If central banks really wanted to reduce inflation, they would reduce the liquidity in the system. One way to do that is via QT, i.e. selling the vast number of bonds they hold on their balance sheets. However, in so doing, as with the Bank of England's proposal to do that, the consequence is that the price of bonds then falls sharply, in conditions where bond prices have been falling at the fastest pace ever. That itself is a consequence of the fact that, for 30 years, we have had excess liquidity pumped into the system to inflate those asset prices, and even the prospect of it ending is enough to scare speculators witless.
The Bank of England had proposed selling £80 billion of bonds, but ended up buying an additional £65 billion, instead, to avert a gilt crash. In doing so, its put an additional £65 billion of liquidity into the system, adding to inflation, and also weakening the Pound, rather than strengthening it! Does anyone seriously believe its going to actually sell the proposed £80 billion of bonds, now, starting at the end of this month, in conditions where another gilt crash would be likely, where workers are engaging in increasingly coordinated action for higher wages to compensate for the higher inflation, and so where firms need the additional liquidity in order to be able to raise their prices and offset the higher wages, and other input costs?
So, it is faced, again, with placing its reliance on the wrong tool for the job. To respond to the higher inflation, and lower Pound, it is led into raising Bank Rate, but, as set out earlier, raising Bank Rate will not reduce inflation, and, unless it was raised to something like 10%, will not even slow the economy. What higher rates do, however, is itself to cause asset prices to fall further, and that, in itself, has second round effects. That was also seen in today's US inflation data. Despite repeatedly raising the Fed's Fund rate, US inflation stayed high. The headline rate came in almost unchanged at 8.2%, as against 8.3%, but with estimates of it coming in at 8.1%, and hopes for it to be lower still. The month on month core CPI data came in unchanged at 0.6%, as against estimates of 0.4%, and again hopes of it being lower.
Those who claim that inflation rises sharply and then falls sharply have again been proved wrong. A look at the 1960's, and 70's illustrates the point. During the 1960's, inflation rose gradually, despite rising interest rates. They both had the same cause. As the long wave uptrend strengthened, the demand for labour rose, enabling wages to rise. Central banks increased liquidity so that firms could absorb the rising costs in higher prices, rather than lower profits. The same uptrend increased the demand for capital, and rising wage share increased the demand for wage goods, leading firms to respond to the rising demand by accumulating additional capital, but in conditions where profits were declining relatively, and so, meaning the supply of additional money-capital from realised profits declined relatively, at the very moment the demand for it was rising. The inevitable consequence of that is rising interest rates.
The process did not culminate until the early 1980's, but disproving the transitory inflation thesis, it accelerated in the 1970's, as the boom turned into its crisis phase, as labour supplies ran out forcing wages higher, and leading to a crisis of overproduction of capital, as higher wages squeezed profits. Central banks continued to try to accommodate the higher costs by increasing liquidity, to enable firms to raise prices, with the inevitable consequence that the pace of inflation quickened, reaching more than 25% in Britain, under Thatcher, in the early 1980's. What ended it, then, was the technological revolution that ended the labour shortage, by replacing labour with new technologies, but we are not at that point, today, rather we are at the same point as in the early 1960's.
With large scale defaults on mortgages, that has implications for banks and building societies, and the wider shadow banking and financial system, which, as the events of the last few days showed, has ways of materialising in crises in unexpected quarters of the system. The fact remains that the underlying cause of rising global interest rates is an increase in the demand for money-capital relative to its supply, and, as governments have engaged in massive additional borrowing, to finance the idiocy of their lockdowns, that cause is not going away.
For Britain that is added to by the idiocy of Brexit, and also by the idiocy of the Brexitory government, as manifest in its last budget, based on Voodoo Economics. The hard right, anarcho-capitalists, and free marketeers got their way, in the form of Truss and Kwarteng, and the result has been disaster, which hopefully ought to consign their ideas to the dustbin once more.
Higher interest rates, causing falling bond prices, means that the greatest risk currently resides in what are supposed to be risk free assets, and upon which the prices of other assets are then determined. Rapidly collapsing bond prices, and rising yields, means collapsing property prices, and also share prices.
Stock markets have already fallen by large amounts, although from astronomically inflated levels to begin with. The NASDAQ has fallen from a high of 16,000 to 10,500, a fall of around 38%; the Dow Jones has fallen from a high of 37,000 to 29,000, a fall of around 22%, the S&P 500 has fallen from a high of 4,800 to 3600, a fall of around 25%. On the basis of current trends, I expect that the DOW will fall to around 20,000, before the process of capitulation sets in, as part of a global financial crash, which will take it down to around 7-8,000 in a matter of days, and a similar process will unfold for the other stock markets, and asset prices.
The Brexitory government in Britain is already talking about balancing its books following its huge tax giveaway and borrowing, by another round of fiscal austerity, cutting government spending on services and benefits, which is in line with the free market fanaticism that drove Brexit. Currently, its estimated that would require cuts of around £50-60 billion a year in government spending, but that is before any further additional costs from higher interest rates.
As global capital markets now consider Britain's Banana Monarchy in the same terms as an emerging economy, or, as its been termed, a submerging economy, as it has moved, via Brexit, from a developed state to an increasingly bankrupt, declining state, much higher rates for it to borrow are inevitable. Already, its interest burden amounts to the second largest expenditure after the NHS, and, as interest rates rise, it is set to become its largest single expenditure even above the NHS, and, thereby, become unsustainable.
This is not the 1970's, when Callaghan's Labour government began to try to implement monetarism and cut public spending at workers expense, nor the 1980's when Thatcher achieved what Callaghan couldn't. Nor is it even 2010, when the Tories responded to the global financial crisis, caused by rising interest rates, by further such austerity. Across the globe, labour is on the front foot for the first time in 40 years. Workers will resist such austerity being imposed, and what is more, after a decade of austerity, after 2010, the scope for it achieving its ends is, in any case, greatly diminished.
This is a period when labour will advance at the expense of capital, and, at the same time, when real capital will advance at the expense of fictitious capital.
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