Inflation Bursts Through Even Raised Estimates

Inflation data from the US, yesterday, and the UK, today, shows it is continuing to rise, despite central bank claims that it is merely “transitory”. The argument, put in previous months, by authorities, and other financial pundits, keen to avoid a monetary tightening that would cause asset prices to crash, that it can be explained by “base effects”, compared with the same months last year, has worn increasingly thin, and impossible to sustain.

As US inflation data has continued to exceed estimates, in previous months, financial analysts increased their estimate of month on month inflation to 0.5% for last month. Of itself, projected forward for a year, that would give inflation, in the year ahead, of more than 6%. In fact, the figure came in at nearly double that raised estimate, at 0.9%. That is the largest increase since June 2008, when surging economies were leading to rising inflation, and rising interest rates that sparked the financial meltdown of that year. Projected forward a year that would give inflation of around 12%. Even looking back, and so including all those months, over the last year, when the recorded inflation was subdued, due to the constraints imposed by lockouts and lock downs, the figure came in at 5.4%, again the biggest increase since August 2008. In fact, for the reasons set out in previous posts, this figure itself underestimates the real figure, because, over the last year, the figures were distorted by falls in the prices of many goods and services included in the basket used as the basis of calculation, but which were not available, whilst failing to include the sharp rises in prices of goods and services that consumers, stuck at home, switched to instead.

A similar thing can be seen with the continued rise in the price of used cars and trucks. Many people do not want to use public transport, in itself, increasing demand for private transport. However, as a result of lockouts and lock downs imposed by governments, vehicle production was shut down, so that the supply of new vehicles collapsed. Demand for vehicles, therefore, moved to existing used vehicles, pushing their prices sharply higher. Now, vehicle production is restarting, but the surge in global economic activity, had already led to a shortage of microchips used now in everything. The shortage of chips has meant that vehicle producers have not been able to increase production sufficiently, because they do not have an adequate supply of engine management chips, and so on. Its likely to be at least another year before chip production can be increased adequately, and in the meantime, that shortage results in higher chip prices, higher prices of all those goods in which the chips are used, as well as higher market prices for any commodities whose supply is constrained, by such supply bottlenecks, whilst demand, fuelled by liquidity injections, continues to rise.

The BLS reports larger than expected increases across the board. Food prices rose 0.8% in June, double the 0.4% figure in May. Across the globe, food prices are rising sharply along with other primary products, again fuelled by rising economic activity, but also by large amounts of liquidity flooding into circulation, provided by central banks over the last year. The Energy Index rose by 24.5% over the last year.

Today, the inflation data for the UK was also released, again showing it blowing past estimates. The CPI figure came in at 2.5%, already surpassing the Bank of England's 2% target figure. That was up from 2.1% in May, and above estimates. Again this figure fails to take account of the effects of changed consumption patterns resulting from lockouts and lock downs imposed by the government. Similarly, the CPIH figure came in at 2.4%. CPIH includes owner occupier housing costs. But, it is also a fraud. These housing costs are based on monthly mortgage costs, which rise or fall with mortgage rates, as well as actual house prices. But, the real measure of housing inflation is the rise in house prices. Had the soaring real cost of shelter from rising house prices, and the soaring cost of pension provision, from soaring stock and bond markets, been included in inflation data, over the last few decades, then the measure of inflation would have been much higher, putting additional pressure on central banks to raise policy rates, and restrain their liquidity injections. The data showed the same pattern of rising prices as in the US, with rising prices of used cars, food and energy etc.

The narrative from central banks, and from financial analysts employed by the big financial institutions continues to be that the inflation is only transitory caused by supply bottle necks as economies re-open following government imposed lockouts and lock downs, and due to base effects of comparisons with months last year, when prices fell due to those same lockouts and lock downs. They have a reason for pursuing that narrative. For the last 40 years, the central banks have attempted to keep asset prices – the prices of all of that fictitious capital in the form of shares and bonds, which is the form in which the ruling class now owns all its wealth – inflated. It is all the basis for the existence of all those large financial services firms, who make their profits from capital gains on financial markets, and from commissions from clients, themselves in search of such capital gains. Continually inflating asset prices are the lifeblood of those institutions, and the nemesis of those rising asset prices, is rising interest rates. They have to continue the narrative that inflation is only transitory, in order to convey the message that central banks are not going to raise their policy rates, will continue to flood the economy with liquidity, so as to keep those asset prices soaring to the stars.

But, in current conditions, where liquidity is flooding into the real economy, rather than into the purchase of existing assets, as it did in the previous 40 years, any additional liquidity injected by central banks is going to simply ensure that the already rapidly rising inflation, continues to rise, and becomes anything but transitory. Moreover, they make the assumption that rising interest rates are a consequence of rising inflation, but that is not the case. Rising inflation, certainly means that lenders, looking over the medium to long-term, will take into account the net present value of the bonds they purchase, and the coupon on them. If they think that inflation will reduce the current value of a £1,000 10 Year bond to just £400, in 10 year's time, they will account for that in how much they are prepared to pay, now, for such a bond, and the less they are prepared to pay, the higher the yield will then become. The same thing in relation to the coupon. But, the real determinant of interest rates is the demand for and supply of money-capital.

Additional supply of money-capital comes from realised profits, with other sources being additional mobilisation of savings, use of money reserves and hoards, for example for depreciation, or wear and tear of fixed capital. The demand for money-capital comes from the need of firms to accumulate additional capital, as well as from governments that seek to borrow to cover their current expenditure and capital investment costs. In addition, firms and households demand money-capital simply to cover payments. As Marx describes, all money is potentially money-capital, so that those that lend it, lend it as money-capital, interest-bearing capital. That does not mean that all money borrowed is used as money-capital, i.e. for the purchase of the components of productive-capital. As Marx points out, in Capital III, that is why it is during a crisis, when businesses seek to borrow not to invest, but simply in order to pay their bills, to stay afloat, that interest rates reach their highest levels.

A look at the current surge in global economic activity shows that, the supply of money-capital, from realised profits, has been severely reduced over the last year, due to government imposed lockouts and lock downs. In many cases, not only have businesses seen their profits reduced, as they faced continued costs, with reduced sales, but in some cases, they have incurred losses. That has required using any cash balances on their balance sheets, thereby, again removing another source of potential supply of money-capital. The printing of money tokens by central banks has not changed that condition. Money is not the bits of paper printed by central banks, or their digital equivalents; it cannot be simply created by the printing press. Money is only created as a result of new value itself being created by labour, in the economy. Money is merely the equivalent form of that value. Lockouts and lock downs actually reduced the amount of new labour undertaken, and so new value created in economies. That meant that the amount of money constituting the equivalent form of this value was also reduced. As Marx describes in Capital III, in the 19th century, the central bank would have responded to that reduced amount of value circulating in the economy, by also reducing the amount of currency in circulation. By putting more money tokens into circulation, be it coins, bank notes, or bank credit, all this does is to reduce the value of each of these tokens, with a corresponding increase in the nominal prices of all those commodities measured by it.

Increasing, liquidity, then cannot increase the amount of money, or money-capital, and so cannot reduce interest rates. Indeed, by creating inflation, it causes speculators to reduce the amount they are prepared to pay for bonds, to take account of falling net present value. And, in similar manner, rising commodity price inflation may cause consumers to bring forward their spending, to get ahead of the inflation, causing demand to rise, leading suppliers to seek to increase their capital accumulation all the more, and firms may similarly seek to bring forward their own spending for the same reason, which, thereby, increases the demand for money-capital to fund this capital accumulation.

But, even without inflation, it is the increased demand for money-capital relative to supply, resulting from increased capital accumulation that causes interest rates to rise. In current conditions, where realised profits have been decimated, and where balance sheets have been run down, the supply of money-capital is reduced at the same time that sharply rising economic activity is causing the demand for money-capital to rise sharply. That is the foundation of rising interest rates, not inflation. A look at what is happening with demand for additional money-capital, for example with new share issuance illustrates the point.

According to the Lex Column in the FT, recently, 2021 is going to be “the biggest year for traditional IPOs” on record. In the first half of 2021, 105 private equity-backed companies went public in the US. That’s triple the numbers seen in the whole of 2019, and it’s already surpassed the 89 seen in the whole of last year. This is a reversal of what has been seen in recent decades where QE encouraged financial speculation at the expense of real capital accumulation, and where firms used profits to buy back shares to inflate their prices, rather than issuing new shares to finance actual capital investment. Just as buying back shares, and so reducing their supply, causes their prices to rise, and yields on them to fall, so issuing additional shares increases supply, causes their prices to fall, and yields to rise.

Take Richard Branson's Virgin Galactic. Last weekend, Branson engaged in one of his pieces of corporate publicity, edging out Jeff Bezos in beating him into space. With the full wind of this publicity behind him, Branson announced that Virgin Galactic would soon be offering such space tourism to anyone who could stump up the $300,000 for a ticket. You would think that, in being first into this new, and undoubtedly profitable, new market, Virgin shares would rise sharply. In fact, they fell by 17%, because, to finance all of this expansion, they announced a new share issuance amounting to an additional $500 million of shares supplied into the market.

This is just the start as rapidly growing economic activity leads businesses to have to accumulate additional capital to meet sharply rising demand for goods and services. No company will be able to refuse to invest, because if it does, it will be eaten alive by its competitors who will invest, and then seize market share from it. Any company losing sizeable amounts of market share will find it loses economies of scale, becomes increasingly uncompetitive, and is on the road to extinction. Many companies, especially those with high rates of turnover, have been able to restart, requiring only commercial credit to do so. Take something like McDonalds. Its workers are paid wages in arrears; it buys its components on commercial credit. But, once re-opened, on this basis, every couple of minutes, in each of its restaurants, a credit card is swiped through its tills, and the money from it, goes into its bank accounts. Its capital is turned over every few minutes, by this means, and those payments provide it with the money-capital, via which it reproduces its variable-capital, and circulating constant capital, as well as covering the wear and tear on its fixed capital, not to mention giving it the profits from which it can also expand its operations.

But, other companies cannot do this. Some companies will need to replace expensive elements of fixed capital. Some will need to buy raw materials, which are themselves expensive, and whose value may not be turned over for many weeks, months or even years. An aircraft manufacturer or shipbuilder, for example, will need to acquire fixed capital, they will need to buy expensive components, as well as employing labour for months in production, before they are able to sell the plane or ship. To finance that they will need to borrow money-capital on a large scale. Some will have to go to the government for bail-outs to provide the financing, and with such companies being strategic, and significant elements of economies, governments are likely to accede to their demands. That the government provides this money, by borrowing on sovereign bond markets, does not change the fact that this is then an additional demand for money-capital, which acts to raise interest rates.

And, governments themselves have been massive borrowers over the last year, not to finance capital accumulation, but simply to finance unproductive consumption, as they have had to finance their own expenditure at a time of falling tax revenues, and as they have also spent money handing out furlough payments and other forms of substitute incomes. And, across the globe, what has been seen is that, just as companies used profits unproductively to buy back shares, and inflate their prices, rather than invest in real capital, so governments which imposed austerity, created conditions in which the basic infrastructure of economies was left to rot, leading to inefficiency. They did so, so as to reduce the amount of issuance of new bonds to cover such spending, thereby facilitating QE in inflating the prices of existing bonds. But, now, governments are having to spend big on that infrastructure too, which will require them issuing large amounts of new bonds, causing the prices of those bonds to fall, and yields to rise sharply.

The central banks think they can respond to this by creating money. In other words the same delusion as with John Law, and the Pereire Brothers. But, all they do is to stoke even more inflation, and sooner or later, probably sooner, the bond vigilantes will lose their nerve, and decide that the inflation is not that transitory, that interest rates are rising, irrespective of inflation and money printing, and they will rush to jump ship, causing bond markets to crash.