The Bond Market Bear Trap

Just over two weeks ago, global bond markets sold off, yet again, sending bond yields to new highs. Back in November of last year, the US 2 Year Treasury Yield had come close to breaching the 5% level, but, then, gradually fell, as the narrative of approaching recession, a hard or soft landing, caused by repeated Federal Reserve rate hikes, took hold, and, as a series of softer inflation figures were used to back up this story. But, the story was always a fairy tale, as I had set out, last year, and again at Christmas. Inflation was not going away, and the employment and unemployment data showed that economies were continuing to expand, labour supplies were getting tighter, wages were rising, and creating conditions for continued rises in aggregate demand.

By the start of February, the speculators were themselves having to accept that reality refuted their hopes of recession, and the conclusion that there would be neither a hard nor soft landing, but no landing at all, as I had set out last year. At the start of March, a hotter than expected inflation number, another strong jobs number, and Jerome Powell's suggestion that the Fed might have to raise rates by fifty basis points, led to the US 2 Year Yield surging to 5.10%, and the yields on other bonds rising in line with it.

Then, SVB crashed, followed by Signature Bank, Silvergate, and dozens of small regional US banks saw their share prices drop sharply too, and this also led attention back to the fact that the weakness of European banks, exposed during the 2008 global crash, and the 2010 Eurozone Debt Crisis, had never been resolved, and blew up, again, with the collapse in the share price of Credit Suisse, which, despite central bank support, had to be taken over by UBS, reminiscent of the events of 2007/8. All of a sudden, the speculators smelled blood in the water, and quickly returned to their old narrative that central bank rate hikes would break the economy, leading to recession. As set out, before, the purpose of that narrative is to try to get workers to moderate pay claims, a tactic that seems to have worked, at least on British trades union bureaucrats, and businesses to slow expansion, taking the pressure of market rates of interest, and giving space for central banks to cut rates, and so inflate asset prices once more.

In the belief that central banks would, then, have to begin cutting their policy rates, causing, first bond prices to rise, money surged into bonds, pushing their prices higher, and yields much lower. The US 2 Year Yield fell from 5.10% down to 3.6%. But, nothing, fundamentally, in relation to the economy, had changed. Some banks had seen huge drops in their share prices, and the reason for that was that these banks, like most banks, are undercapitalised, and so, when they needed to obtain liquidity, and prevent a bank run, that was exposed, because to get the liquidity, they needed to sell assets whose real market value was way below the inflated book value on the bank's balance sheet. Central banks have, again, staunched that flow, by providing huge amounts of liquidity, and, from Janet Yellen, the promise of even more, to guarantee that depositors do not lose money, in order to discourage them from taking their deposits out. But, that additional liquidity, like that provided by the Bank of England, in September last year, faced with a crisis in the UK Pension industry, as Trussonomics caused UK Gilts to crash, means yet another boost to inflation, as the standard of prices is again trashed.

There is no reason why the problems of banks should be equated with a problem for the economy as a whole. One reason for the problem of the banks is that there are just too many of them, both in Europe and in the US. In the US, particularly, it was amongst the dozens of small regional banks that the falls in share prices, were most notable, and part of the reason for that is not just contagion from SVB, but the fact that the Federal Reserve did not regulate these banks in the way it does the larger banks. Not only are larger banks, relatively better capitalised, but a small number of large banks are much easier to regulate than hundreds of small banks. A rationalisation of banks is inevitable, and as with other industries, such rationalisation, often occurs violently, via a crisis, and many of the firms in that industry going bust, and their capital being taken over, on the cheap, by others.

The speculators claim that the banking crisis means that credit conditions are tightened, because the banks will lend less to businesses to expand capital, or will have to charge higher rates for doing so, and that that is equivalent to a further raising of rates by central banks, meaning the central bank should stop raising, or even cut their rates. But, again, this is largely bunkum. The banks have not been lending large amounts to small businesses for capital investment in previous years, as 90% of that lending went to finance speculation in property of one sort or another. For large companies, if they needed to finance fixed capital investment, they could issue shares, or bonds. In fact, they issued bonds, often not to finance investment, but simply to be able to buy back shares so as to inflate the share price. With bond prices having risen, since the bank crisis, they can, now, again, raise money for investment, at less cost than before it.

But, as I have described, previously, a lot of expansion by firms takes the form, not of fixed capital investment, but of increases in circulating capital, i.e. employing more labour and materials. That is particularly the case with service industry, which, now accounts for around 80% of the economy. A fast food restaurant, does not need to build another restaurant, and buy additional machinery, for example. It can increase its sales simply by using its existing fixed capital more intensively and extensively. Existing restaurants can open for longer, more staff can be employed, and process additional components. But, that is financed by commercial credit. They simply order more from their suppliers, to be paid for in 30 days time, probably long after the money from customers for the food sold in the restaurant, has gone into the restaurants' bank account. Similarly, the workers are paid in arrears.

The bankers and money-capitalists make a big thing out of this, because they have always purveyed the myth that capital is something that its not. They have always presented capital as only money-capital, and the source of this money-capital being capitalists, who continually create it from nowhere and set it to work. Without capitalists we are told, there would be no money-capital to be able to buy factories, machines, materials or to pay wages, and banks are simply the centralising and facilitating means for such capitalists to engage in such altruism, and useful activity. But, that is false. The money-capital required to buy the additional elements of productive-capital does not come from capitalists, who continually pluck it from thin air, nor from banks, but from the realised profits of firms, which is the money equivalent of the surplus product of those firms, i.e. the surplus over and above what is required to reproduce the capital consumed in their own production. It comes from the surplus value produced by workers in production.

Provided this mechanism of enabling the circulation of money, commodities and capital is enabled to continue to function then there is no reason, why, the money-capital, realised in the normal circuit of industrial capital cannot continue to be available to finance the accumulation of capital, of which it is the money equivalent, and that applies also to the money hoards and reserves that have been previously accumulated, as a result of that process, as a result of not being immediately used to purchase other commodities for personal or productive use. The question of interest rates comes down to a matter of those who, in aggregate, hold these money hoards and reserves, as against those, who, in aggregate, seek to borrow them for use in purchasing the elements of industrial capital, and the price of that money-capital, the interest rate, that results from this interaction of demand and supply.

Banks, as commercial capitalists, making profits, as money-dealing capital, from charging a commission to transfer money, including by borrowing money from savers at one rate, and lending money to borrowers at a higher rate, should make bigger profits when interest rates rise, because the absolute difference, the spread, between what they pay to savers/depositors, compared to what they charge borrowers expands. So, the problem for the banks that have experienced problems should not be one of profitability, in relation to their trading activity. It is a problem of lack of capital, and of having relied on using inflated asset prices over a long time as a substitute for adequate capitalisation.

The banks needed to issue many more shares and bonds to increase their capital, but, like most large businesses over the last 30 years, they have sought to minimise the issue of shares, in order to inflate their own share prices, so as to inflate the paper wealth of shareholders. When that has resulted in crises, they have relied on the state coming to the rescue of the banks, and, unlike with other industries, the state has been far more likely to effect such a rescue, by providing the deficient capital, or by substituting additional liquidity for it. That is an indication of the extent to which the state simply defends the interests of the ruling class that owns its wealth in this form of fictitious capital, as against defending the interests of real industrial capital.

The ruling class speculators, and their representatives are convinced that central banks will now have to reverse course, just as they had convinced themselves of that before Christmas. But, they are wrong, and the sharp rise in bond prices, over the last couple of weeks, and fall in yields, will prove to be simply a huge bear trap, that will see those that have gambled on it losing large amounts of their money. 

There is a good reason, why some people have bought bonds, illustrated by the UK 1 Year Gilt. Currently, it is providing a yield of 3.8%. Compare that with an interest rate on most savings accounts of around 2-3%, and the attraction of taking your money out of the bank is obvious. But, the speculators, do not buy bonds, shares or other assets in order to obtain these yields (which in real inflation adjusted terms remain hugely negative, with UK inflation running at 10.4%), rather they have rushed into them, in the expectation that the yield will fall massively, as the price of the bond rises significantly, on the back of lower market rates of interest, and falling Bank of England rates.

One thing this also illustrates is the extent to which banks have not been passing higher interest rates on to savers, and part of the reason for that is that, they would also have to charge higher rates to borrowers, the majority of whom are not the beleaguered small businesses we are being told will suffer, but the vast number of borrowers for the purchase of property, whose prices are also massively inflated. What banks and building societies are worried about, as also seen in the aftermath of Trussonomics, is the effect that rising lending rates will have on property prices, which as it also crashes will mean that all of those assets, sitting on banks' balance sheets will also be seen to be actually worth only a fraction of its current book value, and so requiring even greater capital injections.

The ECB, seeing EU inflation still at 8.5%, as against 8.6% the previous month, but, having also risen by 0.8% month on month, confounding predictions of further falls, was led to raise its policy rate by a further 0.5% points. The idea that EU inflation is going to fall significantly this year, or to 2% by the end of 2024, is total fantasy. Excess liquidity created over a long period, continues to wash into the economy, and a look at energy prices, food prices and so on, all rising in high double digits, indicates that prices are set to continue to rise.

La France en flammes

The fact that Macron has tried to make French workers pay for the higher prices that flow from that excess liquidity, and from the EU's boycott of Russian energy and grain supplies, and that the response of French workers has been to take to the streets, shows the problem facing the ruling class, as labour supplies across the globe continue to tighten, improving the position of labour as against capital.

And, the same was seen in the UK, where even the headline rate of inflation rose from 10.1% to 10.4%, confounding the assertions that inflation had peaked. The trades union bureaucrats that persuaded their members to take lower than inflation pay rises, i.e. to take a pay cut, at least partly on the basis of government assurances that inflation was going to fall rapidly, will have to answer to those members, as UK inflation continues to rise above wages. Currently, workers are gaining bigger increases in their wages by simply moving jobs – average increase around 14% - than unions are getting for them, in annual pay negotiations, other than in the private sector, cases like Rolls Royce, where workers won a 16.9% rise. That is likely to mean, as it did in similar conditions in the 1960's, a further radicalisation of workers, and demands from them that their unions pull their finger out. We will need a dramatic democratisation of the unions, and new more militant union leadership in coming months.

The US, also saw the Federal Reserve raise rates by a further quarter of a point, last week, though before the recent events, a half point increase had been possible. But, as with the EU and UK, the idea that US inflation is going to fall significantly in the next couple of years is a fantasy, and the further liquidity injections in response to the bank crisis makes that even more certain. US jobs numbers continue to rise significantly, and again, the weekly initial jobs claims came in at historically low levels, confounding the speculators continual hopes that the economy would slow, and unemployment rise. It will not, as we are in a similar period to that of the early 1960's.

May '68 barricades in Bordeaux

It doesn't mean there may not be temporary slow downs, as there was during that period too, but the tightness of labour markets, rise in wages, and growing strength of labour relative to capital is now set on course, boosted by the effects of lockdowns and their removal, and the huge deluge of liquidity thrown into the real economy, as a result of it. Those are not the conditions in which employers can continue to hold down wages, nor the state impose the solutions it seeks, as with Macron's measures simply resulting in France in flames, reminiscent of May '68.

In the last couple of weeks, bonds have behaved more like meme stocks, with huge movements in prices. The speculators have convinced themselves that central banks will have to stop raising rates, and even cut them. They are wrong. Inflation may moderate, slightly, but only to rise again, as it ebbs and flows in waves, with all the data showing underlying inflation still persistent, and even rising. Central banks, as I set out last year, will continue to inject liquidity, whether its to simply enable firms to raise prices to protect profits from rising wages, or in large tranches in response to crises of pension funds, or banks, and the consequence is a further devaluation of the standard of prices, and rise in inflation.

What the central banks should do, if they really wanted to reduce inflation, is to speed up QT, to remove the excess liquidity. If they provide liquidity to banks, to prevent bank runs, they should compensate by selling more bonds off their balance sheet. But, they will not do that, because it would prevent firms raising prices to protect their profits, and would cause bond prices also to fall much more, causing the paper wealth of the ruling class to evaporate, as well as exposing the under-capitalisation of financial institutions to an even greater degree.

It is chickens coming home to roost, after 40 years of conservative social-democratic attempts to protect the interests of the fictitious-capital of the ruling-class, at the expense of real capital, and the real economy. It weakened the material base of social-democracy itself, founded upon large-scale socialised capital, and massively strengthened the position of the petty-bourgeoisie, whose numbers expanded from the 1980's onwards, in defiance of the long-term trajectory of its dissolution, and descent into the ranks of the proletariat. As a result, it strengthened all of those reactionary tendencies that go with it, of nationalism, populism and bigotry, as witnessed by their take over of conservative social-democratic parties like the Tories, victory of Brexit and so on.

Sharp class struggles are approaching as occurred in the 1960's, and the world labour movement is very ill prepared for it, as the collapse of what remains of a very confused, and misguided Left into social-imperialism, in relation to the NATO/Ukraine – Russia~China war, illustrates. Most of it is going to be rolled over and swept away like so much petty-bourgeois effluent, by workers who are finding their feet once more, but who will rapidly have to take advantage of the new material conditions that present themselves, via new technologies, to rapidly educate and organise themselves, and build the revolutionary party, and institutions required for their success. In the process, they make it impossible, as France is showing, for the ruling class and its state to revert to the old solutions of the last 40 years. When the ruling class speculators begin to realise that, as central banks are led to have to continue raising their rates in face of continued inflation, those bond markets are going to sell off on an even greater scale.