By Dick Nichols and Chow Wei Cheng
World financial market are in turmoil: interest rates soaring, stock markets plunging and the US dollar in free fall against the yen and the mark. On June 27, the Australian stock market lost $10 billion, its largest fall in three years.
Since world financial markets became fully "globalised" in the early 1980s, the potential for chaos on the present scale has always been present. Nowadays less than 5% of world financial flows correspond to trade in goods and services; the rest is funds being shifted from one financial asset to another in search of the best deal. Such a situation is pregnant with instability.
The present mayhem began with foreign holders of US government bonds, especially German and Japanese investment houses, selling these assets in February. This drove bond prices down and set yields soaring (see box). Between February and June, US 10-year bond yields went from 5.5 to over 7%, Australian yields from 6.4% to 9.7%.
Japanese finance houses had become convinced that the Clinton administration was deliberately letting the US dollar fall against the yen as part of its ongoing campaign to prise open Japanese markets to US exports. (Depreciation of the dollar against the yen reduces the value in yen of Japanese investments in the US.) The vast Japanese investment in US government paper began to look less and less attractive.
Secondly, financial markets became convinced that US job growth was too quick and the trade deficit too big — and that the Federal Reserve (the US central bank) wasn't serious enough about containing the rise in inflation these trends portended. Bond yields had to rise to match the expected rise in inflation.
As Japanese and German holders of US bonds sold them off (converting US dollars into yen and marks), the US dollar depreciated further, prompting currency speculators also to unload dollars and further drive down the currency against its rivals.
However, the rise in rates is not just speculative. Over the 1990-1993 recession all governments in the advanced capitalist world have run large deficits, funded by issuing government debt. As these economies begin to move out of recession, private capitalists are looking to increase investment, adding to the demand for funds. Increased demand for credit also comes from expanding economies in South America, Asia and, to a lesser degree, eastern Europe.
'Real economy'
There are signs that Australian 10-year bond rates are steadying at under 10%. In this situation a rise in official rates is inevitable.
Home mortgage rates will rise for the average home owner by about $60 per week for every 0.5 percentage point increase in the mortgage rate. With wage indexation now a thing of the past, these increases will translate into a direct decline in living standards.
There is a danger, too, that the rise in rates will take the wind out of recovery, by causing capitalists to postpone or modify their investment decisions. This could sink the 14.5% increase in private investment forecast in this year's budget.
Overseas, economic forecasters are already considering the possibility that the rise in interest rates will reduce growth rates by anything up to 1.5%.
Australian interest rates must follow US rates if Australia wants to maintain low inflation. If Australian rates fall too far below the US rate, the Australian dollar will tend to depreciate because there is little demand for it from speculators. This increases the price of imports, adding to inflationary pressures.
Towards re-regulation?
When the rate of interest rises, finance capital draws off a larger share of all profits from industrial capital, which will thus have less funds for investment in production. Moreover, finance and speculative capital benefit directly from volatility in markets: if interest rates and exchange rates were stable, there would be no price movements to speculate against.
In financial speculation, the players must sniff out the slightest hint of price movements. Anyone who hung onto bonds during the recent mayhem would have taken a huge loss. This can and must happen irrespective of the conditions of the "real economy".
On the other hand, exchange and interest rate turmoil make it difficult for exporters to plan investment for long-term export markets. There is already considerable evidence that deregulation of exchange rates has skewed investment away from exports.
Against this background, even some of yesterday's deregulationists are advocating a return to more regulated financial markets. The debate between regulationists and deregulationists is heating up once again.
The truth is that these contradictions are intrinsic to capitalism. Only when there is a comprehensive socialisation of the entire finance sector will they be overcome.
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How bonds work
A bond is a commitment to pay a regular amount, called the coupon, to its purchaser. The ratio of the coupon to the bond price is the yield (or interest rate) of the bond. That is:
Y (yield) = C (coupon)/P (price)
For example, a bond purchased for $100 with an annual coupon payment of $10 would have a yield of 10% (10/100).
Because bonds are traded, their price varies. This means that the yield too must vary, moving in the opposite direction to the price. If the price of the bond above fell to $80, the yield would increase to 12.5% (10/80).
Thus, when we read that "bond markets rallied today", it means that bond rates fell as bond prices rose.