As boom slows, political instability rises in the imperialist countries
As 2018 winds down, political instability is sweeping the Western imperialist countries – both the United States and Western Europe. In the United States, as part of a plea bargain with federal prosecutors, Michael Cohen, Trump’s former lawyer and “fixer,” pleaded guilty to violating with “Individual 1” U.S. campaign finance laws. Cohen faces three years in prison.
It is no secret that “Individual 1” is one Donald J. Trump, the current president of the United States. According to Cohen’s plea, Trump directed Cohen to break U.S. campaign finance laws in order to pay “hush money” to porn star Stormy Daniels and “Playboy playmate” Karen McDougall. Trump paid the hush money because he didn’t want the headlines of his extramarital affairs to dominate the news in the weeks leading up to the U.S. presidential election.
Since these payments violated federal election law, it is clear that Trump committed felonies. These felonies, it should be pointed out, are not connected with the so-called Mueller probe into whether Trump, other members of the Trump family, or other associates violated U.S. laws as part of their alleged collusion with Russia in the 2016 elections. That is a separate matter. So far, Mueller and his prosecutors have not presented concrete evidence of law-breaking on the part of Trump in this matter, though there continues to be much speculation about this possibility in the media.
Theoretically, Trump can now be impeached because he committed felonies, which meets the U.S. constitutional standard for impeachment for “high crimes and misdemeanors.” Some Democrats have suggested that in light of these facts impeachment proceedings against Trump in the House of Representatives should now commence. However, there is also a general feeling that crimes centered on sexual affairs are not sufficient grounds to remove a president from office. After all, who in Washington has not had an affair or two or more? While the Democrats will have a majority in the U.S. House of Representatives beginning in January, they would need a large number of Republican votes in the Senate to reach the two-thirds’ majority necessary to remove Trump from office.
The Republicans are reluctant to remove Trump on impeachment charges. If they do vote to remove him, they will likely lose Trump’s white racist “base,” which continues to adore him. The “Trump base” will be furious if their adored leader is removed over what is essentially a sex scandal. Can Trump – and this is a concern for those ruling-class circles of the “Party of Order” who do not like Trump – be removed from office without splitting the Republican Party in such a way that its continued existence as one of the two “major parties” in the two-party system would be in question? (1)
Those in the Party of Order who contend that it is too dangerous to leave Trump in office for another two years prefer to wait for Mueller to come up with charges in the “Russia probe” that can be presented as virtual “treason” to the “patriotic” Trump base. If Mueller cannot or chooses not to produce the treason charges, perhaps this faction of the Party of Order believes it would be best to soldier on through the next two years and then remove Trump through the normal process of a regularly scheduled presidential election. Given Trump’s low approval numbers and gains made by the Democrats in the mid-term elections, it is assumed that Trump would lose his re-election bid.
Reflecting this trend of ruling-class thinking, the Democratic Party leadership of incoming Speaker Nancy Pelosi is, for now at least, showing little enthusiasm for impeachment. The “corporate Democrats,” who Pelosi represents, very much want to preserve the Republican Party as the only realistic alternative to the Democratic Party presented to U.S. voters. So for now, Trump clings to power.
As I write these words (Dec. 21, 2018), it has just been announced that Trump’s “Party of Order” secretary of defense, General James “Maddog” Mattis, is quitting – or has been fired – because he disagrees with Trump on how the U.S. treats its “allies” and “adversaries.” Trump has just announced that against the advice of “Mad Dog” Maddox and virtually the entire Party of Order – liberal Democrats and conservative Republicans alike – he is withdrawing 2,000 U.S. troops from Syria and plans to drastically reduce the number of U.S. troops in Afghanistan.
These stunning developments follow hot on the heals of the announcement that Trump’s White House chief of staff, General John Kelly, is also leaving. These developments follow a reshuffle of the top Pentagon brass, reportedly in defiance of the advice of the soon-to-be-departed “Maddog.” It appears Trump is virtually daring the Party of Order to either impeach him or shut up.
Political instability in Europe
Political instability among the Western imperialist countries is not confined to the U.S. In December, British Prime Minister Theresa May barely survived a no-confidence vote in Parliament over her handling of the Brexit negotiations. The only thing that saved her was the fear that a general election under current
circumstances could lead to a British government headed by left-wing Labour Party leader Jeremy Corbyn.
In France, the now hated French President Emmanuel Macron is facing a mass rebellion complete with barricades and street fighting by the broad multi-class “Yellow Vest” movement. When the “pro-business” Macron defeated candidates on both the left and the far right, the U.S. Party of Order was delighted. They viewed Macron as a card-carrying member of the international Party of Order. But it has not taken long, much to the horror of the U.S. Party of Order, for Macron to become a thoroughly hated figure, not only among the working class but the middle class as well.
The current French developments show that France’s revolutionary traditions going back to 1789 are still alive. (2) An important difference between the May-June 1968 workers’ general strike and student demonstrations and the current French developments is that the 1968 events followed several decades of industrial upsurge and rising standards of living for both the working and middle class. The result was a conservative middle class. The yellow-vest rebellion occurs after years of “de-industrialization” and economic austerity that have led to declining living standards for both the working and middle class. As a result, both have radicalized. What is yet to be determined is whether this radicalization will express itself in a left-wing, pro-socialist or right-wing potentially fascist direction. The question can only be answered by the course of the class struggle now unfolding in France.
Signs of political destabilization in Germany
Signs of political destabilization in continental Europe are not confined to France. Signs multiply that capitalist Germany’s long post-1945 period of political stability is finally unraveling. When Trump was elected president in 2016, some saw Germany’s “Atlantist” (3) Chancellor Angela Merkel as becoming “leader of the free world” in place of the obviously unqualified Donald Trump. But though Germany is a relatively strong imperialist state, it is not that strong. It was the U.S. and not Germany, after all, that won World War II.
Instead of Merkel emerging as the de facto head of “the Empire,” her star has been in sharp decline since Trump became U.S. president. The refugee crisis caused by the U.S. Party of Order opposing the emergence of any strong independent country in the Arab world led directly to Germany’s refugee crisis. President Obama’s attempt to overthrow the governments of Libya – unfortunately successful – and Syria – so far fortunately unsuccessful – caused a major outflow of people fleeing the imperialist-inspired wars. Not surprisingly, many refugees sought refuge in the richest and most stable country in Europe, which happens to be Germany.
This has enabled Germany’s racist, nationalist far-right movements, which had been reduced to the political margins since the fall of the Third Reich, to make a comeback. This, in turn, just like the case with Trump’s rise to power in the U.S., has led to growing resistance on the part of the majority of German people, who have no desire to embark on the same path that led to the Third Reich and the consequent near destruction of the German nation.
So far, the main political expression of this situation has been the decline of Germany’s own version of the international Party of Order, which consists of the thoroughly pro-imperialist German Social Democratic Party and the Christian Democratic Party. The Christian Democrats – and their Bavarian sister party, the Social Christian Union section of the Party of Order – was cobbled together after World War II from the remains of the old Catholic Center Party and numerous “former” Nazis willing to accept U.S. political and military domination of a “democratic” imperialist (West) Germany after World War II.
Postwar West Germany (now Germany) is the classic example of what I call a satellite imperialist country. I define such a country as one dominated by powerful financial and industrial monopolies – finance capital – that appropriate enough of the global surplus value to allow it to maintain a relatively high standard of living for a broad layer of its working class, and that accepts, or is obliged to accept, the political and military domination of another, more powerful imperialist country.
After the last general election, held in 2017, the Germany Social Democratic Party broke its promise not to enter into yet another “Grand Coalition” with the Christian Democrats. As a result, the SPD has suffered defeat after defeat in German state and local elections. The SPD decision to enter into the Grand Coalition has enabled the far-right, racist nationalist Alternative for Germany Party to function as Germany’s “official” opposition. This is, sad to say, an alarming development.
Recently, Merkel resigned her post as head of the Christian Democratic Party and announced she won’t be a candidate for re-election to the chancellorship in 2021, making her a “lame duck” chancellor. Germany appears to be entering into a new era of multi-party instability that occurs while the German economy is enjoying a boom with relatively low unemployment.
Germany’s modest prosperity has been largely driven by exports. In other words, German prosperity has been maintained largely at the expense of other European nations. What will happen when German capitalism (4) faces major resistance to its export drive – resistance already beginning in the form of the Trump tariffs – and once again suffers major economic difficulties and rising unemployment?
The boom weakens
In recent weeks, there have been growing indications that the pace of the ongoing U.S. and global economic boom has slowed. In late November, General Motors announced that it will lay off 14,000 workers – both factory workers and white-collar employees – and is considering closing five plants. GM plans to lay off 3,600 factory workers in the U.S. and 3,000 in Canada, while the jobs of 8,100 will be eliminated by either buyouts or outright job terminations. Residential construction has slowed as rising mortgage rates and housing prices have put the cost of purchasing homes out of the range of more and more consumers.
Demand for houses, automobiles, and other durable consumer goods bought on credit typically weakens in the later stages of the capitalist industrial cycle. As capital spending – expanded capitalist reproduction – increases during a boom, industrial capitalists enter into competition for the remaining supply of credit with home buyers and other purchasers of durable consumer goods such as automobile and appliances – as well as merchant capitalists building up their inventories.
This puts upward pressure on long-term interest rates and even more on short-term rates. Therefore, just as industrial capitalists expand the ability of the economy to build additional homes, cars and appliances, the demand for the additional commodities that the newly built or expanded factories can produce declines. This happens first in the area of residential buildings and other durable consumer goods and then becomes generalized as increasingly tight credit conditions oblige merchant capitalists to cut back on their inventories. In Marxist terms, the capitalists shift from the accumulation of commodity capital to the de-accumulation – liquidation – of their commodity capital. (5) Once this happens, the boom ends and the recession begins.
A possible sign of strength running counter to weakening demand for housing and autos is a sharp fall – after a modest rising trend – in the U.S. weekly claims for unemployment insurance, though these claims remain slightly above their most recent level. In recent years, it has become far more difficult to obtain unemployment insurance. This reflects both the relentless capitalist offensive and computerization that enables officials at the unemployment office to quickly determine whether you are telling the truth when you claim unemployment benefits. These factors have led to a decline in claims for unemployment insurance to the lowest numbers in the last 50 years.
The U.S. media falsely represents this to give the impression that demand for labor (power) is unusually high even for a boom and the rate of unemployment unusually low. However, other figures confirm that the boom, at least within the U.S. and other imperialist countries, is actually one of the weakest on record, as is overall participation of the potential working population in the labor market.
Mid-cycle downturn
Europe experienced a mid-cycle “mini-recession” in 2015-16, which affected the U.S. as well if you use overall industrial production as opposed to GDP as the criteria. U.S. industrial production peaked in November 2014 at an index of 106.7 and bottomed out more than a year later at 101.6 in May 2016, a rather large decline for a mid-cycle recession. These types of minor mid-cycle industrial downturns, whose existence was noted by Marx, are sometimes called “Kitchin recessions” after Joseph Kitchin (1861-1932), who described them.
Marx, as well as bourgeois students of the “business cycle,” however, differentiated between these minor recessions and the major recessions that mark transitions from one industrial cycle to another. By the way, if you count Kitchin recessions as “periods of contraction” – as the National Bureau of Economic Research does for Kitchin recessions that occurred before the Great Depression – but count Kitchin recessions as part of “expansions” that have occurred since the Depression, the current business “expansion” would date only from April or May of 2016 instead of July 2009.
In reality, the current cyclical expansion has been weak overall, with a much stronger than average mid-cycle Kitchin recession. Therefore, when the bourgeois media point to the fact that unemployment insurance claims are unusually low as evidence that the demand for labor is unusually high in the current boom, they simply provide an illustration of the old saying that “figures don’t lie, but liars can figure.”
What remains true is that unemployment is at or near its low point for the current industrial cycle, and that we expect initial claims for unemployment insurance to rise modestly as the boom slows and then much more rapidly when a full-scale recession arrives.
In addition, according to the U.S. Labor Department’s initial estimate, only 155,000 jobs were created in November 2018. This is well above the levels that would be expected during a recession when the number of jobs created stagnates or declines below the around 200,000 per month created recently. In October 2018, according to its report released just before the election, the U.S. Labor Department estimated that 250,000 jobs were created, so the creation of only 155,000 would be quite a deceleration. It should be borne in mind, however, that these figures are highly volatile, are only preliminary estimates, and are affected by natural disasters such as Hurricanes Florence and Michael that battered the U.S. during this year’s hurricane season.
Finally, since October and continuing into December, there have been repeated waves of selling – followed by sharp but short-lived rallies in stock market prices. However, we have to be careful in interpreting the relationship between stock market prices and a change in the phase of the industrial cycle. While sharp stock market declines precede or accompany virtually every major recession, not every sharp decline indicates that a major recession is imminent. Stock market prices can decline for many reasons, including purely internal stock market forces. That said, in combination with the other indicators the recent stock market sell-offs reinforce the impression that a new recession is not far off.
Has a recession already begun?
Has a new recession already quietly begun? It is possible that when we have the full advantages of hindsight, we will conclude that a full-scale recession began in the fourth quarter of 2018. If this is true, the recession is still in its early stage and will be expected to deepen well into 2019. In approaching this question, we have to keep in mind that the transition from boom to recession is not instantaneous but a process that extends over a period of time. This transitional period may last for a few months but can extend for a year or more.
Downturns in the industrial cycle go through essentially three stages. The first stage, which precedes the recession proper, is what I call the critical point or phase. After a period of rising interest rates, sales of homes, automobiles and other durable consumer goods begin to decline.
During this stage, unemployment bottoms out but overall unemployment remains low relative to other stages of the industrial cycle. There has not yet been a general shift by the commercial capitalists from inventory accumulation to inventory de-accumulation. Industrial production levels out but the decline is not yet – outside of the consumer durable goods sector such as housing construction and automobiles – generalized.
It is a matter of definition whether you count this as the last stage of the boom or the first stage of the recession. In reality, it is the transitional phase that connects the boom with the recession.
In the second phase, inventory de-accumulation by the commercial and industrial capitalists – which as sellers of commodities also act as merchant capitalists – becomes general. The result is that the decline in industrial production also becomes general. The recession proper begins.
If a major banking-credit crisis occurs – in which case we refer to the downturn as a crisis rather than a mere “recession,” though every crisis contains a recession – it most likely will break out at this point. Recessions associated with such “financial crises” are much more severe than “ordinary” recessions. (6)
Finally, capital spending by the industrial capitalists drops. Industries that produce the means of production, such as steel and machine-building, are hard hit. Unemployment continues to rise rapidly. However, interest rates now drop sharply and the stock market begins to recover. A cyclical downturn has reached its final stage.
The last major downturn in the industrial cycle, now dubbed the “Great Recession,” gives a classic example of these successive stages of cyclical downturn. Housing construction was slowing as early as 2006, though the U.S. and world economies as a whole were still considered in a cyclical expansion. However, the overall pace of the expansion was slowing from the pace that prevailed between mid-2003 and mid-2005. Then, in August 2007, what was originally called the “sub-prime mortgage” crisis caused a major freeze-up in credit, and housing starts entered a free fall.
Every recession to a greater or lesser extent involves a break in what Marx calls the chain of payments. B, for example, is counting on getting paid by C to repay A. If C cannot repay B, B cannot repay A. Like all chains, the chain of payments always breaks at its weakest link. What is the weakest link in the chain of payments, however, differs from crisis to crisis. In the last crisis, the weakest link turned out to be sub-prime home mortgages.
This is why the crisis was initially called the sub-prime mortgage crisis. The financial press and most – though not all – professional economists and the leaders of the Federal Reserve System such as Ben Bernanke claimed that the sub-mortgage crisis was “contained” and did not indicate that a general recession would soon break out. But it turned out that the sub-prime mortgage crisis only represented the weakest link in the chain of payments. Once the chain broke at that link, it began to break at many others as well.
Far from being a limited localized crisis, the crisis turned out to be a general crisis of overproduction that affected – to varying degrees – the entire global capitalist economy. Today, in retrospect, while you often read about the “financial crisis of 2007-09,” the original name given to the crisis, the sub-prime mortgage crisis, is now largely forgotten. As it turned out, the August 2007 credit market freeze-up was not the main financial crisis of the developing industrial cycle downturn.
From the ‘sub-prime mortgage crisis’ to the ‘financial crisis’ and Great Recession
In the wake of the credit freeze-up caused by the sub-prime mortgage crisis of August 2007, while clearly slowing, the general economy was not yet in recession. Officially, the National Bureau of Economic Research, the private outfit that unofficially “calls” the dates of turning points between “expansions and contractions,” claims the recession that was to become the Great Recession didn’t begin until December 2007. However, even after December 2007 overall economic activity did not decline sharply until the third or even fourth quarter of 2008 when the global banking system teetered on the brink of collapse and credit froze up worldwide. The Lehman bankruptcy proved to be the turning point of the entire downturn.
Following the Lehman collapse, credit markets froze far more radically than they had after the sub-prime mortgage crisis in August 2007. Distrust was so great the commercial banks were for awhile afraid to loan to one another. With banks that form the pivot of the credit system afraid to lend to one another, they were unwilling to lend to anybody else. Credit now became almost impossible to obtain. The commercial and industrial capitalists had no choice but to begin a massive inventory liquidation in a desperate struggle for cash to meet payments coming due.
Only at that point did “exchanges between the capitalists,” as Marx put it, decline dramatically, leaving no doubt that the U.S. and global economies as a whole had entered a major generalized crisis of overproduction. Across the globe – though the intensity varied from country to country – industrial production and employment and world trade contracted while unemployment rose sharply.
The massive credit collapse, however, meant that demand for money – which under the dollar system means the demand for the U.S. dollar as a means of payment – rose sharply. Almost overnight, the dollar, which had been weak against both gold and other currencies became “strong.” As the Fed increased the “monetary base” at annualized four-digit rates, the dollar price of gold actually fell for several months.
Under any other circumstances but a general credit collapse, the dollar – or main world currency – price of gold would soar if the central banking system increased the monetary base at four-digit rates. The sudden shift from a “weak dollar” to a “strong dollar” marked the transition from the critical phase to the crisis proper.
Global overproduction was brought to a screeching halt and replaced by a phase of underproduction of commodities relative to the long-term ability of the market to expand. The downturn now entered into its final stage as industrial corporations and other industrial capitalists cut their capital spending, spreading the downturn to industries that produce the means of production. However, the generalized under-production and resulting inventory (commodity capital) contraction meant that the crisis was now being resolved at the expense of the unemployed. By July 2009, a new cyclical economic expansion was underway.
The current industrial cycle
Let’s now return to the question of exactly where we are in the current industrial cycle. On balance, I think for now we can draw the tentative conclusion that both the U.S. economy and the global capitalist economy have entered a “critical phase” somewhere between the now fading boom that began in late 2016 and the coming recession.
The arrival of the next major recession whenever it occurs – not necessarily on the scale of 2008 but bigger than the 2015-16 Kitchin recession – will mark the definite end of the industrial cycle that began with the Great Recession. However, this critical phase is unfolding in a particular economic and above all political context. When these special factors are added, the current critical phase is far more critical than most such critical points have been in the history of industrial cycles.
Under the present international monetary system dominated by the U.S. dollar, as opposed to various forms of the gold standard that preceded the dollar standard, the critical point preceding the recession proper – or occasionally more serious crisis – takes on special importance. Concretely, under present institutional arrangements, the critical point arrives when after a period of boom and gradual tightening by the Federal Reserve System, credit is squeezed, interest rates shoot up, and economic growth begins to slow.
During the critical phase, unemployment is still “low” relative to other phases of the industrial cycle – the media insists the U.S. economy is at or near “full employment” – but the danger of near-term recession is clearly rising. The media then points out a dilemma that the Federal Reserve System faces. Should it continue to raise interest rates to head off the “danger of inflation,” allegedly caused by “full employment” and the growing danger of “wage inflation”? That is the danger the workers will get raises that will erode the all-important (for the capitalists) rate of surplus value and rate of profit. Or should “the Fed,” as the media explains it, cut interest rates to head off the threatening recession.
Or perhaps, the media suggests, the Fed should “pause” – that is, leave the interest rate unchanged – and see what happens. During the last critical point, the Federal Reserve System indeed paused and the result was the Great Recession. So pausing is no magic bullet.
The current critical point
Because it coincides with an increasingly critical political situation, the current critical point is more critical than many that have occurred since 1971, when the “dollar standard” emerged from the ruins of the gold-dollar exchange Bretton Woods international monetary system. This context includes the present U.S. paper dollar-centered monetary system, the general decline of U.S. capitalism relative to other countries engaged in capitalist production, the Trump presidency and its tariffs wars, the political crisis in France, the fading of the German government of Angela Merkel, and the Brexit crisis that almost brought down the Theresa May government of Britain.
This creates the possibility that the political and economic crises could combine and feed on each other in a “perfect economic and political storm.” We will examine this possibility, not prediction, in next month’s post.
To examine how such a perfect storm might arise, we first have to examine how the general characteristics of the critical point of the industrial cycle under the post-1971 U.S. dollar international monetary system interacts with the policies of the Federal Reserve System.
The Federal Reserve System and the critical point of the industrial cycle under the dollar system
Under today’s conditions, the critical point always follows a series of “tightening moves” by the Federal Reserve System. But what exactly do we mean when we say the Federal Reserve Board is “tightening,” or “easing? And why does the Federal Reserve System sometimes “tighten” and sometimes “ease”?
When we say the Fed is tightening, we actually mean that it is slowing down the rate at which it is creating its dollar-denominated currency, or as it has been doing for many months now, destroying the currency it previously created through several rounds of “quantitative easing.”
The currency the Fed creates takes two main forms, actual paper dollar bills of various denominations – green money – and accounting IOUs – promises by the Federal Reserve to redeem on demand of commercial banks that by law maintain accounts in the 12 Federal Reserve Banks. There is also a third form of money – coins made of base metals issued by the U.S. Treasury, formally called Treasury money. For all practical purposes, coins made of base metals are identical to Federal Reserve Notes under the present monetary system.
All forms of currency created by the Federal Reserve System are examples of what Marx called token money. Token money is money issued by either the state or central banks bound up with the state power that is not made up of actual money material – like gold coins – or is convertible into money material in the form of gold coins made up of a legally determined quantity of money material – gold bullion. Token currency is declared by the state legal-tender money for payment of all debts public or private. The economists often call what Marx called token money “fiat money.”
The money created by the Federal Reserve System shouldn’t be confused with the money created by the commercial banking system through loans. When a commercial bank issues a loan, it creates an imaginary deposit that can then be transferred to another person by a traditional check, credit card, or smartphone. Marx considered this type of money a form of credit money.
The credit money created by commercial banks depends on the fact that deposit owners are unlikely to attempt to redeem their bank accounts in legal-tender money at the same time. If they did, the entire system of credit money would collapse.
When the economists talk about the “money supply,” they mean the token legal-tender money created by the central bank plus the credit money created by the commercial banks. Since the credit money created by the commercial banks is built on a base of legal-tender token money, this monetary base is sometimes called “high-powered money.”
The ratio between the quantity of “high-powered money” and credit money – called bank money by the economists – is quite elastic and can vary widely depending on general economic conditions. However, the ability of the commercial banking system to create credit money is ultimately limited by the quantity of legal-tender token money.
Central banks do not determine interest rates
The media and economists often claim that the Federal Reserve System and other central banks set or determine interest rates. In our discussion and critique of Modern Monetary Theory, we saw that MMT economists believe that the central banking system can set interest rates at any level it might desire. Though this is widely believed, nothing could be further from the truth.
In reality, the Federal Reserve directly sets only two interest rates. These are the discount rate, the rate Federal Reserve Banks charge commercial banks for loans, and the rate Federal Reserve Banks pay to commercial banks on their deposits with the Federal Reserve banks.
The main rate that under the present arrangements the Federal Reserve System manipulates, but does not set, is the “federal funds rate” – the annualized rate of interest commercial banks charge for overnight loans they make to one another.
If the Federal Reserve System wishes to lower interest rates, it creates additional token money, which all things remaining equal causes the federal funds rate to fall. Since the federal funds rate is actually the rate of interest one commercial bank charges another, the Fed sets a target for a range of fluctuation. If the fed funds rate rises above the target range, the Fed creates additional token money. If it falls below the target, it destroys some token money it previously created. When the Fed “eases,” it lowers its federal funds rate target through the creation of additional token money. When it “tightens,” it raises its fed funds target.
The critical point of the industrial cycle and the fed funds rate under the dollar system
As we noted above, under the present international monetary system the approach of the critical phase is announced when, after a series of federal fund rate increases – or “tightening moves” – by the Federal Reserve Board, economic growth within the U.S. and on a world scale begins to slow. This is exactly what is happening now. Remember, under the dollar system the Federal Reserve Board acts not only as the U.S. central bank but the central bank of the entire capitalist world economy.
At the critical point, the Fed has three choices. It can continue to raise the fed funds target until the economy has clearly entered an actual recession; it can “pause” by maintaining the fed funds rate at its current level and wait to see what happens; or it can attempt to limit or even head off the looming recession by lowering its fed funds target rate.
While this topic may seem dry and technical, the choice the Federal Reserve System makes at the critical point of the industrial cycle can have dramatic consequences for virtually everybody on Earth. The choices the Fed makes in changing its fed funds target range – if at all – in coming weeks or months will play no small role in how current political crises affecting almost all capitalist countries to one degree or another are resolved. (7)
How economists and the media represent, or rather misrepresent, the ‘critical point’
After a period of post-recession stagnation, Fed leaders and the capitalist press always misrepresent the reasons they are “raising” – or rather raising their target for – the federal funds interest rate. They claim the Fed is now able to raise interest rates without threatening the now solidly established capitalist prosperity. In reality, they are not actually lying, since even the central bankers don’t really understand the real reasons why they must act the way they do.
To understand why they are forced to act the way they do, we must first master the theory of value, money, and price developed by Karl Marx. Here, we indeed need Marx; David Ricardo, who developed classical political economy to its highest point, is not good enough. And official economics based on neoclassical marginalism is useless when it comes to understanding why the Federal Reserve System must raise its target for fed funds at a certain point in the industrial cycle. (8)
First, let’s examine the official story, which goes like this. The economy has now overcome the problems we faced in recent years following the recession from which we are now happily recovering. We now, economists and economic journalists explain, have a “Goldilocks economy” – not so cold that we have “involuntary unemployment” and not so hot that we have dangerous inflation.
As the economy has entered the Goldilocks zone, the Fed and other central banks can now “set interest rates” – notice the false assumption that the Federal System determines what the rate of interest is – at a level where interest rates neither stimulate nor check the economy. The actions of the Federal Reserve System – and more generally the central banks as a whole – are called “monetary policy.” Once we are in the Goldilocks zone, the economists, media and central bank all insist that the supreme aim of monetary policy is to keep us there.
According to the economists, the long-term rate of growth of the economy is determined by the rate of increase of labor productivity plus the rate of increase of the working population. The job of the central bank now that at last the recession is well behind us is to set the rate of interest at a level that keeps the actual rate of growth at the potential rate of growth (determined by the growth of the population and labor productivity). This, economists explain, is the Goldilocks zone.
If the central bank were to set the rate of interest too high, the economists and media explain, the economy will run below the Goldilocks level and we will have involuntary unemployment, or in the worst case even fall into a new recession. If the central bank sets the rate of interest too low, they explain, the economy will “overheat,” which will cause inflation in nominal wages and prices that will then force the Fed to tighten and possibly throw us into a new recession.
Therefore, the job of the Federal Reserve System, the learned economists and economic journalists (whose job is to communicate the findings of the economists to the general public) explain, is to set – manipulate – the federal funds rate to the “neutral level,” where the economy is neither stimulated nor restrained.
Ben Bernanke – the head of the Federal Reserve just before and during the Great Recession – claimed that after many false starts, which included the Great Depression and the stagflation of the 1970s, he and the Fed had finally learned how to keep the economy within the Goldilocks zone with only slight recessions and minor inflations. Bernanke even invented a term for an economy supposedly permanently in the Goldilocks zone – the “Great Moderation.”
Then came the Great Recession, and a decade later Bernanke and his fellow – or former – central bankers are still trying to figure out how things could have gone so wrong after monetary policy had reached such a state of perfection.
In reality, the story told by the economists, central bankers, and media is a fiction. It assumes that crises of overproduction do not really occur and that Say’s Law is essentially valid. That law is named after the French economist Jean Baptiste Say (1767-1832), who claimed that commodities are purchased by other commodities. Therefore, Say reasoned, general gluts of commodities cannot occur, though there is always the possibility that some commodities will be produced in excessive amounts relative to other commodities. Say assumed that money was a mere token that simply circulates commodities.
A related idea is that modern money is “fiat” money – or in the case of Modern Monetary Theory money has always been fiat money – which can be created by the central government at will. According to these schools of thought, if the government creates “too little” money and a recession threatens, the situation can always be corrected by the monetary authority simply stepping up the rate at which it creates money.
But as we Marxists – but not the economists – know, this is based on a misunderstanding of the nature of commodities and money that separates one or a few commodities – and yes, money must be a commodity that functions as money separate from all other commodities. While it is true that not all commodities can be overproduced, it is perfectly possible for all – or most – commodities to be overproduced relative to the commodity that serves as money.
When this situation arises, we have a general overproduction of commodities. Such a situation, as long as we retain capitalism, has to be resolved through an economic crisis that replaces the overproduction of commodities with a balancing period of underproduction of commodities. In this way, successive periods of the overproduction and underproduction of commodities are necessary to equalize the increasing production of commodities by the industrial capitalists on one side and the ability of the market to absorb these commodities in the long run. There is no other way under highly developed capitalism to resolve this contradiction.
Therefore, the tendency of production to exceed the growth of the market is built into the commodity foundations of capitalism, though it takes a developed capitalism to make the tendency an actuality. To understand this, the wealth of a developed capitalist society can be visualized as two piles of money. One pile is actual money material – gold bullion. This pile of wealth is measured by the unit of weight appropriate to the use value of gold bullion – for example, metric tons.
Accumulated money capital – gold bullion – is not “consumed” like other commodities but rather grows over time as gold mining and refining industries increase the quantity of gold bullion in the world. The rate of growth of this pile governs the rate of growth of the world market — its growth over the long run, not the short run. This provides capitalism with the expanding markets it needs for the commodities it produces, allowing it to continue to exist. (9)
Another – much larger – pile of gold, also measured in terms of some unit of weight of gold bullion, exists. However, unlike the first pile, the gold in this pile is imaginary. Instead of consisting of glittering gold, this pile physically consists of all the commodity use values that make up the actual wealth of the world created by human labor that is currently “on the market” – being offered for sale. But how do we measure the quantity of commodities in terms of their use values? What unit of measure can we use, since this pile is made up of many commodities with varying use values each of which has its own unit of measure?
The only thing that all the commodities – gold in one pile and all other commodities in the other pile – have in common is that they are products of human labor. We can therefore relate the two piles through the quantity of embodied human labor they represent. This is indeed the essence of the matter, and realizing this represented the greatest breakthrough of classical political economy. This is the point in the analysis where Ricardo – and with him classical political economy – stopped, but Marx went further.
The founder of scientific socialism explained that under capitalism the quantity of labor necessary to produce a commodity is not known and cannot be known to the buyers and sellers of commodities. Individual capitalists know and strictly measure the quantity of labor their workers add to the value of the commodities they produce, but they have no idea how much labor their inputs – raw and auxiliary materials plus fixed capital used up – represents. And even if the capitalists did know this, they would still have no way of knowing whether the labor they were expending on the production of commodities of a given use value meets an actual social need. How could the capitalists, each producing for their own private account, know whether they are producing commodities of given use values in the right proportions to reproduce their system?
As a result, Marx explained in Volume I of “Capital” and elsewhere, value must take the form of exchange value where the value of one commodity is measured in terms of the use value of another commodity. In its developed form, exchange value takes the form of price, where the value of a commodity is measured in terms of the use value of gold bullion. The use value of gold bullion is measured in terms of ounces of gold.
The only way capitalists can do this is to measure not the actual use values of the commodities but rather add up the price tags attached to them. In order to do this, we first have to convert currency prices into the quantities of gold these prices represent. By adding up the price tags of all the commodities that are for sale, and carrying out this conversion, we arrive at a pile of purely imaginary gold – called by Marx money of account – that, just like real physical gold, can be measured by some unit of weight such as metric tons.
In the long run, thanks to what Marx called the “law of value,” the two piles must grow at more or less the same rate. But for reasons discussed here, while they must grow at more or less the same rate in the long run, the same law of value determines that they cannot grow at the same rate in the short run.
When the imaginary total of commodity price tags measured in gold grows more slowly than the pile of real gold, we have underproduction. During periods of underproduction, we have recession, depression, stagnation and high unemployment. Indeed, during recessions, the pile of imaginary gold actually shrinks – something that never happens to the pile of real gold. (10)
During periods of prosperity, it is the pile of imaginary gold – the sum of price tags measured in gold – that grows faster than the pile of real gold. This is a situation of overproduction. During overproduction, we have relatively low unemployment and overall capitalist prosperity. However, overproduction must always end in an economic crisis – what Marx called a crisis of the relative overproduction of commodities. Overproduction does not, however, immediately lead to a crisis or recession but passes through a series of stages that end in recession. At a certain point, a critical phase is reached, which it appears, if indicators don’t deceive us, we are passing through now.
While purely economic forces see to it that our two piles of gold – one real and one imaginary – grow at unequal rates, external forces also affect the rates of growth of our two golden piles. Large-scale wars that cause the “golden” prices of commodities to rise also can cause the rate of growth of the pile of real gold to drop. Such periods tend to be followed by crises of extra-severity, the most infamous case being the super-crisis of 1929-33.[link to appropriate posts] (11)
But changes in the physical conditions of production of gold – the depletion of existing gold mines and discovery of new rich gold mines, and the introduction of methods to produce gold cheaper from ores of a given richness can at times play an important role in the magnitude of particular crises and booms. For example, the discovery of the California and Australian gold fields between 1848 and 1851 and in the 1890s in Canada and Alaska, combined with the introduction of the cyanide process for extracting gold from ore, led to eras of exceptionally rapid growth of world markets, which had vast political consequences for the course of 19th-century and early 20th-century politics. Most importantly of all, the discovery of gold and silver in the New World in the 16th century led to what bourgeois historians call the “commercial revolution,” which ushered into existence the capitalist mode of production and its world market.
On the other hand, as the 21st century dawned, the depletion of the South African gold mines, which had been the main source of money material for the world capitalist economy for more than a century, led to a decline in world gold production between 2001 and 2008. This played a major role in the severity of the Great Recession, notwithstanding the “excellent monetary policy” followed by Mr. Bernanke and his colleagues at the Federal Reserve Board. The Great Recession, because of its unusual severity, in turn, stimulated the production of gold, helping to re-balance capitalism’s two “golden piles” once again. This enabled the industrial upswing that began in 2009, despite its rocky start, to last for more than nine years as of this writing.
It is the shifts in the relative rate of growth of these two golden piles that ultimately determine the monetary policy that the central bank must follow. This is true regardless of the formal structure of the international monetary system, whether the classic gold standard, the gold-dollar exchange standard, or since 1971 the paper dollar standard.
During recessions, when the commodity pile of imaginary gold is shrinking the central bank must reduce interest rates. However, once the rate of the golden pile represented by commodity price tags starts to grow faster than the pile of actual physical gold – that is, when overproduction begins – central bankers are forced to begin raising interest rates.
The various schools of bourgeois economics – and many socialists, especially those of reformist inclinations – do not like this reality because it means the cyclical instability of the capitalist economy sooner or later leads to political instability and finally to the overthrow of the system and cannot really be controlled by the intervention of the capitalist state and its central bank. At most, it means that the capitalist state and its central bank can avoid exacerbating the cyclical instability that is built into the system. How to achieve this is the valid kernel in what is called “stabilization policy.”
The capitalist state cannot really stabilize the economy but it can avoid, at least in theory, policies that make the capitalist economy even more unstable than it otherwise would be. Whether it does so in practice is another matter entirely. This is something as regards the current situation that we will examine in next month’s post.
The evolution of ‘stabilization policy’
Since the first half of the 19th century, when crises of overproduction first appeared, capitalist economists have attempted to develop policies that would eliminate them. Under the classic gold standard, it was pretty obvious that the ability of the central banks to create additional currency to hold down interest rates and support demand was ultimately limited by the quantity of physical gold in their vaults. In order to get rid of what appeared to be a purely legal limitation on capitalist production, central bankers by degrees abandoned their promise to redeem their banknotes for actual physical gold, whether in the form of coin or bullion.
Today, the legal limits imposed by the physical quantity of gold on the central bankers are gone. The limits to the ability of the central banks to create currency – and thus hold interest rates in check – is clearly economic not legal. These limits impress themselves on the minds of the central bankers as the dangers of inflation and the huge rises in interest rates that inflation brings about from the depreciation of paper currency against the money commodity.
In the 1970s, it was the rise in interest rates caused by currency depreciation-driven inflation that more than inflation as such limited the ability of the central banks to create additional currency of a given purchasing power, and therefore demand. The job of the bought-and-paid-for economists of the ruling class and their media is to hide the fact that the limits on production caused by the central banks’ need to “fight inflation” are imposed by capitalism and not nature.
The approach of the capitalist-imposed limits on production under the dollar system is signaled by rising primary commodity prices in central bank-created currency such as the dollar. These rising dollar prices are actually caused by a decline of the amount of gold that each dollar represents – a smaller amount of gold that expresses itself in a rising dollar price of gold. Though official economic theory – and Modern Monetary Theory – insist the dollar price of gold has little importance, the financial media remains obsessed with this supposedly meaningless indicator.
Inflation in the form of rising dollar commodity prices signals to the Federal Reserve System that as the “central bank of central banks” under the dollar system it must begin to push up the federal funds rate.[link to posts which explain this]. Indeed, it even anticipates the arrival of the inflationary signal whenever economic growth seems to be picking up.
The Federal Reserve System does this by reducing the rate at which it is creating new dollar-denominated currency. Since under the dollar system, the dollar forms most of the reserves of the other central banks, the ability of the other central banks to create their own currency declines when the Federal Reserve Board curbs the rate at which it is creating additional dollars. If the Federal Reserve System ignores these signals, the rate of inflation in terms of the U.S. dollar and its satellite currencies rises. More importantly, interest rates rise sharply. Here we see the specifically capitalist limits of production.
Interest rates cannot rise to any arbitrary level because interest represents only a portion of the surplus value that represents the unpaid labor of the working class. With the rate of profits and rents given, a rise in the rate of interest means a lower profit of enterprise. The industrial capitalists will not undertake new investments unless they expect to make a rate of return in excess of the rate of interest.
Under the dollar standard – or any other paper money system – the critical point of the industrial cycle that forms the transitional stage between boom and recession takes on a special importance that it lacked under the various forms of the gold standard. Under the gold standard, the central banks are legally obliged to maintain the convertibility into gold at a given rate of the currency they create. At the critical point, when their ability to issue additional currency is legally restrained by a lack of gold in their vaults, they have no choice but to allow the recession to unfold. But under the current system, where there are no such legal limits, they appear to have a choice.
They can, for example, refuse to finance the rising prices in terms of the currency they create. The classic example of this was the “Volcker shock” of 1979-82. When the central banks follow this course, interest rates at first rise sharply. But rising interest rates then cause investors to dump gold in favor of the U.S. dollar and other paper currencies, and inflation tapers off. This heads off inflation – or halts or at least radically slows currency depreciation and inflation once it has gotten started. This happened under the Volcker shock but at the price of kicking off inventory liquidation-recession. The combination restores confidence in the currency, and recession lowers interest rates allowing production to continue on a capitalist basis. But this occurs at the price of recession and its resulting mass unemployment, as occurred after the Volcker shock.
However, the White House and other politicians facing reelection tend to pressure the central banks once the critical point is reached to ignore the signals and maintain an “expansionary” policy, at least until the next election. They say to themselves, I might survive “a little inflation,” but my reelection chances will be sunk if a recession hits. This is why the doctrine of the “independence of the central bank” is so important under a paper currency standard. This is all the more obvious to the politicians because the economists do everything they can do to hide that it is not the natural limits of production that are being approached but capitalist limits of production.
Once the critical point of the industrial cycle gives way to the recession proper, the importance of money as a means of payment takes on special importance. Under the dollar system, after a period of weak demand for the U.S. dollar it suddenly soars. The dollar is suddenly a “strong currency” again, the dollar price of gold falls, while dollar prices of primary commodities fall even more. We saw this in 2008 and before that during the Volcker shock.
The Federal Reserve System gets the signal that it is now time to greatly accelerate the rate at which it is creating new dollar currency in order to drive down the rate of interest. The critical point of the industrial cycle has now passed. While the overproduction of commodities is indeed being overcome, it is being overcome at the costs of the jobs of tens of millions of workers.
During the critical point of the cycle, unemployment is still very low relative to the other phases of the cycle. This is the situation at present. But once the critical point of the cycle gives way to recession, unemployment will rise sharply, which can cause a political crisis for the capitalist government.
Next month, I will examine the concept of the critical point within the framework of the unique economic and political situation that prevails today. By then we will have more data on exactly where we are in the industrial cycle such as whether we are perhaps merely approaching the critical point or, on the other hand, have already passed it and entered the recession proper. I will also examine the concrete circumstances that exist today and two other aspects of the critical phase of the industrial cycle that we have yet to examine.
To be continued.
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1 It has recently been announced (Dec. 14, 2018) that California State Supreme Court Justice Tani Cantil-Sakauye has announced she is quitting the Republican Party and re-registering as “no party preference.” Chief Justice Cantil-Sakauye has clearly drawn the conclusion that to retain any credibility as head of the California State courts in “black-brown” California, she has to sever her ties with an increasingly hated Republican Party. (back)
2 Since 1789, France has experienced the limited monarchy established in 1789 that lasted from 1789 to 1792. The limited monarchy was followed by the First French Republic, which lasted from 1792 to 1804. The First Republic then yielded to the First Empire under Napoleon I, which ended with France’s defeat by Britain and Russia in 1815. This was followed by the restoration of the Bourbon monarchy that ended with the July Revolution of 1830, which established the “July Monarchy” of Louis Phillipe. This monarchy was replaced by the second Republic established by the February Revolution of 1848 and lasted only until 1852. The Second Empire under France’s Trump-like Emperor Louis Bonaparte, who ruled as Napoleon III, lasted from 1852 to 1870. The Third Republic established after France’s defeat by Germany in the Franco-Prussian war of 1870 lasted until 1940, when France was defeated by Nazi Germany and then was headed by the pro-Nazi Germany Vichy regime under Marshal Petain and Pierre Laval. Vichy fell in 1944 as Nazi Germany was defeated by the Soviet Union, the United States and Britain. The Vichy regime was succeeded by the Fourth Republic, which was formally established in 1946 but lasted only until 1958. The current Fifth Republic was established after General Charles DeGaulle’s coup d’etat in 1958.
None of these regimes lasted more than 70 years, a mere human lifetime. The longest was the Third Republic between 1870 and 1940. The current Fifth Republic is only a little over 60-years-old as of this writing. The Yellow Vest movement shows that it is very much an open question whether the Fifth Republic will still be around in 2028 when, if it still exists, will only then match the Third Republic in term of longevity. This is in contrast to interrupted constitutional Britain, which has prevailed since 1688 and the United States since 1789. (back)
3 “Atlantism” was the term applied to the political tendency associated with West German chancellor Konrad Adenauer (1876-1967), which accepted complete political and military subordination to the U.S. This was in return for the U.S. and its world empire guaranteeing access to U.S. and other markets the U.S. controlled, plus sources of raw materials that had been denied to Germany by the victors after World War I. (back)
4 It should be pointed out that while Germany’s economic performance is better than any other developed European economy, the conditions of rapid growth – the so-called economic miracle of the 1950s and 1960s that did so much to stabilize post-Nazi capitalist West Germany – have not returned. This is not to mention the terrible conditions that exist in the former East Germany, which a generation after the counterrevolution of 1989 remains the most impoverished and politically unstable part of present-day Germany. (back)
5 Marx described commodity capital as commodities containing surplus value that are being offered for sale on the market. (back)
6 A reader recently questioned the assertion that a new crisis is approaching. He pointed to the recent record gold production (which has continued, measured year over year, through the first quarter of 2018). I think the difference with the reader is essentially terminological. Since the mid-19th century, “business cycle” experts have periodically announced that “crises” no longer occur but only recessions. But periodically crises have always returned.
I believe all indications are that we are approaching a general decline in industrial production and rising unemployment in many capitalist countries. That will surely have implications for world trade on top of Trump’s tariff war. This decline will, I believe, though there is no absolute certainty when it comes to predicting industrial cycles, count as a recession marking the end of the current industrial cycle and not a mere mid-cycle “Kitchin recession” sometime in the next few years.
Whether we experience a crisis such as the one that occurred in 2008, or even a super-crisis defined as a crisis severe enough to stimulate gold production as much as a major geological discovery or breakthrough in the technology of mining and extracting gold – which implies a Depression on the scale of the Great Depression – is another question altogether.
For now, I am not predicting such a crisis will occur in the next few years and am merely indicating the approach of a “normal” industrial cycle-ending recession. The reader points out, however, that global gold production is now increasing very slowly. This is exactly the situation that prevailed in 1913 just before World War I and the mid to late 1960s. So unless unexpected gold discoveries or a major technological breakthrough occurs in gold mining in the next few years – which of course is always possible – and assuming we have only an “ordinary” recession over the next couple of years that does not stimulate global gold production very much – a far more serious crisis is likely to follow within a decade. (back)
7 Notice, I say “affects” and not determines. Ultimately, resolutions of the current political crises will be determined by the class struggle. (back)
8 This is, by the way, the real reason that, from the 1930s on, university-taught economics was split into micro-economics, which serves to justify the capitalist system, and macroeconomics, which attempts to teach policymakers how to avoid making crises worse than they have to be. (back)
9 During every recession, I am asked by hopeful if impatient revolutionaries whether we are finally in the “final” crisis of capitalism. Because the pile of gold bullion never shrinks, I have to explain that a recovery in the capitalist economy is not only possible but inevitable. (back)
10 This is slightly simplified, since gold bullion also has non-monetary use values. However, the necessary modifications do not change the general picture presented here. (back)
11 This didn’t happen after World War II because of the preceding years of Depression under-production, Depression-stimulated global gold production, and low – relative to the “golden” prices of production – “golden” commodity prices. Notwithstanding the sharply negative effect of World War II inflation on gold production, the pile of real gold was large enough relative to the pile of imaginary gold to stave off a deep economic crisis for many years after the war, though this didn’t prevent lesser recessions. (back)
A Critique of Crisis Theory 