The latest buzz phrase in financial circles is yield curve control. It is a fantasy, based on a misunderstanding of what money, money-capital and interest rates are. The same misunderstanding is the basis of Modern Monetary Theory.
Central banks, via QE, print money tokens, and use them to buy bonds. When they buy bonds, that pushes up the price of the bonds. Yields are the ratio of the revenue produced by an asset to the price of the asset. So, if the revenue of the asset remains constant – and the coupon, or interest on a bond is a fixed amount – any rise in the price of the asset results in a fall in the yield, and vice versa. When central banks engage in the buying of bonds to drive up their price, this encourages other speculators to also buy those bonds, because, in doing so, they obtain a capital gain from the higher price. When yields on assets are already very low, and so any loss of revenue is minimal, this capital gain far outweighs the loss of revenue, in terms of the total return.
Central banks also determine policy rates of interest, in other words, the rate of interest paid by commercial banks to borrow, short-term, from the central bank, and by the central bank to commercial banks on their deposits with it. By lowering these rates, they encourage commercial banks to borrow, and then also to use this money to speculate in assets themselves so as to obtain these capital gains. These policy rates affect the short-term yields on assets, because the lending from the central bank is itself short-term lending. If financial institutions, or other borrowers, wish to undertake long-term borrowing they have to look to other sources of lending, and these lenders will seek to obtain higher returns than does the central bank, especially where it is seeking to encourage additional borrowing, so as to expand liquidity.
In other words, a company that seeks to finance a large expansion of its operations, may seek to borrow over a ten year period. It might sell additional shares, or it may sell ten year commercial bonds to raise the necessary finance. These bonds might be bought by financial institutions, or they might be bought by private speculators. The money to buy these bonds comes from either the current increase in the supply of money-capital from realised profits, or else it comes from accumulated savings in the economy, i.e. from the money-capital previously created by realised profits, in past years, not already used to finance an accumulation of real capital, or consumption.
The former is fairly straightforward. When companies realise profits via the sale of their output, these realised profits go in part to provide revenues to capitalists for their own personal consumption, including the payment of interest to money lending capitalists (shareholders, bondholders, banks) to landlords as rents, and to the state in taxes. Another part of the profit may go to finance capital accumulation by the firm itself, so that it provides the demand for its own supply of additional money-capital, and the rest becomes a reserve of money-capital available to increase the supply in money markets. Of course, some of those that receive revenues in the form of interest and rent, or profits may not use all of it for personal consumption – certainly not immediately – and so will also accumulate it as savings. Even workers may not use all of their wages for consumption immediately, and will save some of it for future use. The banks are able to pool such savings from all these sources, and so make it available as the supply of money-capital.
The relation of this supply of money-capital to the demand for it from businesses seeking to accumulate and expand their capital, from the state to fund its own spending, and from all those that seek money as currency to pay bills, and so on, is what determines the rate of interest.
When it comes to the accumulated savings, things are a bit more complicated. If we take someone who has accumulated £1 million in savings over the years, say £100,000 a year in interest over a period of ten years, these revenues were themselves the product of realised profits during that period. If they now lend this £1 million to a company by purchasing its bonds, then its obvious this £1 million is no longer available for them to lend. They could sell, in the secondary market, the bond they have purchased, but then whoever buys this bond no longer has £1 million to lend. Say they have bought a ten year company bond, each year they will receive interest, which is itself a deduction from the realised profits of the company. At the end of the ten years, they will redeem the bond, getting back the original £1 million capital sum. They now have this money that they can lend out again. However, for the firm to be able to redeem the bond, they must now pay this £1 million to the bondholder, and this again can only come from its realised profits in the current year.
In other words, the pool of savings, from which part of the supply of money-capital derives, expands year on year, and this is why, as Marx and Engels say, in long established countries, this accumulated pool of savings, in the hands of people who take no part in production, but simply loan out this money-capital, results in the rate of interest tending to decline over time. A large part of these savings is already employed, however, at any one time, in lending to companies to finance their capital accumulation, via the purchase of shares or bonds etc. The main increase in the supply of money-capital derives from the realised profits in the current year.
If companies seek to expand their capital, because demand is growing rapidly in the economy, they will increase the demand for money-capital, to finance this expansion. If the supply of money-capital does not increase in proportion – either by more unused savings being mobilised, or as a result of realised profits expanding – then interest rates will rise. It may be the case that the increased pace of economic activity results in increased profits, in which case, the greater volume of realised profits will expand the supply of money-capital, so that interest rates may not rise, or might even fall. Similarly, the mass of profits might increase, but not as fast as the demand for additional capital, so that interest rates would rise, and finally, firms might see rising demand, as economic activity quickens, and so be forced by competition to expand, so as not to lose market share, even as their profits get squeezed due to the booming economy causing wages to rise, in which case the demand for capital will rise much faster than the supply of additional money-capital, causing interest rates to rise sharply.
Because, central banks can print money tokens and use them to buy up bonds, raising the price of those bonds, and, thereby, reducing the yields on those bonds, this creates the delusion that the central bank can determine interest rates. The fact it does this, whilst also setting policy rates of interest, i.e. what it charges commercial banks to borrow from it, or pays to them for their deposits with it, further strengthens this delusion. These various policy instruments are seen as control over short-term interest rates by central banks, whilst they are, in fact, only control over the yields on these debt instruments. The delusion has been further strengthened in the last thirty years, because the vast majority of lending has gone to finance the purchase of debt instruments themselves, rather than to finance the purchase of commodities either for personal consumption, or productive consumption, i.e. capital accumulation. In other words, the central banks have printed additional money tokens, or extended credit to commercial banks almost exclusively for them, and other speculators to simply buy up existing financial assets, and thereby hyper inflate the prices of those assets, which has the effect of, thereby, reducing yields, now to the ridiculous extent of creating negative yields on vast quantities of such bonds, a large proportion of which are themselves now held on the balance sheets of central banks themselves.
But, in fact, even in relation to these short-term rates of interest, they are irrelevant to what is happening in the real economy. For example, large numbers of households are dependent upon credit cards to exist from one pay check to another. Whilst the Bank of England's policy rate is 0.1% p.a. this does not stop the banks from charging between 20-30% p.a. for borrowing on credit cards. Large numbers of people borrow on credit cards, and many others depend on even more usurious borrowing from payday lenders and loan sharks, to cover their consumption, because their wages are too low. But, if wages were higher, then profits would be lower, and instead of households borrowing to fund their consumption, firms would have to borrow more to finance their capital accumulation, and that would cause the demand for money-capital to rise, leading to them paying higher rates of interest.
The low policy rates of interest, and low yields on bonds does not change the fact that millions of small businesses cannot borrow from banks, and do not have access to bond and other capital markets. The banks do not lend to them, because of the risks, and because the policies of the central banks, and of the state, encourages them, instead, to speculate in the purchase of existing financial assets, or to lend to borrowers for property, where a similar speculative bubble exists. Consequently, these small businesses are themselves forced to borrow against credit cards, or else from peer to peer lenders, themselves charging around 10% p.a.
Governments borrow in these bond markets, but they themselves instituted policies of fiscal austerity, which reduced budget deficits, and reduced overall levels of debt relative to GDP, so that this reduces the relative demand for money-capital from this sphere. Large corporations have increased borrowing in the commercial bond markets, but the borrowing has not been to finance expansion. It has been used simply to buy back shares, thereby, transferring from one form of debt instrument to another, and in the process increasing the prices of shares, and so the paper wealth of shareholders. That rise in share prices was further enhanced by the use of realised profits to also buy back shares, rather than fund capital accumulation. Had all of this borrowing been used to finance spending in the real economy, either for personal consumption, or capital accumulation, then the effect would have been to inflate commodity prices, which would have meant that the money required to finance such capital accumulation would have increased, so that the demand for money-capital would have risen, causing interest rates, and now the yields on those bonds to have risen.
The delusion was created that interest rates are determined not by the interaction of the demand and supply for money-capital, but by simply the supply of money tokens. So, if the quantity of money tokens/credit put into circulation is increased, this is the same as an increase in the supply of money-capital, resulting in a reduction in interest rates. This is the mistake that the Governor of the Bank of England, Lord Overstone made, in the 19th century, as discussed by Marx and Engels in Capital III. As Marx sets out, it is, in fact, obvious that if simply more liquidity is put into circulation, this cannot change the underlying relation of the demand and supply for money-capital. It simply results in the metric in which these quantities are measured being reduced by an equal amount on either side of the equation. The only question is where this additional liquidity materialises itself in the form of inflation.
Normally, it would feed into the real economy, and so cause commodity prices to rise, thereby creating a proportional increase in the demand for money-capital to purchase those commodities. For example, if a machine costs £100, and a firm needs to borrow £100 to buy it, its demand for this £100 of capital, set against a given supply of money-capital, will result in a particular rate of interest, at which this demand and supply is balanced, say 6% p.a. If the currency in circulation is doubled, resulting in 100% inflation, then the price of the machine will now rise to £200. Although, now, in these new inflationary conditions, the amount of money-capital available as supply is also doubled, the relation of the demand to the supply is proportionally unchanged. £200 demand:2x supply of loanable money-capital, is the same as £100 demand:x supply of loanable money-capital, and so the rate of interest that balances this supply and demand remains 6%.
Marx sets this out in Theories of Surplus Value, Part I, Addenda, quoting Massie.
“Hume attacks Locke, Massie attacks both Petty and Locke, both of whom still held the view that the level of interest depends on the quantity of money, and that in fact the real object of the loan is money (not capital).” (p 373)
Hume also realised what many modern economists do not seem to realise, in this context, that simply printing money tokens – and thereby devaluing them – cannot be a means of reducing interest rates, because money only acts as a means of measurement of value via prices. A devaluation of the currency simply changes the unit of measurement of all prices proportionally, so that the nominal value of demand for money capital, and the nominal supply of money-capital increase by the same amount leaving the balance between the two unchanged.
“Massie laid down more categorically than did Hume, that interest is merely a part of profit. 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.” (p 373)
In fact, because such inflation will create uncertainty about the future purchasing power of the capital sum when it is returned, and of the annual interest, lenders will tend to seek higher rates of interest on longer term loans, so as to protect themselves against such losses. Rather than reducing interest rates, therefore, the uncertainty created by inflation, resulting from the money printing will tend to increase the precautionary demand for money, and cause longer-term interest rates to rise.
The delusion has been created that such money printing reduces interest rates only because interest rates have been equated with yields on bonds, along with the policy rates of central banks, whilst the peculiar conditions of the last thirty years has seen the increased liquidity diverted into the creation of a hyperinflation of asset prices, draining liquidity out of general circulation, which along with policies of fiscal austerity has created a disinflationary environment for commodity prices. What has shocked financial speculators and pundits, most of whom are too young to have experienced real inflation – anyone under 60 has not seen real inflation – is the suddenness, and strength with which it has now appeared, across the globe, as soon as those artificial conditions of the last 30 years have been removed.
In place of fiscal austerity, massive fiscal expansion; in place of relative declines in public debt to GDP, a phenomenal expansion; in place of liquidity used to finance the purchase of assets, the use of liquidity to finance unproductive consumption; instead of rising productivity and falling values of commodities, a massive contraction in productivity due to lockouts, and an increase in the value of commodities; instead of expanding realised profits being used to finance the purchase of assets, and so the inflation of their price, the disappearance of profits due to lockouts, and the need to draw down from profits and balance sheets to finance continued costs. And, as businesses find, as they open up, that monetary demand expands rapidly, so they must now expand their output rapidly or risk losing market share to competitors. With balance sheets run down, and with supplies of inputs in short supply from microchips to timber to labour-power, and as all of the oceans of liquidity now flows into an increase in the prices of these commodities, so firms have to borrow on a massive scale to finance that expansion, causing the demand for money-capital to rise sharply in relation to the supply, causing interest rates in the real economy to spike higher.
Its in this context that yield curve control is being talked of. The idea is simply to extend the current scope of QE, and to focus the purchase of bonds upon the longer dated paper rather than the short dated paper. In other words, to inflate the prices of 30 year bonds relative to 10 year bonds, ten year bonds relative to 5 year bonds, and 5 year bonds relative to 2 year bonds. In this way, the yields on the longer dated bonds is forced down relative to the shorter dated bonds, with the intention of encouraging borrowing over this longer timescale. The purpose of that is seen as being to reduce the cost of capital, as borrowing for capital projects is generally undertaken over this longer timeframe.
But, its obvious from what has been set out above, why, in these current conditions, this will not work. If central banks print more money tokens to buy up more ten or thirty year bonds, relative to 2's and 5's, the consequence will still be an increase in liquidity that will simply feed into higher levels of inflation. The ten and thirty year bonds being issued by governments are now being used to finance their own spending on infrastructure seen as needed to restart economies following the economic damage they have done to themselves as a result of lockouts. It is being used to replenish balance sheets denuded as a result of paying out tens of billions in transfer payments as a replacement for wages and other revenues, that were stopped, again, as a result of lockouts. Moreover, it is being used to bail-out all of those large strategic businesses that were put in jeopardy as a result of those lockouts, but whose importance to the economy is such that states cannot allow them to go bust.
Governments are constrained in financing these policies through higher taxes, or austerity as they did after 2008, because of the continued effects of that austerity over the previous ten years, and because governments fear losing elections, having made promises to electors about “levelling up”, and so on. The scale of debt and of spending is now so great that any suggestion the gap is going to be bridged by taxing more heavily a few hundred billionaires is pure fantasy.
And, that is even before considering the need for additional borrowing by companies that seek to expand production, driven by the needs of competition in an environment of rapidly rising monetary demand. It is quite likely, as I have said previously, that central banks will try to respond to rising interest rates by such measures of yield curve control, printing even more money tokens to buy longer dated paper. But, the consequence will simply be to feed all of this additional liquidity out into the real economy, and so inflating commodity prices, even further, in the new changed conditions. And, with those higher prices for inputs firms will demand even greater quantities of money-capital, to pay for them. As consumer prices rise, and firms have to bid for labour, wages will rise, squeezing money profits, and firms will have to borrow even more money-capital to pay for this additional labour, and its higher wages. Rather than causing interest rates to fall as a result of this attempt at yield curve control, the result will be yet higher levels of inflation, and higher levels of interest rates.
The genie is out of the bottle.
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