Central Banks In Crisis Mode

Yesterday, the US Federal Reserve raised rates by 75 basis points; the ECB held an emergency meeting, less than a week after its last policy meeting; the SNB called a special meeting and raised rates by fifty basis points; the Japanese central bank is seeing the value of the Yen collapse, as it tries to act like Canute, in trying to hold up Japanese bond prices, and keep yields down, by printing ever more ludicrous amounts of currency; the Chinese central bank is facing an approaching hyper inflation, as it has also printed astronomical amounts of currency, at the same time as repeatedly cratering Chinese output by the use of its zero-Covid lockdowns, as it fears the Chinese economy overheating, if allowed to function normally, with then surging wages and interest rates, which would crater Chinese asset prices, and burst its huge debt bubble as epitomised by Evergrande, and the enormous property bubble it was built on; and today, the Bank of England met and raised its rates by twenty-five basis points, as it confronts a UK economy being crippled by the effects of Brexit, as it now faces the slow crucifixion from a self-inflicted trade war with the EU, as well as its own self-inflicted inflation arising from the printing of vast amounts of money tokens, and of the imposition of lockdowns.

A year ago, the Federal Reserve assured us that inflation was merely transitory, but, instead, as each month has gone by, the inflation rate has moved ever higher. Last year, it was being said that it would be 2024, before central banks began raising rates, and I said, then, that such a scenario was ludicrous. Sure enough, before last year was out, the Bank of England had raised rates, followed, shortly after, by the Federal Reserve. Even a few weeks ago, it was being said that the ECB would not raise rates until 2023, and, now, its about to join the club. The BOJ continues to try to hold out, but the consequence is that the Yen is collapsing, and increasingly speculators will test its resolve, much as they did with Britain in 1992. Speculators are driving down the Yen, but also selling JGB's, forcing the Bank of Japan to print even more money tokens so as to buy them, which, in turn, destroys the Japanese currency even more.

China is using direct physical action, via its ridiculous Covid-zero policy, to repeatedly put brakes on its economy, to prevent its wages and interest rates rising, which will cause its huge debt bubble to burst, and its asset prices to crash. But, each time it does so, it simply creates the conditions for an even greater hyper inflation, as it simultaneously reduces new value creation, whilst printing more money tokens to go in search of that value, and, on top of that, it has announced a huge fiscal expansion that will increase aggregate demand relative to aggregate supply even further, enabling all of the excess liquidity to flood out into rising prices.

Despite all of this action by central banks, as they flap around like headless chickens, they all remain way behind the curve. Even just a couple of weeks ago, Federal Reserve Chair, Jerome Powell, was insisting that a 75 basis point increase, in its policy rate, was off the table, as it presumed that inflation had peaked at 8.5%. Now, as inflation has spiked again, not only was 75 basis points firmly back on the table, with Fed members openly guiding markets in that direction, but the speculators and their representatives were saying that, to get ahead of the market, and show some resolve, the Fed would need to raise rates by a whole 100 basis points, and some even saying that they should just go straight to a Fed Funds Rate of 3%.

The problem for the Fed, as for all central banks, is that they have created the conditions for this inflation over the last 40 years, during which time they continually printed money tokens for the purpose of inflating asset prices, and, in the last two years, the fact that they used the same methods to pump liquidity into the real economy, at the same time that they curtailed new value creation, by imposing lockdowns on production, meant that those money tokens were massively devalued, and, as soon as economies opened up, it all flooded out into circulation, bumping up commodity prices, creating a surge of demand that could not be easily and quickly met, which, in turn, led to demands for labour that also could not be met, and which has pushed up wages.

In fact, the foundations of that were always there, as a result of the normal functioning of the long wave cycle. Its just that, after 2010, states and central banks have thrown the works at trying to suppress it, via fiscal austerity, direct diversion of money into financial and property speculation, trade wars, lockdowns and so on. It has all now burst through, with inevitable consequences. And, the hope of the speculators that it will all be brought to a halt by demand destruction, as prices rise ahead of wages is also a forlorn hope.

Its true that prices are rising faster than hourly wages, but that is irrelevant. If, as with the US dockers, the surge in demand results in you working a 60 hour week rather than a 40 hour week, even if your hourly wage remained the same, and even without overtime rates, that means you have 50% more wages to spend, and that is way above the increase in prices. If, you were in precarious employment, working 10 hours one week, 20 another, and now, as the economy expands, you get full-time employment, working 50 hours a week, your wages are two and half to five times what they were. If, in the process, you move from a job where the hourly wage was $10, and now you get a job on $15 an hour, that is not an increase in hourly wages, but it is certainly a 50% increase in your hourly wages, and in the money you have to spend. If members of your household were unemployed, and now have full-time employment that is also now money coming into your household, irrespective of any change in hourly wages.

All of that means that, in communities across America, households see increases in their overall incomes, irrespective of hourly wages, and that gives them money to spend that they did not have before. It means they can renovate their house, spend more money at the local store, go out to a restaurant, and so on, all of which feeds into additional demand for local businesses, who are then led to employ yet more workers, and so on. And, the data shows that there are now 2 jobs for every unemployed worker, and, despite continued hopes, from the speculators, that demand for goods and services is going to decline, it continues to rise, now, particularly, moving into demand for services, as households have begun to meet their needs for goods that were not satisfied during lockdowns. And, that applies not just in the US, but across the globe.

Moreover, as the impending US dockers strike shows, it is only a matter of time before workers, feeling this firmer ground beneath their feet, also demand higher hourly wages, shorter hours and better conditions too, and that, too, will then feed into their ability to meet rising prices, as they maintain and expand their consumption. GDP is really a measure of the social working-day, and productivity. As employment has expanded, and firms begin to have difficulty recruiting labour, that puts an inevitable constrain on further expansion of GDP, especially as with workers starting to demand shorter hours, it will further restrict productivity growth. But, a slower growth of GDP, does not mean that, within it, there is not then a shift from profits to wages, and subsequent increase in demand for wage goods, which firms have to respond to.  This is what the speculators are now panicked by.

With this underlying strength of aggregate demand, driving forward economic expansion, the proposed increases in central bank policy rates are puny by comparison, and will have no noticeable impact on consumer demand, or on the need of companies to respond to it, by accumulating additional capital. As Maurice Levy said on Bloomberg, given a choice between swallowing a reduction in profit margin or losing market share, firms will always choose the former, because some profit is better than none, and once you lose market share, it tends to be gone for good, and starts a downward slope, whereas, profit margins can always be increased later.

If firms have only a 5% profit margin, but turn over their circulating capital, even just ten times a year, their annual rate of profit might be as high as 50%, so interest rates of a mere 3-4% are insignificant. Yet, central banks are suggesting that a terminal rate might be around 4%, and they base that on suggestions, still, that the inflation is transitory, and will quickly fall back to around 2-2.5%. The Federal Reserve sees US inflation down to around 5.9% by the end of this year, and just over 2% next year. The is pure fantasy. Inflation has never fallen that quickly, and we are only experiencing the first wave of it. Moreover, it takes two years for changes in monetary policy to impact the real economy, unless they are so severe as to deliberately cause a recession, which would require much, much higher rates than currently proposed.

The last time UK inflation was this high, Bank of England Base Rate was at 13%, more than ten times higher than it is now. Even in 2007, when UK inflation was just 4.29%, UK Base Rate was between 5.50% and 5.75%. Similarly, in the US, in 2007, inflation was just 2.85%, whilst Fed Funds Rate was at 5%. In other words, the central bank policy rates were significantly above the inflation rate. Today, UK Bank Rate is about 10% points below the official inflation rate, which understates the actual position, and pretty much the same applies to the US.

This also plays into the other thing that is perplexing the pundits on the financial speculation channels, which is why share prices are continuing to fall, as firms' profits forecasts continue to rise. The increased profits are a function of projections of continued future strong sales, which itself shows, at a granular level, that firms do not see signs of economic weakness or recession ahead, no matter how much the speculators are praying for a recession so as to slow wages growth, and interest rate rises. But, increased profits are entirely compatible with lower profit margins, if wages increase at a faster pace. The smaller profit margin, at a time when firms continue, then, to have to invest so as to grab market share, requires that a greater proportion of this profit goes to cover that investment, and less is available to pay out in dividends. The demand for money-capital rises relative to its supply, causing interest rates to rise, and the manifestation of that is lower asset prices, i.e. falling prices of shares, and of bonds.

There are two determinants of share prices. One is their relative valuation compared to bonds. Bonds traditionally have a higher yield, because they do not offer the same potential for capital gain as do shares. In recent years that has not been true, largely as a consequence of QE. If bond prices fall, and so bond yields rise that makes shares relatively less attractive, and so depresses share prices and vice versa. Bond prices have fallen at the fastest pace ever over the last year, and so this has a consequent effect on share prices. The second factor is the earnings per share. For earnings, here, read profits. If a company makes more profits, then the amount of profit per share rises. So, the fact that firms continue to forecast higher profits might be thought, now, to put a floor under the share prices, and yet, they continue to drop.

There is a simple reason for that. Over the last 40 years, a growing proportion of profits has gone to dividends, so that a simple equation between earnings and dividends seems to follow. (As Haldane pointed out, in the 1970's, only about 10% of profits went to dividends, as against around 70%, today.) If a company increases its earnings per share, then a rise in its dividends per share would seem to follow. But, from what has been set out, this is no longer true. A company might see its earnings rise substantially, and yet reduce its dividends per share, for the simple reason that a larger proportion of those earnings is now required to fund capital accumulation. Speculators buy shares either to obtain revenue in the form of dividends, or else they buy “growth stocks”, which pay little or no dividends, but whose share prices rises prodigiously on the basis of a rapid expansion of the company, with the shareholders benefiting from capital gains on their shares. That requires faith that this will pay off in the long run.

In recent months, growth stocks have been hit hardest of all, falling between 30-70%, as this faith in their long-term prospects has been bunked. Speculators have again reverted to a focus on “value stocks”, which provide them with revenue in the form of dividends, but if dividends are no longer going to grow, even in line with earnings, then that requires a serious revaluation of share prices, because that price is a function of how much revenue the share is likely to produce, in the form of dividends. So speculators are faced with both falling bond prices, and falling share prices, not to mention the collapse of other speculative fads such as Bitcoin.

At the same time, the real economy continues to move ahead strongly, despite all the attempts to hold it back, to frighten consumers with warnings about Covid infections, Monkey-Pox, war in Europe, soaring energy prices, and potential job losses, even as workers see all around them labour shortages! Even as the ECB was holding an emergency meeting, yesterday, the Governor of the Portuguese central bank, was holding a press conference, forecasting that Portuguese GDP would rise this year by more than 6%! No wonder the speculators are becoming frantic and ever more openly demanding that central banks and states cause a recession, throwing workers on the dole, and damaging the real economy, so that they can again see wages held back, interest rates fall, and so the natural order of their ever rising paper wealth be restored, as it has been for the last 40 years.

And, that also illustrates the problem faced by the ECB. As a result of the Eurozone debt crisis, Mario Draghi, as ECB Governor, said that they would do whatever it takes to prevent the break up of the Euro, as the bond yields on peripheral economy debt soared. They introduced their own QE, and pumped billions of Euros into buying the bonds of the peripheral economies in Greece, Italy, Portugal, Spain and Ireland, thereby, reducing the yields on them, and removing the wide spreads between them and the bonds of Germany, and other Eurozone economies. That was possible, when fiscal austerity was slowing economic growth, across Europe, and, combined with QE, was diverting money into financial speculation, thereby, creating disinflationary conditions in the real economy. But, the opposite conditions now apply.

There has been massive fiscal expansion as a result of lockdowns; there has been huge money printing to finance the fiscal expansion, all of which has fed into the real economy; there is a consequent rise in both debt and inflation, feeding into a sharp rise in interest rates, now requiring central banks to respond by raising their own policy rates, and, at least, being seen to be proposing to curtail QE, even if the likelihood is they continue to operate loose money policies to ensure sufficient liquidity to enable firms to raise prices to avoid profits being squeezed too much by rising wages. Hence the ECB emergency meeting, but, typically, having met, it decided nothing more than it had already previously announced at its regular meeting the week before. Indeed, its hard to see what it can do.

If it continues to pump money into peripheral economy bonds, at the same time as tightening overall, that will simply provoke the speculators into testing its resolve, again, much like they did with Britain in 1992, and with the Eurozone in 2010. They will keep selling peripheral bonds, driving their yields higher, forcing the ECB to print more and more money tokens to buy them up, and prevent the yields rising, much as the Bank of Japan is also now facing. They will not have enough firepower to continue that battle. In the end, it will come down to the question faced by every other state in the process of formation, the need to establish a single political entity, with a single fiscal and monetary regime, to go along with a single currency, and a single debt management office issuing Eurozone Bonds to finance the deficits of Eurozone economies as a whole. In short, it makes imminent the question of creating a single European state. In that context, Britain being out of it, makes life easier for the EU.

The announcement of the ECB emergency meeting had the effect of causing bond yields across Europe to fall sharply in the expectation of some emergency measures to resolve the issue of Italian bond yields having soared past 4% the previous day. It also fed through into a fall in US bond yields, but the fact that the ECB only came out with a statement saying it had discussed a plan to formulate a plan, some time in the future, is likely to simply reinforce the idea that central banks are drowning not waving. They are being overcome by economic forces far more powerful than they are, and hence bringing to an end the delusion that central bankers are masters of the universe, with semi-mystical powers of determining prices, particularly the most important price, that of capital itself.

The announcement from the Federal Reserve resulted in further falls in US bond yields, but, as usual that was again reversed, as markets digest the reality, and realise that the Fed's forecasts are a triumph of hope over reality, and still in the realms of fantasy. The action of the SNB, where inflation is still only just above 2%, is the first move since 2007, and is a pre-emptive move ahead of the inevitable move from the ECB, as Switzerland seeks to protect the Franc from currency devaluation against the Euro, and imported inflation. As the Euro, like the Yen and the Pound continues to sink rapidly against the Dollar, the ECB may have to call another emergency meeting to raise rates, even before its next scheduled meeting in July.

Similarly, the pathetic increase of 25 basis points by the Bank of England, saw a further rapid sell-off in the Pound, which has also been falling steadily against the Euro. The £ is headed below $1.20, and appears again to be moving towards parity, with all the attendant problems of imported inflation, as all of the things already rising sharply in prices such as oil and gas are priced in Dollars. The Pound is looking increasingly like an emerging economy currency, with Bank of England policy geared to its continual and steady devaluation, as a means of trying to preserve UK competitiveness, but with all of the attendants costs of higher inflation, and reductions in workers' living standards. That goes along with Britain's declining significance following Brexit, and its increasing status as a pariah state as it threatens to break international law over the NI Protocol, and in its treatment of refugees.

With the more rapid decline in the Pound, its likely that the Bank of England will, now, have to call an emergency meeting itself, in July, so as to increase its policy rates further.