A Return to Austerity

On June 23, President Joseph Biden announced a bi-partisan deal between the Democrats and “moderate” Senate Republicans to pass a $953 billion infrastructure plan, which includes only $559 billion in new spending. This was a small fraction of Biden’s original promise to push for a $4 trillion infrastructure plan. Biden claims he still seeks to pass his original plan. But considering the GOP’s virtual veto power in the U.S. Congress, the plan seems as good as dead. It is worth noting that the $953 billion compromise contains none of the “green energy” proposals that were part of the original plan.

What the bipartisan deal does include is “asset-recycling,” which had also been central to Trump’s infrastructure plans. Under “asset-recycling,” the federal government borrows money at high interest rates from private for-profit companies that the federal government depends on to build infrastructure projects. As collateral on the loans, the companies take possession of roads, bridges, and other public works for the life of the loan — about 30 years.

The private companies then set up toll booths on previously public roads and bridges that the federal government has leased to them as collateral, in effect treating them as their private property until the loans are repaid with interest. The public is skinned twice, once through paying off the loans and the interest on the loans as taxpayers, and second through paying tolls on previously public roads and bridges. The government then uses the borrowed money to carry out other parts of the infrastructure plan.

The proposed “compromise” with the GOP on infrastructure is typical of Joseph Biden’s 50-year-long political career in the service of U.S. capital. The “compromise” is so reactionary that members of the “progressive” Justice Democrat faction of the Democratic Party in Congress threaten to vote against it.

Earlier this year, it was widely believed in progressive circles that the Biden administration was breaking with decades of neoliberal austerity policies and returning to full-blooded “Keynesianism” of the “golden years” of the 1950s and 1960s. The $4 trillion infrastructure plan was supposed to mark the definitive end of the neo-liberal policies that have dominated Washington’s policies since the “Volcker shock” under Carter and then the election of Ronald Reagan some 40 years ago.

Progressives were hoping that a massive “Keynesian” public works program would bring about a return of the kind of full-blooded capitalist prosperity not seen in decades. True, the Biden administration did restore half of the $600 a week in extra unemployment benefits the U.S. government under Donald Trump instituted in the spring (northern hemisphere) of 2020 but then allowed to run out after a few months. And this spring, the Biden administration mailed out $1,400 checks to all “legal” adult working-class and lower-middle-class U.S. residents. It also granted temporary tax relief to families raising young children.

Since it took office on Jan. 20, the Biden administration has been running down the U.S. government’s swollen checking account at the Federal Reserve Bank of New York. This has allowed the U.S. government to slow the rate at which it has been borrowing money, allowing long-term interest rates to dip in recent months.

Hence, a huge amount of purchasing power has been pumped into the U.S. and world capitalist economy in the opening months of the Biden administration. As a result, according to the U.S. Labor Department, total employment rose 850,000 in June. For the first time in months, this number met the expectation of economic pundits. But maintaining this economic momentum long enough to set off a sustained rise in the industrial cycle capable of restoring old-time capitalist prosperity is another matter entirely.

The U.S. capitalists claim they are facing a huge labor shortage even as employment remains millions below the level that prevailed in February 2020 just before COVID-19 hit with full force. However, the capitalists’ complaints about the “labor shortage” are having their effect on government policy in the U.S., at both the federal and state levels.

Republican state governments have already ended the expanded unemployment benefits, while the Democrat-run government of California has announced that people must now give evidence that they are actively seeking employment or lose benefits. This occurs even as COVID-19 cases are once again rising, especially among the unvaccinated or partially vaccinated. In September, the extended unemployment benefits are scheduled to run out entirely. There is virtually no chance in light of the alleged “labor shortage” being trumpeted by the media that the extra benefits will be extended.

Nor is there much chance in light of the “labor shortage” of any more stimulus checks. The mailing out of additional stimulus checks would encourage workers to hold out for wages and working conditions higher than the bosses are offering. The capitalists are therefore using their control over both the Democrats and the Republicans to make sure there are no more stimulus checks.

In addition, the U.S. Treasury is nearing the end of the rundown of its checking account at the New York Fed. As the account balance shrinks, either U.S. government borrowing will have to rise once again, which will renew upward pressure on interest rates, or government spending will have to fall, or some combination of the above. This means that U.S. fiscal policy will be a great deal less expansionary beginning in the second half of 2021 and beyond than it was in the first half of the year.

The drift back to the fiscal austerity typical of post-Volcker shock neo-liberalism almost certainly means that the rate of economic growth and with it the rise in employment will soon be slowing down.

Double-digit inflation now here

Another factor working toward a sharp slowdown in the rate of growth in 2021-22 has been the “unexpected” surge in the rate of increase of dollar prices of commodities. (1) Rising prices, all other things remaining equal, reduce purchasing power. The U.S. government reported that its consumer price index rose 0.9% in June, an annualized rate of 10.8%, while producer (wholesale) prices rose 1%, an annualized rate of 12%. Double-digit inflation is not threatening, it is here.

Rising prices encourage consumers and (far more importantly) businesses to buy now before prices rise even higher. Businesses also react to inflation by withholding products from the market in the belief that prices will rise still more. The resulting apparent shortages lead to still more price rises. The result has been a surge in demand as businesses have moved to build up their inventories. The surge in demand has also led to a wave of hiring, reflected in the 850,000 rise in employment recorded for June. The rise of wholesale inventories in the U.S. of an unusual 1.3% in May illustrates the inventory-building process driving both the double-digit inflation and rise in employment.

If the inventory buildup continues over the coming months, demand will drive wholesale and then retail prices even higher. However, it is also possible inflationary sentiment could be replaced by expectations of lower prices in the months ahead. If inflation so much as pauses, businesses will conclude that prices are not rising as expected, and prices can suddenly plunge. The reason is that hoarded commodities are dumped on the market all at once. Businesses move to liquidate their inventories before prices fall even more. Apparent shortages of commodities turn overnight into gluts. Economic growth turns to contraction and surging hiring is replaced by massive layoffs as inventories are run down.

The waning of the fiscal stimulus by the federal government is also working in the direction of a sudden shift from inflationary inventory accumulation to deflationary inventory liquidation in the coming months.

If — rather when — business shifts from its current inflationary inventory buildup to inventory liquidation, at the very least a “Kitchin recession” — named after the early 20th-century statistician Joseph Kitchin (1861-1932), who analyzed inventory recessions — will occur. In a “pure” inventory recession, unlike a full-scale recession, the fixed business investment that drives long-term economic growth falls very little if at all.

Other names for Kitchin inventory recessions are “slowdowns,” “mid-cycle adjustments,” and “mini-recessions.” Major recessions, as opposed to Kitchin recessions, occur about every 10 years. They begin as inventory recessions that then trigger major declines in fixed investment. This means a far greater drop in production and employment than is experienced in a Kitchin recession.

Normally, Kitchin recessions occur every three to five years, which is why they are sometimes referred to as mid-cycle slowdowns. However, the COVID pandemic, the lockdowns, and the resulting recession followed by hasty “re-openings for business” accompanied by the huge central government deficits and massive monetary expansion by the central banks have created an exceptional economic situation. It resembles in some ways the situation that typically occurs immediately after a major war. In 1918-1920, after World War I, and in 1945–1948 after World War II, we saw inventory-driven bouts of inflation that turned into deflationary recessions with falling prices.

During World Wars I and II, production of means of destruction and other war supplies soared but civilian production both of consumer goods and the means of production was sharply curtailed. As a result, businesses scrambled to rebuild inventories of civilian goods whose production had been sharply curtailed during the war years.

Between 1918 and 1920 and again between 1945 and 1948, inventory accumulation drove inflation just as it is doing today. In 1920, the newly established Federal Reserve System, facing a drain on U.S. gold reserves, sharply raised its (re)discount rate on commercial paper to defend the gold convertibility of the dollar.

As a result, business expectations of ever-higher prices changed almost overnight to expectations of lower prices. As businesses moved to liquidate inventories of unsold commodities before prices fell even more, production and employment contracted sharply. When the resulting sharp recession bottomed out in the first half of 1921, the economy staged a rapid recovery that led to a new rise in the industrial cycle that lasted until 1929. (2)

In 1948, the Truman administration imposed controls on consumer credit to curb the ongoing double-digit inflation. The result was the recession of 1948-49, which was also accompanied by falling prices, though it was far less severe than the 1920-21 recession.

We haven’t been through a world war nor has normal civilian business investment been curtailed to the degree and for as long as it was during World Wars I and II. The COVID pandemic and lockdowns did lead to a sharp curtailment of production and a resulting rundown in inventories. Now business is moving to rebuild these inventories, which has led to a wave of inflation that resembles the postwar inflations of 1918-20 and 1945-48. However, a huge difference between the situation in 1945-48 and today is that in 1945-48 private debt, both consumer and corporate had been largely wiped out by the Depression and then WWII. Only the debt of the federal government had soared.

Today, in contrast, while consumer debt declined during the COVID recession — though it is still huge compared to 1945-48 — an already historically high level of corporate debt increased sharply in addition to a huge rise in the debt of the federal government. This means it will be hard to contain an inflation-stopping inventory recession to the relatively modest proportions of the 1948-49 recession. In the elections held during the 1920-21 recession, the Democrats suffered a massive defeat at the hands of the Republicans. The last thing the Biden administration and the Democrats need is another 1920-21-type recession — or worse — just as the mid-term elections of 2022 approach.

A decline in lumber prices that began in May and recently a decline in used-car prices may mean an inflation-ending inventory recession is about to begin. Whether the economic situation evolves in the coming weeks and months toward accelerating inflation turning into stagflation or toward an “inventory recession” with decelerating inflation or even deflation can turn on a dime. And that dime is in the hands of the Federal Reserve System and its Open Market Committee.

If the Federal Reserve allows the inventory buildup-driven inflation to continue, things could get out of hand. While the dollar price of gold has increased sharply in recent years, it is no higher than it was a year ago. Last summer, the dollar price of gold rose above $2,000 an ounce. But it so far has not done so this year.

This makes the production of gold relatively unprofitable compared to the production and selling of many other types of commodities whose dollar prices have risen while the dollar price of gold has remained more or less unchanged. This situation makes the production of gold bullion relatively unprofitable and discourages gold production. The current inflation is therefore raising prices not only in terms of U.S. dollars — and the other currencies linked to the dollar under the dollar-centered international monetary system — but in terms of gold as well. The more prices of non-monetary commodities rise in terms of gold, the less profitable the production of gold becomes.

If this process were to continue, at some point it will lead to a new shortage of gold and a new rush into gold. This would occur if general prices rise above the prices of production of commodities. The crisis of 2008 lowered prices in terms of gold so it is possible that prices are below the prices of production today. If this true, the Federal Reserve System will be able to let the current surge in prices continue for a longer period than it would be able to otherwise. However, if the Fed allows the current inflationary surge to carry market prices of commodities above the prices of production, the dollar’s depreciation against gold will resume and a new wave of currency-depreciation inflation will add to the current inventory building-driven inflation. This is the road to hyperinflation. To avoid this, the Fed at some point must take action to halt the inflation.

Assuming the Federal Reserve System stops the inflation before it turns into hyperinflation (and the Fed has good reasons — and the means — to do that) but the prices of commodities are stabilized at prices too high relative to their prices of production (with all prices measured in terms of gold), gold production will be depressed during the upward phase of the industrial cycle following the end of whatever recession that follows the current inventory buildup-driven inflation. The depression in gold production will then intensify the normal cyclical crisis of overproduction that will inevitably occur at the end of the industrial cycle. This is the process that turned the cyclical recession that began in 1929 into the Great Depression.

The Federal Reserve is aiming for a mild Kitchin recession that would end the inflationary surge without the kind of deep recession that occurred in 1920-21 and to a lesser extent in 1948. The Fed hopes that the rate of growth of the U.S. economy will then slow down toward “cruising speed” for the rest of the 10-year industrial cycle.

If, however, an inventory recession triggered by falling federal government stimulus combined with a policy of the Federal Reserve that breaks “inflationary expectations” cause a major drop in fixed investment, or even worse the inflationary surge continues and develops into stagflation, the current apparent upturn in the industrial cycle will abort. In either case, a real upturn in the industrial cycle could still be years away.

Only if a mild Kitchin recession can slow inflation over the coming months without triggering a full-fledged recession will the current surge in business activity turn into a sustained upswing in the industrial cycle (lasting 10 years give or take a year or two). This is the outcome both the Biden administration and Federal Reserve are aiming for. Whether they can bring it off remains to be seen. If they can’t, Donald Trump may be packing his bags for his return to the White House on Jan. 20, 2025.

Another factor working towards a near-term slowdown

Another factor working towards a near-term economic slowdown is yet another surge in COVID infections. As scientists predicted, the COVID virus, obeying the laws of Darwinian natural selection, is mutating into new forms. The latest has been dubbed the Delta variant. Fortunately, current vaccines provide a considerable degree of protection against current COVID strains including the Delta variant.

But this protection is not absolute. There are cases of what scientists and doctors call “breakthrough infections.” How effective the vaccines are in a particular person depends on the general state of the health and immune system of the person receiving the vaccine. If a person has a weak immune system due to age, medical condition, or medical treatment, the person’s immune system may be unable to fight off a COVID infection completely. Whether a fully vaccinated person can fight off a COVID infection also depends on how many virus particles the person is exposed to.

It is therefore extremely important to get vaccinated (if you have not already done so) as soon as you possibly can — remember, it takes two weeks after the last shot to receive the full protection of the vaccine. It is also important once you are fully vaccinated to continue to take other precautions such as wearing a mask where large numbers of people gather, especially indoors. The more lines of defense you have against COVID — being vaccinated and wearing masks when necessary — the better your chances of avoiding a COVID infection in the first place. And if you do come down with COVID, of avoiding serious illness, hospitalization or death. Despite the premature re-openings for business occurring around the world, the global pandemic is far from over.

One of the reasons why COVID remains a major menace despite the vaccines, at least in the United States, is that the U.S. Republican Party, in its attempts to win white working-class and white lower-middle-class voters, appeals to, and promotes, irrational anti-science, anti-vaccine sentiments. As a result, in areas where the Republican Party is strong, especially in the U.S. South with its ghastly heritage of slavery, and in parts of the Mid-west, vaccination rates remain very low.

Overall, as of mid-year less than half of the U.S. population is fully vaccinated. Children under the age of 12 remain entirely unvaccinated. In Europe, where COVID infections are also on the rise, only 44% are fully vaccinated. This is far too low to achieve so-called herd immunity. Vaccines rates remain low among people of color, especially African Americans. Here, too, we see slavery’s long shadow.

The presence of large numbers of unvaccinated people is a threat to the fully vaccinated as well. The chance is increased that the COVID virus as it spreads through unvaccinated populations will mutate into a variant that can break through the protections provided by current vaccines. The sooner everybody in the world is fully vaccinated the sooner global herd immunity will be achieved and the sooner the COVID virus will join the smallpox virus on the road to extinction.

An even bigger threat than the still large number of either unvaccinated people or only partially vaccinated people in the U.S. and Europe is the far larger number of people in the Global South remaining unvaccinated This is not because they are refusing vaccination out of ignorance. Neither they nor their governments have the money to purchase the vaccines at the patent-protected monopoly prices demanded by the pharmaceutical monopolies. On the Africa continent, in particular, only a small percentage of people have been vaccinated.

“Last month,” the July 5 issue Nature News reports, “the leaders of the G7 group of wealthy nations pledged extra doses for low- and middle-income countries (LMICs) by the end of 2022, at a summit in Cornwall, UK. The centrepiece was a promise from US President Joe Biden to donate 500 million doses of the vaccine made by pharmaceutical company Pfizer of New York City and biotechnology company BioNTech in Mainz, Germany.”

This is grotesquely inadequate to achieve the global herd immunity needed. But it gets worse. “The extra pledges will be offset by restrictions on exports. The European Union and the United States both prohibit exports of some vaccines and vaccine ingredients.”

“Meanwhile,” the article continues, “COVID-19 cases are now surging across Africa. The World Health Organization’s Africa office, based in Brazzaville, Republic of Congo, says the number of COVID-19 infections rose by 39% from 13 to 20 June, and by 25% in the week ending 27 June. At least 20 countries, including Zambia, Uganda, South Africa and the Democratic Republic of the Congo, are experiencing a third wave of infections. …”

Summing up the circulation of money

I want to finish my examination of the circulation of money before I move onto my critical examination of Anwar Shaikh’s monumental work “Capitalism,” published in 2016.

Researching this post, I was struck that even today the theories of currency among economists largely trace back to the 19th-century Currency School and Banking School. The former school was inspired by David Ricardo. The latter, led by British economists Thomas Tooke and John Fullarton, developed during the 1840s in opposition to the Currency School.

The Banking School based itself on the work of the 18th-century economist Sir James Steuart. His most important contribution was the realization that a flux defined as the issue of currency must be offset by a reflux mechanism that removes currency from circulation. For example, when a bank grants a loan, currency thrown into circulation — the flux — is offset when the loan is repaid — the reflux. The other main reflux mechanism is depositing into a bank account currency not immediately needed to make payments or purchases.

Steuart, and after him the Banking School, realized that a certain but varying percentage of the total money supply is hoarded in the banking system. The money hoarded is called bank reserves. If the quantity of commodities in circulation increases, or if the prices of commodities rise, some of the money hoarded will enter into circulation. On the other hand, if the quantity of commodities in circulation declines, or if the prices of commodities fall, a certain quantity of the currency will be rendered redundant, fall out of circulation, and be added to the hoard of money within the banking system.

This mechanism, however, works only within certain limits — an adequate quantity of hoarded money that can be drawn into circulation. Ultimately, this hoard must consist of money material — gold bullion. If the monetary authority attempts to get around a shortage of gold by issuing paper money not backed by gold, the paper money price of gold bullion will rise. This will, if it continues, cause commodity prices in terms of paper currency (but not gold) to rise.

The reflux mechanisms (3) become increasingly paralyzed as prices rise in currency terms, causing a rise in the quantity of currency necessary to circulate commodities. As a result, the portion of the total money supply held in the reserves of banks falls while the velocity of the circulation of a currency rises.

Eventually, if this process is allowed to proceed to its logical conclusion, the reserves of the banking system will be exhausted and the monetary authority will end up chasing the ever-higher currency general price level by printing more and more paper money. The end result is hyperinflation such as the one that occurred in Germany in 1923.

The process opening the door to hyperinflation always begins with the issuance of too much currency relative to the quantity of gold available to back the currency — or to foreign currency that represents gold. (4) The supporters of the quantity theory of money make no distinction between a situation where the quantity of gold money grows faster than the growth of the number of commodities at a given price, on one hand, and when currency is issued in excess of available money material, on the other. A situation where the rate of growth of the quantity of money material exceeds the growth of commodities within a country leads through the reflux mechanism to the growth of hoards of idle money in its banking system. This leads to “easy money” and a fall in interest rates.

Under normal capitalist conditions — outside of war or pandemics — where the main check on production is the growth of the market for additional commodities, an increase in the quantity of gold money expands the monetarily effective demand for commodities. This in turn leads to a rise in the number of commodities produced and in circulation. In contrast, in a pre-capitalist or early-stage capitalist economy where the main check on production is the number of potential additional workers, a rise in the quantity of money material leads to increased hoarding of money material.

The effect on prices of changes in the quantity of gold and the value of gold

Supporters of the quantity theory of money believe that a rise in the quantity of gold will have the same effect as an equal rise in the quantity of paper money. Let’s assume that large new goldfields were discovered but they are not more productive than the least productive goldfields already in production. The capital invested in the least productive fields — those that bear no differential rent — constitutes the regulating capital.

Under the above conditions, the individual value of gold produced by the regulating capital will remain unchanged. Assuming everything else remains unchanged — there is no change in the values of other commodities — there will be no permanent rise in the general price level and most likely not even a temporary rise in prices. It is possible, however, that if the existing marginal goldfields were fully utilized before the new discoveries, an increased gold production might trigger an economic boom that could temporarily push up the general price level.

However, as soon as this were to happen, the rate of profit of the regulating capitals in gold mining and refining industries would decline due to the rising prices of the inputs of the commodities necessary to mine and refine gold. Capital would then be withdrawn from the gold mining and refining industries and flow to industries where the rate of profit was higher causing the production of gold to decline. This would lead to overproduction of commodities relative to gold, which would trigger a crisis of overproduction that would then lower prices once more. Therefore, a mere discovery of additional goldfields of the same productivity of the least productive fields already in production will not permanently raise golden commodity prices.

The discovery of richer goldfields in sufficient quantity will, however, raise prices in terms of gold because it will lead to a fall in the individual value of gold mined from the worst gold-bearing land relative to commodities. As in the case of a rising rate of growth of the total quantity of gold, because of the discoveries of new goldfields equal in productivity to the existing marginal goldfields, an expansion of the quantity of gold produced will lead to an increase in the monetarily effective demand for non-money commodities. This will continue until demand increases faster than supply at existing prices causing a rise in commodity prices.

Rising commodity prices will begin to reduce the rate of profit both relatively and absolutely of capital invested in gold mining and refining. The reduced profit will cause the previous marginal mines to close down. However, until the rise in the cost of gold mining reduces the rate of profit of the regulating capitals in the gold-mining industries to the average rate of profit, the flow of capital in search of rates of profit that exceed the average will continue to flow into the gold-mining and refining industries. The result will be an acceleration of the rate of growth of the global quantity of gold bullion.

As prices rise, a portion of the total quantity of hoarded money will now be drawn into circulation. While this will tend to reduce the hoard of gold, the reduction will be counteracted by a rise in the volume of gold production. The result will be a strong economic boom with little or no rise in interest rates. Prices (in terms of gold) will keep rising until the rate of profit on the regulating capitals invested in the marginal gold mines is reduced to the average rate of profit. Beyond this point, gold production will decline, eventually leading to a crisis of the overproduction of commodities relative to gold, lowering prices once again. However, in this case, golden prices will stabilize at a higher level than before reflecting the reduced value of gold — money material — relative to non-money commodities.

To achieve a permanent rise in the golden prices of commodities, therefore, merely increasing gold production is not enough. It is necessary to reduce the value of gold relative to the values of the commodities that gold measures in terms of its use value. In practice, major gold (and silver) discoveries such as those of the 16th century launching capitalism, the discoveries in California (1848) and Australia (1851), and in the mid-1890s in Alaska and Canada, both increased the quantity of gold (and silver) and lowered the value of the money metals relative most non-money commodities.

Supporters of the quantity theory of money see only the increase in the quantity of gold produced and not the devaluation of gold. The periods following the 1848-51 and 1890s gold discoveries saw a rise in the prices of commodities combined with a sharp rise in capitalist production and world trade. Both periods saw a rise in trade union strength. The later period saw the establishment and increase in strength of the Social Democratic parties of the Second International accompanied by the growth of opportunist tendencies within them.

The spectacular discoveries of rich gold and silver mines in the Americas during the 16th century led to the rise of the capitalist mode of production. As demand increased, the modes of production handed down from the Middle Ages in Europe could no longer meet the increased demand for commodities. This process was accompanied by the development of modern slavery, the trans-Atlantic slave trade, on one side, and the massive expropriation — often by force — of direct producers and their transformation into modern proletarians, on the other.

As a result of the explosive growth in the monetarily effective demand for commodities, new large-scale forms of production where the labors of many workers were combined had to be developed. This was done over a period of several centuries with the development of modern slavery and large-scale wage labor.

The basic mistake made by supporters of the quantity theory of money, from David Hume through Milton Friedman and present-day advocates, is the failure to distinguish between the effect of an increase in the quantity of money material, on one side, and the fall of the value of money material relative to the value of other commodities, on the other. This mistake is all the easier to make because in practice the two phenomena tend to occur together.

Instead of attributing the fall in the value of the precious metals that followed the discoveries of the 16th century and the latter part of the 19th century to the fall in the quantity of labor necessary to produce a given quantity of precious metal, the quantity theory of money attributes the fall of the value of the precious metals to an increase in their quantity.

Most supporters of the quantity theory of money — all the modern ones — make no distinction between the effects of an increase in gold production and a policy of expanding the number of monetary tokens by the central banks. Similarly, no distinction is made by the quantity school between the effects of increasing the number of monetary tokens relative to the quantity of money material and increasing the number of monetary tokens relative to the quantity of non-money commodities.

Some final notes on the Banking School

The Banking School emerged as the main opposition to the Currency School. It believed that currency would not be over-issued as long as the banks discounted only “real bills” backed by actual commodities. If more commodities were produced — or if their prices rose — the thinking went, more real bills would be created and the quantity of currency in circulation would rise as the bills were presented for re-discounting to the Bank of England.

If the quantity of commodities declined — or if commodity prices fell — fewer bills would be presented by the banks and bill brokers to the Bank of England for re-discounting. As long as the banks discounted only real bills, the Banking School believed, the proper amount of currency would be created to circulate commodities. The result would be an “elastic” currency that expanded when commodity circulation — or prices — rose and contracted when commodity circulation or prices declined. If according to the Banking School, the quantity of currency was tied to the quantity of gold in the vaults of the Bank of England, there would always be a chance that not enough currency would be created when the number of commodities in circulation or their prices rose, creating a crisis.

Presumably, a government following the Banking School’s advice would have to establish and enforce banking regulations that would ban discounts on “accommodation” paper that could cause currency above the needs of commodity circulation to be created. Considering the ability of the business world to evade regulations, this might be difficult to achieve in practice under the capitalist system.

More fundamentally, it is not true that currency cannot be over-issued as long as the loans or discounts are backed by commodities. The bills of exchange and the banknotes created by the discounting of bills of exchange are payable in money, not commodities. If commodities are overproduced relative to gold, too many bills of exchange and banknotes will be created relative to money material. This will lead to the over-issue of banknotes relative to gold even if only “real bills” are discounted leading sooner or later to the breakdown of the convertibility of banknotes into gold and the depreciation of the banknotes. The resulting depreciation of the banknotes would then weaken the reflux mechanism leading to inflation.

Tooke advocated that the Bank of England maintain a large enough gold reserve to weather gold drains without having to restrict the creation of new banknotes through the mechanism of (re)discounting bills of exchange backed by actual commodities. However, where would the Bank of England get the gold enabling it to weather gold drains without threatening the convertibility into gold of its banknotes? Ultimately, the additional gold would have to be produced by the gold mining and refining industries. Under the capitalist system, gold just like any other commodity is produced only to extent that it is profitable to produce it.

Some observations on the Currency School and the quantity theory of money

How do the supporters of the quantity theory of money explain the failure of the Bank Act of 1844 to prevent the crises of 1847, 1857 and 1866? They claim that the Currency School had defined money too narrowly. The Currency School considered only coins and banknotes to be “money.” Modern supporters of the quantity theory of money claim that commercial bank checking accounts which can be created by either deposits or through the creation of imaginary deposits through discounts or loans should also be viewed as money.

In Britain before 1844, banknotes were the chief form of currency for large-scale transactions. But after 1844, checkable bank deposits played an increasingly important role in the currency system. The result was a decline in the circulation of banknotes. Supporters of the quantity theory of money claim that British prices failed to decline as soon as British prices were high enough relative to world prices to cause a British balance of payments deficit because, despite the decline in the number of banknotes, the quantity of checkbook money kept on rising.

In the 1970s, Milton Friedman, unlike the old Currency School, was careful to include checking accounts in his definition of “money”. Friedman advocated that the central bank — Federal Reserve System — should not target short-term interest rates as standard Keynesian theory advocated but rather the rate of growth of the “money supply,” which in Friedman’s definition included commercial bank checking accounts as well as legal-tender paper money and coins.

The problem with this is that the Federal Reserve does not control the volume of commercial bank loans and discounts that create checking account balances. However, Friedman as a neoclassical economist insisted that the capitalist economy is “extremely stable,” except for the rate of growth of the “money supply” as defined by Friedman. Friedman thereby assumed that if the Federal Reserve System stabilized the rate of growth of the dollars it creates — Federal Reserve notes and commercial bank deposits with the Federal Reserve Banks — the natural stability of the capitalist economy would ensure that the rate of growth of commercial bank loans and discounts that create additional checking account balances would also be stable.

Marx’s views on the Currency School

The Bank of England’s policies were dictated after 1844 by the Currency School. While there was a fiduciary issue of banknotes backed by government bonds, most of them had to be backed by gold (and to a certain extent silver). In this way, the number of banknotes created by the Issue Department was tied to the rise and fall of the quantity of gold in the vaults of the Bank of England. The existence of a rigid rule led to panic during crises when the public feared that the commercial banks and even the Bank of England itself would run out of Bank of England banknotes. The result was a vast increase in the demand for banknotes. Only the suspension of the rule that banknotes had to be almost fully backed by gold saved Britain from economic catastrophe in 1847, 1857 and 1866.

The Banking School (and Marx) drew the conclusion that the existence of a rule that limited how many additional banknotes the Bank of England could create in a crisis would greatly aggravate a crisis. However, unlike the bourgeois economists, Marx believed that no banking reform could eliminate banking crises and economic crises as long as capitalism existed.

Unlike modern progressives, however, Marx was no fan of inconvertible (into gold) paper money. However, Marx believed that the central bank should be left to its own devices on how it defended the convertibility into gold of its banknotes. To establish a rigid rule, Marx believed, as the Currency School succeeded in doing with the Bank Act of 1844, was bound to make the inevitable banking and economic crises far worse than they had to be.

The supporters of the quantity theory of money, in contrast, believe that “monetary rules” — and many have been proposed over the years — will force the central banks to stabilize the rate at which they create additional currency and thus prevent severe economic fluctuations and inflation in the otherwise “extremely stable” capitalist economy. Those economists (and Marx) such as John Maynard Keynes who believe that the capitalist economy is naturally “extremely unstable” believe that rigid “monetary rules” such as advocated in their day by the Currency School and later Milton Friedman and his “monetarist” supporters and their counterparts today will only make the “extremely unstable” capitalist economy even more unstable.

The Federal Reserve System and the Banking School

During the first period of its operation — between 1914 and the New Deal — the Federal Reserve System in contrast to the Bank of England before 1914 operated by rules that were largely inspired by the Banking School. The Federal Reserve Banks had to keep only 40 cents in gold for each Federal Reserve Note they created. The other 60 cents in notes could be backed by high-grade commercial paper backed by actual commodities — “real bills”.

During the super-crisis of 1929-33, the number of commodities in circulation as well as their prices fell and so did the number of real bills. As a result, the Federal Reserve Banks had to depend increasingly on their gold reserves (5) to back their Federal Reserve Notes. In a sense, the Banking School-inspired Federal Reserve System was operating as it was supposed to. As the number of commodities in circulation fell along with their prices, so did the “money supply” made up of dollar bills, coins, and commercial bank checking accounts.

However, Milton Friedman and his followers developed a critique of the Banking School that is widely accepted by bourgeois economists today. Friedman claimed that the shrinkage of the quantity of currency in circulation in the U.S. between 1929 and 1933 was not caused by the decline in the circulation of commodities — and their prices — but the other way around. Rather, it was the shrinkage of the quantity of money in circulation, according to Friedman, that led both to the decline of the number of commodities in circulation and their prices.

Thanks to the influence of the Banking School, Friedman claimed, the Federal Reserve failed to aggressively expand the quantity of currency, which according to Friedman they could have done even within the limits of the gold standard rules then in effect. Instead, the Federal Reserve passively allowed the quantity of currency in circulation to keep shrinking, which according to Friedman caused the number of commodities as well as their prices to keep on declining.

Some final thoughts on Pichit Likitkijsomboon

Likitkijsomboon wants to remove from Marxist economic theory the criticisms Tooke and Fullarton made of the Currency School and the quantity theory of money on which it rested and replace it with a somewhat modified version of Ricardo’s theory of money as supplemented by Henry Thorton (1760-1815) and Robert Torrens (1780-1864). Likitkijsomboon writes:

“The concept of money-velocity which is variable and sensitive to ‘public confidence’ and changes in the interest rate was developed by Thornton, pointing towards the replacement of the concept of Marx’s Anti-Quantity Theory of Money by the modern concept of money demand. Torrens expands Ricardo’s concept of money to include ‘auxiliary media’ such as secondary deposits and other credit instruments, pointing towards the modern concept of the broad money supply.”

Likitkijsomboon supports the modern version of the quantity theory of money. Marx’s aim, Likitkijsomboon writes, was “to show that the capitalist crisis is not a monetary phenomenon but rooted in capitalist production. He is too hasty to import the anti-quantity theory into his framework, as the supplement to his original and important theory of value-form and capital-form which gives a critical role to money in capital accumulation and crises, hence rendering Marx’s over-all monetary theory incoherent.”

I agree that what passes for monetary theory by modern Marxists is indeed often incoherent. I think, however, the problem does not lie with the rejection of the modern quantity theory of money by our modern Marxists. The problem identified by Likitkijsomboon lies elsewhere. With few exceptions, most Marxists have not understood Marx’s theory of the “value form,” which is indeed the foundation of Marx’s theory of money and therefore of currency circulation. This is shown by the fact that our modern Marxists, with all too few exceptions, confuse today’s inconvertible-into-gold legal-tender token money with “non-commodity money.”

However, Marx’s analysis of the “value form” shows that “non-commodity money” is impossible under the capitalist mode of production. If you try to combine Marx’s theory of money with the concept of “non-commodity money,” you inevitably arrive at an incoherent theory of money and currency. Not only that but an incoherent theory of the industrial cycle and crises. Ultimately, a wrong theory of money and currency leads to inadequate or simply wrong theories of competition, monopoly, bank capital, imperialism, and the limits of winning reforms within capitalist society.

Marx argued against the view of the bourgeois economists of his day — and ours as well — that cyclical crises are not organic to the capitalist system but rather caused by some flaw in the credit, banking and currency system that can be remedied by proper reforms. From the time that cyclical crises first began until the present, bourgeois economists of various schools have proposed various reforms involving banking, credit and currency that they claim banish crises once and for all. Many such reforms have been proposed beginning with the proposals of the Currency and Banking schools until the present.

For example, supporters of the Currency School advocated that the number of banknotes should be strictly tied to the quantity of gold in the vaults of the Bank of England. The Banking School believed that banks should be allowed to discount only “real bills” — bills of exchange backed by actual commodities. In the U.S. in the late 19th century, the proposal that the free coining of silver — ended in 1873 — should be resumed at a ratio of 16 to one (the silver dollar should be sixteen times the weight of one gold dollar) became a mass movement. The demand that the free coining of silver at a ratio of 16 silver dollars to one gold dollar became the main campaign plank of Democrat William Jennings Bryan’s presidential campaign in the 1896 election.

A currency reform associated with the supporters of John Maynard Keynes involves the abolition of the gold standard entirely. Freed of the need to defend the convertibility of their banknotes into gold, central banks, he believed, would be free to lower short-term interest rates by increasing the quantity of currency they create whenever a slump threatens. However, when inflation threatened, the central banks should, Keynes believed, raise short-term interest rates by reducing the quantity of currency they create. In this way, he believed, it would be possible without abolishing capitalism to maintain “full employment” and reasonably stable prices.

In the 1970s, supporters of the modern version of the quantity theory of money led by Milton Friedman advocated that central banks adopt a specific target for the growth of the money supply defined as the currency that central banks create in circulation plus checking accounts. Under this proposal, if the rate of growth of the total money supply grows faster than the target rate of growth, the central bank-created currency should be reduced. If the rate of growth of the total money supply falls below the central bank’s target, the central bank should accelerate the creation of additional legal-tender money. In contrast to Keynes’ recommendation, central banks would under Friedman’s policy pay no attention to changes in interest rates. Such a policy, Friedman claimed, would bring out the natural stability of the capitalist economy and ensure permanent prosperity.

The current official doctrine is called inflation targeting. Under this policy, central banks set a target of inflation of about 2% a year. If inflation is less than that, they lower interest rates by increasing the amount of currency they create. If inflation rises above the 2% target, the central banks raise interest rates by reducing the quantity of currency they create.

Other currency reforms

We should for the sake of completeness say a few words about the currency reforms supported by the Austrian school and adherents of Modern Monetary Theory.

The Austrian school blames the industrial cycle and its crises on the tendency of central banks to set interest rates below the “natural rate of interest.” According to the Austrian school, the natural rate of interest is the rate that equalizes savings with investment. People, the Austrians advocate, should again be “allowed” to use gold, silver or anything else as money. The Austrians, therefore, advocate the abolition of central banking and a return to having commercial banks issue their own banknotes — called “free banking.”

The Austrian economist Frederick von Hayek believed that if the commercial banks and other entities were allowed to issue currency, competition among the various currency-issuing entities would ensure that the best currency would win out. The current bitcoin and cryptocurrency craze reflects the influence of Hayek’s ideas.

Finally on the left are the proposals of Modern Monetary Theory. MMT advocates that central governments should increase their budget deficits whenever unemployment threatens and reduce them whenever inflation threatens. MMT believes that money is created through central government deficit spending. If central government deficit spending didn’t exist, no money would ever be created and capitalism would never have come into existence. As long as there are idle workers and machines, it is a sign that the deficits of the central government are too small, and therefore not enough money is being created. If inflation does develop, MMT believes that currency should be withdrawn from circulation through taxes levied by the central government. Taxes levied by the currency-issuing central government, MMT believes, are not necessary to raise revenue for the government since the central government can create money by a stroke of the pen. Rather taxes are necessary only to withdraw excess currency from circulation.

MMT leans to the view that the central banks should be abolished and that the right of central government treasuries to issue currency should be restored (6). This way not only will the ability of idle capitalists to earn interest on central government bonds be abolished but the central banks will no longer be able to interfere with the unique money-creating role of the central government by refusing to “monetize” the central government’s debt.

And there is the old utopia of “labor money”. Under this proposal, a bank would be established that would issue currency against products in proportion to the quantity of labor that goes into their production. If this were done, there would always be just enough monetary demand to purchase all the commodities produced. Supply and demand would be equalized.

In contrast to all these suggestions, Marx believed that no reform of the banking, credit or currency system could eliminate banking crises and periodic crises of the general relative overproduction of commodities as long as capitalist production continues. Marx, unlike Keynes and modern progressives, was no fan of paper money under capitalism. However, Marx believed that proposals to establish rigid monetary rules, such as linking the number of banknotes to the gold in the vaults of the Bank of England associated with the supporters of the quantity theory of money, make the inevitable banking and economic crises even worse. Marx believed that the central bank should be left to its own devices when it comes to defending the gold convertibility of its currency. However, Marx’s main interest was not in figuring out how best to stabilize capitalism but rather in hastening the inevitable transformation of capitalism into socialism by the victorious working class.

The real cause of cyclical crises is found not in capitalist production as Likitkijsomboon believes but rather in the contradiction between capitalist production and capitalist circulation. This contradiction arises because of the conflict between large-scale and increasingly socialized production and the continued private appropriation of the product that characterizes the capitalist system. Capitalism has one foot in the past of simple small-scale commodity production where both production and the appropriation of the product were private and one foot in the socialist future where both production and appropriation are social.

Until this contradiction is resolved, the continued private appropriation of the product means that the products of large-scale socialized production remain commodities. Under these conditions, the contradictions of the commodity relationship of production present in any system of commodity production are brought to a head. Under all forms of commodities production, there is a contradiction between the commodity’s nature as a use value and a value. We have a contradiction between concrete labor that is the producer of use values and abstract labor that produces value.

This contradiction leads to the contradiction between value and its value form, exchange value. Though all commodities possess exchange value, exchange value must always exist as a thing separate from all other commodities. This thing is the money commodity the independent existence of exchange value.

The existence of exchange value as a thing that exists beside all other commodities leads to the contradiction between commodities and money that comes to a head in crises. We have the paradox that the value of commodities — abstract human labor — must be measured by the use value of the product of a specific type of concrete human labor. And finally, it leads to that outcome unique to highly developed capitalist production where all these contradictions are developed to their highest level: the universal general crises of the relative overproduction of commodities that returns periodically during which there is great poverty and want because too much wealth has been produced.

There are many other interesting articles in Fred Moseley’s book dealing with the crucial question of whether money must be a commodity. As regards the question of whether money must be a commodity, despite Moseley leaning to the opposite view, Moseley cannot help but sense that he is making a mistake here — hence his doubt. We can see that the answer to this question of whether money must be an actual commodity not only in terms of Marx’s theory but even more importantly in terms of reality can only be answered with a resounding yes. All attempts to abolish the contradiction between commodities and money by establishing “non-commodity money” that makes all commodities money so that no commodity is money is doomed to failure. The only way to abolish commodity money is to abolish commodity production itself and that means the transformation of capitalist production into socialist production.

The next task is to critically examine Anwar Shaikh’s monumental 1,000-page book “Capitalism,” which came out in 2016. This will bring together not only questions of monetary theory and circulation that we have been examining in our posts on Moseley’s anthology but of many other aspects of political economy and its Marxist critique as well.


1 The dollar price of gold, which inversely measures the amount of gold that a U.S. dollar represents, has risen from under $300 at the turn of the century to over $1,800 at the time of this writing. Sooner or later, such a huge depreciation of the U.S. dollar against gold will express itself in a sharp rise in the dollar prices of commodities. In the 1930s, the 40% devaluation of the U.S. dollar against gold — the dollar price of gold was raised from $20.67 to $35 an ounce — was not expressed immediately in higher dollar prices since the depressed economic conditions prevented dollar prices from rising. However, dollar prices rose steadily from 1940 until 1968. Only then was Roosevelt’s dollar devaluation fully expressed in terms of the higher dollar prices of commodities. (back)

2 The resulting 1921-1929 upswing in the industrial cycle — with two Kitchin recessions thrown in — ended in the disaster of the super-crisis of 1929-33. During World War I, which began in Europe in August 1914, the production of both consumer and capital goods had been curtailed. Instead, the production of the means of destruction replaced them. This, however, was unsustainable in the long run because it meant that the world capitalist economy was not even reproducing itself let alone engaging in the normal capitalist expanded reproduction. This is the crucial difference between normal capitalist prosperity based on expanded capitalist reproduction and “war prosperity” based on contracted reproduction.

However, the shortages of commodities produced during normal capitalist prosperity meant that the prices of these commodities increased sharply. When the production of war commodities was largely discontinued after 1918, the move to rebuild inventories drove prices still higher between the end of 1918 and 1920. The skyrocketing prices of commodities also sharply raised the costs of producing gold bullion leading gold production already declining to decline further. This meant that the total amount of gold in the world, though it continued to increase, increased at a reduced rate.

By 1920, there was a glut of commodities relative to gold when the quantity of gold then existing in the world measured in terms of some unit of weight was compared to the number of commodities measured in terms of their price tags — imaginary quantities of gold measured in some unit of weight. However, while in a normal industrial cycle the ratio of the total prices of commodities to gold — with both gold and prices of commodities measured by the same unit of weight — rises, the rise is achieved by a modest increase in the prices of commodities combined with a much greater increase in their quantity measured in terms of units of use value appropriate to particular types of commodity. During World War I, however, the rise in the ratio of total commodity prices to gold was achieved almost entirely by the huge increase in golden prices of commodities.

The result was that during the recession of 1920-21 the fall in the prices of commodities was unusually severe compared to a normal industrial cycle recession. But unlike a normal industrial cycle, between 1914 and 1920 there was little real overproduction of commodities — excluding the means of destruction — thanks to World War I. The result was that while gold production did rise after 1921, it remained below the levels of 1913. This meant that the rate of growth of the total quantity of gold in the world after 1921 lagged behind the rate of growth of (non-money) commodity production more than is normally the case during the upward phase of the industrial cycle. The result was the super-crisis of 1929-33 and the Great Depression.

The situation in 1948 was similar to the situation in 1920 as regards inventories but very different in other respects. When World War I began, commodity prices were already high relative to their prices of production. We know this because the rise in world gold production had all but ceased even before World War I began. However, in the decade leading up to World War II, the Depression had caused the market prices of commodities to fall far below the prices of production. This is shown by the rapid rise in gold production that had begun during the super-crisis and had continued right up to the outbreak of World War II.

The production of (non)money commodities was sharply curtailed during the 1930s as the production of gold increased rapidly. Once the war began, however, commodity prices began to rise sharply and gold production fell. However, the accumulation of money capital — production and hoarding of gold bullion — relative to the accumulation of real capital before World War II was so high that U.S. interest rates failed to rise despite the soaring U.S. federal government deficits brought about by the war. The Depression followed by WWII largely wiped out private debt. Not only was the inflation-stopping inventory recession of 1948-49 much milder than the 1920-21 recession, the rise in the industrial cycle that followed the 1948-49 recession ended in the much milder 1957-58 recession — with a double dip in 1960-61. As a result, the depression and unemployment of the late 1950s and early 1960s were much milder than the 1930s Depression. (back)

3 Since we are now amid an inventory-rebuilding inflation, if a major new depreciation of the U.S. dollar develops against gold, the rate of dollar inflation could quickly rise above the levels that were seen in the 1970s. Indeed, this is exactly what happened in Germany and other defeated countries after World War I. In the victorious countries, there was little or, in the case of the U.S. no, currency depreciation experienced during the war or the post-war inventory rebuilding recession. The severe inventory liquidation of 1920-21 then ended inflation and sharply lowered prices. The 1920-21 inventory liquidation was the price these countries had to pay to stabilize their currencies. However, in Germany and other defeated countries, the fall in commodity prices in terms of gold was achieved through huge currency depreciation ending in the disastrous German hyperinflation of 1923. (back)

4 Marx was not an opponent of the issuance of paper money under all circumstances. For example, during the wars of the French Revolution and the U.S. Civil War — war of the slaveholders’ rebellion — the issuance of legal-tender paper currency not backed by gold made it possible for the French and U.S. governments to finance these wars. (back)

5 Before Roosevelt assumed office in March 1933, the Federal Reserve Banks that make up the Federal Reserve System maintained their own gold reserves. In 1933, the Federal Reserve Banks were obliged to exchange their gold reserves with the U.S. Treasury for gold certificates. Since then, the Federal Reserve Banks have maintained no gold reserves and do not buy or sell gold. All U.S. official gold reserves are held by the U.S. Treasury. The effect of this reform was to centralize control of the U.S. gold reserve in the hands of the White House. (back)

6 In the past, the U.S. Treasury sometimes directly issued its own legal-tender paper currency. During the U.S. Civil War, the Treasury issued paper currency popularly called greenbacks, which is still the nickname of U.S. paper currency. Later, the U.S. Treasury issued gold and silver certificates that once played an important role in the U.S. currency system. In exchange for gold and silver, certificates were issued by the U.S. Treasury that served as currency. A great number of silver certificates were created under the New Deal. While the issuance of gold certificates ended in 1933, the issuance of silver certificates continued until the 1960s.

Today, in contrast, the U.S. Treasury is not allowed to issue paper currency. All paper currency created today is issued only by the Federal Reserve Banks, though the Treasury runs the mint that prints U.S. paper dollars that are then allowed to enter circulation only through the Federal Reserve Banks. (back)


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