The US Federal Reserve, as expected, has raised its policy rate by fifty basis points. It is the biggest increase since 2000. Surveys show economists also now think it could raise rates by as much as 75 basis points at its next meeting in June. They also expect as many as another ten rate hikes in the coming year, taking policy rates to around 3.50 – 4.00%. That's likely to be an underestimate as inflation continues to rise. The Fed's move followed a surprise 40 basis point rise in the Bank of India policy rate earlier in the day, which took its rate to 4.40%. Tomorrow, the Bank of England meets, and is likely to follow suit with its own fifty basis point increase, and announcement of Qualitative Tightening, beginning to sell bonds from its balance sheet, and so reduce liquidity.
Central banks are way behind the curve. The last time inflation was at these levels, Bank Rate in Britain was at 13%, and similar rates applied in the US, and other economies. With US inflation already at 8% on official figures, and over 10% if measured against a more realistic workers' cost of living, even interest rates of 4% would be hugely negative in real terms, and although the Federal Reserve is talking about reducing its QE programme that still means it is increasing liquidity, just not by so much, so quickly. In addition, as I set out recently, it has pumped so much additional liquidity into circulation over the last two years, under cover of lockdowns, so as to inflate asset prices, again, that even its proposed faster pace of tightening, when it eventually starts, would take many months just to get back to the position prior to 2020.
And, many think that as soon as it has an excuse, it would even stop that. In fact, as I've set out before, the likely scenario is that, faced with businesses needing to raise prices, as workers begin to get higher wages, which, in turn will feed through into additional demand for wage goods, meaning that firms will want to continue hiring, and producing more, central banks will indeed respond with continued increases in liquidity, devaluing currencies further. But, they will do so, whilst continuing to raise their policy rates, just as the additional demands for money-capital, will also cause market rates of interest to rise. With the low rates of interest that currently exist, and given sharply rising monetary demand – which is currently only being held back by Ukraine war fever, and attempts to impose zero-Covid policies – higher absolute rates of interest will not hold back firms from investing. They will scramble after market share, and higher profits, even as rising wages squeeze their rate of profit, but central banks will ameliorate the latter by providing the required liquidity. The point, here, is to understand the role of additional liquidity in creating inflation, but not in causing interest rates to fall.
Inflation, as Marx describes in A Contribution To The Critique of Political Economy, is a monetary phenomenon. Prices are an expression of exchange value, measured in the money commodity. Exchange values are always an indirect, and relative measure of value. If gold is the money commodity, then the exchange-value/price of linen is not only determined by the value of linen, but also by the value of gold. If the value of gold falls, so that a gram of gold now represents 5 hours of labour rather than 10 hours of labour, the value of linen can remain constant, and yet, its exchange-value/price as against gold will double. In other words, 2 grams of gold will now have to be paid to buy the quantity of linen that previously 1 gram bought. When gold is replaced by money tokens such as bank notes, then, as Marx says, the value of each of these notes, which have no intrinsic value of their own, as gold does, is determined not by their own value, but simply by the quantity of them put into circulation. When central banks engage in QE that is what they do, they increase the quantity of such notes in circulation, and so devalue each of them, so that more of them have to be given to buy any given value of commodities. That appears as an increase in the prices of all those commodities – inflation.
Over the last thirty years, central banks printed more money tokens, and used it in a specific way. They bought up bonds, or else they provided money tokens to commercial banks and finance houses, who bought bonds. That created very high levels of inflation of these specific assets – asset price inflation. The high price of bonds, caused their yields to fall, and this made other assets more attractive, such as shares and property. That inflated those prices, which is why we have bubbles in stock, bond and property markets that will burst as interest rates rise. So, long as this liquidity was being diverted into these asset price bubbles it was not acting to cause consumer price inflation, and, in fact, by encouraging speculation in assets, it drained liquidity from consumption and investment, so acting to deflate prices in the real economy. The last two years, changed all that, and the liquidity has flooded into consumer's pockets, and into an inflation of commodity prices.
The Keynesians, who see inflation as being caused by rising costs, and supply constraints have argued that the current inflation is temporary, therefore, because when the current supply restrictions end, costs will fall, supply will rise and prices will fall, or at least stop rising at the current pace. Michael Roberts claims to be putting forward a Marxist explanation of inflation, but his explanation, as I set out months ago, is itself just a variant of this Keynesian, cost push theory. Last year, he argued that this temporary inflation would reach 3%, but, even at the time he wrote it, his prediction was out of date, and US inflation, ended the year, pretty much where I had predicted at over 7%. Its no surprise that Roberts sees a slump on the horizon, because there is virtually no time he doesn't see a slump on the horizon,
But, whilst excessive liquidity is the cause of inflation, it is not a means of reducing interest rates, as again Marx demonstrates. Contrary to the bourgeois notion that the rate of interest is “the price of money”, a nonsensical idea because the price of £1 can only ever be £1, the rate of interest is rather the price of capital, the price to be paid for the use value of capital, i.e. its ability to produce the average rate ofprofit. The rate of interest is determined by the demand for and supply of money-capital (though as he describes a machine that is leased as capital also attracts the rate of interest). Lenders will no give the use-value of capital away for free, so zero forms the base for the rate of interest, whilst borrowers will not pay a rate of interest that wipes out their profit, so the rate of profit sets its higher bound. The actual rate depends upon the struggle between borrowers and lenders.
The source of the supply of money-capital is mostly realised money profits, but additional supplies can come from additional savings. It cannot come from simply printing additional money tokens, because this does not increase the amount of money, or money-capital, but only more money tokens, which, for the reasons set out above, simply become individually devalued. So, if demand for money-capital is £100 billion, and, in order to obtain this supply of money-capital an interest rate of 6% is required, if additional money tokens are printed, this cannot result in a lower rate of interest. Suppose liquidity is doubled. The £100 billion of money-capital required, is used to buy machines, materials, and labour-power, but with liquidity doubled, the prices of all these things also double, so now, its not £100 billion of money-capital that is required, but £200 billion, even though its actual value has not changed. And, the same applies to the supply. With prices having doubled, the money profits of companies will have doubled, so that they now have twice as much, nominally, to throw into money markets as supply of money-capital. In short, both sides of the demand-supply equation will have simply been inflated by the same amount, leaving the rate of interest the same at 6%. As Marx puts it in Theories of Surplus Value.
“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).
“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.”
(Theories of Surplus Value, Part I, Addenda )
Of course, that is the case comparing one period with another, but, what we also have, here, is a process of transition from one period to another. Then, in fact, far from increasing liquidity causing interest rates to fall, they can result in them rising. If liquidity flows into assets, creating asset price inflation, which also then leads to capital gains on those assets, the inflation, rather than deterring “lending” at current rates encourages it further. But, of course, this is a specific type of lending that is really not lending at all. It is just speculation, gambling on being able to make a capital gain. The proof of that is that, until recently, $18 trillion of bonds across the globe, had negative nominal yields. In other words, the lenders paid the borrower to borrow their money. Why, because, they expected the price of the bond to rise further, so that they could sell it at this higher price.
If, I buy a $100 1 Year bond for $105, and it pays a coupon of $2, at the end of the year, I will get back $100 plus the $2 coupon, meaning I will have had a negative yield of $3 (3%). Why would I do that? Because, I expect that, a month after I buy it, the price will actually rise to $110, and so, I will sell it at that price, obtaining a capital gain of $5, equal to a return of 5%. The same can be seen with all of the technology and other high growth stocks, many of which never paid any dividends/interest, meaning that those that bought them, at ever higher prices, were not doing so in order to obtain a revenue, but simply on the basis of expecting large capital gains as the prices continued to rise. The same can be seen with all the residential property blocks in London and elsewhere, many of which remained unoccupied, and so producing no rents, but whose owners were quite happy on the basis that every month, the price of the property rose by another 2 or 3%. And, the same motivation gripped the buy-to-let landlords, and even just ordinary people thinking they had to buy a house before prices rose further.
This is not lending to finance investment in productive capacity, it is just buying assets as a means of gambling on their prices rising. The fact that the price of the asset my be higher in a week's time, is all the more reason to buy it today, i.e. to “lend” money. The fact that for so long, central banks have reinforced that mindset by stepping in to buy bonds when their prices have fallen, gives even more incentive to engage in such gambling. But, what happens when speculators think that the central bank is no longer playing that role? What happens when instead of anticipating that bond prices will be guaranteed to rise, they will fall, and so, instead of capital gains, there is the prospect of capital losses? Then speculators will want to get out, as soon as possible, and if they come to buy bonds for the longer term, they will want to pay as little for them as possible, to guard against the potential of those prices falling. The less they are prepared to pay for the bonds, the higher the yield on them becomes, as its an inverse of their price. So, in the last few months we have seen the fastest sell off in bonds in history, and sharp rises in yields. The amount of bonds with negative nominal yields has fallen to around $2 trillion, though there are still a large quantity with real negative yields i.e. after inflation.
But, if capital gains cease to be the basis for buying assets, the focus returns to their ability to provide revenue in the form of interest or rent. Now, you will be concerned with commodity price inflation, because this will determine the real value of your capital in the period ahead. You face the prospect not only that the price you can obtain for your bond, or share might itself be lower in five years than it is today, and certainly in inflation adjusted terms is likely to be so, but that the real value of the interest/dividends/rent you obtain will be lower too. That means that the price for any of these assets you buy today, will have to be correspondingly lower, the rate of interest/rent/yield on them that much higher to compensate for the future inflation. So, in the conditions that are now emerging, rather than central bank liquidity injections leading to higher asset prices, and so lower yields, they will result in higher inflation, resulting in higher levels of interest/rent, that will cause lower asset prices, be it in financial or in property markets.
Over the last 30 years, with consumer prices not rising much, but with house prices rising fast, spurred on by this speculation, and government policy, people were incentivised to buy property now, before prices rose further, whereas buying consumer goods could be delayed, because their price would either be lower, or else lower in real terms, in a year's time. Boards of Director's acting in the short-term interests of shareholders, rather than the interests of companies, diverted profits into share buybacks rather than real capital investment. But, now, if you are a consumer, you see food prices, car prices and so on rising in high double digits. There is an incentive to buy them now rather than have to pay more later. That pushes higher demand for all these things. Companies, see the potential to produce all these things, and know they must or their competitors will. They see higher future prices for the things they produce today, and so higher nominal profit margins on them. They see, that the machines, the materials and so on, they require will be more expensive tomorrow, and so they try to buy them today, either using their current profits, or else borrowing to do so. That not only causes demand for all these things to rise, creating another support for increasing economic activity and demand, but it also means that the supply of money-capital into money markets is reduced, and the demand for money-capital is increased, causing interest rates to rise, and asset price to fall further.
With the basis of speculative capital gains undermined, and the potential of increased profits from real investment in productive-capital, the dynamic is shifted. If you have £1 million, it becomes more attractive to use it to buy machines and material, than it does to buy £1 million of shares bonds, or property, in the hope of capital gains. At the same time, firms issue more new shares and bonds to finance this real expansion, and the increased supply, as against the buy backs of shares of the past, means that a further downward pressure is applied to them.
Tomorrow, the Bank of England will raise rates, probably also by fifty basis points. That will represent a rise of 66.6% from its current rate of 0.75%. It means it is still at a very low level, in absolute terms, which is why, in terms of the behaviour of firms in accumulating additional capital, it will have no effect. But, a two-thirds increase does have meaningful effects in others ways, as I have set out before. What determines what house buyers can pay for houses, is what they can afford as far as a monthly mortgage payment is concerned. If the amount of interest you pay increases by two-thirds that increases the monthly payment significantly, and so the price buyers can pay falls significantly. Given the large rises in other costs for households that becomes even more significant. So, anyone looking to buy a house, or who has a a house, and is looking to buy a better one, will now have to significantly reduce what they can afford to pay for it, and so what they will offer for any houses. For anyone looking to buy a better house, the fact that they will get less for their existing house, will mean they can afford even less for the one they seek to buy.
But, all of these asset prices are substitutes for each other, and changes in the price of one carries into the prices of the others. Interest rates are rising, and asset prices are going to continue to fall hard.
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