st 2010, matured on December 31st 2019. It was a loan, by the bondholder, for ten years, to the UK government, of a given amount of money, as indicated by the issue price of the bond. Each year, the bondholder receives an amount of fixed interest, called the coupon. The relation between the coupon and the price of the bond is the yield. If a £1,000 bond pays an annual coupon of £100, then the yield is 10%. Each year for ten years the bondholder receives £100 of interest, and at the end of the ten years, they get back the £1,000 value of the bond, as it matures. But, bonds can be sold in the bond markets at any time before maturity. If interest rates are rising, then speculators may think that this 10% is less than they could obtain elsewhere. They will want to sell the bond, and use the cash to speculate in some other asset. But, as they sell these bonds, the price of the bond itself will fall. It may only be possible to get £900 for the bond. For the new owner of the bond, it will still pay £100 in coupon, and this will represent a yield of 11%, and come its maturity, they will still be able to get the full £1,000 face value of the bond.
But, likewise, if interest rates are falling, more speculators may seek to own bonds, in order to obtain this fixed £100 of interest on it. The price of bonds in the secondary market will rise, and so the yield on these bonds will fall, reflecting the fall in market rates of interest. The price of a bond might rise to £1200, so that now the £100 coupon represents a yield of just 8.3%. But, this demand for bonds is not the only factor in determining their price. The other factor is supply. The government increases the supply of bonds when it needs to increase its level of borrowing. In terms of the total supply of bonds, then, it is determined by whether the government issues more new bonds than are retired each month as they mature. If the government issues less in new bonds than are retired, then the supply of bonds will fall, and, if demand for them remained the same, the price of these bonds would rise, and so yields would fall.
Now, compare what has been happening in recent years. It is not that governments have stopped borrowing, or issuing debt to cover that borrowing, but measures of fiscal austerity means that the level of additional borrowing is reduced. More bonds are issued, increasing supply, but a greater value of bonds mature so that the supply is reduced. Austerity is a deliberate government policy to increase the value of bonds, and thereby, the paper wealth of the top 0.01%. At the same time, this austerity holds back the growth of the economy. In so doing, it holds back the growth of employment, which holds back the rise in wages, which would start to squeeze profits. It also holds back the pace at which firms seek to accumulate capital, and so their demand for money-capital, which would cause interest rates to rise. That again enables bond prices to rise, and so inflates the paper wealth of the holders of those bonds.
Yet, time and again, in the last thirty years, the normal laws of the capitalist economy has seen growth increase, which causes the demand for capital to rise, which in turn causes interest rates to rise. As the economy grows, and employment rises, so wages start to rise, which creates an even bigger stimulus for the economy to grow, and for interest rates to rise. As these market rates of interest rise, the rates that actual small and medium sized businesses have to pay, so it begins to impact the prices of the bonds and other financial assets, whose prices are grossly manipulated by the interventions of central banks. When the central banks see the prices of financial assets and property begin to fall, they worry, because its in that form that the ruling class owns its wealth. So, the central banks print money tokens and use them to buy up the bonds whose prices are falling.
All of this additional liquidity, then, does not create consumer price inflation, because it is directed into the purchase of these financial assets and property. For good measure, conservative governments also encourage speculation in these assets. For example, although we are continually told that the property market is booming, for the last 12 years there have been one set of measures after another to try to inflate demand for property, which could only have the effect of pushing up property prices even further, putting them more and more out of the reach of most potential buyers. We have had Help-To-Buy, reductions in Stamp Duty, and a multiplicity of schemes and subsidies to try to prevent house prices from falling. And, although that is not directly to benefit the top 0.01%, it is to benefit the banks and other financial institutions who have pumped billions into the property market, and whose balance sheets are a fiction based on the inflated prices of property as much as the inflated prices of shares and bonds. As in 2008, which started with the crash in the US housing market, as the lunacy of all the sub-prime mortgages, and mortgage backed securities, created on the back of it, was exposed, a crash in property prices will quickly spread throughout the financial markets.
But, as I have written recently, the current conditions represent something completely different. Its this that Paul, and the proponents of the Magic Money Tree do not seem to have understood. Its not that all the money printing did not cause inflation. It did. It caused a hyperinflation of asset prices. In the process, it sucked liquidity out of general circulation, and so caused disinflationary conditions in the real economy. If you can make a 20% a year capital gain from rising property prices, why would you use any money you have productively, when instead you could just buy up property and sit on it. You don't even have to rent it out to obtain a revenue. If you are a shareholder why would you want to use your company profits to invest in expanding the company, when instead you can have the Directors use those profits to buy back shares, and further inflate their price, or you can have them pay out more and more of the profits as dividends, or capital transfers, so that you can use that money yourself to speculate further in buying shares, confident in the knowledge that if asset prices fall, the central bank will print more money tokens to buy them up, and inflate them once again.
In recent days we have seen Elon Musk risk the future of his company by using its resources to buy $1.5 billion worth of Bitcoin, and agreeing to accept it in payment for cars. Okay whilst the current mania over Bitcoin has led its price to surge to over $50,000, but not so good when its price collapses back to, or near, zero again, which it is bound to do, given that it has no value whatsoever, and no utility other than as an artificially created object of speculation. Even tulips had some value, whereas Bitcoin and other cryptocurrencies have none.
So long as all of the additional liquidity was confined to speculation in assets then it would simply cause an increasing hyperinflation of those asset prices, creating disinflation in the real economy. The supposed near zero cost of borrowing based on those heavily manipulated yields on financial assets is then a mirage. As soon as the liquidity instead goes into the real economy it leads to rapidly rising inflation, and the dynamic of a strongly growing economy causes the demand for capital to rise sharply, which causes real market rates of interest to rise sharply.
That was seen in 2007/8, which led to the crash in asset prices, and global financial meltdown. It can be seen happening again, as governments have borrowed huge amounts of money requiring large amounts of new debt issuance, and have used that money to finance unproductive consumption via furlough schemes and other income replacement. They have pumped liquidity into the real economy at precisely the time when they have reduced the supply of goods and services into the economy as a result of their imposition of lockouts. The combination of increased liquidity and monetary demand alongside reduced supply inevitably means rising inflation. When economies come out of the lockouts, there will be a further surge in demand causing inflation to rise even faster. Rising money profits on the back of it will force firms to expand production so as to not lose market share The rising demand for capital will cause interest rates to rise, and the effect on asset prices will be an inevitable sharp fall.
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