by Michael Roberts
This is a big week for the central banks of the major economies.
The US Federal Reserve meets on Wednesday to decide on whether to
resume its planned series of hikes in its policy rate that sets the
floor for all interest rates domestically and often internationally. On
the same day, the Bank of Japan (BoJ) must decide whether to resume its
negative interest rate policy (NIRP) by going even deeper into negative
territory on its policy rate.
While both central banks appear to be going in different directions
(one raising interest rates because it wants to ‘control’ a budding
economic recovery and the other lowering rates in order to ‘stimulate’ a
stagnant economy) in reality both banks are in a similar position.
Their reason for existence and the credibility of their strategies are
in serious jeopardy.
The reality is that despite nine years of holding rates (until last
December) by the Fed and despite cuts and negative rates by the BoJ,
along with massive credit injections by both into the banking system
through ‘quantitative easing’ (buying government and corporate bonds
with the creation of new money), the economies of the US and Japan have
failed to recover to anything like the trend growth in real GDP (and per
capita) that was achieved before the Great Recession of 2008-9.
In effect, monetary policy as a weapon for economic recovery has
miserably failed. The members of both the US Fed and BoJ monetary
committees are divided on what to do. The Fed’s chair Janet
Yellen reckoned at the beginning of this year that the US economy was
on the road to achieving trend growth and full employment. But the latest data on the economy make dismal reading.
Not only has the real GDP rate slowed to near 1% with industrial
production falling, but now even retail sales growth, an indicator of
consumer spending and a key plus up to now for the US recovery, has
dropped back (at only +0.8% yoy after inflation is deducted).
The Fed has been following a monetary policy theory that there is
some ‘equilibrium’ rate of interest that can be identified that would be
appropriate for an economy to be back at trend growth and full
employment without serious inflation. The Fed calls this (imaginary)
rate, R*. This
idea is based on the theory of the neo-classical economist Kurt
Wicksell. The trouble is that it is nonsense – there is no equilibrium
rate. Even worse, the Fed’s economists have no idea what it should
be anyway. In their latest projection, they reckon R* is anywhere
between 1% and 5% for two years ahead, with a best guess at about 2%.
The current Fed rate is 0.5%.
And because the US economy has failed to get back towards pre-crisis
trend growth, the Fed’s economists keep revising down that estimate.
It’s the same with the BoJ. Their economists have no idea what
policy rate to set in order to kick-start the economy and get Japan out
of a deflationary environment. That is why they are conducting a ‘full review’ of monetary policy to be discussed at their meeting this week.
It’s clear that monetary policy has failed. As this was a major plank of so-called Abenomics in Japan (and strongly promoted by American monetarist Ben Bernanke and Keynesian Paul Krugman),
there should be egg on many faces. The response of the mainstream
economists has been to look for even more extreme measures of monetary
easing: NIRP is one, helicopter money is another.
Keynesian economic journalist Martin Wolf has been calling for
helicopter money. You see, R* is not really anywhere near as high as
the Fed economists think. The major economies are in a state of ‘secular stagnation’ caused
by ageing, slowing productivity growth, falling prices of investment
goods, reductions in public investment, rising inequality, the “global savings glut”
and shifting preferences for less risky assets. If we recognise that
R* is really low, then we can adopt the policy of handing out cash to
companies and individuals directly and combine that with more public
spending (with larger government budget deficits) on investment projects
– something advocated by many Keynesians, like Larry Summers.
But these answers are really an admission of the failure of
monetarism and monetary policy, something that Marxist economics could
have told the mainstream (and some did) years ago. Mainstream economics
(like Wolf above) still fails (or refuses) to recognise what Marxist
economics can explain: the capitalist economy does not respond to
injections of money (or, for that matter, injections of government
spending) but to the profitability of investment. The rate of profit on
capital invested is the best indicator for investment and growth, not
the rate of interest on borrowing. It is r, not R*, that matters.
I and other Marxist economists have spelt this out
both theoretically and empirically over several years. But it is not
only Marxist economists. Mainstream academic economics may ignore
profits as a key driver of investment and growth, but economists in
investment banks (who have the money and profits for investors on the
line) have started to recognise it.
First, there was Goldman Sachs, even if its analysis was locked into a neoclassical marginalist approach. Then there was JP Morgan. In a recent repprt, JP Morgan economists reckon that business investment and profits are closely correlated – “both business confidence and profit growth are highly statistically significant in explaining capital spending.” JP Morgan reckons that business spending “is
less a function of borrowing costs than of an assessment of the outlook
and profitability. On balance, this model explains 70-85% of the
variation in business equipment spending growth”.
Now there is Deutsche Bank. Deutsche Bank’s economists have noticed that “Profit margins always peak in advance of recession. Indeed,
there has not been one business cycle in the post-WWII era where this
has not been the case. The reason margins are a leading indicator is
simple:When corporate profitability declines, a pullback in spending and
hiring eventually ensues.”
From Q3 2014, when profit margins
peaked, to Q1 2016, domestic profits have declined by a little over
-$175 billion. Not surprisingly, the decline in profit growth has
occurred alongside a deceleration in domestic demand.
As Deutsche points out, the year-over-year growth rate of real final sales to private domestic purchasers, “our favorite indicator of underlying demand”, peaked at 3.6% in Q4 2014 and has since slowed to 2.6% as of last quarter. Deutsche goes on: “With
that in mind, the historical data reveals that the average and median
lead times between the peak in margins and the onset of recession are
nine and eight quarters, respectively, which, as DB concludes, “would imply that the economy could enter recession as soon as the second half of this year.”
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