The Federal Reserve System, Its History and Function, Part 1

This is a special post in two parts on the U.S. Federal Reserve System. It is in response to the rise of the Occupy Wall Street movement. Part 2 will be published on November 6, and the next regularly scheduled reply on the crisis of the dollar system will be published on November 20.

The last weeks in the United States have seen a sudden surge of anti-Wall Street demonstrations that have targeted the policy of the U.S. government of “bailing out banks and not people.” The occupation movement has since spread first across the United States and now the world.

The followers of Ron Paul, a right-wing Republican congressman and presidential primary candidate from Texas, have appeared at some of the occupations and raised the slogan “End the Fed.” Paul believes that not only “the Fed” but democracy in any form should be abolished. Paul’s followers blame the Federal Reserve System for virtually all the problems faced by the lower 99 percent—high unemployment, the high cost of living, mass indebtedness, “underwater” homes, and foreclosures.

But what actually is the Fed, or to use its formal name, the Federal Reserve System? Is it some kind of privately owned bank, or is it a government agency? What is the difference between the Federal Reserve Board and a Federal Reserve bank? Is the Fed really to blame for the problems of the lower 99 percent of the population? And if the answer is yes, why would such an evil institution have been established in the first place?

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World Trade and the False Theory of Comparative Advantage

Some introductory remarks

This reply and the one that will follow should be seen as a continuation of my reply criticizing the view of economist Dean Baker that the U.S. dollar is “overvalued” and his claim that the U.S. trade deficit could easily be corrected and the U.S. unemployment crisis eased by simply lowering the exchange rate of the U.S. dollar against other currencies.

I had originally planned to continue the discussion of world trade and currency exchange rates the following month but the contrived U.S. government debt crisis in August forced a change of plans.

Reader Mike has made some interesting remarks about world trade and the dollar system—the foundation of the American empire, which has dominated the world politically, militarily as well as economically since World War II. To understand the growing threat of a renewed crisis barely two years after the official end of the “Great Recession” of 2007-09, it is important to understand both world trade and the dollar system.

Discussing Baker’s arguments for a lower dollar, Mike wants to know if there is an objective basis for determining if currencies are “high” or “low” in relation to one another. Baker summarizes his argument as follows:

“The U.S. pattern of spending more than it takes in is due to the fact that the dollar is too high. In a system of floating exchange rates, like the one we have, the price of currencies is supposed to fluctuate to bring trade into balance. This means that the trade deficit is caused by the over-valued dollar and a decline in the dollar is the predictable result.”

The obvious problem with the view that the U.S. dollar is “overvalued” is that ever since the end of the Bretton Woods system 40 years ago, the exchange rate of the U.S. dollar has shown a secular tendency to decline against other currencies. If the dollar was “too high” in the sense that there is a correct level of exchange rates that would end the U.S. trade deficit, why hasn’t the secular fall in the dollar brought the U.S. trade account into balance?

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The Oil Reserve Sales and Stagflation

Reader Jon B asks, what in my opinion are the reasons behind the decision of the U.S. to sell some 30 million barrels of oil from the U.S. strategic petroleum reserve? Could it reflect the cutoff of Libyan oi production and plans for increased warfare by the U.S. government in the Middle East and Africa over the coming months?

The unexpected failure of the Libyan government to quickly collapse before the combined U.S.-NATO-rebel assault means that disruption of Libya’s oil production and exports is likely to last longer than the U.S. government planners expected back in March when the U.S.-NATO war against Libya began. U.S. military activity against Yemen also appears to be increasing. There is also a growing danger of a U.S.-NATO war against Syria. This danger will increase if Libya’s resistance finally crumbles before the overwhelming firepower of the U.S-NATO assault.

It seems likely now, however, that the motive for the sale of oil reserves is largely economic. By driving down the price of crude oil and gasoline, the U.S. and other capitalist governments are attempting to boost purchasing power and thus pump some life into the faltering economic recovery from the “Great Recession.”

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Dean Baker on the Price of Oil

Recently, Mrzine, the online magazine of the Monthly Review Foundation, published the testimony of the left Keynesian economist Dean Baker to the U.S Congress. Baker attempted in his testimony to refute the claims made by right-wing bourgeois economists that the spike in oil and gasoline prices earlier this year was caused by the U.S. Federal Reserve Board’s policy of “quantitative easing.”

What is “quantitative easing”? And why has the U.S. Federal Reserve System, which under the dollar system acts in effect as the world’s central bank, been following such a policy?

Last year, the outbreak of the European sovereign debt crisis, followed by a distinct pause in the global economic recovery, brought fears of a renewed global recession. The U.S. Federal Reserve Board announced that it would purchase $600 billion worth of U.S. bonds in a bid to stave off a “double-dip” global recession. Or what comes to exactly the same thing, the Fed in effect announced that it was going to transform $600 billion in U.S. government debt into green U.S. paper dollars—or their electronic equivalent.

Since last December when the quantitative easing program actually kicked in—it had been announced earlier—the quantity of token money denominated in U.S. dollars has jumped by more than 35 percent. To put this number into perspective, during the prosperous post-World War II years, the quantity of U.S. token money rarely grew more than 3 percent per year.

Between May 21, 2010, and April 29, 2011, oil prices jumped almost 62 percent, peaking out at over $113 per barrel. In response, gasoline prices have soared. World food prices have also increased sharply in terms of the depreciated U.S. dollar.

Even before the explosion in the quantity of dollar token money began, speculators anticipating the expected increase in token dollars began to push up the dollar price of gold, oil and primary food commodities. The dollar price of gold rose from $1,177 per troy ounce on May 21, 2010, to $1,556 per troy ounce on April 29, 2011. Or what comes to exactly the same thing, the U.S. dollar in terms of gold was devalued against gold by more than 24 percent in the same period.

When speculators expect a change in the quantity, or rate of growth of the quantity, of token money, they act accordingly, causing currency prices of gold and primary commodities to change even before the expected change actually occurs. If the expected change fails to materialize, markets will then react sharply in the opposite direction. This is exactly what happened in late 2008. But this was not the case in 2010 and 2011, since this time the expected changes in the quantity of dollar token money have indeed fully materialized.

So it would seem on this issue that the right-wing bourgeois economists who blame the U.S. Federal Reserve System for the spiking oil, gasoline and food prices have a point, though the alternative might well have been a renewed global recession.

However, in his congressional testimony the progressive economist Dean Baker challenged the view that the Federal Reserve policies have had much to do with this year’s spiking oil and gasoline prices. (Baker didn’t deal with the question of food prices in his congressional testimony.) Since the MRzine editors decided that Baker’s testimony was worth publishing, it is worth examining Baker’s arguments in some detail.

Presumably, MRzine published Dean Baker’s testimony because the editors believe that Baker is the kind of left Keynesian that Marxists can and should be working with as part of Monthly Review’s general policy of attempting to push the U.S. economics profession back toward Keynesianism, which dominated it in the years immediately after World War II, as opposed to the neo-liberal theories that have dominated since the 1970s. Indeed, Baker as an economist is probably about as far to the left as you can get in the U.S. and still be a bourgeois economist. It is therefore instructive to examine Baker’s approach to the question of the recent rise in oil and gasoline prices.

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A Keynesian Takes on Karl Marx

In this reply, unless otherwise noted, text in italics and in brackets in Marx quotes is carried over from the version taken from the Marxist Internet Archive.

A friend N has asked if there is any difference between “the over-accumulation of capital” and “the overproduction of commodities.” Another friend M sent me a critical article by leading American Keynesian economist Brad DeLong on Chapter 17 of Marx’s “Theories of Surplus Value.” DeLong’s article is titled “Marx’s Half Baked Crisis Theory and His Theories of Surplus Value, Chapter 17.”

It so happens that in Chapter 17 Marx deals with the relationship between the “overproduction of capital”—also called the “over-accumulation of capital”—and “the overproduction of commodities.” The economists of Marx’s time—the middle years of the 19th century—admitted the “overproduction of capital”—equivalent to the over-accumulation of capital—while denying the “overproduction of commodities.”

Therefore, DeLong’s critique of Marx and N’s question about the relationship between the overproduction of commodities and the over-accumulation of capital are connected by Chapter 17 of “Theories of Surplus Value,” the target of Brad DeLong. It is therefore possible to deal with DeLong’s critique and N’s question in a single reply.

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Is the Economic Crisis Over?

According to the media, the world capitalist economy has been in a recovery for almost two years. Yet there remains a widespread impression that the economic crisis that began in 2007 is far from over. True, the rate of profit has risen sharply since 2009, and the mass of profits is at record levels. Yet the crisis of mass unemployment persists.

At the current rates of job creation in the U.S. and other imperialist countries, it will be years before the number of jobs returns to the levels that prevailed in 2007 on the eve of the crisis. And even the pre-crisis 2007 levels were far from full employment. Therefore, is the economic crisis that began in 2007 really over?

The passage of a cyclical crisis described

Rosa Luxemburg in “What Is Economics?”—which was written shortly after the economic crisis of 1907-08—gave this vivid description of how a cyclical crisis of overproduction is reflected in the capitalist media:

“…once the crisis is in full swing, then the argument starts about who is to blame for it. The businessmen blame the abrupt credit refusals by the banks, the speculative mania of the stockbrokers; the stockbrokers blame the industrialists; the industrialists blame the shortage of money, etc.”

Though these words were written a century ago shortly after the 1907-08 crisis, they could just as well have been written to describe the crisis that began exactly a century later in 2007.

The recovery

“And when business finally picks up again,” Luxemburg continued, “then the stock exchange and the newspapers note the first signs of improvement with relief, until, at last, hope, peace, and security stop over for a short stay once more.”

“Modern society,” Luxemburg further explained, “notes its [the cyclical crisis—SW] approach with horror; it bows its head trembling under the blows coming down as thick as hail; it waits for the end of the ordeal, then lifts its head once more—at first timidly and skeptically; only much later is society almost reassured again.”

Crisis of 1907-08 in historical perspective

As it turned out, after the crisis of 1907-08 capitalist society had little time to get “reassured again.” If the industrial cycle that began with the crisis of 1907 had followed the typical 10-year course, the next crisis of overproduction would have been due around 1917.

Instead, a new worldwide recession began in 1913, about four years early. In Europe, this new recession did not end with a new upswing that left society “almost reassured again.” Instead, it ended with the “Guns of August”—the outbreak of World War I.

Capitalism ‘celebrates’ the anniversary of 1907 crisis

The capitalist economy “celebrated” the 100-year anniversary of the crisis of 1907 in the most “appropriate” way possible—with yet another crisis. And like its predecessor a century earlier, the crisis that began in 2007 proved to be unusually severe. There is a feeling now that the crisis of 2007-09 is perhaps, like the crisis of 1907-08, no ordinary crisis. Could this crisis, too, be the herald of a far more fundamental crisis of capitalist society?

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A New Imperialist War

The last few weeks have seen the beginning of a new imperialist war, this time against the small oil-rich country of Libya. The war began on March 19, when the United States, Britain and France launched a missile attack against Libya’s air defenses.

The opening of this new U.S.-led imperialist war of aggression occurred on the eighth anniversary of the U.S.-led invasion of Iraq. To add to the irony, the first missiles began to fall during U.S. West Coast anti-war demonstrations timed to mark the beginning of the imperialist invasion of Iraq—a first in the history of anti-war demonstrations, I believe.

I had been asked what is my opinion of the current economic conjuncture. I had intended to devote a reply to this question, since I have not written about this for some time and there have been some interesting developments on this front. However, the explosive events in North Africa and the Persian Gulf region combined with the Japanese earthquake, tsunami and nuclear disasters are raising a different set of questions that should be dealt with first.

What will be the effects of these events on the world capitalist economy? These events are external to the industrial cycle, though they will no doubt exert an influence on the evolution of the current global industrial cycle that began with the outbreak of the last general crisis of overproduction in 2007. Therefore, this month I will examine the effects of the North African and Persian Gulf events and the Japanese disasters on the capitalist world economy. I will postpone until next month an examination of the current conjuncture in the global industrial cycle.

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Are Marx and Keynes Compatible? Pt 5

Keynesian economists blame their failure on the trade unions

Keynesian economists in general—and some Marxists influenced by them—blame the failure of the Keynesian policies of the 1970s on the trade unions. Basing themselves on Keynes, they falsely blame the inflation of the 1970s not on the inflationary monetary policies of the central banks that were so strongly supported by Keynesian economists at the time but on the trade unions.

These economists claim that by achieving raises in money wages during the inflation, “over-strong” unions were responsible for the inflation of the 1970s. Supposedly, a “wage-price spiral” pushed money wages relentlessly higher forcing the central banks to periodically raise interest rates to prevent even worse inflation, which in turn led to the recessions and unemployment of the 1970s and early 1980s.

However, in reality it was the trade unions that found themselves increasingly on the defensive as both inflation and unemployment rose during the 1970s and into the early 1980s. What the Keynesian economists call the “wage-price spiral” of the 1970s was really a “price-wage spiral.” The unions were only reacting to the ongoing inflation in their attempts to maintain—not entirely successfully—the living standards of their members.

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Are Marx and Keynes Compatible? Pt 4

The Keynesian revolution in economic policy

Before Keynes, neo-classical marginalist economists believed that capitalism was stable if left to its own devices. These economists held that a capitalist economy tended strongly toward an equilibrium at full employment of both workers and machines. Therefore, if a recession were to occur the response of the authorities should be pretty much confined to having the central bank lower the discount rate. Otherwise, the government should stay out of the way. As long as it did, the marginalists claimed, the capitalist economy would quickly move back to its only possible equilibrium position, “full employment.”

The events that followed World War I, especially the U.S.-centered Great Depression of 1929-1941, discredited this view. Under the influence of Keynes—and more importantly the Depression itself—most of the new generation of (bourgeois) economists believed that it was now the duty of the capitalist government to actively intervene whenever recession threatened.

Bourgeois economics split in two. One branch, purely theoretical, is called “microeconomics.” Microeconomics is simply the old marginalism. The branch that emerged from the Keynesian revolution is called “macroeconomics.”

Macroeconomics tries to explain the movements of the industrial cycle. More importantly, it seeks to arm the capitalist governments and “monetary authorities” with “tools” that will keep the capitalist economy from sinking again into deep depression with the resulting mass unemployment. The new stance of the bourgeois economists was that if the capitalist governments and their monetary authorities use the “tool chest” provided them by macroeconomics correctly, they should be able to maintain “near to full employment with low inflation.”

Full employment was defined by this new generation of (bourgeois) economists not the way workers would define it—everybody who desires a job can quickly find one—but rather as a level of unemployment sufficiently high to keep the wage demands of the workers and their unions in check but low enough to prevent wide-scale unrest that could lead to working-class radicalization and eventually socialist revolution.

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Are Keynes and Marx Compatible? Pt 2

John Bellamy Foster’s Case for Keynes

I explained in last month’s reply that John Maynard Keynes is the leading economist of non-Marxist progressives. Marxists themselves are sharply divided on the nature and usefulness of Keynes’s work and its relationship to Marxism.

As a rule, Marxists who support the Grossman-Mattick school or other schools that blame capitalist crises on the periodic inability of the capitalists to produce sufficient surplus value to maintain capitalist prosperity are quite hostile to Keynes’s work. According to these schools, the only way out of a capitalist crisis within the limits of the capitalist system is to increase the rate of surplus value―the rate of exploitation of the workers―and thus restore an “adequate” rate of profit for the capitalists.

Any attempts by a government inspired by Keynes’s theories to restore the purchasing power of the people during a capitalist crisis only makes it more difficult for the capitalists to restore an adequate production of surplus value. Therefore, the “not enough production of surplus value” schools of Marxist crisis theory hold that Keynesian policies only make a capitalist crisis worse. By spreading dangerous reformist illusions about the possibility of improving the condition of the working class and its allies within the capitalist system, these schools of Marxists claim the “Keynesian Marxist” tendencies such as the Monthly Review School build support for opportunist reformist tendencies within the workers’ movement.

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