The US Federal Reserve is taking a risk. Yesterday the Fed’s Monetary Policy Committee raised its so-called ‘policy’ interest rate that sets the floor for all interest rates for borrowing in the US and often overseas. This means the cost of borrowing to spend in the shops or to invest in business expansion will rise.
Sure the increase was only 25bp (0.25%), from 1% to 1.25% but the Fed clearly intends to continue with further hikes (up to a target of 3% eventually). It has already stopped its quantitative easing programme (boosting bank reserves).
and now it is raising the price of money as well as reducing the quantity available. Money is getting ‘tighter’ to get.
The Fed is doing this because it believes (or hopes) that the US economy is now set on a sustained acceleration of real GDP growth back to the trend levels of 3%-plus seen before the Great Recession. The Long Depression, at least in the US, is over, according to the Fed.
But there are indicators in the US economy that the Fed has got it wrong. First, the Fed thinks that price inflation in the shops and for household services will eventually average 2%-plus a year and so it needs to raise rates to control rising inflation. And yet the very latest figures for inflation released this week show that it is slowing down, not accelerating. In April, US personal consumer inflation dropped back to 1.7% a year (core inflation is just 1.5%), with three months of little or no rise. Although the labour market is ‘tight’ with the unemployment rate very low, there is little or no acceleration in wage rises and consumer spending is weak.
This is very much against the traditional Keynesian economic thinking that tight labour markets lead to rising wages and inflation, in the so-called Phillips curve. The trade-off between low unemployment and rising inflation was exposed as wrong in the 1970s when capitalist economies had both high unemployment and inflation: stagflation. Now the Fed faces low unemployment and low inflation: ’secular stagnation’? The Phillips curve is not operating.
The Fed committee is ignoring the low inflation data and instead is emphasising the proposed pick-up in US economic growth that is to come. Yet the latest real GDP data do not justify that optimism. In the first quarter of 2017, annual real GDP growth was just 1.2%. Most forecasts for the current quarter (April-June) suggest a annualised growth rate of 2.5%. That means in the first half of the year, the US economy would be growing at around 1.8% a year, actually slower than in 2016.
The Fed is forecasting 2.2% for the whole of 2017 – hardly matching pre-crash growth rates. But even reaching that would require an annual growth rate of 2.6% for the second half of 2017. Indeed, the Fed expects a growth rate of only 2.1% next year and 1.9% in 2019, with a long-term growth rate of only 1.8%. This is hardly Trump-type projections of 3-4% a year that Trump claims he can achieve. Indeed, as John Ross shows in an excellent post, US capitalism has consistently shown a declining trend in growth rates, particularly in the 21st century. And that is due to the slowdown in business investment.
All this assumes no new recession before 2020. And that is the risk. Hiking the cost of borrowing when the economy is only growing moderately and inflation is low will put pressure on corporate debtors, causing a new reduction in investment and even bankruptcies. US corporate debt has never been higher as companies have piled up bonds and loans at very low rates of interest. Rising costs of borrowing could begin to turn the boom into bust.
Some Keynesians reckon the Fed should change its target for inflation to 4% so its policy rate would not be hiked until inflation reaches that level. Others say that letting inflation rise to that level and keeping interest rates low for much longer would create a huge financial credit bubble that could be uncontrollable as the economy accelerates. In other words, mainstream economics is flying blind, unsure what to do.
When the Fed started its hiking plan last December, I warned that the Fed was taking a risk that, given weak business investment, hiking interest rates might push a layer of US companies into difficulty and trigger a new recession or slump. Indeed, that was why the Fed held off further hikes for a while. But now it is taking a further leap into the unknown.
It’s true that, after falling in most of 2016, US corporate profits recovered a little towards the end of 2017. But corporate profits fell back again in Q1 2017, although they were up 3.7% from a year ago. But only including financial sector gains: non-financial sector profits were down on the year.
Globally, corporate profits have also picked up. Investment bank JP Morgan now follows closely the connection between global corporate profits and business investment (at least one set of mainstream economists who recognise the importance of profit in capitalist economies!). Readers of this blog will know that there is a close connection between profits, investment and growth in capitalist economies. JPM finds that global profits are now rising at 5% a year and thus project a similar rise in investment and growth. So maybe the improvement in profits, investment and growth in Japan and Europe will compensate for the continued weakness in the US. We shall see.
Moreover, the interest rate set in the US also drives interest rates globally, given the powerful role of US capital. There has been no real reduction in the build-up of private-sector debt in the major economies that took place in the early 2000s and culminated in the global credit crunch of 2007. That accumulated debt took place against a backdrop of favourable borrowing conditions—low interest rates and easy credit. Between 2000 and 2007, the ratio of global private-sector debt to GDP surged from about 140% to 163%, according to the IMF.
In the emerging economies, after the Great Recession the increase in private sector debt has been massive. Most of this extra debt is the result of corporations in these countries borrowing more to increase investment, but often in unproductive areas like property and finance. And much of this extra borrowing was done in dollars. So the Fed’s move to raise the cost of borrowing dollars will feed through to these corporate debts. The relative recovery in global corporate profits and economic activity in the last part of 2016 may not last through 2017.
Michael Roberts Blog 
“This means the cost of borrowing to spend in the shops or to invest in business expansion will rise.”
No it doesn’t. As Marx and particularly Engels pointed out, market rates of interest often move in the opposite direction to the official central bank interest rate. Already yesterday, the yield on US Treasuries actually dropped after the Fed decision, rather than rose.
When the Bank of England was cutting its rates over the last few years it didn’t stop the rates on credit cards staying at 30%, and didn’t stop the pay day lenders increasing their rates to 4000% p.a.
In the last few years, many small and medium sized firms could not borrow at all, because as you pointed out in one of your posts some time ago, the majority of british bank lending has been going to finance speculation in property, where the policy of the state has ensured they had guaranteed returns. Large firms have been able to borrow at low rates, via the rigged bond markets, but then used the proceeds in a similar way, to speculate in other financial assets including buying back their own stock to artificially inflate earnings per share figures, and simultaneously boost executives stock options.
“it is raising the price of money”
No it isn’t, because as Marx says the notion of a price of money is absurd. How can the price of £10 be say £12, as Marx asked the bankers of his time? It can’t. The rate of interest is not a price of money, but as Marx describes the market price of the use value of capital. That is also why that price cannot be determined by central banks, any more than central banks can determine the price of any other commodity. If they could, then as Marx says, why not have them set the prices of all commodities and thereby avoid all crises?
The rate of interest is the market price of the use value of capital, and determined by the demand and supply of capital. In fact, the secular fall in interest rates since the 1980’s, has been the clearest indication of the rise in the rate of profit that occurred during that period, because the major source of new supplies of loanable money-capital is realised profits.
That new supply of loanable money-capital has risen faster than the demand for it, hence the fall in the rate of interest over the last thirty years. In fact, by raising official interest rates, and sending the message that it intends to end its policy of inflating financial asset prices, the fed will remove the guarantee that speculators have had of continuing to make large capital gains, which has simultaneously thereby drained money-capital from the real economy and real productive investment. If anything it will act to encourage money-capital away from financial speculation and into real investment in productive-capital.
The Central Bank’s interest rate is the floor. Commercial interest rates may rise or fall, but they’ll never be bellow that of the Central Bank’s (unless madness is commanding those banks).
The Central Bank may or may be not paying attention to the general profit rate. Most of the time they are, since their very existence depend on that (that’s the dilemma the Fed is in now: can the American economy sustain a higher interest rate?).
Profit rates may be higher or lower than that of the average profit rate — but if they are higher they are basically a dead bill: you can charge 1,000,000,000% interest if you want, it doesn’t mean you’ll receive it.
“As Marx and particularly Engels pointed out, market rates of interest often move in the opposite direction to the official central bank interest rate.”
No, they never said that. You’re just plain wrong.
“Already yesterday, the yield on US Treasuries actually dropped after the Fed decision, rather than rose.”
So what?
“When the Bank of England was cutting its rates over the last few years it didn’t stop the rates on credit cards staying at 30%, and didn’t stop the pay day lenders increasing their rates to 4000% p.a.”
It’s not a problem for capitalism, because the commerical interest rate is still higher than the Central Bank’s interest rate. The BoE just determines the floor. What determines the ceiling for interest is the average profit rate and, in the case of borrowing for the working classes, how much they can be flayed without dying.
You say,
The central bank official rate should set a floor, but as Marx and Engels indicate there is no theoretical reason why it should, because the actual market rate depends upon the demand and supply for money-capital. As they show, it is easier for central banks to cause rates to rise, by withdrawing currency, than it is for them to decrease by putting additional currency into circulation. The reason being that the demand for money-capital necessarily requires that money-capital to be in the physical form of money (though as Marx shows it can take the form of the loaning out of machinery etc.). If money itself is withdrawn from circulation that restricts the availability of money-capital. However, as Marx indicates from the Banking Committee discussion, even this is not guaranteed to work, because firms can simply increase their use of commercial credit in their dealings with each other to replace the currency taken out of circulation. Given that firms nowadays deal with each on the basis of such commercial credit and electronic transfers that is even more the case.
By contrast, although money-capital necessarily takes the form of money/money tokens, money/money tokens do not necessarily take the form of money-capital. Additional liquidity thrown into circulation by central banks may just increase the circulation of currency, reducing the value of the currency and causing an inflation of commodity prices. Or, as has happened over the last 25 years, or so it goes to inflate asset prices, whenever those asset prices have threatened to crash, or after they have crashed – the Greenspan Put. Indeed, additional money/money tokens put into circulation can simply be hoarded. There is absolutely no mechanism by which it automatically becomes money-capital. So, its easier for a central bank to cause rates to rise by withdrawing currency than it is to reduce interest rates by adding currency.
“The Central Bank may or may be not paying attention to the general profit rate. Most of the time they are, since their very existence depend on that (that’s the dilemma the Fed is in now: can the American economy sustain a higher interest rate?).”
No, the Central Banks for the last 25 years or so have only been concerned to keep asset prices inflated, because it is the possession of financial assets and property that is the main form that capitalists hold their wealth. If bond, share or property prices crash, the wealth of private capitalists gets obliterated, and its from the ownership of that wealth that they exercise power in society.
The owners of that private fictitious wealth, and their representatives in the central banks do not give a toss if the real economy tanks, provided those fictitious capital values are kept inflated. At the very least, they want them kept inflated for as long as possible so as to offload any of their private holdings of those assets on to the state – as has been done with Greek sovereign bonds etc. – or on to workers pensions funds, so that when those asset prices crash it is workers via the state, or via their pension funds/ mutual funds that suffer the capital losses, not the private capitalists.
That is the process under way now, as the representatives of those private capitalists recognise that the end of the road has been reached of the process of using central banks to keep those asset prices inflated, because it now causes distortions due to negative yields, and the ability to keep asset prices inflated by becomes ever more difficult.
You say that I’m wrong that Marx and Engels said that market rates of interest can move in opposite directions to the central bank rate. No you are wrong.
Here is Marx’s comment,
“The power of the Bank of England is revealed by its regulation of the market rate of interest. In times of normal activity, it may happen that the Bank cannot prevent a moderate drain of gold from its bullion reserve by raising the discount rate because the demand for means of payment is satisfied by private banks, stock banks and bill-brokers, who have gained considerably in capital power during the last thirty years. In such case, the Bank of England must have recourse to other means. But the statement made by banker Glyn (of Glyn, Mills, Currie & Co.) before the C. D. 1848/57 still holds good for critical periods:
“1709. Under circumstances of great pressure upon the country the Bank of England commands the rate of interest.” — “1740. In times of extraordinary pressure … whenever the discounts of the private bankers or brokers become comparatively limited, they fall upon the Bank of England, and then it is that the Bank of England has the power of commanding the market rate.””
And in a note Engels notes,
“At the general meeting of stockholders of the Union Bank of London on January 17, 1894, President Ritchie relates that the Bank of England raised the discount in 1893 from 2½% in July to 3 and 4% in August, and since it lost within four weeks fully £4½ million in gold despite this, it raised the bank-rate to 5%, whereupon gold flowed back to it and the bank rate was reduced to 4% in September and then to 3% in October. But this bank-rate was not recognised in the market. “When the bank-rate was 5%, the discount rate was 3½%, and the rate for money 2½%; when the bank-rate fell to 4%, the discount rate was 2 3/8% and the money rate 1¾%; when the bank-rate was 3%, the discount rate fell to 1½% and the money rate to something below that.” (Daily News, January 18, 1894.) — F.E.”
That also shows that your comment,
“It’s not a problem for capitalism, because the commercial interest rate is still higher than the Central Bank’s interest rate. The BoE just determines the floor. What determines the ceiling for interest is the average profit rate and, in the case of borrowing for the working classes, how much they can be flayed without dying.”
is also wrong, because it depends upon market conditions, and the demand and supply of money-capital to what extent the central bank can influence market rates. But, more importantly, my point was that a rise in the Fed’s official rate does not necessarily mean that market rates of interest will rise, where those rates are already significantly above the central banks official rate. A pay day lender already charging 4000% p.a. will not raise their rate to 4000.25%, or 4100% p.a. just because the fed raises its rate by a quarter point.
The main effect is the effect on psychology in relation to asset prices, because asset prices are capitalised revenues. Yields have fallen to next to zero, because central banks have put a floor under asset prices by buying those assets whenever they fell. By indicating that that strategy has reached the buffers, the private owners of all that fictitious wealth know the game is up, and they have to start shifting out of those assets.
As Marx put it, though central bank QE policy has distorted and delayed the process,
“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.” (Capital III, Chapter 23, p 378)
And that is precisely the position they face now. They thought they could continually get wealthier not by productive investment and producing profit, but simply by enjoying paper capital gains, as the central bank guaranteed the constant rise of asset prices. Now their delusion becomes apparent, and all of the potential money-capital tied up in these speculative assets must be released and used as real money-capital for real productive purposes, to create the profit without which the financial asset prices collapse anyway.
That is why removing the adrenalin drip from those asset prices, is not going to cause real investment and economic activity to contract, but to expand, as once again the drive for profit rather than capital gains or interest becomes determinant.
The extent to which the central banks don’t give a toss about whether the real economy tanks provided financial asset prices are kept inflated is indicated by Marx’s comment,
“The credit system, which has its focus in the so-called national banks and the big money-lenders and usurers surrounding them, constitutes enormous centralisation, and gives to this class of parasites the fabulous power, not only to periodically despoil industrial capitalists, but also to interfere in actual production in a most dangerous manner — and this gang knows nothing about production and has nothing to do with it. The Acts of 1844 and 1845 are proof of the growing power of these bandits, who are augmented by financiers and stock-jobbers.”
Aside from the macro economic impact, could you please clarify what exactly the Fed does with the money once it receives a balloon principal payment from the Treasury, and it is no longer re-investing in new Treasuries?
The Fed, after all, never reports “cash” on the asset side of it’s balance sheet, like any other business might do!
Does the principal payment get *returned* to Treasury as “excess profits from operations”?!?!?! I can’t get an answer to this question. Perhaps it’s too basic a question, but would greatly appreciate understanding this.
https://www.wsj.com/articles/federal-reserve-sent-92-billion-in-profit-to-u-s-treasury-in-2016-1484067602?mg=id-wsj
Once a year.
Thanks for the definitive link!
SO….are the main stream economists and media RAVING MAD? what’s the big concern about “tightening”? what tightening? Treasury is, in effect, getting a HOLIDAY on principal repayment (+/- one year of maturity) on the Fed’s holding of treasury bonds! That’s free money to Treasury! Loose Fiscal conditions, no?
Could you please comment on why this article didn’t touch on the assumed reason for the hike – as a measure to cool the effects of a likely bubble in finance/tech/real estate, which are especially prevalent in the US?
I’m not sure Yellen hiked because of a bubble in real estate etc.