R* And R**

Last year I set out the problem facing the ruling class of speculators and coupon-clippers, and their state, which is summarised in the difference between “the neutral rate of interest” (R*), above which the economy is supposed to be constrained, and R**, the rate of interest that results in a crisis in financial markets, as asset prices are significantly reduced. As I have previously set out, Marx demonstrated that there is no such thing as a “natural rate of interest”, because the rate of interest is the market price of the use-value of capital (its ability to produce the average rate of profit), but capital is a social relation, and not a thing. It is not produced by labour (as against the commodities that comprise the physical elements of capital), and so has no value, or price of production, around which such a market price would fluctuate, as a natural or equilibrium price.

As I explained, the figure for R* is, now, much higher than for R**, meaning that the aim of the speculators to create a recession, to reduce wages, and boost profits, was impossible to achieve, because, long before that happened, there would be a financial crisis causing asset prices to crash, the prevention of which is the sole aim of the speculators and central banks. That has proved right, as, in the last few days, rising interest rates, leading to falling asset prices, caused a series of bank crashes, all of which now starts to resemble the last days prior to the collapse of Lehman Brothers, and the onset of the 2008 global financial meltdown.

This is a worse problem than was faced by Fed Chair Arthur Burns, in the 1970's.  He also began tightening monetary policy, but had to change course, as profits got squeezed, and asset prices fell.  In the 1970's, continued tight labour markets, strengthened the position of labour v capital, preventing prices from rising above wages, so squeezing profits.  Inflation spiralled higher, as wages chased prices, and interest rates rose, causing inflation adjusted asset prices to fall.  But, today we have the conditions of the early 1960's, when the process of tightening labour markets is still under way, not the 1970's, when they were about to be quickly relaxed as a technological revolution, replaced huge masses of labour across the globe.

Of course, the speculators must think they have had some success, because for months they have been saying that the central banks would risk raising interest rates to a point where something would break, and then they would have to begin cutting rates and loosening policy again. The collapse of SVB, and Signature Bank, and sharp sell-off in the shares of dozens of others, is touted that something broke, and central banks would need to start cutting rates. Sure enough money poured into government bonds, particularly at the short end, as speculators anticipated interest rate cuts, and also as some people decided that, instead of having money sitting in risky bank accounts, or bond funds, paying low yields, and with a risk of big capital losses, they may as well just hold short dated government bonds directly, in which they can avoid a capital loss, by holding them to maturity, and which are now paying higher yields than available on bond funds, or savings deposits.

Indeed, the latter is a problem for banks trying to attract deposits, because with short dated bond yields paying around 3-4%, that is nearly double the interest rate on savings deposit accounts offered by banks, other than for fixed rate, longer term accounts. To attract funds from savers they will need to raise those interest rates significantly, as they need to attract additional funds to overcome some of their current funding problems. That will reduce their trading profits, and require them to raise lending rates too, pushing market rates of interest higher, and putting further pressure on asset prices, leading to a further round of asset price falls.

On the one hand, as speculators gamble that central banks will have to stop raising rates or even cut them, and will also have to end QT, bond prices have shot up bringing bond yields down, but, with the same fear that a series of banks, including big banks like Credit Suisse are about to get crushed, stock markets have sold off by large amounts in the last few days, only to bounce when central banks promised yet more huge doses of QE and liquidity injections directly into the banks, which will again fuel inflation, to which the central banks will respond with higher interest rates, causing further asset price crashes, further undermining the balance sheets of banks, and so on.

Another part of the reason for that is that, not only are these banks now seen to be susceptible to large capital losses on their own bond holdings, as with SVB, but also, as asset prices fall, the other assets on their books, such as property, are also going to show large capital losses too. Even if banks do not go bust, they will need to raise large amounts of capital to fill the gap, by issuing large amounts of additional shares and bonds, which, in turn, will reduce their share and bond prices. In the last few days, as speculators fled banks and shares, they surged into government bonds, for safety, causing bond prices to rise and yields to fall, but, as seen with the ECB decision, yesterday, central banks then have to deal with the continued inflation now being further stoked by the additional liquidity being pumped into circulation to shore up the financial system.

The recent data across the globe shows that even headline inflation remains high, despite manipulation of energy prices by states, and some falls in global energy prices, mostly due to an abnormally warm Autumn and Winter in the Northern hemisphere, and built up stocks of gas in Europe that did not need to be replenished, but will in coming months. The data also shows continued economic growth, despite all the predictions of global recession, which also shows that whilst current levels of R* have not come anywhere near “breaking” the real economy – and will not at current levels of inflation - they are above R**, and have already started to break the fictitious economy, and destroy the paper wealth of the ruling class speculators.

Labour markets continue to tighten, meaning that total wages continue to rise, fuelling consumption, and so the need of businesses to accumulate capital. Food prices continue to rise by around 15%, and the measures of core and “sticky prices”, as well as of median levels of CPI, continue to remain high if not rise further, even as headline rates drop slightly. Service industry accounts for 80% of the economy, and services inflation continues to rise.

Some consolation, for speculators, in the US was given by the latest data for Producer Prices and Retail Sales, which showed moderation, but that is likely to be a fluke. With labour shortages, rising wages, a new round of liquidity injections by central banks, and still large amounts of liquidity sitting in consumers bank accounts (which they may want to spend rather than risk losing them in any bank failures) a new wave of inflation is being prepared.

In the US, UK and EU, the authorities are predicting that inflation will fall from current levels of between 6% to 10%, respectively, to around 3% by the end of this year, nad back to the target 2% in 2024. That is pie in the sky, as the figures for the trimmed mean, median, and core and sticky prices indicate. That is before the current huge liquidity injections to backstop the banks lead to a further fall in the value of the standards of prices, $,£, € and so on, causing further rises in prices measured by those shrinking yardsticks. The predictions of these lower levels are really just propaganda aimed at workers currently demanding higher wages to compensate for those rising prices, and specifically those employed by the capitalist state who are being forced into strike action to obtain it.

Next week, the Federal Reserve meets amid debate as to whether it will follow the ECB in also raising rates, as it had intimated, prior to the current round of bank runs, by as much as 50 basis points, or whether it will restrict its increase to 25 basis points, no increase at all, or, as some speculators are calling for, even cutting its rates, at the same time that it is engaged in huge new doses of QE, when it was supposed to be undertaking QT. My guess, and in current conditions no one can do more than guess, is that it will copy its last decision and raise by 25 basis points, as any other move might spook the markets. It will gauge the response, and then tack accordingly in its dialogue following the decision.

But, the fact remains that central banks are engaged in contradictory policy moves. They have needed to continue providing liquidity, first to enable firms to raise prices to cover rising wages, to avoid squeezed profits, and now they are injecting even more liquidity to try to rescue collapsing banks whose real problem is not lack of liquidity, but lack of capital, and fictitious balance sheets based on astronomically inflated asset prices. That has manifested itself first in the small regional banks, that are now being bailed out by the Fed, and also by other large banks, the FDIC and so on, but that increasingly means contagion to larger banks and financial institutions, via all of the range of derivatives such as Credit Default Swaps and so on, that happened in 2008. But, the big banks have the same underlying problem too, its just that they are not facing the same requirements to realise the losses on their asset portfolios yet, but, at some point, they will.

A look at Credit Suisse, a bank that, systemically, is as significant as Lehman's shows that. Its share price has collapsed; its main share owned the Saudi National Bank, has refused to provide any additional support; the cost of insuring against a default on its credit soared by more than 1000% during the week, as other speculators ditched credit default swaps, fearing they would lose their shirts if it defaults; and it has only found temporary respite from a liquidity injection and backing from the Swiss National Bank, with now calls for it to be merged with UBS, a move similar to those in 2008, which only succeeded in dragging down other banks by the problems of the ones they take over.

As I pointed out last year, in fact, the policy of raising rates by central banks is the wrong tool for reducing inflation. Inflation is a monetary phenomenon resulting from the creation of excess money tokens/credit, and to remedy it, it is necessary to remove that excess, i.e. a policy of QT. But, central banks would not do that aggressively or consistently, because to do so would prevent firms from raising prices to protect profits in the face of rising wages. On the contrary, they would continue to undertake QE, and be sluggish with any QT, precisely so that firms could do that. And, indeed, when they did start raising rates, and it began even at very low rates, to cause asset price corrections, that is what was seen. In Britain, the Bank of England had to step in to undertake new QE, at the time of Truss/Kwarteng's budget, and sharp sell off in longer dated bonds, and crisis in the pension funds, whilst the ECB, faced with soaring spreads between German Bunds, and Italian BTP's, reminiscent of the Eurozone Debt Crisis, also introduced a new version of QE to support peripheral country bonds.

The hiking of policy rates is not a means of reducing inflation, but a means of trying to provoke a recession or economic slowdown, similar to austerity, or lockdowns, with the intention of raising unemployment and so causing wages to fall, and, also, thereby, to slow down economic expansion in the real economy, reducing the demand for capital, and so reducing interest rates, and allowing asset prices to rise once more. But, for the reasons previously described, that could never work, in current conditions.

Firstly, inflation is not caused by rising wages. Secondly, it is not caused by an excess of aggregate demand relative to supply. A look at Argentina currently illustrates that point. Its inflation rate has just topped 100%. But its economy is about to go into recession, and its GDP is falling in constant prices. It has an unemployment rate of 7.1%, and wages are growing at only 4.5%. In other words, this is simply an illustration that slowing economic activity does not lead to falling inflation, but only to stagflation, as economies found in the 1970's. Reduced output, or even very slowly growing output, will, in fact, lead to higher inflation, if the currency supply, thereby, grows relatively faster, and that is exacerbated if the lower levels of output results in higher costs of production via lower levels of productivity.

But, also, as described earlier, the hikes in central bank rates, although they have been rapid, when they eventually started, have still taken them to relatively low levels. We are still way off the 5% plus levels of interest rates that existed in 2007, and yet, today, inflation, in the US, is more than double what it was then, and in Britain and Europe, is three or four times what it was then. In other words, real, after inflation interest rates, are actually negative, continuing to give an incentive for consumers to borrow to spend, rather than to save. But, as also described, current consumption spending, as with the circulating capital of businesses, is not funded from borrowing, but from current income. With employment rising, and household wages rising, that funds additional consumption, which drives additional demand for goods and services, which is what continues to be seen in the data for retail sales and so on.

Firms have to compete for this rising level of demand, and so have to increase their circulating capital, buying additional materials, employing additional workers, which again is what the data shows, especially in relation to service industry, and to growing employment levels. Firms can fund additional materials and so on via commercial credit, from suppliers, unaffected by rising interest rates. So, rising central bank rates were never going to significantly slow the economy, at these levels, and yet, already, those levels were enough to start to cause a financial crisis, as asset prices began to crash.

The demands from speculators have heightened for the central banks to stop raising rates and end QT, before they have really even started. Yet, inflation rates, particularly for services, have not fallen significantly, indeed, for services, the largest part of the economy, they continue to rise, and, now, the core rates of inflation are remaining sticky, in some cases exceeding the headline rates, creating further problems for central banks. 

As I wrote at the end of last year, inflation, even if it drops slightly is not going away any time soon, and that is all the more the case the more central banks fail to implement QT. But, the central banks are there to respond to the interests of the speculators, and so, its likely that they will heed those demands and restrain their hikes in rates, and certainly will continue to introduce new doses of QE, as the Federal Reserve did this week in its programme to allow banks to borrow from it using Treasury Bonds as collateral at par, even though the market value of those bonds, currently, is only around 80% of that figure. Increased liquidity will simply lead to a further rise in inflation, meaning that they will only have again deferred a solution.

The speculators who only a week ago were having to accept that their hopes of recession were not going to be fulfilled, and that rather than there being either a hard or soft landing for the economy, there would be no landing, as it continues to expand, are now proclaiming that a recession is imminent. But, that is, again, simply their hopes being expressed, along with their perpetual confusion of the financial markets with the real economy. There is no reason why the problems of banks and finance houses, who are suffering from decades of speculation in grossly over priced financial and property assets, as those prices again crash, or of the ruling class that is similarly suffering large capital losses, should have any impact on the real economy.

Provided that the function of banks and finance houses as money-dealing capital, i.e. as a transmission mechanism for currency, via payments and receipts, continues to operate smoothly, then capital, commodities and currency can continue to circulate, and firms can continue to sell goods and services and be paid for them, so that capital is reproduced, and production continues as normal, on an expanding scale. Not only does a large part of that expansion of capital, as circulating capital, derive from profits, and is financed by commercial credit, but those same profits are the basis of investment in fixed capital too. The idea that this capital is somehow continually injected into the economy from outside it, by “capitalists” from nowhere, is a fiction concocted by those capitalists and by the banks and finance houses.

It shows why the operation of banks and finance houses in this role of money-dealing capital, should be separated off from their role as money-lending capital, or vehicles for financial and property speculation. If the former is threatened, then, in the first instance, it is necessary to insist that the state steps in, to ensure its efficient operation, but, the real solution, under capitalism, resides in workers establishing their own cooperative banking system. It also requires workers to have control over their collective property in the form of socialised capital, so that they can ensure that the profits they produce can be used to finance the expansion of real capital, and reserves built up to that effect. But, the real solution is to end the casino economy that creates these conditions, driven by the needs of fictitious rather than real capital. It resides in a transition of socialised capital, owned by workers, but controlled by speculators, to socially owned and controlled means of production used to meet the needs of society, not the greed for paper wealth by speculators.

We should not allow 2008 to happen again, in the way the money lenders and speculators were bailed out, and it was paid for at workers expense, including by the imposition of austerity to slow economic activity, and reduce interest rates. That simply showed the way that the ruling class speculators have become entirely parasitic on real capital, as “coupon-clippers”, as Marx and Engels described them, without any social function, and in fact, how their interests have now become a fetter even on the further development of capital, let alone its transformation into socialist property, means of production used to meet the needs of society.