The Problem For and Of The Banks

The problems in the banking sector, seen with the collapse of SVB and Signature, in the US, and Credit Suisse in Switzerland, are not over. The last week or so has seen continued selling of the shares of US regional banks, and further collapses, with larger banks, like J.P. Morgan, having to come in to bail them out or take them over. Further consolidation is inevitable and desirable, but also draws the larger banks closer into the vortex, as in 2008. As I set out recently, the problem is not with the profitability of the banks, as higher interest rates lead to wider spreads between their borrowing and lending rates, or, at least, they should. The problem is in relation to their capitalisation, and the value of assets on their books, and, unfortunately, for the banks, those valuations are also a function of interest rates. The next shoe to drop is property prices.

The problem the banks are facing is this. When interest rates rise, they should become more profitable, because the spread between what it costs them to borrow, and what they are able to charge on loans rises. If interest rates are at 3%, a bank might borrow at 2%, and lend at 4%, but if interest rates rise to 5%, it might borrow at 3.75%, and lend at 6.25%. On £1 million, it originally makes £20,000 profit, and now makes £25,000 profit.

The failure of SVB came as a result of customers taking part in an old fashioned bank run, except that, today, with internet, and electronic banking, customers can sit at home, and transfer money out of their accounts in an instant. To avoid a bank run, banks need to be able to show to customers that they don't need to get their money out, because the bank has sufficient capital to cover their withdrawals. That's why the US Federal Reserve stepped in, a few weeks ago, to assure bank customers that they would not lose money, in the case of a bank failure, because the federal deposit guarantee system would cover all of their deposits. That's a big commitment if all bank customers did panic, and start a bank run, on large numbers of banks.

For SVB, to cover withdrawals from customers, it needed to convert some of the assets held on its books. In particular, it needed to sell some of its government bonds, so as to get cash to hand to customers. The trouble is that, as interest rates have risen, the market price of those bonds has fallen. If the bonds could be held to maturity, they can be redeemed at their face value, of, say, $1,000, but the bank needed the money, now, not in two, five or ten years time, when the bonds were due to mature. Selling the bonds now, in the secondary markets, therefore, means that they can only fetch their current market price, which might be only $800. That left a big hole in the banks actual capital, which only becomes apparent when these assets have to be marked to market rather than to book. A similar problem happened in 2008.

Then, it was the value of property assets held on banks' books, at a time of a preceding property bubble, and impending bursting of that bubble. This time around, it has been a massive bond bubble that was inflated in the preceding period, as a result of an even greater amount of QE, and the bursting of that bubble that has provided the initial tinder for the conflagration. Another flicker of it came with the crisis in UK Pension funds, in the Autumn of last year, when the policies of Liz Truss caused UK interest rates to spike, leading to a sudden crash in bond prices, which left some pension funds with a huge drop in the value of their assets, assets which, with the model of the last 30 years, they have relied on to be able to sell to cover liabilities, on the basis of continually inflating asset prices, and capital gains.

Central banks have stepped in to try to prevent that crisis. Last year, at a time when the Bank of England was supposed to be starting QT, it, instead promised a further £65 billion of QE, to provide a breathing space for the pension funds to deal with their funding crisis. The removal of Truss's government, and subsequent rise in UK bond prices, ended the immediate problem. The ECB, fearing a new crisis for its peripheral economies, as with the 2010 Eurozone Debt Crisis, as interest rates rose, sharply, for economies in Greece, Portugal, Italy and Spain, also introduced a new programme of QE targeted at the bonds of those countries, to stop interest rates for them rising, sharply, as against those in Germany and other Northern European countries. In the US, the Federal Reserve has used its open ended backing for the FDIC's guarantee of deposits, along with encouraging the larger banks to bail-out the regional banks, whilst in Switzerland the Swiss National Bank, first tried bailing-out Credit Suisse, and then facilitated its take over by UBS.

But, that is not the whole problem, and so, in the last couple of weeks, we have seen US regional banks continue to come under pressure. The huge US banks are under continual scrutiny from the Federal Reserve. But, they also have larger resources, anyway. But, there is another difference, and that is that these huge national banks, tend to hold different kinds of assets, and liabilities. They are able to borrow more cheaply in money markets, and when they lend money, a greater proportion of it is to large corporations. This where the issue of R* and R** that I wrote about a while ago also comes in.

Why do interest rates rise? Real interest rates rise because the demand for money-capital rises relative to the supply of money-capital. In short, when the economy is expanding more rapidly, the demand from businesses for money-capital to finance the purchase of buildings, equipment, materials and labour-power rises at a faster rate than the increase in realised profits, which supplies the money-capital for that purpose. Those that obtain revenues, be they wages, rent, interest or profit of enterprise, in excess of what they require to finance their current consumption, or who have savings from previous such excess, can be incentivised to lend it by being offered a higher rate of interest for doing so.

Nominal interest rates can also rise as a consequence of inflation, which acts like depreciation. In other words, if I have £1,000 to lend, and the current rate of interest is 3%, but inflation is 10%, at the end of a year, when I get back the £1,000, it will only be actually worth £900, in today's terms. It will have been depreciated by 10%, just as with, say, a machine, whose value falls by 10% over the period of a one year lease. If I lease the machine, I would want to cover that £100 of depreciation, as well as the normal interest of £30, and so would want back £1,130. In the same way, if I lend £1,000, I will want back £1,130, to cover the depreciation of the capital, plus the normal interest. It will look as though the rate of interest was 13%.

So, if businesses, in a more rapidly growing economy, demand more money-capital, interest rates will rise. Consumers might also demand more money to finance the purchase of more expensive consumer durables, such as cars. Banks lending money for such purposes, then, can charge higher rates of interest for these loans, and, as described above, when this happens, the spread between what they pay to borrow, and what they charge to lend, grows wider, and so their profits expand. As their costs for things like bank buildings, equipment, and wages have not changed, these bigger profits mean a larger rate of profit. Indeed, for the bigger banks, the latest earnings season has seen these bigger profits, and rates of profit.

But, the picture is different for the smaller, regional banks. In the US, these regional banks are more akin to the Building Societies that existed in the UK up to the 1990's, and early 2000's, when most of them converted into banks. They rely more on deposits from savers, be they local businesses or households, rather than on financing from operations in the money markets – when they did do that, as with the UK's Northern Rock, prior to 2008, they were hammered when the costs of that short-term borrowing soared, due to the credit crunch – and to retain those savers, or attract more of them, they need to pay higher rates of interest on deposits. Here is where the problem for them resides.

The vast bulk of the loans these banks have made, not just in the US, but also in Britain and the EU, as well as across the globe, has not been to finance capital accumulation by businesses, nor consumption by households. Around 90% of it has been to finance the purchase of property, or other forms of speculation in property. So, whilst these banks could take advantage of wider spreads, as interest rates rise, on loans to businesses, they have an obvious problem charging higher rates to people who have borrowed money to buy a house.

A business seeing the demand for its products and services rise sharply, and the prices it can charge for them, can afford to pay more interest to borrow the necessary money to expand. But, someone who has borrowed money to buy a house, build houses and so on, sees no such ability. Indeed, as interest rates rise, and property prices fall, builders see their own profits drop. In the US, UK, and the EU, as well as in China and other parts of Asia, as interest rates rose, and mortgage rates rose, the demand for mortgages fell sharply, and property prices dropped. Yet, those interest rates are not yet covering the continued high levels of inflation.

In addition, as I have set out before, investment in large scale fixed capital tends to be lumpy. Take something like provision of broadband infrastructure. For a country, it requires a huge investment in fibre optic cables, switching gear and so on, all of which takes place in a relatively short-time. But, you don't build it only to cover current requirements. Once built, the traffic along it can increase every year for many years without any substantial additional investment. The same is true for a business that puts in place its own IT infrastructure, and so on. And, fixed capital can always be used more extensively and intensively, by introducing shift systems, and so on. So, output can increase significantly when demand rises, without any additional fixed capital investment, or borrowing to finance that investment.

What does increase is investment in circulating capital. In other words, businesses may be able to continue using their existing fixed capital, but will need to buy additional materials, and employ additional workers. However, the nature of this circulating capital is that, often, it can simply be financed by an expansion of commercial credit, which always expands in periods of economic expansion, and requires no additional borrowing. But, even where it can't be financed simply from an expansion of commercial credit, often firms can simply finance it out of their own profits, particularly where those profits are themselves expanding in real or nominal terms.

Consequently, a sluggish increase in bank lending to businesses need not reflect any considerable economic weakness. But, overall bank lending figures are even less a guide, given what has been said above, because with a large part of that lending going to finance property purchases and speculation, it simply reflects the fact that rising interest rates are hitting demand for mortgages and property. There is a big difference between that, and lending to finance either business investment, which creates additional employment and aggregate demand, or consumption, which increases consumer demand, and thus leads to business engaging in additional investment to meet it. The majority of house purchases are for existing properties, not new properties.

The appropriate response to the rise in interest rates in relation to property is a fall in property prices. That would mean that demand for mortgages, and for property would then recover, at these lower prices. It also means lower land prices, which, today, account for a disproportionate amount of the cost of building new properties. A fall in land prices would not only reduce the price of new houses, so encouraging additional demand, but it would boost builders rate of profit, stimulating additional supply, and employment, giving a further boost to the economy.

However, its clear why the banks that have built their model around continually inflating asset prices, and which have focussed 90% of their lending on property, do not see things that way. Higher mortgage rates, until such time as property and land prices adjust, means smaller demand for them, and so less profit for the banks. It might also mean that some existing borrowers cannot pay their mortgages and default. But, even without that, a large part of the capital on the banks' balance sheet is in the form of the property held as collateral against the mortgage. Just as with SVB, and rapidly falling bond prices, rapidly falling property prices would again hit their balance sheet requiring them to raise large amounts of capital from share or bond issues.

Banks that have built their model on lending to finance property purchase and speculation find they cannot raise their mortgage rates, because it would choke off demand for mortgages, and would also cause property prices to crash. That is not just the case for residential property, but also for commercial property, the demand for which has already been hit by the fact of people working from home, during lockdowns. If banks can't charge higher levels of interest for these mortgages and property loans, they also can't pay higher rates of interest to the savers they now need to retain and attract. It doesn't require customers to fear a bank run, to bring about a significant fall in deposits. Savers can get a higher rate of return on short-term money market funds than they can get on their savings in a bank.

So, this is the problem faced by the banks. They should be making bigger profits in this environment, on the basis of wider spreads, but for many of them, that isn't happening, because their model is based on lending for property purchase and speculation. Higher lending rates for that will crush demand for loans, and also bring about a crash in property prices, and so impact the balance sheets of the banks, as happened in 2008. To hold down those lending rates, they have to hold down deposit rates, and that makes them uncompetitive with money market rates, leading to a drain of funds, which undermines that capital base, requiring either additional capital raising or bail-outs, sharp drops in their share price, and take over by larger banks, which then get sucked into this maelstrom.

And, that creates problems for central banks. Central banks have created inflation as a result of excessive liquidity creation. To reduce that inflation they need to reduce that excess liquidity, which is what QT should do. However, QT, by preventing firms from raising prices, hits the profits of those firms, as they face higher wages, as a result of the demand for labour exceeding supply. It also means that, instead of buying bonds, central banks have to sell them, increasing the supply of them in the market, causing their prices to fall, and yields to rise.

That would also lead to a fall in share prices, and property prices. Given that the ruling class now owns all of its wealth in the form of these assets (fictitious capital), it is keen not to see that happen, as occurred in 1987, 2000, and 2008, and so its state, via the central bank does all it can to avoid it. Hence QE, and hence the variations of it, in the last year, even at a time when central banks were supposed to be engaging in QT, and were simultaneously raising their interest rates in an attempt to cause recessions, and so slow the pressure on rising wages.

But, the rising inflation means that even with the rise in central banks nominal interest rates, those rates are still significantly negative. So, consumers still have an incentive to spend their incomes rather than save them, especially as rates on deposits are only a fraction of central bank policy rates. Firms have an incentive to continue to expand to satisfy rising demand for their goods and services, especially as they can finance most of it from commercial credit, or else from their rising money profits.

So, the inflation in the system continues, even if it moderates slightly from earlier levels, and central banks then have a problem that if they raise their policy rates further, it simply causes bond prices to fall, and puts further pressure on those banks that cannot raise their mortgage rates accordingly, for fear of choking demand, and causing defaults and a sharp drop in property prices. They face the potential that what it costs them to borrow in capital markets becomes greater than what they can charge on their mortgages, and they can't even keep let alone attract additional deposits from savers, because they can't increase their deposit rates, whilst savers see the ability to get much higher yields on money market funds, and the purchase of short term Treasuries.

Central banks are being posed with the options of either giving an open ended commitment to bail-out these banks as they see their deposit base disappear, or else to engage in even more QE to push up bond prices and try to reduce yields, which would lead to a surge in inflation, once again, or to pivot and reduce their own policy rates, despite having failed to reduce inflation.

Another Huge Dose of QE

Last Friday morning, I wrote about the crash of SVB before most people had ever heard of it. By today, nearly everyone with money in a bank has heard of it. When I wrote about it on Friday morning, the bank had not yet gone bust, but its shares had collapsed, as it went to the capital markets to try to raise nearly $2 billion from new shares, to cover its capital losses from a forced sale of Treasury Bonds. Not surprisingly, few wanted to buy the new shares, and its depositors started a run in the bank, similar to that in Northern Rock, in 2007, except now, with electronic banking, you can try to shift your money at the press of a computer key. The bank became insolvent, and the authorities closed it down, leaving them with the question of what to do next.

In the hours following the closure of SVB, other similar small banks were forced to close their doors, such as Signature Bank in New York. But, dozens of small US regional banks have also seen their share prices crash, and the crisis-ridden European banks have also seen a continued sharp fall in their shares, in early Monday trading. The basic reason for the problem is what I explained more than a decade ago, and again summarised on Friday. The huge asset prices bubbles blown up as a result of central banks creating excess liquidity over the last 30 years, to protect and enhance the form of property of the ruling class – fictitious capital – means that the balance sheets of banks and finance houses are themselves a fiction, because the book value of the assets sitting on those balance sheets, massively overstate any real value of them, which is manifest whenever a crisis erupts, as in 2007/8.

In theory, the value of the Treasury Bonds on the books of SVB, provided it with adequate capital that could be used to cover any trading losses or deposit withdrawals by its customers. But, that ws only true provided those bonds could be sold at their book value, or at their nominal value if held to maturity. The problem is that, when the bank did face a requirement for cash to cover trading losses and deposit withdrawals from customers, it could not wait a year, 5 years, or 10 years for those bond to mature, so as to redeem them at par. It had to sell some of them immediately. But, as interest rates have risen the market value of those bonds has crashed, meaning that it would suffer a huge capital loss on the sale, of around $2 billion. Other banks, and not just small banks are in the same situation.

The problem also arises because the structure of banking and finance has changed over the last 30 years along with this action by central banks to create huge asset price inflation, via the injection of excess liquidity. Banks used to operate by having shareholders provide a large chunk of the bank's capital; they also used to rely on depositors to put money into the bank, which they used alongside that capital to make loans. The loans themselves also used to be to finance things like real capital accumulation by businesses. Where they made loans to consumers for things like buying a car, the car and so on, acted as something that could be used as collateral and sold to redeem the loan value. Even with mortgages, the loans were limited, usually to just 2.5 times the household income of the borrower, and then only after the borrower had shown they had been able to save a considerable amount, so as to provide at least a 10% deposit to buy a house.

But, in the 1980's, as a result of the deregulation brought about by Thatcher, in Britain, and Reagan, in the US, all that changed. Prior to the 1980's, the large majority of people, in Britain, lived at home with their parents, until they got married, usually in their mid 20's, before they would consider buying a house, or applying for a council house. A comparison of household composition over time illustrates that point.

In 1971, 79% of UK households were multi-occupancy, 70% were occupied by married couples. Only 19% were occupied by single people, with a further 2% occupied by lone parents. By 2011, those figures had changed drastically. Only 59% were multi-occupancy, the number of married couples had dropped to just 40% with a further 12% co-habiting, and another 7% other multi-occupants. By contrast, the number of homes occupied by one person had almost doubled to 33%, with 8% occupied by lone parents. Of the 19%, in 1971, that were single occupancy, the majority of those were old people who had lived in the house for a long time, and whose families had grown up and left, and spouses had died etc.

The fact that borrowers could only borrow 2.5 times their combined income, limited how much they could offer to pay for houses, and that put a limit on how fast house prices could rise. But, when Thatcher deregulated financial markets, in 1986, this limit on borrowing went. Now, the limit on how much you could offer for a house depended not on how much your income was, directly, but on how much you could afford to spend each month on a mortgage, and that depended on mortgage rates. In the 1980's, banks and building societies also introduced interest only mortgages, which further exacerbated that. As interest rates fell throughout the 1980's, and 90's, so the amount borrowers could afford each month on a morgage translated into larger and larger mortgages, which in turn meant they could offer larger and larger amounts for houses, directly pushing house prices higher.

It was also manifest in the fact that not only did banks and building societies, then, enable borrowers to borrow many, many more times their income, but they also gave mortgages for more than 100% of the market price of the house, on the basis that house prices would continue rising significantly each year, enabling them to get their money back, if they needed to foreclose. With everyone encouraged to borrow, whether to cover consumption, or to speculate – be it on a house, or to buy shares, PEP's, ISA's or private pensions – and no one saving, the banks and building societies increasingly financed their own lending, by borrowing themselves in capital markets. They loaned money long, at higher interest rates for mortgages and so on, but borrowed short, at lower interest rates, making a trading profit on the difference in rates.

But, that model collapsed overnight in 2007, when Northern Rock and other banks and finance houses found that overnight borrowing costs soared, as a credit crunch developed. The interest rates at which they could now borrow, were higher than the interest rates they were charging, and often locked into on the loans and mortgages they had provided, leaving them with trading losses, and a lack of liquidity. In reality, however, that lack of liquidity was a result of a lack of capital. But, that was just one aspect of the change that had occurred, because, now, 90% of bank lending went to finance this kind of property speculation that depended on ever rising house prices, with very little going to finance real capital accumulation by firms, particularly small firms, who found they could only borrow by much more expensive means, using personal credit cards, overdraughts, and so on.

Ironically, big companies that could borrow easily by issuing their own corporate bonds, did so, and enjoyed low rates of interest on those bonds, as asset prices rose, but used the proceeds, largely, not to finance real capital accumulation, but to finance the buy back of shares, inflating share prices, as part of the ever upward spiral of asset prices. And, although this fiction, based upon an ever expanding web of inter-connected debt instruments was exposed with the crash of 2008, unlike previous financial crashes, such as 1847, 1857, or 1929, this time, the state and central banks acted to simply reflate those asset prices, and so restore the paper wealth of the ruling-class, which owns its wealth, now, in that form, even at the cost of destroying the real economy, with austerity, the use of tax to buy up the worthless paper assets, and bail-out their owners, to inflate the currency by even larger amounts, so as to buy up and inflate the asset prices, and to hold back economic growth, whether by austerity, trade restrictions, or physical lockdowns, so as to hold down interest rate rises, which cause asset prices to fall.

In 2007, at its height, before the crash, the Dow Jones was at 14,000. Until recent falls it was at 37,000, and is still at around 33,000, or around 2.5 times its level at the bubble top. It fell to around 6,500. Even that was secured, only, by huge levels of support by the state asset purchase programme, and central bank intervention. But, compared to that, its now more than 5 times that level, almost entirely due to the actions of the central bank in inflating the currency supply, and the liquidity being diverted into speculation in assets.

And, all of the house of cards of derivatives that led to contagion in 2008, and during the Eurozone Debt Crisis of 2010, is still there. Back in 2013, I noted the reports that Germany's Deutsche Bank had exposure to around €55 trillion of derivatives, an amount equal to the entire global GDP. The position has not improved, but been papered over, and now we have other large European banks like Credit Suisse teetering on the edge. Its shares have been falling for months, and today, as bank shares continue to be hit, they have fallen another 12%, to just 2.20 Swiss Francs.

The response is again to rely on central banks not to raise interest rates further, and to engage in another bout of QE to bail out the banks and reflate asset prices, even though that is the cause of the problem, and also of the high levels of commodity price inflation also now afflicting the global economy. SVB Bank in Britain has been bought by HSBC for just £1, showing that the British government can drop its objections to Chinese interference when it wants to! States have generally said that depositors in SVB will be guaranteed 100% of their deposits, and not just what is guaranteed under various existing deposit guarantee schemes.

Depositors should be protected 100%, because, if you put your saving in a bank, you should expect that they are safe, and that the state is ensuring that by properly regulating the banks. Its not like speculating, in which you know the risk that you might lose some or all of your money. In addition, such guarantees are necessary to ensure the circulation of money, and so also of capital and commodities, required for the continued operation of the real economy. Businesses have money from sales going into bank accounts continuously, and similarly going out to make payments to suppliers, workers and so on. There is no reason why a financial crisis, resulting from speculation in assets should be allowed to affect that.

Or take someone selling a house. The money from the sale goes into their account, or into the account of the conveyancer. If that money in the account was not fully guaranteed, people would be unwilling to even engage in buying and selling their houses, if they feared at any time, the bank might collapse, and they would lose their money. This protection of deposits, and of the continued operation of the mechanism of liquidity circulation is the responsibility of the state, and quite separate from any speculative losses that individuals or institutions might suffer from the fall of various asset prices.

In the US, the Federal Reserve has now said that banks that require liquidity, and who face the same problem as SVB that if they sell bonds, they will suffer large capital losses, can now sell those bonds to the Fed at par. In other words, this is a new large dose of QE. The Fed is agreeing to buy Treasury bonds from banks at their face value, even though the current market value of those bonds might be only a fraction of it. The Fed will have to print more money tokens to be able to buy up those bonds, i.e. QE. This is at a time when it and other central banks were supposed to be stepping up QT!.

So far, this Bank Term Funding Programme is limited to $25 billion and lasts for a year. But, much more than that is likely to be required. The following chart shows that US Banks have securities the current losses on which, if they had to realise them, via sale, would amount to around $600 billion.

The speed with which that potential crisis has developed, is also indicated in the chart. But, SVB, and other small banks, plus what happened last year, with UK Pension Funds, shows just how quickly the crisis can erupt, as banks and other financial institutions have to sell assets whose prices have been grossly inflated, as a result of speculation driven by excess liquidity, and a global economy that has increasingly been driven not by the needs and laws of real capital, but purely by the requirement to keep asset prices inflated, so as to protect the form of wealth of the ruling class.

It indicates the extent to which that ruling class is now simply parasitic on the real economy, on the further development even of capital.

SVB Crash and Bank Capitalisation

Silicon Valley Bank (SVB), yesterday saw its share price crash by 60%, as it was forced to raise additional capital, by issuing $1.75 billion of new shares to shore up its balance sheet, following a capital loss of $1.8 billion from having to sell bonds with a value of $21 billion. The bonds, mostly US Treasuries, were yielding 1.79%, compared to the current yield on US 10 Year Treasuries of 3.9%. The crash spread panic across the US banking sector, with US bank shares dropping by around 6%, wiping $80 of their share prices. So much for banks being well capitalised following the lessons of the 2008 crash.

SVB has not gone bust, as with Lehman's in 2008, but it has had to raise capital to stay in business, i.e. it has had to sell a load of new shares to draw in additional capital, to plug the capital loss. This illustrates many of the things I have discussed over the last 15 years since the 2008 crash. Firstly, it shows the difference, highlighted by Marx, between profits and losses (resulting from surplus value), as against capital gains and losses (resulting from changes in prices). For a company that produces commodities, its profits (assuming prices equal exchange value) is a function of the surplus value produced by the labour it employs. If that labour produces more new value than the value of the labour-power (wages), it produces surplus value/profit. If it produces less new value than the value of the labour-power/wages, it results in a loss.

But, a firm might also benefit from having paid, say, £1 a kilo for the cotton it uses to produce yarn, whilst the price of cotton rises to £1.20 a kilo, by the time it sells the yarn, and which is reflected in the price it charges for the yarn. That would not change the amount of surplus value the firm's labour produced, but would appear as additional profit, when, in fact, it is merely a capital gain of £0.20 per kilo resulting from the change in the price of cotton. If the reverse happened it would result in a capital loss.  (See: The Tie-Up and Release of Capital)

For banks, their raw material is not cotton, but money itself. Their profit is made from the difference between the interest they pay to borrow money, and the interest they receive from lending money. Consequently, its often been argued that in conditions of rising interest rates such as those we have now, it benefits banks profits, because it widens the gap between the two. However, the other effect of rising interest rates, as I have set out in numerous posts, is to cause asset prices to fall. Because banks and financial institutions hold capital on their balance sheets in the form of financial assets, when interest rates rise, and these asset prices fall, they make capital losses.

If we take a government bond, as with those that SVB had to sell, a 10 Year US Treasury might have a face value of $1,000. The coupon interest rate on it, may be 2%, i.e. it pays $20 in interest each year to the holder. If held to maturity, the holder also gets back the $1,000 face value of the bond. However, bonds, like shares, are bought and sold in secondary markets. If interest rates are rising, the buyer of a new $1,000 10 Year US Treasury might get $30 in interest on it. That means the value of existing US 10 Year Treasuries fall. No one would want to pay $1,000 for these existing bonds, and get only $20 of interest a year, when they could buy a newly issued bond for $1,000, and get $30 in interest a year.

So, the market price of bonds falls. However, if the holder of those bonds holds them to maturity, whilst they will be losing out on $10 of interest a year, compared to the current rate of interest, they will avoid making a capital loss on the sale of the bond. Bond prices would have fallen to $666, from $1,000, creating a capital loss of $333, if they sold it in the market. This is the problem that SVB faced, and it was also the problem that British pension funds faced last Autumn following the sharp rise in interest rates, and fall in long-dated bonds, as a result of Truss and Kwarteng's Voodoo Economics.

SVB is not the only bank to have crashed in recent weeks, as interest rates have continued to rise, and asset prices fall. As I have set out previously, last year saw the biggest ever fall in bond prices in history, and when I say in history, I don't mean in the way the media usually mean, of in the last ten or twenty years experience of young journalists, but, literally, the biggest drop ever. Am I surprised? No, because I have been pointing out for the last 15 years that this was inevitable, and that despite all the assurances from central banks and governments that 2008 would not happen again, because banks balance sheets had been recapitalised and so on, it inevitably would. It would not happen in exactly the same way as in 2008, but it would happen, because the underlying causes of 2008 of massively inflated asset prices, be it shares, bonds, property or anything else that people can speculate in, had not been resolved. On the contrary, a look at the rise in global stock markets of around 150%, even from the peak of the 2007/8 bubble, the $18 trillion of bonds, globally, that had negative yields, the inflation of property prices once more, and so on, showed that it had grown much worse. All of that huge inflation of asset prices has been caused by the printing of excess money tokens and creation of credit.

As I stated more than a decade ago, the supposed recapitalisation of banks, particularly in Europe, following the Eurozone Debt Crisis of 2010, was a mirage. The capitalisation took the form of the assets on the banks balance sheets, and those levels of capital were flattered, precisely by the inflation of the prices of those assets. Again, that is precisely what has been shown now in relation to SVB, and undoubtedly many more will follow. These assets on bank balance sheets are valued at the prices the bank paid for them. As seen, if bonds are held to maturity, the holder can get back the face value of the bond. However, as a result of the idiocy of negative interest rates, some bonds were sold at prices higher than their face value. So, if you had paid $1,100 for a 10 Year US Treasury with a face value of $1,000, even holding it to maturity would still leave you with a $100 capital loss.

So, the capital adequacy of many banks is a fiction, and so are the so called “Stress Tests” carried out on them by central banks. Banks do not hold sterile assets if they can avoid it. In other words, they hold government or corporate bonds that pay interest. The investment banking side of banks and finance houses, of course, also hold shares in companies, and as with all such speculators over the last 30 years, their attention turned away from the revenue they could obtain from these assets (interest, dividends, rent) to the capital gains that could be obtained as asset prices continually rose due to the implementation of QE, and other methods of creating excess liquidity. But, now, as liquidity has sloshed out into the real economy, and inflation has risen, central banks have had to try to curtail that excess liquidity.

Their preferred method is to try to reduce inflation, by, again, hitting workers. The interest rate rises they have introduced have been designed to try to slow the real economy, causing workers to be unemployed, so that they do not demand higher wages to cover rising prices, and also to dampen demand so that firms do not expand, and demand additional capital causing market rates of interest to rise. It hasn't, and will not work, in current conditions, for the reasons I have set out in previous posts. The real means of reducing inflation would be to curtail liquidity by reversing QE, and implementing QT, but central banks will not do that aggressively, as it would lead to a squeeze on profits from higher wages.

So, they are stuck. They have to keep raising their policy rates, but, doing so hits asset prices far more than it slows the economy, or dampens inflation, as the current data on jobs, retail sales, and inflation shows. As asset prices fall, the true extent of under capitalisation of banks and financial institutions is again revealed, and especially, when, as with SVB, they are forced to sell those assets at market prices, which are now much lower than the book value of those assets on the balance sheet. That is also what happened in 2008. It is also what happened on an even bigger scale in Japan in 1990, when asset prices crashed, and with property prices crashing 90%.

SVB has been highlighted, because it is in Silicon Valley with a lot of high net worth customers. It has also suffered, as a creditor to a number of tech start ups, from the fact that following the ending of the tech boom created by enforced lock downs, the share prices of many of those companies has crashed, and the large expansions they undertook have been cut back. If you had invested in a bond fund that you saw producing a yield of just 1.79%, whilst you see the possibility of getting 4%, by simply buying a US Treasury, you will want to take your money out of the fund, and buy the Treasuries. That creates pressure from redemptions on the fund, an so, when banks and other financial institutions, then, have to sell the bonds in those funds, to meet the redemptions of customers, they have to sell them at current market prices, and not the face value. That is what happened to SVB, but it will no be alone.

And, nor is it just in relation to bonds. As interest rates have risen so also share prices have fallen, though by nowhere near enough to remove the froth in that asset class. 90% of the lending of banks has gone not to finance capital investment by businesses, but to finance property purchases and speculation. Recent UK data shows that sellers have been reducing asking prices for houses by an average £14,000 in recent months, as the effects of rising interest and mortgage rates take effect. Yet, you still see the adverts for all of the equity release scams. This time the lenders on these scams are likely to be the ones burned. They lend money to the unwary against the value of their house, on the basis that when they die, the lender gets their money back plus a large wodge of interest on it, from the proceeds of selling the house. The premise, as with the 125% mortgages provided by Northern Rock prior to 2007, is that house prices continue to soar. But, a sharp fall in house prices would leave them trying to get their money back from houses whose value might, then, be lower than the amount they loaned.

It might be said, as with 2008, that the problem is the complexity of financial systems, but that complexity arose to try to get around the underlying problem. Mortgage backed securities arose to get around the problem that some mortgages were a bad credit risk, but by bundling them with other mortgages the risk was spread. It allowed the paper chase to continue, but the real problem was the fact that money had been lent to buy properties whose prices were way too high, and caused buyers to go into unsustainable levels of debt compared to their earnings. It is the fact that asset prices have been astronomically inflated, and that the balance sheets of banks and financial institutions are a fiction based upon those inflated prices that is the real problem, and as higher interest rates now cause those asset prices to fall, that underlying problem is again exposed.

Following the Eurozone Debt Crisis, and crash of a number of EU banks, I pointed out that the actions of the ECB in simply increasing liquidity, pumped into those banks was a sticking plaster over the real problem, which was their lack of adequate capital. The ECB produced one scheme of QE after another under different names, and continued to do so up until this year. Europe has a further problem, which is that it has too many banks, which need to be rationalised into a smaller number of bigger banks, with better capitalisation.

Following the sharp drop in US bank shares yesterday, the price of bank shares in Asia also fell sharply overnight, and as trading began in Europe this morning drops of around 6% were seen there too in bank shares. The shares of some of those banks whose precarious condition I have set out before, such as Deutsche Bank, fell even more. As with 2008, and as with the crisis faced with UK pension funds last year, the interconnected nature of banks and financial institutions means the danger of contagion is ever present. It hasn't just been bank shares that fell, but stock markets overall have fallen by around 2% in the last 24 hours. It shows the insane nature of this casino as against the real economy, and yet it is the casino that central banks and states have nurtured in the last 30 years, at the expense of the real economy. That is because the ruling class owns its wealth in these fictitious assets, rather than in the form of real capital.

As the gamblers in the casino again lose their shirts, workers should not be too worried about it, but must instead insist that the madness there not be allowed to affect the real economy. We need to ensure that the banking system, as a transmission mechanism for currency and means of payment, continues to function smoothly, which is why it should be separated from the lending and speculation sides of banking and finance. We should refuse to allow the state to impose austerity or other means of compensating the speculators for their capital losses, as happened in 2008. If banks collapse, their workers should be allowed to simply take them over, and run them as cooperatives, and we should bring hem all together in one large financial cooperative designed to meet the needs of workers rather than speculators.

Bank of England Doublespeak

The Bank of England, yesterday, as with other central banks described its reasons for engaging in more QE, i.e. printing money tokens on a vast scale, despite the fact that the world is awash in such worthless paper.  The Bank admitted that without addition QE, the level of borrowing by the UK government to finance its insane lockdown policy had reached a level where it would not have been able to borrow enough in capital markets, and where, consequently interest rates would have skyrocketed.  What the bank did not admit is that is the reality, and that the actions of central banks have not changed that reality, but only delayed, and changed the form of its appearance.

Bank of England Governor, Andrew Bailey, proclaimed that, of course, the Bank does not but government paper in the primary market.  In other words, when the government debt office issues new government bonds to borrow money, the Bank of England does not print money in order to buy those bonds.  That is possibly against its charter.  It amounts to monetising the government debt, the equivalent of what in previous times was achieved by states reducing the amount of gold in the coins they minted, and using these devalued coins to pay its creditors.  The Bank of England, Bailey pronounced, only buys government bonds in the secondary markets, i.e. existing government bonds that individuals and institutions have previously bought, and now seek to sell.

But, of course, this is just Doublespeak.  What Bailey didn't say was that when the Ban buys these bonds in the secondary markets, the money tokens it pays for them, money tokens it has just printed, does not just disappear.  It goes into the bank accounts of those who sold those bonds.  Then that money is used by the sellers of those bonds to buy other financial assets, and at a time when central banks are printed oodles more money tokens, with the stated purpose of buying bonds and inflating their prices, the sensible thing for the owners of that newly minted, devalued currency is to buy those also newly printed government bonds, because their prices are likely to rise, and so large capital gains can be had on them.  Moreover, if that doesn't happen, then those bonds will themselves become saleable in the secondary markets, and so the Bank of England can always then be on hand to buy those bonds too, so as to reflate their price, and avoid the top 0.01% who are the main owners of such fictitious capital from suffering any capital loss from it.  This is what is called moral hazard.  It means the super rich, the owners of all this fictitious capital get to keep any capital gains from the rises in these asset prices, but any capital losses they might have suffered are not born buy them, but are socialised, because the state steps in to rescue them, by printing money to buy up those bonds, and inflate their price.  Its like the government saying it will repay you any money you spend on the lottery, but you can keep any winnings you get from it.

No wonder the owners of this fictitious capital, the shareholders in companies, have been loathe to use profits to invest in new productive capacity, and instead prefer to continue speculating in the casinos of the financial and property markets.

But, what Bailey also didn't say, is that the fact that the government almost came to a point, in the last few weeks, where the level of borrowing to finance its lockdown policy was unsustainable, is not just a matter of the astronomical scale of that borrowing but of what that borrowing is for.  When central banks print money tokens and use it to buy bonds, whilst governments are not issuing them, or issuing them on a reduced scale, a part of their programme of austerity, the money tokens that the Bank throws into circulation, simply goes to buy up existing bonds (or other financial and property assets) which causes their price to rise, and the yield on those assets to fall.  It gives the delusion of falling interest rates.  What is different now, is that governments are issuing bonds to finance astronomically inflated levels of borrowing to cover astronomical levels of unproductive consumption.

Its one thing when governments borrow money for productive consumption, for example to build a new road, school, or to employ more teachers, and so on.  All of this represents capital accumulation, and the value it represents get put back into the economy, at shorter or longer time periods.  A new road, for example, is value that is reproduced, via the wear and tear of the road, as part of the value of goods and people along that road, which is repaid to the government either out of tolls, or out of taxes.  But, the vast amounts of government borrowing now being undertaken are not for such investment, quite the opposite.  It is government borrowing to finance consumption, whilst simultaneously paying people not to produce all of the commodities whose consumption is being financed!  Its the equivalent of the Common Agricultural Policy paying farmers not to produce food, whilst the subsidies given to those farmers, provide them with a revenue that enables them to consume commodities.

So, assume I own £100 million of government bonds.  The Bank of England prints £100 billion of new funny money, via QE, and uses it to buy £100 billion of existing bonds in the secondary markets from me, and 1,000 or so other people also holding a similar quantity of bonds.  So, now the £100 million that the Bank of England pays me for my bonds, goes into my Bank Account.  I now have £100 million to spend, as does each of the other 1,000 or so people who sold their bonds to the Bank.  But, now the government issues £100 billion of new bonds to finance all of its borrowing.  Seeing, that the Bank of England continues to be prepared to destroy the currency via QE to keep bond prices inflated, I use the £100 million the bank has given me, and buy £100 million of these newly issued government bonds, confident that, even though they are now producing a negative yield in nominal let alone real terms, the price of the bond is likely to go higher still, given the role of the central bank, and so I stand to make a 10, 20,30, 40, 50 or 60% capital gain, in short order, more or less free of any risk, so long as the Bank can step in to bail me out. 

As I pointed out a while ago, that is what happened with Austrian 100 year bonds, which were issued with a 2% coupon, but which within a matter of a few years had risen in price by 60%!

The difference now is that, instead of me using the £100 million the Bank has given me for the bonds it bought from me, to myself buy existing bonds, or shares, or property, in anticipation of them providing me with these large risk free capital gains, I buy the newly issued government bonds.  Previously, in buying existing bonds, shares, or property, my £100 million would go into the bank accounts of the pother speculators who owned those assets, and they would, in turn us the money to buy other existing assets, in an endless paper chase that simply pushes these asset prices to ever higher and more ridiculous and unsustainable levels.   It means that more bigger fools get on the treadmill driving prices higher.  For example, recently a new stock trading platform - Robinhood - has come into existence that charges no commissions on the buying and selling of shares.  It has encouraged large numbers of amateur speculators into the market.  In recent days on the announcement that Kodaak was going to be producing chemicals for use in COVID19 medications, its share price rose 20 fold from $2 to $40, driven by large numbers of retail speculators using Robinhood.  This is a pretty sure sign that all of this speculation is in hyper bubble territory, which inevitably means a massive crash is at hand.  It has been driven by the vast oceans of funny money that central banks have pumped into circulation precisely to bring about such rises in asset prices, to protect the paper wealth of the top 0.01%.

But, now, instead of buying these existing bonds, shares, and property, and thereby inflating their prices further, I buy the newly issued government bonds.  Given that share prices have rocketed in the last two years, driven by all of this speculation, and I might now feel a bit wary of these high prices at a time when government lockdown of economies might send companies out of business, so that their shares become worthless no matter how many money tokens are printed, I am more likely to buy bonds than shares.  But, also, the last few weeks has shown that with negative yields on bonds, and that reflecting the fact that their prices are at astronomically high levels, I might also be a bit wary of buying bonds too.  So, I might decide to buy something that appears to have real value like gold.  So, the price of gold has gone from around $1200 an ounce a few months ago, to over $2000 an ounce.  Gold, of course, unlike Bitcoin, does have real value.  It is a commodity, and so a use value, and it requires labour to produce it.  But, its exchange-value, or more precisely its price of production (cost of production plus average profit) is more like the $1200 an ounce it was selling at previously that the $2,000 it has been driven up to by speculation.  It is again an indication that massive bubbles in asset prices have been created in all asset classes as a result of central bank money printing, and that when they burst they will all burst spectacularly.

Instead of all this funny money simply going round and round to push up asset prices, therefore, the fact that the government issues large quantities of bonds itself changes things.  The fact that the government issues these bonds not even to pay for productive consumption but to finance unproductive consumption changes things even more.  Now, as the government issues its £100 billion of bonds, the £100 billion of new funny money printed by the Bank of England, and used to buy existing bonds from me and other bondholders, goes out of my bank account, and buys these new government bonds.  The money tokens then goes into the governments bank account.  From the government bank account it goes out to individuals via companies, as part of the furlough scheme, and other similar schemes.

So, now, this £100 billion of funny money printed by the Bank of England goes into circulation and is used by its recipients to buy commodities such as food, clothing and so on.  But, these payments were payments for people to stay at home, and not produce all of this food and clothing etc. that they are now being paid to consume!  The consequence of all this funny money chasing after the goods and services that have not been produced, because the government has paid them instead to stay at home as part of its lockdown that has destroyed the economy, is that inflation inevitably rises.

But, as inflation rises, this has other consequences.  The households that see the prices of food, clothing hair cuts and so on rising, need higher wages to cover these inflated costs.  Businesses, faced with higher prices for the raw materials and the wages they must now pay as a result of the inflation, themselves increase their prices, causing inflation to rise faster, but they must also borrow more money tokens to be able to buy these commodities in order to produce.  The government, also sees the prices of commodities rise, such as the things it buys for hospitals, schools, to build and repair roads, and so on, as well as seeing its own wage bill rise sharply.  So, it too has to borrow on an even more massive scale in order to deal with the inflation that the printing of funny money by the Bank of England, to cover all this borrowing, has in the first place created.

And, so as households, businesses, and government have to borrow on an ever increasing scale to compensate for this ever rising inflation, this increased borrowing again pushes up interest rates that the inflation inducing money printing was supposed to have prevented!  It hasn't, its simply deferred it, changed its form, and made it worse.  But, it hasn't even started yet.  Its not just all of the unproductive consumption that the government has financed that represents the biggest borrowing that is to come.  Its the loss or government taxation as businesses go bust, and workers lose their jobs in the millions.  Its the vast rise in welfare payments to cover that mass unemployment.  It is the loss of taxation, as company profits disappear, and the trillions of Pounds that will have to be spent bailing out the large strategic companies such as airlines, aircraft manufacturers, and so on that will put the £2 trillion bail-out of the banks after 2008 in the shade.

There is no amount of printing of funny money that is going to cover all of that borrowing to finance unproductive consumption, as inflation rises inexorably over coming months.  And, as in 1990, when unemployment rises, and interest rates rise, causing mortgage rates to rise, so that even those in work find them can't pay them, and those not in work, become forced sellers of massively overpriced, and rapidly depreciating houses, the collapse in asset prices that ensues will expose the true nature of the continued bankruptcy of the banks and financial institutions that has simply been paper over by money printing to inflate the prices of assets on their balance sheets.  So, this time round the bail-out of the big industrial companies will not be instead of but, in addition to the need to bail-out those banks and financial institutions.

Alternatively, of course, we could demand that the government undertakes no such bail-outs, which amount to a bailout of the shareholders in all these companies.  We could say, them go bust on paper, let their shares and bonds become worthless.  The let the workers in all those companies simply take over what is really important - the actual productive-capital, the factories, shops and offices, the machines and equipment, the raw materials and so on.  That is, let the associated producers exercise the control over the socialised capital, which is actually their collective property in the first place.  Let us end the control over that capital by the shareholders and speculators that have created this economy of the asylum, and begin to produce for human needs, and to use profits rationally to expand that production, rather than to pay out dividends to speculators so that they can continue to gamble with our futures. 

No Capitulation Yet

Yesterday, global financial markets fell by around 10%. Its a big drop. Over the last month, the drop is comparable to the 1987 crash. But, in 1987, stock markets dropped 25% in a day. Moreover, in 1987, it was the start of the process of inflating asset prices, as a result of falling global interest rates, supplemented by central bank policies to reflate them whenever, as in 1987, those bubbles burst.

Today, we are at the end of that process, with sequential bubbles having been built up, burst, and then reflated throughout the 1990's, and early 2000's, leading to the 2008 crisis, and even larger reflation of those bubbles by central banks on the back of an unprecedented destruction of currencies by central banks, via money printing, and associated destruction of real capital, and economies via that very process, and via measures of fiscal austerity. It has signalled the death knell of private capitalism as, now, the state has taken over the last function that private capital was claimed to perform – supplying money capital for investment. It has driven capitalism deep inside the rabbit hole, with negative interest rates. The 10% drops do not yet represent capitulation – when all those market bulls who think that falling prices are an opportunity to buy, give up, and themselves begin to sell. It represents only a bit of the froth built up over the last year, being blown off. Given the difference between now and 1987, a real capitulation will see asset prices drop by around 75-80% in a couple of days. 

Today, after central banks, around the globe, have again acted to destroy currencies by even more money printing, in order to buy up those worthless paper assets, governments have proposed, as in 2008, to return to Keynesian fiscal intervention with large-scale spending to stabilise the chaos. Financial exchanges have introduced restrictions on short-selling, which is a desperate measure that history shows acts to limit falls in prices, in the short-term, by creating an artificial short squeeze, but which only results in even greater selling and panic down the road. There is after all a reason why the short sellers think that asset prices are going to fall, and are prepared to bet on it. So, after all that firepower was unleashed, today, (at the time of writing in early afternoon)  has seen a dead cat bounce that has restored about half of the falls seen yesterday. So, no capitulation yet, though its Friday 13th. and, in the current climate, its a brave or foolhardy speculator who will go into the weekend holding long positions on anything. 

The problem for central banks, and for states is that, in a few weeks time, all of the people that have been encouraged to take time off work will return. Over the current period, inventories are being run down. Its not just supermarket shelves being emptied by panic buying, but the suppliers of those supermarkets and other outlets that are running down their inventories so as to resupply them. With at least some of the workers in those firms being off work, production is slowing down. Their supply chains, particularly those that extend across the globe, are being broken, so that they begin to run short of supplies, and the prices of those supplies where they can get them start to rise. Its a microcosm of what lies ahead, for Britain, as a result of Brexit. 

A look at Britain, in the last few months, illustrates the point. In the three months to the end of January, UK GDP was zero. In the period before the election, the economy shrank, as expectations of Brexit increased. Its being proposed that this kind of stagnation in production, or even recession will result in a fall in prices. What, however, was the reality? UK CPI inflation, in fact, in January, came in at 1.8%, compared to a figure of 1.4% the previous month, a jump of 22%. In fact, at 1.8%, the figure is a hair's breadth from the Bank of England's target figure of 2%. The RPI figure came in at 2.7%, as against forecasts for 2.6%. So, rather than a stagnant economy causing a fall in inflation, it has been accompanied by a rapid acceleration, a sure indication of stagflation appearing. 

The US economy has also slowed due to Trump's global trade war, which is based on the same kind of economic nationalist nonsense as Brexit. Yet, the US also saw employment rise by 225,000 in January, and by an even larger 275,000 last month. What is more, the US has also seen inflation rising, alongside that slowdown, and alongside COVID19. US CPI rose 2.5% in January, and by a further 2.3% last month. One simple reason is that Trump's trade war, by imposing barriers to trade, and thereby imposing additional costs on production, has increased the value of a whole range of commodities, reversing a process that had been going on for more than 40 years, when the value of commodities has been falling, because of rising productivity in production and distribution. With the world awash in liquidity, pumped out by central banks, and more being flushed into the system by the hour, these rising costs are finding their way into prices. With coronavirus constraining supply even further, and inventories being run down at a rapid rate, the imbalance of supply and demand is now likely to see further rising prices feeding through, and when the panic subsides, and consumers rush to the shops to restock their larders, freezers and cupboards, and retailers rush to restock their shelves, and producers rush to buy in supplies, and take on additional workers to meet these demands, a further imbalance of supply and demand is likely to cause prices to spike even more. With employment at high levels already, its likely to cause a spike in wages. 

Already, with firms being told to pay their workers two weeks sick pay for self-isolating, and with the state agreeing to bankroll some of those small firms for doing so, some of the ocean of liquidity is being sent into circulation, whilst, for some firms, the payment of sick pay will come either from their profits, or from working-capital financed by circulating credit lines. There are already reports that some large companies, facing cash flow problems, as demand for their goods and services dries up, are drawing down their credit lines from banks, and, if this happens on a large scale, this could mean that banks liquidity begins to be drained, causing them to need to liquidate assets to restore liquidity. Its for that reason that central banks have relaxed banks capital reserve ratios, but that simply increases the likelihood of another 2008 style financial crash, if they run down their cash relative to assets, and then find that they have to liquidate assets quickly, in a period of panic when the prices of those assets is dropping like a stone. 

Either way, it means that firms are either not putting as much of their profits into the capital markets, or are even having to supplement their working-capital by additional borrowing simply to keep trading and pay bills, be it for wages, or to suppliers. That is happening alongside states also borrowing additional money, be it to pay out for current revenue as benefits, bungs to businesses or else to finance the capital spending programmes they have been led to announce as part of a counter-cyclical Keynesian fiscal stimulus. Yes, borrowing costs for states are at record low levels, and even, in many cases negative in nominal terms, and in many more cases, negative in real, inflation adjusted terms. So, that means that governments are being paid by speculators to borrow money. But, in reality, that is a delusion. Those low bond yields are a function of the fact that central banks have printed money so as to buy up those bonds, and keep their prices inflated, and even rising, so that the owners of that fictitious capital, the top 0.01% did not suffer large capital losses on their assets. 

The low yields on those bonds, was premised on the fact that the central bank would buy them up with printed money, so as to inflate the price, so long as governments did not engage in additional borrowing, which would increase the supply (and so depress the price of) bonds, let alone that they would use that borrowing to put additional demand for goods and services into the economy. The same is true with corporate bonds. Large corporations have been allowed to borrow at the same kinds of rates as states, so long as the money they borrowed was used to buy back shares, or to speculate in the shares and assets of other companies, thereby inflating those asset prices. It would have been a completely different matter had large corporations issued those bonds so as to finance real capital investment, which would also have then stimulated the economy, and increased aggregate demand for goods, services and labour-power. The asset prices bubbles blown up over the last decade have been based on such a requirement that printed money went into buying assets and pushing up their prices, whilst governments implemented austerity to restrain economic growth, and corporations borrowed money only to finance financial speculation, and capital transfers to shareholders. 

The rest of us, of course, did not benefit from those low interest rates. We have continued to have to pay 30% p.a. for credit card debt, and up to 4000% if you are unlucky enough to have to borrow from a payday lender. Some of the smallest businesses, and self-employed are in the same position, when it comes to financing their businesses. Even medium sized businesses, find themselves paying up to 10% to borrow from peer to peer lenders, and so on, unable to enter the bond or stock markets to raise finance, and finding that many banks either will not lend to them, or will do so only at higher rates of interest. In fact, for many individuals, the low interest rates on savings deposits means that those on fixed incomes get screwed, reducing their real incomes, and so depressing aggregate demand. It acts as a further encouragement to engage in speculation, either to become a buy to let landlord, or to speculate in stocks and shares. It is all part and parcel of the drive to keep those asset prices inflated, whilst depressing the real economy, and thereby to keep the paper wealth of the top 0.01% protected. 

When people return to work, and, before that, when they find they must replenish their cupboards and freezers, the immediate effect will be to expose the shortages that have built up, and will result in a spike in prices, as the available supplies get rationed out by the price mechanism. Seeing this spike in prices, and consequently of profits, retailers will scramble to restock so as to sell more while that situation lasts. Having depleted their cash balances, and working-capital, they will have to borrow to do so, particularly the smaller retailers. This spike in borrowing will cause real interest rates to spike, i.e. not the rigged official interest rates of central banks, or the similarly rigged yields on government and corporate bonds, but the actual interest rates that individuals and businesses have to pay, in the market, for every day purposes. But, that too will feed through. As those businesses seek to restock, their suppliers will also face a similar problem. That problem is made worse, in Britain, due to the frictions that Brexit is imposing, and, in the US, by the effects of Trump's tariffs. It means the prices of those inputs will also spike. 

Its at this point, when all of the liquidity begins to swill into the real economy, and finances rapidly rising prices caused by shortages of supply for labour and materials, exacerbated by the frictions imposed by policies of economic nationalism such as Brexit, that interest rates will rise sharply, and its at that point that we are likely to see the real capitulation, as rising interest rates cause asset prices to crash.

Bank of England Fires Blanks

The Bank of England this morning, in a clear act of sheer panic, slashed its main interest rate by 66.6% from 0.75% to just 0.25%. If it had cut any more, it would have been a 100% cut, reducing the rate to 0%. It shows that capitalism has well and truly disappeared down the rabbit hole that the owners of fictitious capital and their representatives in the state, and central banks, have dug over the last thirty years. In reality, even at 0.25% this amounts to a negative real rate of interest after inflation. Inflation, as currently measured by CPI, is 1.8%, meaning that the Bank's main rate now stands at -1.55%, in real terms. The bank is paying borrowers to take money off its hands! 

Of course, those borrowers are not the likes of you and me. The best we can get from this is a mortgage rate of around 3.5%. in order to encourage us to speculate in property, so as to keep that particular asset class inflated in price along with the prices of other assets such as shares, bonds and their derivatives. If, on the other hand, you want to borrow to consume, then you face an interest rate of up to 30% p.a. on your credit card, and more on store cards. If you are in the unfortunate position of being even more desperate to borrow to consume, given more than a decade of stagnant or falling real wages, and have to borrow from a payday lender, you face interest rates of up to 4000% p.a. Nor is it it just the likes of you and me in this position. 

Small, and medium sized businesses have also been put in a similar position. Often they can't get loans from banks at all. Where they have, stories, over the last few years, have shown the way they were also tied into various costly protection schemes, much like the PPI racket that banks inflicted on individual borrowers. Its often resulted in businesses closing down, and the banks liquidating their assets. To be fair, there is often a good reason for the banks not lending to many of these companies, because they are fundamentally unprofitable. Around 75% of new businesses go bust within the first five years; a large proportion in the first year. So, its not surprising banks are loathe to lend to such companies, given that there is far more profitable and secure areas into which they can lend, such as that which finances the speculation in property and other assets, whose prices have been massively inflated, as a result of central bank and state intervention over previous decades. 

There are over 150,000 zombie businesses, in Britain, that can barely cover the interest on the bank loans they have, let alone repay the capital sum they borrowed. These firms have been given every assistance by conservative governments over the last 40 years. Starting with Thatcher, the state used its power to undermine the power of workers and their unions to defend wages and conditions. That disproportionately benefits this plethora of small private capitals that tend to be labour intensive, and rely on cheap labour, and poor conditions for their existence. Thatcher's government also gave them other incentives, including the creation of Enterprise Zones, which meant that those that could get into them were given an unfair advantage over their local competitors, because they were relieved of various costs and taxes, and exempted from having to abide by certain minimum standards. Cameron's government revived the idea, but failed to implement it, but the current Tory government is reviving it in the form of proposals for free ports. 

Conservative governments have also provided support and subsidies for these small businesses in other forms. On the one hand, the policy adopted by Thatcher in the 1980's of deregulating credit and financial markets, is what has led to the sequential bubbles in asset prices that have been blown up and then burst, since 1987. On the other hand, one purpose of that policy was to enable small companies to get away with paying low wages, because workers were encouraged to make up the difference by borrowing. The more their house price rose, the more they could borrow against it, and use the borrowed money to finance their current consumption. Its the very thing that conservatives object to when it comes to the state itself engaging in such activity.

UK Household Debt % of income

In reality, of course, despite all of the lies and hyperbola put out by the Tories, Thatcher's government, and Major's government after it, did not shrink the size of the state, they simply shifted where it spent money, and that in a bad way. Under them, state spending to finance burgeoning unemployment, and various forms of subsidies, such as Housing Benefit, increased, whilst spending on infrastructure, such as roads, railways, schools, hospitals, council houses and so on, which could have raised productivity levels, and profitability, was cut. To coin a phrase, not only did they sell off the family silver, but they failed to mend the off whilst the sun was shining. Like a bad landlord, they let the fabric of the building rot around the tenants, whilst demanding ever higher amounts of rent. 

 

UK Deficit To GDP Under Tory and Labour Governments.
Despite the Lies, the figure under Blair/Brown was half that
under Thatcher/Major.

From the 1980's onwards this conservative policy built a low wage dependent economy, with low productivity. It relied on growing debt. The biggest increase in debt was in the private household sector, as the burden was shifted on to individuals. But, the unproductive expenditure of conservative governments also increased that debt. Despite the lies told by the Tories, the average level of budget deficit to GDP during the Thatcher/Major years was double that during the Blair/Brown years up to 2007. Whilst Thatcher and Major managed just two years of budget surplus in the 18 years they were in government, Blair/Brown managed 4 years of budget surplus. 

The Bank of England's frantic measure to slash its main interest rate simply follows in this long line of failed, and destructive policies. As I wrote recently, in relation to the decision of the Federal Reserve to cut its rates, they present it as being to provide support for the economy, but nobody believes that any more. They can barely present such a statement with a straight face. The problems facing British capitalism are not down to the fact that its cost of capital is too high at 0.75%, and are not going to be resolved by cutting it to 0.25%! That is just a drop in the ocean compared to the hit to their fortune that Brexit will impose on them, which is likely to reduce UK GDP by at least 8%. 

Large UK corporations, like large corporations throughout the globe can borrow at very low rates. Unlike, the small and medium sized businesses, the large corporations generate huge amounts of cash flow. They can utilise vast amounts of realised profits to finance their own expansion. On top of that, the sheer size of their operations means that they have large cash hoards separate from such profits. With huge amounts of fixed capital, as Marx describes in Capital III, and Theories of Surplus Value, they also produce huge cash hoards for amortisation (i.e. to cover the wear and tear of the fixed capital). They do not have to keep that money sterile, but can utilise it to fund current spending and expansion, simply replenishing their amortisation fund at a later date, prior to needing to physically replace their fixed capital. Because other, particularly smaller capitals, are dependent on these large capitals for orders, the big firms can obtain commercial credit from them. They buy in materials and so on, but only pay for it later, and when liquidity becomes constrained, they simply use their power to extend the time that credit is extended to them, by making later payments. But, the large corporations can borrow in capital markets cheaply in a way that is not open to small and medium sized companies, because the large corporations can issue shares, via rights issues, or else by issuing corporate bonds. 

In fact, because the size of these large corporations is now so vast, bigger than some small economies, and because they make such large masses of profits, their bonds are AAA rated along with some of the more secure government bonds. As I wrote some years ago, describing the various bifurcations that exist in the global economy, on the one hand, we have small and medium sized businesses that need and want to borrow to finance their actual business activities, but which cannot do so, or can only do so at higher rates of interest, and, on the other hand, we have large corporations that can borrow easily, at low rates of interest, but who have little interest in borrowing to finance the expansion of their activities, because the shareholders in these companies are more interested in ensuring that they continue to be paid large amounts of dividends, or get capital transfers to them in other forms, or that the price of their shares be inflated, by the company using its profits, and its additional borrowing in the bond market, to finance the buy back of existing shares. A few years ago, Michael Roberts provided the following information. 

“as of August 2013, loans outstanding to UK residents from banks were £2.4tn (160% of GDP). Of this, 34% went to financial institutions, 42.7% went to households, secured on dwellings, and another 10.1% went to real estate and construction. Manufacturing received just 1.4% of the total! UK banking’s principal activity is just leveraging up existing property assets. I identified the same point in work done for the pamphlet for the Fire Brigades Union on the need for public ownership of the banks and found that the big five banks in the UK hold £6trn in assets. This is equivalent to the amount that more than 60 million British people produce in four years. Yet the banks have earmarked just £200bn of this to investment in industry in the UK, a measly 3% of the total.” 

The Bank of England, in its announcement, has said that it is introducing other measures of funding for the banks to encourage them to lend to these small businesses to address this criticism. But, its unlikely to be effective. The only small businesses likely to want to borrow, and to offer a viable prospect for the banks, will continue to be those involved in this same kind of property speculation. It will be people who want to become property speculators under cover of a company framework, and who borrow money to buy or renovate property in the expectation of making a capital gain from rising property prices, as central banks once more pour liquidity into the system, to reflate asset prices that have crashed over the last two weeks. There will no doubt be many small businesses that have seen their business disappear as a result of the moral panic over coronavirus unleashed in the last few weeks, but as Marx says in Capital III, their need for borrowing will not be to finance capital accumulation, but merely to be able to pay bills and stay afloat for a while longer, before going bust. Again, no matter how low a rate the banks are given by the Bank of England, it does not make lending to such borrowers any more attractive, when they risk losing the money they have loaned! 

The real purpose of the Bank of England's panic measure, as with all previous interest rates cuts, and QE, is not to support the real economy. On the contrary, it does the opposite. Its real purpose is to inflate asset prices, because it is those assets, fictitious capital, that now constitutes the form in which the top 0.01% hold their wealth. By continually inflating those asset prices, what the actions of the central banks does, is to divert money from the real economy into that speculation, and to divert money-capital that could have gone to real capital accumulation into such speculation. Who wouldn't engage in such speculation when you get to keep any capital gains you make, but when any losses you face are instead taken over by the state? 

The real nature of the Bank's measure was seen in those asset markets. Orthodox economic theory says that when a central bank cuts its interest rate, it should result in the currency of the country falling, as speculators move their money to other countries where they can get a higher rate of interest. But, as I pointed out some time ago, the Alice in Wonderland world capitalism has now entered, as a result of years of central bank intervention, means the opposite is true. Speculators are no longer interested in yield, and the lower those yields go, the less still are they interested in marginal absolute differences between one country and another. Instead they are interested in capital gain, and/or the avoidance of capital losses. So, when the Bank slashed its interest rate, the Pound rose by around half a percent against the Dollar, as money flowed into UK Gilts, whose price was bound to rise, as a consequence of the Bank's action. And, as money flowed into Gilts, reducing Bond Yields, it also, thereby made UK shares look cheaper, so the FTSE 100 rose by around 1.5%. No clearer indication of the real purpose of this kind of central bank intervention could be seen. 

But, these kinds of interventions have now been going on for 33 years, ever since the 1987 financial crash, and the introduction of the Greenspan Put. With each new financial bubble, and its subsequent bursting, the central banks have had to respond with ever lower official rates, ever more liquidity pumped into the system, ever more frantically trying to reflate the bubbles. All the time the action has undermined the real economy, and thereby the only sustainable basis for those asset prices. Within an hour, the gain on the FTSE had been halved, as I write, it has more or less disappeared entirely. 

In other words, the Bank of England fired its big bazooka. There was a loud noise, a huge cloud of smoke, but when the smoke cleared its target remained untouched. The Bank, it seems, is now firing blanks, which can only serve to instil even more panic into financial markets, and into the hearts of the owners of fictitious capital, because, at effectively zero interest rates, and below zero real interest rates, its clear that the Bank of England, like the Federal Reserve has shot its bolt. As James Bond said in Dr. No, “You've had your six, now its my turn.” 

To see, just how far down the rabbit hole capitalism has been sent, just consider what the current situation of negative real interest rates, let alone negative nominal yields on bonds actually means. When a lender lends money, then, as Marx describes, what this is is a sale of capital as a commodity. The use value of capital is that it produces the average rate of profit, and it is this use value that the borrower buys and pays for. The only difference in this sale of capital as a commodity, is that it is for a given period of time. What negative interest means is that the seller of this commodity – capital – is paying the buyer of this commodity, the borrower, to take it off their hands. It reminds me of the comment of Jed Clampett in the Beverley Hillbillies who commented what a nice fella Mr. Drysdale was for taking his $25 million and keeping it in his bank without charging him anything for doing so. 

Imagine that you went into your local TESCO, and when you went through the checkout, the cashier said, "here you are, we are paying you £50 for taking all of these items off our hands"! But, that is what is happening currently in the capital markets. Marx, in Capital III, said that a crisis of overproduction of commodities could not be resolved by having the bank buy up all of the overproduced commodities, but that is precisely what the central banks are currently trying to do with fictitious capital. Marx noted in Capital III, Chapter 23, that this fictitious capital, or interest-bearing capital is subordinate to real capital, i.e. productive-capital, because it is only productive-capital that produces profits, and its out of profits that interest is paid. If too much money went into becoming interest-bearing capital, therefore, the mass of profit would expand more slowly, whilst the price of capital itself, the rate of interest would fall. The value of money-capital would be massively depreciated, because not only would it produce a lower rate of interest, but the prices of financial assets would rise, so that the money-capital would buy fewer and fewer of them. 

“It would be still more absurd to presume that capital would yield interest on the basis of capitalist production without performing any productive function, i.e., without creating surplus-value, of which interest is just a part; that the capitalist mode of production would run its course without capitalist production. If an untowardly large section of capitalists were to convert their capital into money-capital, the result would be a frightful depreciation of money-capital and a frightful fall in the rate of interest; many would at once face the impossibility of living on their interest, and would hence be compelled to reconvert into industrial capitalists.” 

And, that is exactly what has been seen. For millions of ordinary savers, the near zero interest they get on their savings deposits would be impossible to live on. The near zero yields on the assets in pension funds, means they cannot produce the revenues required to meet their pension liabilities, so that they have had to sell the underlying capital assets in the fund, realising capital gains, to make up the difference, at the expense of thereby undermining the future potential of the fund to produce the required revenues. But, for the top 0.01% who now hold their wealth in the form of this fictitious capital, rather than in the form of productive-capital, this same fact, that instead of depending on revenues (bond interest, dividends), they can instead draw a revenue by realising capital gains, means they have no compulsion to have to convert themselves once more into productive-capitalists. At least, they do not so long as the state and central banks can continue to ensure that their assets rise in price, and they continue to obtain these capital gains. 

That is what central banks have done since 1987. It is what led to the financial meltdown of 2008. The underlying problem was not resolved after 2008. Instead, even more astronomical amounts of liquidity was pumped into the system to buy up worthless paper assets, and to reflate astronomically overpriced property. The Dow Jones today is 300% higher than it was in 2009, and similar rises in asset prices have occurred across the globe, as the interests of the owners of fictitious capital have been protected at the expense of the real economy, and real capital. The response to the Fed's rate cut was muted, little more than a dead cat bounce. The response to the Bank of England's rate cut does not even qualify as that. Watch out below!!!