Estimates of the US Federal Reserve's terminal Fed Funds Rate, vary between 3.5% and 5%. That is the rate at which speculators anticipate it will stop raising rates, and prepare to start cutting them. Even the 5% figure is an outlier, with most not being more than 4%. It is a triumph of hope over reason. It is based on the hope that rates will only rise that much, before falling, so that asset prices can resume their relentless rise, and so restore the paper wealth of speculators. The figure is based on the Federal Reserve raising rates sharply, so as to squeeze inflation from the system (which itself shows a failure to understand inflation), probably by also causing a recession (which further shows a failure to understand inflation), so that the current, essentially, double digit figures for inflation will quickly fall to the Fed's estimates of 5% by the end of 2022, and its target of around 2%, by the end of 2023. Its delusional.
In the UK, the last time inflation was at this level, Bank Rate was at 13%. A real rate of interest, requires it to be higher than the rate of inflation, and currently US inflation is over 9%, and the last Producer Price Inflation data rose again, to 11.3%, indicating further rises in consumer prices to come.
The idea that it is rises in interest rates that are the means to reduce inflation is itself wrong. Inflation is a monetary phenomenon. It rises due to excess liquidity, and is reduced by removing that excess liquidity. The idea that raising interest rates is the means to reduce inflation is confused with this requirement to reduce excess liquidity. Moreover, although nominal interest rates rise as a result of higher inflation – because lenders seek to protect themselves against falls in the real value of their capital and interest, whilst borrowers seek to borrow to buy, now, ahead of higher future prices, and in order to obtain higher future nominal revenues out of which to cover interest – the cause of movements in real interest rates is changes in the demand and supply of money-capital, and that has nothing to do with the amount of liquidity pumped into the system, unless a) there is spare capacity that is being stimulated, via government intervention, so raising the demand for money-capital, or b) conversely, a credit crunch is created.
The idea that inflation is reduced by raising interest rates comes from this last factor. In other words, because inflation is seen by orthodox economics as arising from either cost-push or demand-pull, i.e. essentially an imbalance between aggregate demand and supply, just as prices for commodities, in general, are seen as being determined solely by supply and demand, the solution is seen as being to reduce economic activity. Essentially, what is seen as the cause, in both cases, is rising wages, which either cause rising costs, and/or lead to increasing demand. The idea of raising interest rates is to deliberately slow the economy so as to cause a recession, by reducing final demand from consumers who are incentivised to save rather than spend, and demand for labour by capital, which is dis-incentivised to invest, as the cost of capital is raised. In short, raising interest rates is seen as a means of raising unemployment and so lowering wages.
But, if consumers are financing consumption, not from borrowing, but from revenues, which, as wages rise, in a period of long-wave economic expansion, they increasingly will, then such rises in interest rates are unlikely to deter their consumption, and resulting final demand. Higher interest rates on their savings deposits may cause slight changes in their marginal propensity to consume, but that is still compatible with steadily rising consumption and final demand. Moreover, they may use such opportunities to save money for the purchase of larger items, which previously they would have bought using credit or loans, but, now, which they would be able to buy for cash, particularly having had their savings supplemented by larger amounts of interest on them. Such would be the case, for example, of savings for the purchase of cars or houses, as happened in the post-war period.
So, what such interest rate rises do is not to dampen final demand but to shift it to other types of consumption. Given that higher interest rates also lead to falling asset prices, savings made for the purchase of houses are boosted further, because rather than being reduced by inflation, such savings are, in fact, increased in real terms, because £10,000 of savings goes further to buying a house when house prices fall to an average £100,000, compared to when it was £200,000. And, higher absolute levels of interest rates do not have the same effect in reducing demand for capital by firms in periods of strongly rising economic activity as they do during periods of crisis or longer term economic stagnation, such as during the late 1970's, and early 1980's. That is even more the case when interest rates are at low absolute levels, which they are now, and when profits are high in absolute levels, which they are now, and have scope to rise further, as economic activity expands.
And, as with falling house prices providing an incentive for additional demand for housing, so falling share and bond prices provide the basis for additional demand for real capital. Over the last 30 years, speculators have seen rising asset prices as the basis of their wealth, and the ability to transform a portion of their capital gains from it into revenues, as the basis of obtaining income, rather than the need to produce profits from which to pay dividends. If asset prices crash that delusion is removed. Where the representatives of shareholders, on company boards, sought to use profits to buy back shares, and so on, to boost share prices, to stimulate capital gains, now they would be led to use profits to accumulate capital, so as to produce additional profits, so as to pay additional dividends.
Indeed, as economic activity continues to expand, in conditions of high levels of employment, combined with high levels of inflation, companies are forced to accumulate additional capital, even with rising interest rates, for fear of losing market share to competitors. With interest rates at historically low absolute levels, and massively negative in real terms, even large proportional rises represent no obstacle to them borrowing to do so. If larger companies, still hoping for a return of the conditions of the last 30 years, seek to hold that back, in the hope of being able to continue to boost share prices, they will simply be eclipsed by smaller firms, seizing the day and taking business from them. True there are hundreds of thousands of small zombie firms unable to do that, and as rates rise, those firms are more likely to go bust, but not all are in that position, and as Marx describes in Capital, in times of economic expansion, there are always many more waiting to take their place. Some of the existing small and medium sized firms, along with new ones being created, will simply buy up the capital of the zombie firms on the cheap, and expand on the basis of it. So the large capitals will eventually also have to respond.
But, also, the truth is that higher interest rates are only an impediment to real capital accumulation in respect of the need to borrow to finance larger scale fixed capital investment. A lot of capital accumulation is accumulation, not of fixed capital, but of circulating capital, and, as Marx describes in Capital II, and in Theories of Surplus Value, what this amounts to is just an expansion of production itself. Take the most obvious example of that. Workers are paid in arrears – mostly now a month in arrears. If a firm seeks even to double its output, it can simply employ double the number of workers, or double the hours of its existing workers, if possible. There is no need to lay out any additional capital for that, because the workers are paid a month in arrears. For many businesses, that circulating capital is turned over within the month, for many within the week, and in service industry, even within the day, or even hour.
Take, say, a fast food restaurant, seeing increased demand. It increases its number of workers, and immediately, it receives additional sales income. So, long before the firm has to pay the wages of the additional workers it has hired, it has received a month of additional sales income, which itself covers those wages, as well as covering the costs of the materials used, the wear and tear of fixed capital, and producing the profits of the firm. The same applies to the materials used, because they are also bought using commercial credit, so that long before it has to settle the invoices for those additional supplies, it has received the additional income from sales, and banked it. So, higher interest rates affect this demand for capital, not one bit, because the firm has not had to borrow to finance it. Indeed, having banked these sales receipts, whilst not having to use them for payments for a month or more, it may even benefit from higher levels of interest on its bank deposits!
And, what is true for the fast food restaurant, here, is true for its suppliers, as Marx describes, because this commercial credit simply expands naturally along with the expansion of economic activity. If a firm normally buys materials, being invoiced for payment within 30 days, when its business expands, so that it requires 20% more materials, it simply buys the additional materials, and is invoiced in exactly the same way, for payment in 30 days, so that the commercial credit extended has increased by 20%. In fact, as activity increases, firms may offer even greater commercial credit in order to retain and expand their business, offering 60 days within which to pay rather than 30, for example. As Marx sets out, this commercial credit is quite separate from bank credit, because it is based upon mutual arrangements between capitals themselves. Each capital can offer commercial credit to its customers, because it, in turn, obtains commercial credit from its own suppliers.
What is more, this commercial credit operates as currency, increasing liquidity without taking part in the actual circulation of commodities. As Marx describes in A Contribution To The Critique of Political Economy, and in Capital III, with any given velocity of circulation of currency, the amount required in circulation is determined by the value of transactions, but that is not the case with commercial credit. With commercial credit, A buys from B, who buys from C, who buys from D, who buys from A. If, in each transaction, the debt is £10, then, in total, all debts cancel out, and, when cleared, no money is required. If they do not all cancel, then it is still only the outstanding balance that requires actual payment in money, and so a much larger value of commodities are circulated in this way whilst requiring much less in the way of actual money to achieve it. And, as Marx describes, citing evidence to the Parliamentary Inquiries, this stands largely outside the control of the central bank, and its monetary and interest rate policies.
This is the difference between money as means of circulation, and money as means of payments, as Marx describes. As means of circulation there is C – M – C. But, with means of payment, commodities are bought and sold, but without any exchange of money for commodity. Money only enters the fray later, when settlement of all the mutual debts arising from these sales is due. As means of circulation, much more money is required than as means of payment. If A buys from B who buys from C, who buys from D, who buys from A, and all of these transactions occur simultaneously, each being £10, then A must pay £10 to B, but B buys from C, before receiving the £10 from A, so that B must also have £10 to purchase from C, and so on. In total, £40 would need to be in circulation. Even if the purchases were sequential, £10 would be required, whilst that would slow down the process of circulation, because B would have to wait to receive the £10 from A before buying from C, and so on. With commercial credit, and money as means of payment, none of that is true. All purchases can be simultaneous, and no money is required to settle the balance, because they cancel out.
So, as Marx describes, in a period of increased economic activity, as commercial credit expands, and circulation increases, without need for additional means of circulation, but simply with an expansion in the proportion of transactions conducted by credit, even a constant supply of liquidity may constitute an excess. Not only might B simply increase the volume of purchases from A, as they accumulate additional circulating capital, but, A, seeing this increased demand for their goods, may choose to raise prices, by 10%, even though they might combine this with offering B 60 days to pay rather than 30. B increases their volume of purchases by 10%, and their debt rises by 20%, because of the 10% hike in price of A's goods, but they pay it willingly, because they see sufficient demand arising for their output, especially with the prospect of hiking their own prices, and as they get their sales income, now, whilst only having to settle their debts in 60 days, they have more than enough money coming into them to settle.
In economies where workers are, now, mostly paid by electronic transfers into bank accounts, that applies with wages too, in so far as workers also buy goods and services using credit and debit cards. Suppose that all sales are to workers, and the only input costs are for wages, so that wages equal sales. If total sales are then £1 million, total wages are also £1 million, but if firms increase prices by 10%, workers pay these higher prices, the purchase appearing as a debt on their credit card account, or else being deducted from their current account balance. But, at the end of the month, they receive their wages, which now amounts to £1.1 million, so that, so long as they pay off their credit card balance in full, so incurring no interest, they will be back to exactly where they were at the start of the month.
In effect, all that has happened is the metric for the prices of goods and labour-power has been devalued by 10%, simply resulting in the price labels for both changing in proportion. Of course, in practice, this does not occur automatically, and, in periods where labour is in excess supply, the price of labour-power may not rise at all, and certainly not in real terms. Even, now, with labour starting to be in short supply, wages rise first in those sectors where this shortage is chronic, and it requires workers to have to threaten strikes in other sectors, before firms pay up. That simply means that workers run down savings, or accrue debts, in the intervening period, but that they then reverse that when they get their higher wages. That is being seen now, as savings rates have fallen, and, across the globe, workers are threatening industrial action, joining unions, and employers are being forced to quickly cave and pay higher wages.
So, higher interest rates are irrelevant to any of this as a means of reducing liquidity, and, thereby, facilitating inflation. Indeed, even reducing liquidity by ending QE may have no real effect, as far as inflation is concerned. QE, by ending the artificial demand for assets will cause asset prices to fall, starting with bond prices. But, let's look at some of the effects of that. Take land prices. If land prices fall by 50%, then a capitalist farmer who was facing paying £2 million for a piece of land, now only has to pay £1 million. As Marx describes in Capital III, the price paid for the land contributes nothing to value. It is £2 million that the farmer could have advanced, otherwise, to buy machines, seed, livestock, fertiliser and labour-power. As payment for land it is just dead money. Now, they have saved £1 million of that, which can be so advanced as capital, which, in turn, thereby, acts to stimulate economic activity. Given what is described above, that much of this economic activity can itself be expanded using commercial credit, as well as the fact that £1 million of money, itself, is now added to circulation, rather than being tied up in the realm of assets, the potential for this to result in higher demand as well as higher commodity prices can be seen.
But, it not just in relation to land prices and farming. The effect of lower house prices has been mentioned earlier, and lower house prices means workers have more disposable income to buy other commodities, as well as lower rents having a similar consequence. Those lower costs of labour-power, reduce some of the pressure for higher wages, thereby, also feeding through into higher rates and levels of surplus value, as this represents a transfer out of the hands of landlords, and money lending capitalists into the hands of industrial capital. In so doing, it facilitates a further increase in capital accumulation, and rise in economic activity.
The same is true with other asset prices. If share and bond prices fall by 75%, then every £100 a month saved by workers into pension funds (including employers contributions to them) buys 4 times as many shares and bonds as it did before the fall. If, on average, each share/bond pays £1 in dividend/interest, required to fund pension payments, then, now, the fund provides four times as much revenue as it did previously, because it contains four times as many shares/bonds. So, the costs of pension provision for workers/employers falls significantly, meaning that workers are left with additional disposable income to use on the purchase of goods and services, and this additional revenue enters circulation rather than being tied up as dead money in the purchase of assets, whose inflated prices continually reduce yields. Again, it reduces upward pressure on wages, so raising the rate and mass of surplus value, and consequently stimulating capital accumulation and economic growth.
The idea that raising interest rates will reduce inflation comes from the experience of the 1980's, when Paul Volcker sharply raised the Fed Funds Rate. However, the US and other economies had already entered recession at the time those rates were raised. The 1970's was a period of long wave crisis. Not only was inflation at very elevated levels, reaching 27% under Thatcher, but nominal interest rates were also at very high levels, showing that the latter are not a cure for the former. What is more, the crises led to sharp stoppages of economic activity, again illustrating that recession is no guarantee of reduced inflation. On the contrary, the inflation continued to rise, in a period of stagflation.
But, capital responded by technological innovation that enabled it to replace labour, and, thereby, reduce wages, and raise profits. It meant that prices were able to run ahead of wages for some time, so boosting profits further. The recessionary conditions were in place long before the higher Fed Funds Rate, and it was not higher interest rates that led to lower inflation, but simply that inflation could only continue to increase if more excess liquidity was continually injected. With workers defeated after 1984-5, and wages in retreat, there was no need of that, and excess liquidity also found its way into the purchase of rapidly inflating assets, as interest rates fell, with the supply of money-capital from rapidly rising profits exceeding the demand for money-capital.
But, those are not the conditions of today. Rather we have the conditions of the late 1950's, and early 1960's. Capital does not face a crisis of overproduction due to a shortage of labour, and high levels of wages squeezing profits. Comparable measures of unemployment, today, with that of the early 1960's, would show it at around 6-8%, as against around 1-2% back then. It took another 10-15 years back then for labour shortages to cause wages to rise to a level whereby profits were squeezed to an extent to cause a crisis of overproduction of capital. We are a significant way away from that, currently, even given current labour shortages in specific areas. Most of them will be resolved by zombie capitals collapsing, and unproductive labour being reallocated, as well as by economies having to open up, to allow greater free movement of labour. Economies that resist that, like Britain with Brexit, will quickly suffer a relative decline.
In fact, higher interest rates, as suggested above, will facilitate that, because zombie companies struggled on only because of low wages, and artificially low interest rates, so that capital was misallocated, and labour was kept hoarded in unproductive areas. The attempts of the representatives of the petty-bourgeoisie to perpetuate that condition – attempts to penalise larger capitals with windfall taxes, to subsidise inefficient low paying small businesses, high street retailers and so on – are thoroughly reactionary, therefore, as well as doomed to fail. As interest rates rise, it will shake free all of that mass of misallocated capital, and all of those trapped workers, rescuing them from the idiocy of small production, to paraphrase Marx. But, it will also make possible a much more rapid accumulation of capital, and increase in economic activity, as well as being compatible with higher living standards, whilst the drain of surplus value into welfare payments will be reduced, facilitating further capital accumulation. Rather than depressing economic activity and wages, higher interest rates will be a means to it.
It was a period of intense financial speculation – Railwaymania – with large amounts of shares bought on margin, with private capitalists having used the profits of their firms to buy railway shares. Whilst that is reminiscent of the conditions over the last 30 years, it is not what is being seen currently. Share and bond prices are astronomically inflated, because of all that past speculative activity, but we are not currently seeing huge sums being spent in that way. On the contrary, money is slowly ebbing out of those speculative assets, as witnessed by the steady fall in their prices, or, in the case of Bitcoin and various meme stocks, collapse in their prices. We are not in conditions where rising interest rates are going to lead to private capitalists demanding cash payments, in order to cover their margin calls. In fact, as described above, as asset prices fall, the consequence of that is going to be liquidity flowing from that sector into the real economy, reversing the condition of the last 30 years.
So, inflation is not going to fall as rapidly as central banks and speculators expect, and rising interest rates are not going to slow economic activity, as a means of reducing wages either. Those higher rates will crater asset prices long before the economy, at current levels. They will also act to rationalise capital, and free labour hoarded in unproductive businesses. The reductions in liquidity aimed at by central banks, by ending QE, and tentatively commencing QT, will eventually remove excess liquidity, so that inflation will slow – but prices will not revert to previous levels – but economic activity will simply expand liquidity via commercial credit, meaning that prices can continue to rise for some time. The consequence is that nominal interest rates will continue to rise, and eventually, as inflation does subside, although nominal rates will fall, real rates will continue to rise, meaning that asset prices are set for a long period of decline.
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