Big Challenges Facing Janet Yellen

Yellen testifies

Janet Yellen gave her first report to the House Financial Services Committee since she became chairperson of the Federal Reserve Board in January. In the wake of the 2008 panic, her predecessor Ben Bernanke had indicated that “the Fed” would keep the federal funds rate—the interest rate commercial banks in the U.S. charge one another for overnight loans—at near zero until the unemployment rate, as calculated by the U.S. Labor Department, fell to 6.5 percent, from over 10 percent near the bottom of the crisis in 2009.

However, the Labor Department’s unemployment rate has fallen much faster than most economists expected and is now at “only” 6.6 percent. With the U.S. Labor Department reporting almost monthly declines, it is quite possible that the official unemployment rate will fall to or below 6.5 percent as early as next month’s report.

But there is a catch that the Fed is well aware of. The unexpectedly rapid fall in the official unemployment rate reflects the fact that millions of workers have given up looking for jobs. In effect, what began as a cyclical crisis of short-term mass unemployment has grown into a much more serious crisis of long-term unemployment. As far as the U.S. Labor Department is concerned, when it comes to calculating the unemployment rate these millions might just as well have vanished from the face of the earth.

In reality, the economic recovery from the 2007-09 “Great Recession” has been far weaker than the vast majority of economists had expected. Indeed, a strong case can be made that both in the U.S. and on a world scale—including imperialist countries, developing countries and the ex-socialist countries of the former Soviet Union and Eastern Europe, as well as oppressed countries still bearing the marks of their pre-capitalist past—the current recovery is the weakest in the history of capitalist industrial cycles.

The continued stagnation of the U.S. economy six and a half years since the outbreak of the last crisis has just been underlined by a series of weak reports on employment growth and industrial production. For example, according to the U.S. Federal Reserve Board, U.S. industrial production as a whole declined 0.3 percent in January, while manufacturing, the heart of industrial production, declined by 0.8 percent.

Yellen, as the serious-minded policymaker she undoubtedly is, is well aware of these facts. She told the House committee: “The unemployment rate is still well above levels that Federal Open Market Committee participants estimate is consistent with maximum sustainable employment. Those out of a job for more than six months continue to make up an unusually large fraction of the unemployed, and the number of people who are working part time but would prefer a full-time job remains very high.”

Over the last several months, the growth of employment, which serious economists consider far more meaningful than the the U.S. Labor Department’s “unemployment rate,” has been far below expectations.

Bad weather

Most Wall Street economists are sticking to the line that the recent string of weak figures on employment growth and industrial production reflect bad weather. The eastern U.S. has experienced extreme cold and frequent storms this winter, though the U.S. West has enjoyed unseasonable warmth and a lack of the usual Pacific storms, resulting in a serious drought in California. So it is possible that bad weather has put a kink in employment growth and industrial production.

But there is also concern—clearly shared by the new U.S. Fed chairperson, notwithstanding rosy capitalist optimism maintained by the cheerleaders that pass for economic writers of the Associated Press and Reuters—that the current global upswing in the industrial cycle has failed to gain anything like the momentum to be expected six years after the outbreak of the preceding crisis.

Two ruling-class approaches

This “secular stagnation”–lingering mass unemployment between recessions—has produced a growing split among capitalist economists and writers for the financial press. One school of thought is alarmed by continued high unemployment and underemployment. This school thinks that the government and Federal Reserve System—which, remember, functions not only as the central bank of the U.S. but also of the world under the current dollar-centered international monetary system—should continue to search for ways to improve the situation. Another school of thought, however, believes that all that has to be done is to declare the arrival of “full employment” and prosperity.


We can never forget that capitalist employers like high unemployment, as long as they can sell their products at profitable prices. The higher the level of unemployment the easier it is to cut wages and worsen working conditions, which increases the rate of surplus value and thus profits.

The bosses only become concerned about unemployment when demand is so depressed by recession that they can’t sell their commodities at profitable prices. After all, how bad can the situation be when the stock market keeps on setting records? Isn’t the whole point of the “free enterprise system” to enrich stock market investors—capitalists—not to provide jobs for those who might like and need them. From their point of view, prosperity is going full blaze and has been for quite some time.

The media commentators who reflect this point of view have recently begun to claim that the extremely low “participation in the labor force,” which was developing even before the Great Recession and has grown much worse since, reflects “structural forces”–like the increasing age of the workforce—and therefore is not a cause for alarm. Essentially, they are saying that most of current long-term unemployment is “voluntary,” as the bourgeois economists of the neoclassical marginalist school put it. The long-term unemployed are really choosing leisure over work, or are simply “unemployable” anyway.

‘Full employment’ almost here?

Now, since “full employment” in the U.S. is defined by most U.S. economists as between 5 and 6 percent—using the unemployment rate measure defined by the U.S. Labor Department—the right-wing faction of U.S. “opinion makers” argues that it will probably be less than a year before full employment officially arrives. Beyond that point, the “danger” will be “over-employment,” a situation where the bosses are forced to start hiring some of the “unemployable” millions of long-term unemployed. Why, these opinion makers claim, full employment is practically here already!

With “full employment” here for all practical purposes, these right-wing experts proclaim that it is high time that the emergency measures that were taken during the Great Recession be wound up. The recent suspension in the U.S. of the emergency extension of unemployment insurance payments beyond the usual six months was a major victory for this faction of U.S. policymakers. Now, the right wing is arguing, it is time for the Federal Reserve System to end its extraordinary rate of creating additional U.S. dollars—called the “stimulus,” or quantitative easing. If this is not done promptly, these capitalist authorities fear, an inflation-breeding dollar crisis followed by a brand new deep recession will surely be in store.

The differences in the ruling class were clearly reflected in the minutes of the Fed’s most recent policy meeting in January, released February 19. MarketWatch’s Greg Robb writes:

“Federal Reserve officials couldn’t agree about the outlook for short-term interest rates, forward guidance, inflation and the state of the labor market…. The summary of the closed-door talks reveal that a few hawkish members on the central bank believed that the Fed might need to hike short-term interest rates relatively soon. On the other end of the spectrum, two Fed officials almost balked at continuing the pace of tapering, suggesting that the economy might be too weak for continued reduction in the pace of asset purchases. In a sign of the fractiousness, one official, Fed Governor Daniel Tarullo, dissented from the Fed’s annual monetary policy statement…. In the end, the Fed unanimously agreed to continue to taper and maintain its forward guidance, putting off policy debates until March, when new Fed Chairwoman Janet Yellen would replace Ben Bernanke.”

Yellen aware of the danger of a dollar crisis

Yellen is not unaware of the danger of a dollar crisis, but as a “responsible” policymaker she is also concerned that if tens of millions of potential workers, largely young people, remain either jobless or at least radically under employed—that is, have no prospects of work beyond the occasional low-wage job at MacDonald’s or Walmart—they will sooner or later turn to radical or even socialist ideas.

Indeed, it is happening already. Polls show that among U.S. youth more are favorably inclined toward socialism than to capitalism—an unprecedented situation. And as the world’s central banker, Yellen knows that as bad as things are in the U.S., they are a whole lot worse in many other capitalist countries, especially but not only the “developing” countries of the global South.

Yellen, who is as committed to the preservation of the capitalist system as her right-wing critics, thinks that in the light of these facts it is better to risk a dollar crisis than to simply announce a return to prosperity like the right wing urges. The continued creation of additional dollars—but at a gradually declining rate—Yellen and her supporters hope, will lead to a decline in the real rate of unemployment—not just the fake rate calculated by the Labor Department.

However, she also knows—though of course she lacks a Marxist understanding of the deeper causes—that the objective economic laws that govern capitalism prohibit the Fed from creating dollars at the rate it has been doing since the Great Recession without a disastrous recession-breeding dollar crisis sooner or later. That the danger of a new crisis of the U.S. dollar is very real—notwithstanding the claims of well-meaning liberals to the contrary—was reflected in the gold market in the days after Yellen’s testimony.

The Fed’s real boss

The dollar price of gold closed at $1318.90 on Friday, February 14, up from $1261.50 the Friday a week before Yellen’s testimony. These are the highest dollar gold prices since late last year. Equally important, the rise in the gold price did not reflect a drop in the interest rate on 10-year government bonds. Indeed, this key interest rate rose slightly compared to the previous week.

Basically, the global money market, which is the real boss of the U.S. Federal Reserve System, said to Yellen, in effect: “We didn’t like your testimony. You showed too much concern for the unemployed. The unemployed be dammed! Get on with the business of winding down the stimulus or the consequences won’t be pretty!”

Underlining the problems faced by the new Fed leadership was the wave of selling that hit the currencies of such developing countries as South Africa, Turkey, Brazil and the ex-socialist countries of Russia, Poland, Hungary and so on. This latest crisis of the international monetary system was provoked by the widespread
expectation that the Fed is finally winding up the stimulus.

The same day that Yellen was explaining to right-wing Republican congresspeople that the Fed can’t stop creating additional dollars all at once without disastrous consequences, the Fed announced that the countries whose currencies have been hit must take further deflationary actions—policies that tend to induce recession. By reducing the rate of growth of the “developing” capitalist countries, global overproduction is reduced thus helping stave off a new and perhaps even deeper global economic of crisis of overproduction.

The Yellen-led Fed was forced to acknowledge a point stressed by Karl Marx back in the 19th century. (1) He explained that capitalists cannot utilize the existing forces of production at their full physical potential without disastrous overproduction leading to economic collapse. Of course, neither Yellen nor other Fed spokespeople put it in those words, but that is the reality they are forced to deal with. Global full employment of both workers and the forces of production remains a fantasy under capitalism.

Fed slows stimulus

Under the pressure of this reality, the Fed announced that it would cut another $10 billion in the amount of U.S. bonds and mortgage-backed securities it will buy in February, to “only” $65 billion. This implies a reduced rate of expansion of the U.S. dollar monetary base. To be sure, the Federal Reserve System can make up for this by buying more short-term securities from the commercial banking system, which also creates additional dollars. By buying more short-term government securities and so-called “repos” (2), the Federal Reserve can rebuild its portfolio of short-term government securities that were sold off during “Operation Twist.” This would make possible a repeat of that operation later on if the Fed thinks that it is necessary.

‘Hot money’

Global loan money capital—sometimes called “hot money,” mostly denominated in U.S. dollars—is always seeking the highest rate of interest, just as industrial and trading capital is always seeking the highest rate of profit. In the years that followed the crisis of 2008, the Federal Reserve flooded global money markets with dollars. This drove down interest rates, especially in the economically stagnant imperialist countries of the U.S., Western Europe and Japan.

Imperialist money lenders, therefore, moved some of their hot money from the imperialist countries to developing countries where the rate of surplus value and interest rates were higher. The economic growth that has occurred since the 2008 panic has occurred largely in these countries—for example, Turkey, Brazil, India and China.

With the Fed at last expected to gradually slow the growth in the dollar monetary base, interest rates began to rise in the U.S. At the beginning of this year, interest rates on 10-year government bonds hit 3 percent. This is from a low of below 1.5 percent at times in 2012. This rise was enough to begin to attract hot money back to the U.S. and other imperialist countries. The result is that currencies of many of the developing capitalist countries have come under pressure, putting considerable upward pressure on their internal interest rates. As this has occurred, there has been a reversal in the rise of interest rates in the U.S. in recent weeks, with the rates on U.S. government bonds falling back well below the 3 percent level.

In some respects, this is reminiscent of what happened during the global financial crisis of 1997. Back then, huge amounts of loan money, mostly denominated in U.S. dollars, had been loaned out to the developing countries of Asia, dubbed the “Asian Tigers” by the capitalist media, including Thailand, Indonesia and South Korea. In 1997, large amounts of this hot money was suddenly withdrawn when imperialist money lenders began to suspect that not all this money could be repaid, especially in the case of Indonesia, whose economy plummeted overnight into deep depression as the hot money was withdrawn.

Some financial commentators claim that the comparison with 1997 is overblown. Matthew O’Brien, in the February 4 online issue of The Atlantic, writes, “But falling currencies are only a problem if you borrow in another one [currency]. Emerging markets made that mistake in 1997, but they didn’t this time.”

It is true that since the 2008 global crisis, international credit as a whole has expanded relatively little. Indeed, there has been a tendency toward “de-leveraging,” the contraction of credit that is the typical case during a crisis and post-crisis stagnation.

Those developing countries that have been doing relatively well since 2008 have been able use their exports to the imperialist countries to raise the dollar and euro reserves held in their central banks. These reserves create the basis for expansion of their internal credit systems denominated in their local currencies.

This indeed should make the recent crisis more manageable than the one in 1997, which followed several years of good business on a global scale. This will likely change over the next few years if, as would be expected by both theory and the history of industrial cycles, the stubborn stagnation that has gripped the world economy since the crisis finally gives way to something like a boom that would bring with it a new inflation of the global credit system.

One country that is in real trouble right now, however, is Turkey. Of the debts of Turkish corporations, about 10 percent are in Turkey’s local currency, while the rest are denominated in foreign currencies—presumably dollars or euros. Interestingly enough, Turkey is one of the few countries in the world that experienced anything like an economic boom since the 2008 global panic. (3) Faced with a run on its currency, the Turkish central bank was forced in recent weeks to almost double its main interest rate. These kinds of sudden interest rate hikes are as a rule quickly followed by deep recession.

However, since the global economy is yet to experience the boom phase of the current industrial cycle, international credit is still relatively plentiful, despite the cautious tightening moves by the Fed. Thus, chances are increased that Turkey can be bailed out, which would limit the depth of any Turkish recession—for now.

Overall, higher global interest rates will tend to slow global economic growth, though cyclical forces like the need to replace aging fixed capital can still accelerate growth as long as the overall rise in interest rates is gradual, as is usually the case at this stage in the global industrial cycle.

Indeed, the shift of hot money back toward the imperialist countries has lowered interest rates in these countries. That could extend the housing and auto recoveries in the imperialist countries, which have recently shown signs of stumbling. This will increase the chances that the long expected but stubbornly elusive cyclical capital investment boom might finally get off the ground in the traditional centers of capitalist production.

At the same time, relatively slower growth in the developing countries will impede export growth of the imperialist countries while obliging the industrial capitalists of the “developing world” to increase exports to the imperialist countries. This will work towards a renewed growth in the U.S. trade deficit like happened after 1997, if not perhaps immediately to the same degree. After 1997, the U.S. trade deficit got totally out of control, which played a crucial role in the crisis that began in the U.S. in 2007.

The chain of payments

Back in 1997, 10 years before the Great Recession, loan money capital fleeing the developing countries—which no longer were developing so well—caused interest rates, including mortgage rates, to suddenly plunge in the U.S. during a phase of the industrial cycle when they would normally be expected to rise. The result was that the boom in residential construction was kicked off that was to end so disastrously in 2006-07. This unusual drop in interest rates also helped to set off an incredible boom in tech stocks on Wall Street, which didn’t wait until 2007 to collapse but crashed six years earlier—the famous “dot-com” crash of 2001.

As the current industrial cycle continues to evolve, we shouldn’t expect to see an exact replay of any earlier industrial cycle. Common to all industrial cycles is that during their boom phases a credit inflation develops that generates a chain of payments where creditors end up extremely dependent on repayments by their debtors. As long as the credit system is inflating, a debtor who has difficulty making payments simply borrows more money, which both lengthens and weakens the chain. Every industrial cycle ends with a break somewhere in the inflating and weakening chain of payments.

This leads superficial economists to wrongly see these breaks in the chain of payments as the cause of the crisis rather than as a symptom of overproduction and simply the triggering mechanism of the crisis that they actually are. Like all chains, chains of payments break at the weakest link.

When the industrial cycle of the 1990s began to collapse in 1997, the chain of payments first ruptured in the sphere of debt of the so-called Asian Tigers. This began in Thailand, where a sudden withdrawal of hot money forced the devaluation of the Thai baht, and then much more disastrously in Indonesia.

Indonesia was then still under the dictatorship of Suharto, whose supporters killed upwards of a million people in the wake of his coup against President Sukarno in 1965. Indonesia was considered a favorite country for hot money investors, because for one thing they had few problems with trade unions. As a result, Indonesia acquired over time an unpayable debt. Then, in 1997, the chain of payments generated by the Indonesian debt proved to be the weakest link in the global chain.

Over the next several years, this crisis spread to Latin America and Russia with great force, while it was blunted in the imperialist countries by the return flow of hot money. The imperialist countries experienced economic stagnation but not sharp crisis—with the exception of California’s Silicon Valley, where unprofitable “startups” were ruthlessly weeded out. Then, in the industrial cycle that followed, the chain of payments began to break in the sphere of mortgage credit and more specifically in the area of “sub-prime loans,” which had been so stimulated by the returning flow of hot money from the developing world in 1997 and beyond.

If in 1997, investors began to realize that Thailand and Indonesia would not be able to pay the huge amount of debt they had accrued, in 2006 and 2007 investors began to realize that many of the holders of sub-prime mortgages could not possibly meet their credit obligations. This time, it was the sub-prime mortgages that were the weakest link in the chain of credit. It soon became clear, however, that while the sub-prime mortgages were the weakest link, the chain formed by ordinary mortgages wasn’t so strong either, and in little more than a year the entire global credit system became paralyzed in the panic of 2008.

When the current industrial cycle peaks, we will doubtless see a new break in the chain of payments in what will then be the weakest link. Will it be in the imperialist world like in 2008? Or India or China maybe? Or perhaps somewhere completely unexpected? Time will tell.

The dollar system and the U.S. world empire

To fully understand the latest crisis of the international monetary system, we should review its essential features. The current system, which is often called the “dollar standard,” took its current form when the U.S. repudiated its obligation to redeem U.S. dollars held by foreign governments and central banks in gold—the foundation of the Bretton Woods international monetary system—at the beginning of the 1970s.

However, after the U.S. repudiated this obligation, world primary commodities—most importantly oil—continued to be quoted in U.S. dollars. This was even more the case, since the lingering role of the British pound as a standard of world commodities prices and debts had definitely ended. This obliged large corporations operating on a world scale, banks, and above all central banks to maintain large reserves of dollars. Since internationally traded commodities are mostly priced in U.S. dollars, international debts are denominated in dollars. This entrenched the U.S. dollar as the chief means of payment throughout the world.

Since then, if a country faced devaluation of its currency against the U.S. dollar, its capitalists’ international obligations were still priced in dollars but their assets insomuch as they were denominated in the local currency suddenly represented a lot fewer dollars. This is exactly what happened in Indonesia in 1997.

The result was a wave of bankruptcies, collapsing credit and all the consequences that followed in the form of falling production and employment accompanied by soaring prices in terms of the local currency. Under the dollar system, it is now possible for a country to face runaway inflation in terms of the local currency and drastic dollar deflation at the same time.

In order to avoid or at least reduce the chances of finding itself in such a disastrous situation, countries have been obliged to hold their money reserves mostly in the form of U.S. dollars, even in preference to gold.

Over time, gold has held its purchasing power much better than the dollar; indeed, the purchasing power of gold has been in a long-term upward trend since the deflation of 1920-21. But crises unfold in the short term, not the long term. Periodic rises in the dollar against gold such as occurred in 2013 mean that a country that holds “too much” gold in its reserve could face a devastating crisis because the obligations of its capitalists are not denominated in gold—which would be more rational given the logic of capitalism—but in U.S. dollars.

When this happens, a scramble for dollars is generated that among other things results in a sharp drop in the dollar price of gold. Gold then abruptly, if temporarily, depreciates when measured against dollar obligations that are due. This gives the U.S. and its Federal Reserve System enormous power as the issuer of the currency in which the prices of most internationally traded commodities and debts are denominated. Not surprisingly, the U.S. is determined to keep it that way.

In recent years, the government and central bank of the People’s Republic of China have taken up an old proposal of Keynes that a true world central bank of issue (4) be created that would include representatives of all countries. This bank would issue the currency in which prices of internationally traded commodities and international debts would be defined. Such a revamping of the international monetary system would end the role of the U.S. dollar as the world standard of price and the world means of payment. The U.S. dollar would be reduced to one currency among many in which only local prices and debts would be denominated.

If such a proposal were to be implemented, any devaluation of the U.S. dollar against the world central bank currency would threaten American business with bankruptcy, just as today any devaluation of a country’s currency against the U.S. dollar threatens its dollar-indebted capitalists with bankruptcy. China’s proposal to democratize the international monetary system is going exactly nowhere, just as Keynes’s proposal of 70 years ago went nowhere. The U.S. is not about to give up the role of its Federal Reserve System as the global bank of issue if it can help it.

But hasn’t the relative economic decline of the U.S. eroded the dollar standard? Not as much as one might think. Today, 60 percent of the total central bank reserves are still in dollars, while only 25 percent are in euros. Together, therefore, 85 percent of all central bank reserves are in these imperialist currencies. In contrast, the amount of reserves held by central banks in the Chinese currency is only .01 percent of the total. These numbers should be kept in mind by those who talk lightly about how “Chinese imperialism” is replacing U.S. imperialism.

If sometime in the future, the price of oil and other key internationally traded commodities start to be quoted in Chinese yuan, central banks—as well as commercial banks and large corporations—will have to seriously begin to build up yuan reserves. But despite the tremendous growth of Chinese industrial capitalism in recent decades, we are still a long way from such a development. This underlines a point Lenin made a century ago in his famous pamphlet “Imperialism”: Imperialism is dominated not by industrial capital but by finance capital. Chinese industrial capitalists therefore continue to play a very much subordinate role in today’s global capitalist system.

Under the dollar system when a country other than the U.S. faces a run on its currency, it is forced to quickly sell off its dollar reserves. If the run continues, it must dramatically curb its monetary base denominated in its local currency, even if this means severe recession. It then finds itself at the mercy of the U.S.-dominated International Monetary Fund, which grants countries short-term loans, mostly in dollars, on its—that is, U.S. imperialism’s—terms.

Under the dollar system, the world supply of monetary gold that ultimately backs the dollar and indirectly all other currencies backed by dollar—that is, effectively every currency—is either owned by the U.S.—the famous Fort Knox gold hoard and other lesser known U.S. government-owned gold hoards—or is held physically in the United States, largely in the huge depository located under the Federal Reserve Bank of New York near Wall Street. In a crunch, the U.S. government could easily seize this gold. After all, possession is nine-tenths of the law.

In contrast, the U.S. is under less pressure than other countries to raise interest rates when there is a run on the dollar—a move on world markets to dump dollars for gold. True, there are still limits as explained above, since a dramatic decline in the dollar against gold means severe inflation, which soon degenerates into stagflation, which then makes a deep recession inevitable. And if the U.S. Federal Reserve System were to allow a run on the dollar to continue, at some point the world’s capitalists would be forced to start to denominate their prices in gold and their debts in gold.

This would be the end of the current dollar-centered international monetary system and would probably mark the end of the U.S. world empire. But within these broad limits, the U.S. has considerably more room for maneuver than any other country—including those of the European Union, which issues the euro.

Current state of the gold market

Last month, I promised to say something about the current state of the gold market—really the gold-dollar market. This provides an opportunity to also review some of the underlying economic laws that are making Janet Yellen’s new job such a hard one.

Crises, according to Marx and Engels, arise because in the long run the capitalist system has a peculiar ability to increase production faster than it can expand markets. Periodically, this contradiction comes to a head and is forcibly resolved by global crises of overproduction. During these crisis, production and employment are reduced far below the physical capacity to produce—and all the more radically below the material needs of the masses of people.

But what determines the limits of the market? The majority of bourgeois economists, both the Ricardian classical school and neo-classical marginalists, answer this question by saying that the market is limited only by the ability of industrial capitalists to produce—that is, Say’s Law. Commodities, the argument goes, are in the final analysis bought with other commodities.

If this were true, however, the whole concept of a crisis of overproduction would be nonsense. Essentially, the economists who either explicitly or implicitly accept Say’s Law treat money as simply a technical device to facilitate the exchange of commodities. They ignore money’s other roles, including its roles as a means of payment and means of accumulation or hoarding. Among other consequences, the crucial distinction between money and credit is erased. The foundation of credit is seen to be commodities, and the limits of credit, according to this view, is set by the limits set by the production of commodities.

Marx, in contrast, held that the basis of credit is money—that is, gold or whatever commodity functions as money. It is not commodities in general that form the basis of credit but gold alone. If credit is overextended relative to gold, a credit crisis will occur. Credit will dramatically collapse causing a sudden implosion in demand.

The resulting crisis is then a signal to the industrial capitalists that they are producing too many non-monetary commodities and not enough money material—generalized overproduction. Relative to money material, commodities as a whole—the commodity that functions as money excepted—are being overproduced.

The overproduction of commodities—in relation to the money commodity—necessarily means an overproduction of the means of producing commodities. Before a healthy recovery can occur, it is not enough to reduce inventories—commodity capital. That is only the first step. The means of producing commodities must also be reduced. If they are not, no real recovery in investment can take place and money will fall out of circulation and accumulate as idle hoards in the banks. This is exactly the situation we have been experiencing since the 2008 global crisis.

The liquidation of overproduced means of production takes far longer than the reduction of the quantity of overproduced commodities. The overproduction of the means of production therefore forms the basis of all periods of prolonged stagnation—as opposed to cyclical crises proper lasting a year or so. The reduction of overproduced means of production is achieved both through the suspension of the creation of new means of production—capital investment—but also through the outright destruction of the overproduced means of production. Until the overproduced means of production are sufficiently reduced, no reduction of the (long-term) rate of interest can revive capital investment.

This was the lesson of the stagnation of the 1930s, which so influenced Keynes, and is also the lesson of the post-2008 period. Without a revival of capital investment, capitalist expanded reproduction—prosperity in ordinary language—cannot get off the ground. The result is capitalist economic stagnation—a huge amount of idle means of employment on one side combined with a mass of unemployed or radically underemployed workers on the other.

Here is revealed the major flaw in Keynesian economics. Present-day neo-Keynesian “stabilization policies” have shown that such measures cannot prevent the outbreak of crises as was once hoped. When a crisis does break out, policymakers are forced to settle for second best—to halt the crisis half way through. This is illustrated by Federal Reserve policy beginning in 2007.

Faced by a weak paper currency—a strong demand for gold—the Federal Reserve did not significantly expand the U.S. dollar-denominated monetary base until full-scale panic broke out in September 2008. The panic then created an abnormal demand for U.S. dollars, first of all as a means of payment and then as a reserve against the feared demand for immediate payment of debts—a means hoarding. It was the crisis-generated demand for U.S. dollars as a means of payment and hoarding that enabled the Federal Reserve System to radically expand the quantity of Federal Reserve-created dollars without triggering a run on the dollar.

This halted the actual crisis proper—the sharp contraction of industrial production and world trade by 2009. Former Federal Reserve Chair Ben Bernanke and his supporters, with little else to brag about, boasted that they deserved credit for preventing a full-scale repeat of the Great Depression, which they dubbed Depression II.

But this “achievement” also meant that cutting off the destruction of surplus means of production, as well as the inadequate reduction of commodity capital is coming back to haunt them in the form of the current stubborn and unstable capitalist stagnation. To the extent they expanded the global supply of U.S. dollars at a rate far beyond the expansion of the world’s gold hoard, they laid the basis for a new crisis once the lingering crisis-bred extraordinary demand for U.S. dollars finally ends–which would take the initial form of a dollar crisis—a sudden stampede to dump dollars for gold on the world gold market.

And this is what makes Yellen’s job so tough. If Yellen and her colleagues continue to create dollars at the rate they have been doing since the end of the Great Recession proper, it will be only a matter of time—though nobody knows how much time—before they face a run on the U.S. dollar that will then be only the first stage of a disastrous new crisis.

The only way that a basis for “healthy” capitalist growth, after decades of Keynesian “stabilization”—which in the long run is proving highly de-stabilizing—and the resulting cumulative overproduction that it made possible, is precisely through Bernanke’s feared Depression II. It is likely that due to decades of Keynesian policies, Depression II will bear the same relationship to Depression I in terms of its destruction that World War II bore to World War I. This is the nub of the problem that Yellen and other capitalist policymakers face today.

The other side of the overproduction equation is the production of the commodity that functions as money material—gold bullion. “Output from the world’s gold mines,” Reuters reported on November 20, 2013, not without a note of glee, “is set to hit record highs this year, disappointing bulls who are impatiently waiting for production cuts following this year’s 24 percent plunge in prices.”

According to official economic theory, this should be of little significance, since in this post-gold standard world, gold is supposedly “just another commodity.” But Reuters cannot but sense that the 2013 decline in dollar gold prices was a good thing—and therefore admits on the sly that the official economic theory is, to put it bluntly, bunk—for the economic system of capitalist exploitation that it so enthusiastically defends.

The rising levels of gold production are increasing potential new demand—even if this demand is frozen for now in the form of gold bars in hands of private speculators and the central banks and in the form of excess commercial bank reserves held in the various central bank-issued currencies. One problem is that while this potential demand is increasing, it is not increasing nearly fast enough to solve the secular stagnation that capitalism is now facing. But things would almost certainly be a whole lot worse had gold production continued to decline like it did between 2001 and 2008. In that case, the current recovery, weak as it is, would most likely have collapsed completely by now.

But there is another problem. After decades of unprecedented cumulative overproduction and associated credit inflation, it has become very difficult to transform this potential demand in the form of newly mined and refined gold bars into actual demand without triggering a disastrous dollar crisis that might finally trigger the long dreaded Depression II.

Still, despite the continued “secular stagnation,” 2013 was a very good year for the owners of stocks. During 2013, money capitalists sold gold bullion and bought stocks. Their motives are not hard to discern. Unlike the miser who hoards more and more gold, capitalists want to accumulate capital. Capital consists overwhelmingly of non-monetary commodities—most importantly, purchased labor power, since that form of capital alone produces surplus value—and means of production plus raw and auxiliary materials. By buying corporate shares, money capitalists, though they aren’t directly industrial capitalists, hope to enjoy the fruits of the process of expanded capitalist reproduction in the form of rising dividends and/or capital gains on their shares.

Remember, under modern monopoly capitalism the dominant industrial capitalists are collective entities known as corporations rather than individuals, as tended to be the case in early capitalism. Instead of creating businesses of their own, money capitalists when they anticipate a phase of prosperity buy shares. As profits rise, a portion of these profits is distributed to shareholders in the form of rising dividends. The gradual exclusion of individual industrial capitals, especially in those spheres where production is carried out on a large scale, and their replacement by collectively owned corporations—though not by the producers but rather by money capitalists—points toward the inevitable end of capitalism and the passage of the means of production into the hands of the associated producers.

Money capitalists desire to buy gold in great quantities only when they anticipate a crisis—or when a crisis is already raging—and then sell the gold and get back into the stock market once the crisis has passed. Under the present dollar system, however, this has a direct effect on the prices of commodities in terms of gold and on the profitability both relative and absolute of gold mining and refining. And through its effect on profits, it inevitably feeds back to the production of gold. As stocks soared during 2013, the prices of commodities measured in terms of gold also soared.

Reuters reports: “Some gold miners have felt the squeeze of lower prices this year, and a number, including Canada’s Kinross and Russia’s Polymetal, suspended marginal mines and projects after a dramatic first-half price drop.

“But as prices fall, others are actually increasing output to maintain revenue and profit levels. In some cases, they are targeting higher grade ore to keep marginal mines operating and generating cash, at the expense of future production.”

As falling dollar gold prices—or rising commodity prices in terms of gold—make gold mining less profitable, the worst gold land is becoming altogether unprofitable. However, the rich gold-bearing land—the land that yields gold at a lower individual value—is still profitable. The unfavorable movement of prices from the viewpoint of the gold mining capitalists would have to go further before the richest gold mining land becomes unprofitable—or even falls below the average rate of profit.

Therefore, gold mining capitalists are able to maintain overall profitability for their stockholders—though far below the huge super-profits of recent years—by stepping up production on this land. However, since this land is scarce, it will be exhausted in coming years, and all else remaining equal, gold production will decline in the years ahead if the price movements of 2013 are not soon reversed.

With gold production becoming a relatively unprofitable field of production, exploratory budgets are being cut back, making discoveries of rich gold-bearing land less likely over the next few years compared to recent years. This creates a lag effect even if the price movements of 2013 are quickly reversed.

Reuters quotes William Tankard of GFMS Ltd (a leading precious metals consultancy): “What we’re seeing is an ongoing response not to the slide in prices, but the decade-long stretch of fairly heavy capital investment into the mining industry that preceded it.”

New mines equipped with the latest mining technology are just now coming on line. However, if the recent price and profit trends continue, the “fairly heavy capital investment” will give way to much lighter capital investment.

Therefore, unless dollar gold prices rebound quickly—without triggering offsetting increases in commodity prices expressed in U.S. dollars—gold production could start moderating in 2015. If this comes to pass, it will likely mean increasing upward pressure on dollar gold prices from 2015 onward. This will make the job of the Yellen-led Federal Reserve even harder. Let’s see why.

With most commodities, if production drops the total supply of the commodity declines as the commodity is consumed. Gold, however, insomuch as it is used as means of accumulation—hoarding—is not consumed and lasts forever in capitalist terms. Circulating gold coins do suffer wear and tear in circulation—that is, they get lighter. But under the present-day international monetary system, circulation of gold coins is pretty much confined to the world of illegal commerce, and even there, the U.S. $100 bill is the preferred currency.

Gold used for non-monetary purposes, such as electronics or dentistry, is consumed and can disappear for practical purposes, though during periods of high demand gold is indeed “mined” from junked electronic components. At the height of the recent “gold boom,” there were even reports of people yanking gold out of their dental filings. So some gold that is consumed for non-monetary purposes can reappear as monetary gold in periods of exceptional demand.

The result is that the total quantity of gold bullion in the world constantly rises. Even deep depressions in world gold production never reduces its supply. What is affected, however, is the rate of growth of the world’s total gold hoard. It is also true that even during periods of soaring gold production, the total quantity of gold in the world only increases by a few percent.

Some students of the gold market—particularly so-called “gold bugs,” who are perennial gold bulls and support “Austrian economic theory,” which plays down the role of gold production—claim that the level of production of gold is unimportant in determining the prospects for the dollar price of gold. Instead, they claim it is only the amount of dollars the Federal Reserve System is creating and government deficits that are the key factors. This is quite wrong.

In reality, a dollar crisis is much more likely when gold production is declining, or at least stagnating like it did during 1970s and again between 2001 and 2008, than it is when gold production is at record levels and increasing like it was, for example, during the 1980s and 1990s or in 2013.

Therefore, the level and trend of gold production—though indirectly under the present international monetary system but all the more surely—has a huge effect on the monetary policies that the Federal Reserve System can follow. If gold production is generally declining, this has a strongly bullish effect on the dollar gold price and on the prices of primary commodities when measured in terms of dollars, which greatly limits how many more dollars the Fed can create without triggering a dollar crisis.

This impresses itself on the consciousness of central bankers as the “inflation threat.” If gold production is high and rising, this has a bearish effect on the dollar gold price and through that on the prices of other primary commodities when measured in dollars. The Fed’s policymakers then see the threat of inflation as low and may even see a threat of deflation, or at least a rate of inflation below their “inflation target.” They respond by creating more dollars.

However, when gold production is stagnant or declining, the dollar gold price is much more likely to rise and with it the prices of primary commodities measured in U.S. dollars. Inflation tends to rise above the Fed’s inflation target. The Fed is then under pressure to curb the production of dollars. Therefore, the ability of the Federal Reserve System and capitalist governments in general to fight crises or follow policies that encourage the expansion of demand is in no small measure determined by both the level and the direction and rate of change of gold production.

A note on coming posts

A dangerous development over the last few years is the turn by the leaders of U.S. imperialism toward exploiting the huge fossil reserves of North America as a means toward prolonging the life of their declining but still extremely powerful and dangerous world empire. I hope to devote a post to this alarming development later this year.

This year also marks the 100-year anniversary of the beginning of World War I, an event that more than any other marks the end of the relatively “peaceful” 19th century. It led to both the collapse of the international gold standard, which had played such a crucial role in 19th-century capitalism, and to the Great Depression.

In the political sphere, World War I led to the Russian revolutions of February and October 1917, and all the consequences that followed, including the first attempt to build a socialist society, the rise and fall of fascism, the Chinese Revolution, and the Korean, Vietnamese and Cuban revolutions, to name only a few that made the 20th century so different from the 19th century. The centenary of this event will occur this August. Both the causes and consequences of this event will have to be examined.

Published February 23, 2014


1 Today’s productive forces have grown many times over since Marx wrote in the 19th century. As a consequence, contradictions have become vastly more explosive than they were in the days of Marx and Engels. This is why no reader who has understood this blog will envy Yellen in her new job. (back)

2 Repos are short for “repurchase agreements.” Basically a commercial bank in order to raise quick cash agrees to sell the Federal Reserve Bank of New York a short-term obligation on the U.S. Treasury that it owns but agrees to repurchase it a day or so later. When the Federal Reserve Bank of New York purchases the short-term security, it pays for it by crediting the commercial bank’s reserve account with the Fed, in effect creating new dollars.

When the commercial bank buys the security back, its pays the New York Fed with dollars held in its reserve account, effectively destroying them. The Fed uses these agreements—and the opposite transaction known as “reverse repos”—to make short-term adjustments in the amount of dollar-denominated reserves available to the commercial banking system.

Another method the Fed plans to use in the future is to change the interest rate it pays to its depositors, the commercial banks. In the past, the Fed paid no interest on these accounts, but it now pays a very low rate of interest, currently 0.20 percent. In the future, the Fed plans to increase this interest rate when it wants to restrain the growth in commercial bank loans during boom times by encouraging the banks to save with it rather than make new loans, and to reduce the rate it pays on these accounts when it wants to encourage the commercial banks to “save less” and loan more during periods of recession or stagnation. (back)

3 If a country—in particular a relatively small one like Turkey—grows rapidly during a period of global stagnation or slow growth, it will be obliged to increase its imports much faster than it can increase exports. If companies are unable to finance fully their expansion out of sales either internally or on the world market, they are forced to borrow abroad in so-called “hard currencies,” dollars and euros. The result is a rapid increase in the debt that the country owes to foreign creditors, and this debt will of course be denominated in dollars or euros.

At a certain point, the foreign lenders will fear that they won’t be repaid—perhaps but not necessarily because the U.S. Federal Reserve System is believed to be tightening—and will refuse to make new loans and move to call back existing loans. This tends to create a break in the chain of payments. When this happens, the country’s businesses are forced to use their local currency to purchase foreign exchange—dollars and euros—that are being demanded for repayment. The result is that the local currency—in Turkey’s case the lira—falls suddenly against the dollar and euro.

To prevent the local currency from losing its purchasing power altogether, the country’s central bank is forced to buy back its own currency with its dollar and euro reserves. Threatened by the quick exhaustion of its foreign currency reserves, the local central bank has no choice but to radically raise domestic interest rates—in Turkey’s case, almost doubling them overnight. This forces its businesses to cancel their expansion plans, which in turn reacts on other local businesses. The result is a sudden piling up of unsold commodities in the country, and for foreign businesses that export to it, and a dramatic contraction of local employment and production—at least a local recession.

Local businesses find they can only sell a fraction of the commodities they were able to sell just weeks before. Those businesses that can find markets abroad increase exports just as imports are falling. This ends the balance of payments crisis and trade deficit—while putting pressure on the balance of trade and payments of countries who export to it—but at the price of a deep recession in the home market. (back)

4 A bank of issue is one that makes loans and discounts in what originally was promissory notes drawn upon itself. These promissory notes were declared payable to the bearer on demand in gold or silver coins. These notes, called banknotes, then served as hand-to-hand currency to be used for purchases and means of payment alongside gold and silver coins.

In the modern world, with few and trivial exceptions, commercial banks no longer issue banknotes. Instead central banks like the U.S. Federal Reserve System, the European Central Bank, the Bank of England, the Bank of Japan, the People’s Bank of China, and so on issue “paper money” that are today also called banknotes. But these banknotes are not really promissory notes but rather central bank-issued token money that is declared legal tender for all debts both private and public. (back)

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