Economic Stagnation, Mass Unemployment, Budget Deficits and the Industrial Cycle

A few months ago I had dinner with a some friends from the old days. One of them expressed the view that the current economic situation of prolonged economic stagnation, continuing mass unemployment, and falling real wages represented a fundamental change in the workings of the capitalist system. He asked what is behind this change? This a good question and is worth examining in a non-trivial way.

A month or so ago the media, which had been painting a picture of a steadily improving economy, was startled when the U.S. government announced that its first estimate showed that the fourth-quarter GDP declined at an annual rate of .01 percent. Though slight, this would be a decline nonetheless.

Those economists who make a business of guessing the U.S. government’s GDP estimate expected an annualized rate of growth of 1.5 percent for the fourth quarter (of 2012). This would represent a historically low rate of growth, but growth nonetheless.

The media has been working hard to create an impression of a recovery that is at last gaining momentum. Therefore, if we are to believe the capitalist press, a “new era” of lasting prosperity is on the way. This latest “new era” will be fully assured if only the Obama administration and both Democrats and Republicans can settle their differences on the need to bring the current deficit in the finances of the U.S. federal government under control.

This is to be done by some combination of “entitlement cuts” for the working and middle classes and very modest tax increases for the rich. With the tax question settled by the New Year’s Day agreement, the only question now is how deep the entitlement cuts will be, spending on the military and “national security” being largely untouchable.

Thrown somewhat off balance by the estimated fourth-quarter GDP decline, the economists, bourgeois journalists and Wall Street brokerage houses—ever eager to paint the U.S. economy in glowing terms in order to sell stocks to middle-class savers—explained that “special factors” were behind the slight fall in the estimated GDP, not a new recession.

Most prominent among the special factors cited was a sharp decline in military spending relative to the strange surge—or rather not-so-strange surge considering it was an election year—in military spending in the third quarter. Another special factor was the impact of Hurricane Super-Storm Sandy that hit New Jersey and New York with devastating force in late October.

However, the figures also showed signs of real weakness that cannot be dismissed so easily. These include a drop in inventories—a contraction of commodity capital—after the rapid accumulation of inventories in the fourth quarter, and weakness in exports reflecting recession in Europe and the general slowdown in the world economy that set in last year. There have also been reports that Apple—recently the biggest U.S. corporation by stock market valuation—has been forced to slow its production of the latest iPhone due to slower-than-expected sales.

Therefore, when the government reported a slightly less than expected rise in employment in January, the bourgeois media expressed a wave of relief. If an actual recession had begun in the fourth quarter of 2012, as suggested by the decline in GDP, January employment should have shown an actual decline, or at best remained more or less unchanged.

The Institute for Supply Management also reported a rise in its manufacturing index to around 53 (1). While quite sluggish, this still represents a slight rise in the rate of growth of manufacturing rather than the decline that would be expected if a recession had begun in the fourth quarter of 2012.

Most recently, the U.S, government reported higher U.S. exports and lower imports due to rising U.S. natural gas exports and lower oil imports made possible by the new fracking process. Fracking, while it risks polluting ground water, enables natural gas to be extracted much more cheaply than before. This caused Reuters and the Associated Press—news services that go out of their way to present the U.S. economy in the most optimistic way possible—to predict that the U.S. government will probably revise the fourth quarter GDP upward, showing a slight growth—perhaps 0.5 percent—after all.

Taken as a whole, the most recent batch of economic figures from various governments indicates the continuation of sub-par growth rather than outright recession for the U.S. and world economy, with the exception of Europe. Recession continues for many countries in Europe hit by the government debt crisis last year. Considering today’s highly intertwined globalized economy, it would be highly unlikely the recession in Europe would coincide with strong economic growth in the U.S. or elsewhere.

Despite the slow growth—and actual slight decline in the initial GDP figures for the final quarter of 2012—the U.S. and other world stock markets have been barreling upward, with the major U.S. stock market indices approaching the records reached in October 2007 just after the beginning of the last global economic crisis in July-August 2007. At that time, the U.S. stock market briefly declined in the wake of the initial credit market crisis in August 2007, then rallied and reached record levels just as the “Great Recession” was about to begin. This is a reminder that the stock market is not always good at predicting where the economy is headed.

However, for now as far as Wall Street is concerned the good times are rolling once again. This is reflected in the generally upbeat reporting of the economic news in the media. Bourgeois journalists, after all, generally own stocks, and are not among the unemployed. Next month, I will take a closer look at the reasons for the current bullish movement in stock market prices.

As I explained last month, though the world capitalist economy is still in a stagnation phase five years after the start of the “Great Recession,” there is no reason to think this condition is permanent. Capitalism knows no permanent economic state, whether boom, crisis, depression/stagnation or average prosperity.

Instead, the condition of the world capitalist economy constantly changes as the tendency of the industrial capitalists to expand production without limit periodically collides with the much slower growth of the market for the commodities produced. The result is a vicious circle of boom and bust, what Marx called the industrial cycle.

The current economic situation, however, does exhibit unusual features that cry out for an explanation. The most important is the severity of the preceding crisis followed by a—so far—very weak recovery. This is indeed unusual, perhaps unprecedented, in the history of capitalist industrial cycles. In the past, sharp recessions that liquidated a lot of inventory were followed by strong initial recoveries as business moved to rebuild depleted stocks.

The combined severe recession/weak recovery lies behind the so-called “budget crises” of the governments of the U.S. and other capitalist countries. The debt of the federal government alone is now around $16.4 trillion and rising.

Much of what follows is based on Chapters 30, 31 and 32 of Volume III of “Capital,” entitled “Money-Capital and Real Capital,” parts I, II and III. Readers who want to go deeper should read these chapters, available in English here.

The phase of the industrial cycle and the ability of the state to borrow

As we saw last month, the state has a greater ability to borrow in periods like the current one when the economy is depressed than when the economy is booming. This leads to the paradox that government can more easily borrow when the economy is smaller on a cyclical basis than when it is larger. This is, it should be stressed, true only in relation to cyclical changes in the size of the economy. The governments of richer countries can indeed borrow more than those of poor countries.

Since for now the U.S. and world economies are still bogged down in the stagnation/depression phase of the industrial cycle—a situation that will not last indefinitely—the ability of governments—above all the U.S. government—to borrow remains close to a cyclical high. This explains at least in part why the U.S. government can borrow money without disturbing the rest of the economy, despite its $16.4 trillion debt. Let’s examine more closely the paradox of the government’s increased ability to borrow during depression as opposed to prosperity.

The Keynesian explanation for the government borrowing paradox

Keynesian economists explain the ability of governments to borrow more when the economy is depressed than in periods of boom in terms only of real capital—capital represented by the actual forces of production. (2) During post-crisis depression/stagnation periods such as the present, the Keynesians correctly point out that there are huge numbers of idle workers and machines. This stands in contrast to boom periods, when full employment is supposed to exist. (3) Or as Marx put it in a far more scientific way, there are huge amounts of labor power—unemployed workers—and machines and other productive forces that cannot function as capital—yield a profit for some capitalists.

The state finances a deficit by borrowing from capitalists who want to earn interest on some of their otherwise idle money capital. The government or its dependents then spend the money, which puts idle workers and machines back into production to meet the additional monetarily effective demand that is created for consumer commodities. That is, the resulting growth in demand allows some of the previously unemployed labor power and machines to once again function as capital—enrich some capitalists.

Department II industries (4)—which produce commodities used for personal consumption as well as weapons “consumed” by the state, ranging from beat cops’ nightsticks to nuclear bombs—realize higher profits and use some of these additional profits to hire additional workers. As the capitalists and newly hired workers spend these additional profits and wages on consumer commodities, other consumer goods producing industries are stimulated and hire still more workers. For each additional borrowed dollar the government and its dependents spend, additional dollars, perhaps as much as three or four additional dollars, are spent. This is called by Keynesian and other bourgeois “macro-economists” the “multiplier effect.” (5)

In addition, the industrial capitalists will spend a portion of the additional profits they realize on expanding their enterprises or creating additional enterprises. In Marxist terms, they will transform a portion of their additional profits into new capital. Some of this will be constant capital—new factory buildings, machines and raw and auxiliary materials. Another portion will be transformed into additional variable capital, newly purchased labor power. To the extent that additional realized profits are transformed into variable—as opposed to constant—capital, additional jobs are created. This effect is dubbed the “accelerator effect” by bourgeois “macro-economists.”

This is what Keynesian economists and their politically progressive supporters call “priming the pump.” A small amount of deficit spending by the government ends up creating a much larger expansion of the market for commodities.

During the boom when “full employment,” or at least an approximation to full employment, is supposed to exist, the existing workers and machines are “fully” employed. Therefore, in the “short term,” as the Keynesians put it, there cannot be any additional production even if demand rises. Under conditions of “full employment,” any increase in monetarily effective demand will therefore be reflected in higher prices, not increased employment or output.

If the state increases its borrowing and spending under “full employment,” it will find itself in competition with other buyers for a fixed quantity of output. This type of competition among buyers drives up prices until the higher prices reduce demand to a point where supply and demand are again equalized.

The above analysis is true as far as it goes. But notice that the Keynesians look at it only from the viewpoint of the real capital. They ignore the monetary economy and the quantity of money available for additional loans—loan money capital. They do this because of their false theory of value, price and money shared with virtually all modern non-Marxist economists. Like most other bourgeois economists, the Keynesians assume that money is “backed” by the commodities produced by the industrial capitalists whose material use values make up the real wealth of society. This is, after all, the “common-sense” view. (6)

The Keynesians argue that unless there are artificial legal restraints—such as the gold standard—on the ability of the “monetary authority” to create additional money, any shortage of money loan capital that may exist can be easily overcome by simply printing new money right up to “full employment.” Keynesians do acknowledge that any printing of money beyond that point will bring about inflation—again the “common-sense” view.

The neo-liberal critique of Keynesian economics

Neo-liberal opponents of Keynesian deficit spending—the followers of Milton Friedman, the Austrian school and the rational expectations school—often claim that government borrowing will “crowd out” private-sector borrowers. The neo-liberals point out that as a rule the state does not engage in capitalist production proper—that would be “socialism,” after all—only the private sector—the industrial capitalists—convert borrowed money into new productive capital that creates jobs and expands the real wealth of society. (7)

When the government borrows, according to the neo-liberals, far from accumulating capital and making society richer, the state consumes capital. This, the neo-liberals explain, makes society poorer, rather than richer.

The Keynesian answer to the neo-liberal criticism

The Keynesians answer that the neo-liberals are making the mistake of assuming “full employment.” Remember, Say’s so-called law, along with the closely related quantity theory of money and law of comparative advantage, form the foundation of liberal economic theory. Say claimed that since commodities are purchased by other commodities, there can never be a “general glut” of commodities. Therefore, to use the language of modern economists, “an approximation of full employment” is the only natural state of a capitalist economy in the absence of governmental or trade union interference.

If we assume “full employment,” the Keynesians say, it is true that money borrowed by the state will be spent by the state or its dependents on “consumer” items—including weapons produced by Marx’s Department II—rather than on commodities that will function as productive capital: machinery and additional variable capital—jobs. But, the Keynesians explain, they do not advocate deficit spending under conditions of “an approximation to full employment” but only under conditions of considerable numbers of unemployed workers and idle machines. As the economy approaches full employment, the Keynesians agree, the government must indeed get its financial house in order and move toward a balanced budget.

More than five years after the beginning of the last recession, the Keynesian economists agree that the economy would be expected to be near an “approximation to full employment”—as defined not by workers seeking jobs but by bourgeois economists. However, in the current industrial cycle, the combination of the extraordinary severity of the preceding crisis, combined with the unprecedentedly slow rate of growth for a post-crisis period, means that the economy is still very far from what even bourgeois economists define as “an approximation to full employment.”

This state of affairs has thrown the bourgeois economists into some confusion. Should we move towards a balanced budget—austerity—or should we move to further increase the budget deficits, or at least postpone action to reduce them, in order to further increase monetarily effective demand?

The impact of the slow recovery on the budget deficit

Assuming the rate of taxation is given, government revenue from taxes fluctuates with the industrial cycle. During the boom phase, tax revenues rise and unemployment insurance payments drop, and during the recession phase, tax revenues decline and unemployment insurance payments rise. If the current recovery had been a “normal” recovery, even with the low rate of taxation [see last month’s post] tax revenues would be considerably higher and the federal deficit would be considerably lower.

While neo-liberal and “centrist” bourgeois economists are saying that we must move ahead with austerity and make deep cuts in “entitlements” in order to move toward a balanced budget despite the stubborn economic stagnation and continuing unemployment crisis, the more progressive Keynesian economists correctly point out that we are still far from “full employment.” These Keynesians argue that, if anything, budget deficits have been “too small,” since they have failed to “prime the pump” sufficiently to bring the economy back to “an approximation of full employment.”

The Federal Reserve System, the Keynesians agree, has done its part—it has more than tripled the size of the dollar-denominated monetary base—but Congress and the Obama administration have simply not gotten Keynes’s message. They have failed to borrow and spend enough of the new money that the Federal Reserve System has been so generously creating.

Therefore, these progressive Keynesians argue, if anything the federal deficit and the deficits of other central governments should be increased and certainly not reduced in the near future. The time for austerity will come but only when “an approximation of full employment” is at least in sight. Then, the Keynesians and their progressive supporters explain, as we move into “full employment”—as defined by bourgeois economists, which will still mean many millions of unemployed (8)—we should move toward a balanced budget.

For now, these progressive Keynesian economists appear to be allies of the workers’ movement, because they consider the current austerity drive ill-timed due to the continuing crisis of mass unemployment and economic stagnation.

Marx, the budget deficit and bourgeois economics

All schools of bourgeois economics, from the Austrian and rational expectations schools on the right to left Keynesians, agree that the key to economic recovery is a rise in the rate and mass of profit. Notwithstanding the record profits being reported by the corporations and the consequent “bull market” in stocks, all schools of bourgeois economists agree that corporations are simply not making enough money. If the corporations were making an adequate amount of profit, we would already be experiencing “an approximation to full employment.” The differences among the various schools of bourgeois economists is not whether but how to achieve the needed increase in both the rate and mass of corporate profit.

The right wing—the great majority of the economic profession—claims in effect that not enough surplus value (9) is being produced. Hence their emphasis on the need to “end big government and cut entitlements,” while the left wing of the economics profession sees a lack of “effective demand” as being the cause of the “inadequate”—for the purpose of achieving full employment—amount of profit for the rich.

Political progressives side with the Keynesian economists who realize “the need” to increase the buying power of the workers in order to achieve the “needed” increase in profits of the already wealthy, as opposed to the “neo-liberals” who want to reduce both the wages and social wages—entitlements—of the workers and middle class as the key to achieving the “needed” rise in corporate profits. Like their Keynesian rivals, the “neo-liberals” explain that a rise in profits for the rich is necessary to achieve “full employment” and provide a road out of poverty for the poor.

The Marxist answer to the bourgeois economists of all schools

Marxists challenge the whole notion that the increased profits of the rich are the answer to achieving “full employment.” Instead of making the billionaires even richer, we argue that the only way to achieve genuine and lasting full employment is through the transformation of the capitalist system of production for profit into the a socialist system of production for use.

This does not mean that Marx and his successors have nothing to say about fiscal and monetary policies pursued by government and central bank policy makers. On the contrary, no economist wrote more than Marx did on the theory of profit, money, prices, and balance of trade and payments. Marx wrote in considerable detail about the policies pursued by the central banks of his day.

For example, we only have to point to Marx’s criticism of the British Bank Act of 1844 and the theories of the “currency school”—which were based on Ricardo’s quantity theory of money and theory of comparative advantage. Marx did this not because he was attempting to find a policy that could achieve “full employment” under capitalism—that is impossible, according to Marx—but because he was interested in exploring the laws that govern the capitalist mode of production, which on a global basis is the necessary historical pre-condition for the transition to a socialist society.

Therefore, my criticisms of Keynes-inspired illusions held by political progressives about the possibilities of achieving “full employment” under capitalism in no way should be interpreted as supporting the policies of reactionary advocates of further lowering the standard of living of the working class in the name of achieving full employment!

Keynesian economists are right versus the neo-liberals and “centrist” economists in pointing out that there is little danger that government borrowing and spending will crowd out the “private sector”—at least for the next few years—as far as the “real” economy is concerned. But what about the monetary side of things—the quantity of loan capital? Is it possible that the government could “crowd out” the quantity of loan capital even when there is still a considerable excess of supplies of unemployed labor power and machinery?

True, even glittering gold cannot purchase what is not produced. Gold as the abstract form of social wealth is useless if it cannot be transformed into concrete wealth—the actual material use values of commodities—as the King Midas of legend found out. But contrary to the Keynesians, the opposite is not the case.

Money is a counter value to commodities and must be represented by a commodity that stands apart from all other commodities. Therefore, the “paper” money created by the monetary authorities that forms the base upon which the credit money created by the banking system is built, must itself be “backed” by the commodity that in terms of its material use value measures the value of commodities—in practice, gold bullion.

The ultimate “monetary base” is therefore not the legal tender token money created by the Federal Reserve System—but is and must remain the gold bullion that is produced by industrial capitalists—mine owners and refinery owners—and ultimately the industrial workers they employ. This doesn’t mean that the gold must necessarily be held in the vaults of the monetary authorities.

True, the greater the percentage of the total gold held by the monetary authorities the more the metallic hoard can be wielded in a centralized way during a period of crisis. Unlike individual capitalists who must if they are to remain capitalists act in accordance with their own individual interests, a monetary authority—bound as it must be with the state power—can act in the broader interest of capitalist society as a whole.

For example, if there is a “run to gold” the state power and/or its “monetary authority” can sell some its gold and buy time until the “run to gold” subsides either of its own accord or in response to measures taken by the monetary authority. For example, in order to halt a “run to gold,” the monetary authority can reduce the quantity of token money—the “over-issue” of token money being the most likely cause of the “run to gold” in the first place.

Therefore, Lord Keynes and Michael Kalecki to the contrary notwithstanding, the quantity of loan capital that can exist is ultimately limited by the quantity of gold bullion in existence. In terms of purchasing power, the quantity of money cannot be increased to whatever is sufficient to achieve full employment. If it could be, we would be living in a very different world.

However, the relationship between the gold metallic base and the quantity of loan capital—the quantity of gold bullion being given—fluctuates sharply in accordance with the phases of the industrial cycle. This is key to understanding why the state under the capitalist system cannot increase monetarily effective demand to whatever level is necessary to achieve “full employment.”

In the section of Volume III of “Capital” entitled “Money Capital and Real Capital” (Chapters 30, 31 and 32), Marx examines how the relationship between loan capital and real capital changes during each industrial cycle. Marx found, based on his careful examination of the mid-19th century industrial cycle, that it was during the depression/stagnation phase that money loan capital is in greatest relative abundance in relation to demand. As the economy moves into the boom phase of the industrial cycle, loan money capital becomes increasingly scarce as reflected in a rising rate of interest. Then, with the outbreak of the crisis phase of the industrial cycle, loan capital virtually disappears.

Crisis and stagnation/depression—two stages of the industrial cycle

It is therefore important here to distinguish between two phases of the industrial cycle that are often confused but are radically different as regards the quantity of money loan capital available. These are the crisis proper, characterized by an acute shortage of loan money capital, and the the depression/stagnation phase of the industrial cycle, which features, on the contrary, a glut of loan money capital.

The reason that the crisis phase and the depression/stagnation phase that follows the crisis are often confused is that as far as the workers are concerned both these phases are marked by high unemployment—sharply rising unemployment during the crisis and a very slow rise in jobs and consequently lingering mass unemployment during the depression/stagnation phase of the cycle.

However, if we are to understand the discussions among our class enemies about the size of the budget deficits of the U.S. and other central governments, we must keep the distinction between the crisis phase and stagnation/depression phase of the industrial cycle clearly in mind.

Contrary to Keynes and Kalecki, it is quite possible to have an acute shortage of loan capital combined with a massive surplus of real capital, and this is true regardless of the monetary system—gold standard versus paper money—and the policies of the monetary authority. Marx explained not only is this possible but indeed is inevitable on a periodic basis under developed capitalism from the beginning of the second quarter of the 19th century onwards.

This combination of a surplus of real capital combined with a shortage of loan capital appears to one degree or another at the critical point—the tight money phase that precedes even mild recessions—of every industrial cycle. Marx was able to grasp this and avoid the confusions of the bourgeois economists surrounding the quantity of money loan capital and real capital because of his theory of value, money and price that I have been exploring throughout this blog.

Bourgeois economic historians often claim that the crisis broke out in such and such a period due to a “shortage of capital.” What these bourgeois historians mean is a shortage of loan money capital. The quantity of real capital, in contrast, is always “super-abundant” when the crisis erupts—the essence of capitalist crisis being a general overproduction of commodities, which of necessity means a surplus of productive capital—itself made up of commodities—that makes the overproduction of the commodities possible in the first place.

The crisis of 1931

To clarify this question, let’s examine the most extreme case that has so far occurred in the history of capitalism. I refer to the extreme glut of real capital existing side by side with the most desperate shortage of loan capital that occurred in the year 1931.

During that fateful year, massive runs developed on the banks in the United States, Germany, Austria, Poland and other countries. The runs on the banks in the U.S. played the most important part of this crisis within a crisis, since the U.S. banks were already at that time—and still are—at the very center of the global credit system. As a result of this bank run, bank credit seized up across the globe as the banks tried to hold on to their remaining cash reserves by halting new loans and calling in existing loans.

During the 1931 banking crisis, each individual bank was doing all it could to convert its non-cash assets—loans and securities—into the hard cash that long lines of panic-stricken depositors forming outside their offices were demanding. Remember, bank depositors demanded payment in money—not payment in loans or securities.

No fear of default on U.S. federal debt in 1931

At least as far as the debt of the U.S. federal government was concerned, despite the super-crisis conditions of 1931, there was no real chance that the federal government would default on its debts. But notwithstanding this fact, the U.S. banks could not pay off their depositors in government bonds; they could only pay them off in “lawful money”—green dollars. As a result, the prices of not only corporate bonds plunged—where there was a real possibility of default—but also the bonds of the federal government itself, where there was no possibility of default.

As the price of U.S. government bonds plunged (10)—each bond of a given face value sold for an ever smaller quantity of green dollars—the bankers found it ever harder to raise the cash they needed to pay off their panic-stricken depositors and prevent the collapse of their banks. Therefore, the price of government bonds was very closely linked to the drying up of loan capital, which in 1931 was driving the U.S. and world economies to ever lower levels. The administration of Herbert Hoover faced no more urgent task than halting this fall in the price of U.S. government bonds.

Austerity 1931 style

The Hoover administration and Congress decided to increase federal income taxes with the aim of reducing the quantity of government bonds on the market, thus encouraging their price to rise. This move by Hoover and the U.S. Congress has been sharply criticized by almost all schools of economists—the neo-liberals, who have made a fetish about cutting taxes in virtually all circumstances, but more interestingly by Keynesians economists as well.

The Keynesians correctly point out that in 1931 there was an extreme shortage of monetarily effective demand relative to real capital. Therefore, they argue, the very last thing that the government should have done was to further reduce demand by raising federal income taxes. Instead, the government should have cut taxes and increased its borrowing to expand monetarily effective demand in order to overcome the glut of real capital. Virtually every Keynesian-inspired economic textbook, and economic historians in general, continue to beat the ghost of Herbert Hoover over the tax increase of 1931.

However, Hoover—from the viewpoint of preserving the capitalist system—and the members of Congress of that day weren’t quite as stupid as our present-day economists with their 20-20 hindsight make them seem. As Hoover and the majority in Congress saw it, the virtually complete vanishing of loan capital was the very essence of the crisis they were facing. If under these conditions, the federal government had increased its borrowing, and thus thrown additional government bonds on the market, their price would have fallen even more, and quite likely the crisis would have gotten worse, with even higher unemployment. (11)

How Keynesian stimulus usually works

While the conditions of 1931 were extreme, they do illustrate the basic contradiction that Keynesian economics runs into even during normal industrial cycles.

During the lead-up to a recession, money is “tight” and there is considerable pressure to reduce the growth of spending and “balance the budget”—or at least reduce the budget deficit. The economists, including as a rule Keynesian economists, predict continued prosperity—they explain that the kind of imbalances that “usually” precede recessions “are noticeably absent this time.” Even after the recession begins, it takes many months before the authorities acknowledge a recession is actually underway.

As the National Bureau of Economic Research—the private economic body that semi-officially determines when “contractions,” or recessions, begin and end explains, the decline in economic activity must not only be generalized and severe, it must be “prolonged.” Therefore, by the time the NBER admits a contraction—that is, a recession—is underway, there has already been a “prolonged period” of massive layoffs and resulting skyrocketing unemployment. If the recession is of average length, it is pretty much close to bottoming out by the time the authorities and media acknowledge the fact that a recession is happening. (12)

Once a recession is finally acknowledged, it takes a few months for Congress or Parliament to agree on an appropriate “stimulus program” and even more time for it to take effect. Therefore, it is only the so-called “built in stabilizers” like unemployment insurance that actually kick in while the recession is underway. Only when the recession has created a sufficient amount of idle money to allow it, are additional stimulus policies adopted.

If we leave aside George W. Bush’s failed stimulus tax rebate program of 2008— which by increasing the federal budget deficit, financed by issuing government bonds, just when the quantity of loan money capital was sharply contracting—thereby making the crash in the fourth quarter of 2008 even worse—this is exactly what has happened during the current industrial cycle. Obama’s own far more ambitious “Keynesian” stimulus only took effect after the “Great Recession” proper had bottomed out in 2009.

Therefore, the stimulative programs beyond the built-in stabilizers may not so much shorten the recession proper as cut short the stagnation/depression phase that follows the recession. Because the beginning of a recession is characterized by a shortage of loan capital—”tight money”—Keynesian policies are actually powerless to prevent the outbreak of a crisis, and any attempt to follow a “Keynesian policy” prematurely will only worsen it, as happened in 2008. Keynesian policies are much better at cutting short the stagnation/depression phase that follows the recession proper.

Therefore, “practical” Keynesian stabilization policies (13), contrary to the hopes of Keynes himself, aim not so much at preventing recessions but rather at limiting them and preventing them from turning into prolonged periods of stagnation/depression that lead to prolonged mass unemployment and social crisis that can lead to revolution.

As the recovery gains steam through the multiplier and accelerator effects, intensified by Keynesian “pump priming,” government tax revenues rise and the extra demand generated by state borrowing plays a smaller role in the economy. Instead, the economic expansion is now driven by rising private investment, just like classic industrial cycles without Keynesian interference were. This is how Keynesian policy is “supposed” to work. (14)

In the early post-World War II period—from about 1945 to 1968—Keynesian policies seemed to work well, not so much in avoiding recessions but in preventing recessions from leading to prolonged periods of depression and the resulting mass unemployment and social crisis.

But as is the case when the government attempts to play with the basic economic laws that govern the capitalist economy, there was a catch that was not immediately apparent. Marx explained that during a crisis there is a sharp shift from a credit system to a monetary system. In a classic industrial cycle, as the process of credit deflation unfolds—debts are paid down or liquidated through bankruptcy—prices fall, which increases the purchasing power of the existing quantity of money, and gold production is stimulated, which increases the quantity of money—calculated in terms of weight—of the precious metal on a global basis that constitutes money material.

With more gold available, the central banks are able to create more “legal tender money.” This, combined with the contraction of the real economy, means that the economy becomes far less dependent on credit. Commodities are increasingly purchased with hard cash and not on credit as was the case on the eve of the preceding crisis. In this way, “sound” business conditions are restored. As Marx put it, the system shifts back to a monetary system as opposed to a credit system.

This cyclical transformation from a credit system into a cash system is simply the reflection in the financial sphere of the liquidation of overproduction that occurs in the real economy, just as the previous inflation of credit was the reflection of the previous industrial overproduction that caused the crisis in the first place.

The greatest shift from a credit to a monetary system in the history of capitalism occurred during the super-crisis of 1929-33. Never before—or since—was credit so brutally liquidated through paying off existing debts and through bankruptcy as it was in those years. In the years that followed the crisis, the post-crisis depression, and then the war economy of World War II and during the early postwar years, the economy was awash in hard cash. It was far less dependent on credit than it had been in the years leading up to the beginning of the super-crisis in 1929.

True, there was a sharp rise in the debt of the central governments, especially during the war. But this was matched by a contraction of all other debts—corporate and individual. It was this huge super-abundance of money and of money loan capital that made it possible to expand the market rapidly for a relatively prolonged period of time following the war.

Return to credit system

However, Keynesian policies by cutting short depressions have greatly limited the transformation of a credit system back into a cash system during and after recessions. Indeed, the whole point of post-Depression “stabilization policies” is to limit, if not prevent altogether, the contraction of credit and the consequent shift to a cash system. This seemed to work well in the early post-World War II years, since there was so much cash available thanks to the preceding super-crisis and the Great Depression.

As long as these conditions persisted, Keynesian economics could work reasonably well—though even then they were still powerless to prevent the outbreak of recessions. Even as late as the 1970s, the economy was not as credit-based as it had been in the 1920s on the eve of the super-crisis. But with each successive industrial cycle, the economy has become less and less based on cash and more and more dependent on credit. Commodities are more and more being bought with credit and credit money as opposed to hard cash.

Under Keynesian policies, the overproduction that occurred during the boom was therefore not completely liquidated during the recession/depression phase that followed, like more or less was the case before Keynesian stabilization polices were adopted by capitalist governments.

The result has been a gradual growth of cumulative overproduction across the industrial cycles. The problem is that this cannot go on forever. A powerful trend has been unleashed toward a “super-crash” that will finally forcibly liquidate decades of overproduction and force a return to a “monetary system.”

The last time the economy had a classic recovery was at the end of the super-crisis of 1929-33. The “Great Recession” and the subsequent retarded recovery is therefore no accident but is part of the broader tendency toward a “super-crash” and subsequent Depression with a capital ‘D’ that will finally force a return to a “monetary system” and clear out decades of cumulative overproduction.

The capitalist policymakers, not understanding the bitter lessons of the Great Recession, are still not reconciled to the inevitability of a super-crash that will restore “sound business conditions.” They still hope to head it off by once again pumping up the credit system—inevitably leading to still more overproduction—because they fear that their system might not survive a super-crash and its consequences.

It should be pointed out that even if/when a super-crash eventually occurs, the transformation of the capitalist system into a socialist system is not guaranteed. Capitalism, no matter how far down it goes, will only be transformed into socialism if the working class wins political power. Absent this, no “final crash” will transform capitalism into socialism. This is the bitter lesson of the earlier super-crisis of 1929-33.

If another super-crisis occurs and the capitalist system survives due to the failure of the working class to fulfill its historic mission during the crisis or its aftermath, this would be a great historical tragedy, just as the survival of capitalism during the Depression of the 1930s was. The next time it might end in the destruction of human civilization—for example, if the new super-crisis triggers a new inter-imperialist world war fought with today’s far more destructive weapons.

But even if we leave aside this very real possibility and human civilization survives and capitalism enters into a new historic cycle of expansion and capitalist prosperity, the basic economic laws discovered by Marx show this would be no solution at all. Inevitably, the contradictions of capitalism would start to grow again and lead to an even greater future crisis.

Federal Reserve’s great concern—prevent the collapse of the quantity of loan capital

As part of its ultimately doomed attempt to avoid a crisis that would bring into question the continued existence of the capitalist system, the U.S. Federal Reserve Board is doing all it can to prevent the kind of collapse in the quantity of loan money capital that occurred in 1931. Indeed, Ben Bernanke, the chairman of the Federal Reserve Board, who is seen as an expert on the Depression, considers nothing to be more important.

If loan capital vanishes like it did in 1931, Keynesian deficit spending will be powerless to prevent Depression II, which will likely stand in relation to Depression I in terms of severity as World War II stood in relationship to World War I.

This takes us into the sphere of monetary policy that aims at preventing a sharp contraction in the quantity of money loan capital Next month I will examine some very interesting recent moves by the U.S. Federal Reserve System.


1 A manufacturing index number above 50 indicates a rise in manufacturing output, while a reading below 50 represents a fall in output. During actual recessions, the ISM index generally falls well below 50.

2 Real capital consists of productive capital, such as factory buildings and machines, raw materials and auxiliary materials such as electricity—constant capital—and purchased labor power—the variable capital that alone produces new value and surplus value, plus commodity capital—inventories. The commodities that make up real capital must be purchased with money—or be purchased with credit, and the resulting debts then must be paid with money. The money that is used to purchase the commodities that make up productive and commodity capital represents money capital.

In contrast, the money that you use for personal consumption represents money but not money capital. If you are a worker, you sell your labor power C—M (M representing your wages or salary) and then use the M to purchase your means of personal consumption C. This is the formula for simple circulation C—M—C as opposed to the formula for capital M—C—M’. Capitalists when they use their profits—surplus value realized in money form—to purchase consumer goods, whether necessities or luxuries, are also using money as means of simple circulation and not as money capital.

3 In reality, millions of unemployed workers and considerable quantities of idle machines exist even during economic booms. In the late 1920s, Soviet economic planners were surprised by how much they could raise industrial production above the levels reached in the boom year of 1913 in czarist Russia without undertaking additional new investments that actually increased the forces of production. The only time the capitalist economies come anywhere close to true full employment is during major wars. And this “full employment” cannot be sustained for long because war economy suppresses expanded reproduction in the absence of which capitalism cannot long exist.

4 Some Marxists put weapons and luxury commodities consumed only by the capitalists into a separate Department III because they do not re-enter the productive process. The notion of Department III is important for the various “neo-Ricardian” criticisms of Marx. Marx himself treated luxury items as a sub-department of Department II but did not place them into a separate department.

5 Bourgeois economists debate how strong the “multiplier effect” actually is, with anti-Keynesian “neo-liberals” claiming a very low multiplier, while Keynesian economists claim a much higher multiplier.

6 Modern bourgeois economics, despite its frequent use of higher mathematics, which tends to conceal this fact from the layperson, is built on “common sense.” Marx stated that if “common sense” was adequate there would be no need for science. This applies not only to social sciences like economics but also to natural science. Einstein’s special and general theory of relativity, not to mention quantum mechanics, stand in complete contradiction to our everyday “common sense.”

7 The industrial capitalists strongly resist productive state investment—except when they take the form of subsidies to the industrial capitalists where the private industrial capitalists get to keep all the profits—because the last thing the capitalists want is competition from the state.

8 The most progressive Keynesians would postpone any moves to balance the budget until something like real full employment is achieved, but the more mainstream pro-business Keynesians would consider “full employment” in the U.S. as perhaps six or eight million unemployed, as defined very narrowly by the U.S. Labor Department. Remember, the U.S. Labor Department considers the unemployed to be only those “pounding the pavement.” The rest of the jobless are considered to be voluntarily choosing leisure over employment.

Anything less than six to eight million unemployed, these pro-business Keynesians and other bourgeois economists claim, is “over-employment,” where bosses are forced to hire “unemployable workers.” The pro-business Keynesians agree with “neo-liberal” economists that millions of “unemployable” people should remain unemployed.

9 Of course, all schools of modern bourgeois economics strongly deny that the workers produce surplus value. However, neo-liberal economists do in effect acknowledge the truth of Marx’s theory of surplus value when their practical proposals such as shredding entitlements all have the effect of increasing the rate of surplus value.

Recently, the Keynesian economist Paul Krugman has explained that the problem U.S. and other capitalist countries is facing is not a shortage of skilled workers earning much more than unskilled workers, reflecting an alleged shortage of skilled workers, as Krugman previously claimed. Now he recognizes the problem as the rising share of the national income that goes to capital—not skilled workers—compared to the working class as a whole.

It could be that Krugman is, at least in private, examining Marx’s theory of surplus value—a theory that economics students are, to say the least, not encouraged to study. If at some point Krugman were actually to come out in support of Marx’s theory of surplus value, he would inevitably face serious consequences, much like Paul Sweezy did in the 1930s and 1940s when he defected to Marx from bourgeois economics. If Sweezy had remained loyal to bourgeois economics, he would not only have won tenure at Harvard but almost certainly would have won the Nobel Prize for economics, just has Krugman has.

The financial consequences and social ostracism that Krugamn will face if he continues in his current “dangerous path” will therefore be substantial. If the defection of an economist with the stature of Krugman to the camp of Marx and the working class occurs all the same, it would be a welcome development indeed for the camp of the oppressed.

10 Normally during the downturns in the industrial cycle, the price of government bonds rises.

11 Our modern-day economists and economic historians claim that the Federal Reserve System should have created massive quantities of additional dollars, which they say would have halted the decline in the price of government bonds and enabled the government to increase its borrowing and spending at the same time. This will be examined in next month’s post.

12 The National Bureau of Economic Research dates the beginning of the “Great Recession” to December 2007. Though the initial credit freeze that represents the first stage of the crisis occurred in July-August 2007, it is likely that economic output did peak in December 2007. The dates when economic output peaked in other countries might differ somewhat, though by the fourth quarter of 2008 when the crisis erupted with full force, industrial production was plunging across the globe.

13 In the late 1960s, Keynes-inspired policymakers really thought they might be able to abolish recessions once and for all. However, the stagflation of the 1970s soon put an end to such hopes.

14 At the end of World War II, many impressionistic young economists under the influence of Keynes, as well as many Marxist economists, assumed that the economic stagnation of the 1930s was permanent. The reason was that during their adult lives they had only known the Depression and the World War II war economy.

They drew the conclusion that the huge drop in government spending that would occur when the war economy ended would inevitably plunge the U.S. economy back into deep depression.

This didn’t happen, however, because there was a sharp rise in private investment as the industrial corporations replaced fixed capital that had been run down during the Depression and then the war and then moved to expand their forces of production to meet a “sudden expansion” of market demand.

Most Marxists of the time, who were understandably impatient for the arrival of a socialist revolution, were taken by surprise by this development and many were badly disoriented. But in reality this outcome was quite in accord with the laws discovered by Marx that govern the capitalist economy. Keynesian economic policies played no role in the “sudden expansion of the market” that made the post-World War II economic “Long Boom” possible.


3 thoughts on “Economic Stagnation, Mass Unemployment, Budget Deficits and the Industrial Cycle

  1. I have a question. You say that Marx “was interested in exploring the laws that govern the capitalist mode of production, which on a global basis is the NECESSARY HISTORICAL PRE-CONDITION for the transition to a socialist society” (emphasis mine). Doesn’t this imply a theory of stages? If so, isn’t that a linear theory? In my opinion Marx’s dialectics is vital to his theory, and it is opposed to stages.
    One last question: if I did understand you correctly, how do you explain primitive communism? That wasn’t preceded by a capitalist mode of production, but it was communist nonetheless.

    I really enjoy reading this blog, so please don’t take this as an attempt to criticize just for the hell of it. I’d really like to understand what you mean and what you think Marx meant when he said things like that.

  2. “… prolonged economic stagnation, continuing mass unemployment, and falling real wages represent a fundamental change in the workings of the capitalist system. He asked what is behind this change? This a good question.”

    Yes, workers have suffered stagnant and declining real earnings since 1973. This is the “prolonged” that must be explained.

  3. “With more gold available, the central banks are able to create more “legal tender money.” This, combined with the contraction of the real economy, means that the economy becomes far less dependent on credit.”

    You’re leaving out the impact of Federal Reserve Notes. They are not gold-backed, even though they say they are ” legal tender”. The quantity of these monies that can be created is virtually limitless. QE could go on forever until (?) inflation kicks in. But shouldn’t the govt be soaking up the excess loan capital by borrowing and spending instead of retiring/buying up bonds?

    When you speak of real capital do you mean the sum of productive facilities and resources and gold-backed specie?

    Do you relate this to MMT or chartalism anywhere?

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