wildcat.english

The Role of Central Banks

Wildcat magazine, autumn 2022

This week the Bank of England raised the interest rates once more, now reaching the highest level in 14 years. But what politics hide behind this ‘economic measure’? In the global context we can see that these measures are part of a currency war, where each economic block tries to protect their market, even if the result is that the general economic situation deteriorates further. First and foremost it is an attack on the claims of the working class. This becomes apparent in the recent quote from a member of the UK Monetary Policy Committee, who said that the central bank needed to combat “an inflation psychology that was embedding in wage settlements and inflation expectations”. We translated an article written by comrades from Wildcat that provides more background to the debate about the role of central banks in the global class war. 

Ten years ago, the European Central Bank (ECB) saved the Euro monetary union from breaking up by putting its foot down and then stabilising the currency system by guaranteeing low interest rates and a program of purchasing securities (such as government bonds) worth billions. This has led to a very skewed economic development. For example, the DAX (German stock market index) has risen by 290% since 2011 – whereas German GDP has only grown by about 13% during the same period. On the 27th of July 2022, the ECB raised the key interest rate by 0.5% for the first time in eleven years – 0.25% had been expected. On the 8th of September, the ECB raised interest rates again by a historic 0.75 percentage points. This panic-stricken move showed the central bank’s powerlessness. But why is it raising the key interest rate at all in the midst of an energy price shock and the onset of recession? For context, we bring you the following excerpts from the crisis article in this month’s Wildcat.

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In the US since 2008, government debt has tripled to nearly $32 trillion. Outstanding corporate bonds – which is money that businesses would have to pay back to the purchasers of the bonds – have more than doubled from $3.4 trillion to $7.4 trillion. During this year, credit card debt has increased more than at any time in the previous 20 years and now stands at $890 billion. If you include mortgages and car loans, American private household debt totals more than $16 trillion. If these mountains of debt can no longer be financed, the whole system is in danger of toppling.

That’s why it’s been a problem that interest rates have been rising on both corporate bonds and US government bonds. Since the beginning of 2022, we have seen a bond selling spree – people who hold them are afraid that they’ll drastically lose their value. Normally, bond prices go up when stock prices go down and vice versa. [1] Now both prices were falling – which has never been seen in the US securities market since at least 1945. By the end of April, US government bond losses were the worst since 1788, with talk of the “worst bear market for US bonds in history.” The Federal Reserve Bank, the US equivalent to a central bank, had to act! Already in March, the Fed had raised the key interest rate by 0.25 points – which was obviously too little. The second rate hike of 0.5% in early May was the biggest rate hike since 2000, and when the Fed raised it again by 0.75% in mid-June, it smelled of panic. Together with the renewed 0.75-point hike on the 27th of July, it was the most aggressive tightening of monetary policy in four decades.

How should higher interest rates fight inflation?

The International Monetary Fund (IMF) announced that, with their ”globally synchronised monetary tightening”, central banks risked a deep global recession. But according to the IMF, these measures were necessary, “until inflation is tamed.” Otherwise, “the problems (will) only be prolonged.” Businesses are running out of capital, the working class is running out of money because everything has been getting more expensive over the last year – and the central banks are responding by making restricting money supply even further. Nobody believes that food will become cheaper again just because we have higher interest rates! The Bank of England has raised interest rates the most, yet inflation in the UK is now already in double digits. Historically, attempts to fight inflation with monetary policy have always resulted in at least one recession.

The Fed wants to squeeze society’s ability to pay, or as the FAZ (German daily newspaper) puts it, to bring demand “in line with disrupted supply chains.” (FAZ 19th of May, “Now the bubble bursts”). Powell himself justified the measures by saying that one has to fight a “wage-price spiral” as well as “inflation(ary) expectations”, because the US labor market is “unsustainably hot”. So he wants to slow economic growth to depress demand for labor and thus increase unemployment. That would depress wages so that, in the end, prices don’t continue to rise.

Central banks want to shift the balance of power between capital and labour – and are balancing on a tightrope in the process: they want a severe recession to occur, but not a financial system crash. Back in 1979, the ‘Volcker shock’ was clearly a politically intended attack on the working class via means of recession. Back then, Paul Volcker, head of the Federal Reserve, boosted the interest rate from about 11 to over 20%, triggering a global surge in mass unemployment. Mexico went bankrupt, other emerging markets followed. Since then, according to the IMF, private household and state debt has tripled to over 150% of world GDP.

But in the current moment, are the central banks actually able to go as far as they would need to in order to “cool down” the labour markets in a way that would be in their interest? 

It is hard to imagine that central banks are currently able to raise interest rates to such an extent as to bring “demand in line with labour shortages”; the system would collapse. So what, at first glance, looks like a repetition of history, e.g. the central banks raise interest rates, strangle faltering economic growth for good, the value of the US dollar rises, an emerging market crisis ensues, is, at second glance, the end of what was pushed through and set in motion by the Volcker shock back in the late 1970s. Because a lower rate of inflation must actually be enforced, the money shortage alone did not automatically stop inflation, even in the early 80s. For that to happen, Reagan had to have the striking air traffic controllers taken away in handcuffs, the unions had to be smashed, the IMF had to impose its ‘reforms’ on the indebted countries, and so on. But today, the IMF is no longer the sole lender. And the Fed can no longer count unreservedly on a US dollar hegemony. “With the US dollar now being used as a global political weapon, its position as the main global reserve currency may suffer.” (Nouriel Roubini, WiWo 11th of August 2022) The global balance of power has changed: there are revolts in the global South; an increase in strikes; uprisings and ‘lying flat’ movements against ‘more work’ – even in China. [2]

Germany: “We are facing the biggest crisis the country has ever had” (employers association boss Dulger)

In the US, inflation is driven by strong consumer demand. Europe, on the other hand, is not suffering from too much demand, but from a lack of supply (missing oil and gas deliveries). So it makes even less sense here to raise interest rates to stall the economy. It is the Fed’s interest rate policy that puts pressure on the ECB and the other central banks. Higher interest rates in the US attract capital, the dollar exchange rate rises, the Euro exchange rate plummets, imports become more expensive. The Fed exports inflation and forces the central banks dependent on it to raise interest rates as well. To support the Euro exchange rate, the ECB must keep pace. (Each of the ECB’s last two rate hikes have exacerbated the crisis – and were reversed shortly thereafter). Initially, higher interest rates make everything more expensive: rents, electricity, gas, food….

In the Eurozone, the special conditions of this “half currency” (unlike the dollar or most other currencies the Euro doesn’t have a common government budget behind it) make it even more difficult to deal with the inflation; the ECB has to take into account the government bonds of highly indebted countries like Italy. (…) Interest rates on government bonds are already diverging again: in mid-June, German government bonds reached an eight-year high of more than 1.9%; at the end of June, a ten-year German government bond carried an interest rate of 1.7%, whereas, in comparison, an Italian one carried an interest rate of 3.7%. At the end of July, the rating agency S&P downgraded Italy’s credit rating to one notch above junk bond level.

That is why the ECB launched a new anti-crisis program, the so-called Transmission Protection Instrument (TPI) to buy up, if necessary, government bonds from states whose interest rates are deemed too high. Germany is caught between the Ukraine war and its dependence on China. Hardly any industrialised country is suffering more from the energy price shock. And because of its own economic problems, China is no longer Germany’s export economy’s full insurance policy for growth. According to an Ifo study, the “friendshoring” (meaning, only to include political allies into one’s international supply-chain) demanded by the US would lead to a dramatic economic collapse in Germany; “the export-oriented German economy could not really afford it.” Meanwhile, the DGB trade union association leader Fahimi also warns “of deindustrialisation in Germany” due to high energy prices.

A new debt crisis of the emerging markets and periphery?

Globally, a crisis is looming amongst the so-called ‘emerging market’ nations or the global periphery [Schwellenlaender]. Many countries were already heavily indebted; during Covid, their foreign exchange earnings declined; on top of that, there were the massive hikes in energy prices. Now the Fed is sucking capital into the US by raising interest rates and causing the value of the dollar to rise! This makes import prices more expensive and their dollar-denominated debt more expensive. In addition, the rising dollar is causing capital outflows; in March, April and May, international investors pulled $17.3 billion out of emerging markets, according to data from the Institute of International Finance. According to an article in the Financial Times on 10th of July, $50 billion worth of emerging market government bonds have already been dumped this year: “the most dramatic net outflow in at least 17 years.” In the same period last year, there had been inflows of more than $50 billion.

The situation is becoming untenable.

On the 19th of May, Sri Lanka had declared itself insolvent. The country is in the midst of its biggest supply and financial crisis since independence in 1948. At the beginning of July, the government sent two ministers to Moscow as petitioners, asking Russia to send tourists again – and especially urgently: oil. On the 9th of July, demonstrators stormed the president’s official residence in the capital Colombo and set fire to the prime minister’s house. (…)

On the 24th of July, the government of Bangladesh – after Sri Lanka, Nepal and Pakistan – became the fourth South Asian state to ask the IMF for financial assistance. Laos is also on the verge of national bankruptcy. And the crisis is not limited to Asia; El Salvador is heavily indebted and further burdened by the crashing bitcoin, Lebanon is nearly bankrupt, so are many African countries….

A UNCTAD survey found that 69 countries are suffering from all three shocks simultaneously, 25 of them in Africa, 25 in Asia and 19 in Latin America. JP Morgan bankers examined 52 emerging markets for solvency and saw more than half at risk of payment difficulties, including the Maldives, the Bahamas, Belize, Senegal, Rwanda, Grenada and Ethiopia. The IMF is already in talks with Pakistan, Egypt and Tunisia about possible ‘bailout’ programs…. Ecuador appears to be the next candidate….

In mid-June, the Pakistani government, faced with a mountain of debt it could barely manage, called on its 220 million compatriots (the world’s fifth-largest nation) to drink less tea. Pakistan could barely afford to import even the tea leaves. The Pakistani rupee has lost a third of its value against the US dollar in the past twelve months. Interest payments on the national debt account for more than 40% of the national budget. The government is currently negotiating with the IMF on the resumption of an aid program worth billions. As a prerequisite for this, it has had to cancel subsidies on gasoline, which has led to many protests (see the article on global revolts in the new Wildcat 110).