The 2020 recession was more than the usual cyclical downturn. There were, however, signs a cyclical recession was developing before the COVID-19 pandemic hit with full force in March 2020. Industrial production in most countries had already ceased to rise. The U.S. Federal Reserve System had already initiated an “easing” cycle in an attempt to contain the incipient downturn. That was the situation when it became impossible to deny that the COVID pandemic was rapidly spreading in the United States and around the world.
As the reality of the deadly global pandemic became widely known, the travel, hotel and hospitality industries came to a grinding halt. Many other industries were devastated. As people were forced to hunker down across the globe, both the production of surplus value and its realization were sharply curtailed. As sales of commodities plummeted, the velocity of circulation of the currency dropped drastically. This meant that a given quantity of currency generated far less monetarily effective demand than it would under normal recession conditions.
Eager to get both the production of surplus value and its realization back to normal, capitalist politicians, most notoriously former President Donald Trump, pushed for “reopening” the economy. Trump originally set a target of Easter 2020 for the reopening! (1) So began a cycle of premature “re-openings,” followed by rising COVID cases, hospitalizations, and deaths to new highs leading to renewed, if ever more limited, shutdowns.
Among the countries that dealt with the pandemic the worst was the world’s richest country, the United States. In no other country in the world does the capitalist class have more unbridled power. Business pushed for the fastest reopening possible so that normal profit-making could resume. President Trump was more than willing to oblige since he had planned to pitch his reelection campaign around the theme that the U.S. was experiencing “the greatest economy ever.” Democrats and Republicans competed with one another on who could reopen their state and local economies fastest. As a result, the total number of official U.S. COVID-19 deaths now approaches 600,000. Worldwide, more than 3 million people and rising have died. (2)
Brianna Griffith, writing in the online socialist publication Liberation News, reported: “India, South Africa and 80 other countries proposed a temporary waiver of the Trade-Related Aspects of International Property agreement on patents. The proposal was blocked in February by the United States, European Union, United Kingdom, Japan, and Australia. It is also opposed by the U.S. Chamber of Commerce, Pfizer, BioNTech, Moderna and Johnson & Johnson — key beneficiaries that stand to profit immensely from global suffering.”
So far, the Biden administration, just like its notorious predecessor, prefers to safeguard the monopoly super-profits of big pharmaceutical companies holding the patents on the lifesaving vaccines. The result is that less vaccine is being produced than would be the case without the state-enforced monopolistic profit protection for “Big Pharma,” and the vaccines being produced are selling at prices far above their prices of production.
The greater the price of a vaccine relative to its price of production, the harder it is for governments to find the money to purchase it and the greater the number of preventable deaths and serious illnesses. Naturally, the people of the most exploited countries and classes in the world are hit the hardest. (3) Therefore, safeguarding the patents of the drug companies begun under Trump and continuing under Biden is not just a policy of putting profits over people but rather putting super-profits above human lives.
The Federal Reserve, the credit system, and the COVID crisis
The sudden drop in commodity sales triggered by the COVID pandemic created a huge global credit crisis. The credit system is built on the assumption that commodities will be sold at certain prices within a given period. Anything that disrupts the sale of commodities or that lowers their prices will throw the credit system into crisis. Starting in March 2020, the sale of many commodities came to a grinding halt. The sale of many other commodities declined sharply. However, debts were still coming due and creditors were facing demands for payments by their creditors.
The entire chain of payments threatened to shatter leading to an unprecedented economic collapse. The demand for the U.S. dollar as a means of payment soared just as it had during the more conventional overproduction-fueled credit crisis that hit with full force in 2008, but this time to an even greater extent. (4)
The Federal Reserve System, which issues the dollar-denominated currency that under the dollar system backs the currencies issued by other central banks, flooded the banking system with vast new dollar reserves to stave off an unparalleled credit and economic collapse. The situation was greatly aggravated by the fact that the pandemic broke out at the peak of the industrial cycle when overproduction puts increased pressure on the credit system.
At the same time, under the CARES act, trillions of these newly created dollars were pumped into the U.S. economy by the U.S. Treasury. This purchasing power combined with premature “re-openings” began to revive the U.S. economy after May 2020 though the economy remained well below its February peak. Capitalists began to complain that unemployed workers were collecting more in the temporarily expanded unemployment benefits than they had been earning in wages. How, the capitalists complained, can we force workers to risk their lives by returning to work — there were as yet no anti-COVID vaccines — when they can earn more by staying safely at home while collecting their unemployment insurance.
Responding to these complaints, the Democrats and Republicans allowed the liberalized unemployment benefits under the CARES act to run out. With the pandemic still raging, the U.S. economic recovery soon tapered off. As 2020 ended with the economy set to enter a new downward spiral, Trump, the Republicans, and the Democrats finally agreed to allow a new flood of money to be released into the U.S. economy. Normally, the U.S. Treasury keeps about half a trillion dollars in its checking account at the New York Federal Reserve Bank. But during 2020, it raised so much money through its borrowing that its checking account balance at the New York Fed swelled to $1.6 trillion.
The new Biden administration, to keep the recovery going is determined to run down the federal government’s checking account balance over the next few months to a more normal level of a trillion dollars. Meanwhile, The cash balances of U.S. commercial banks held in the district Federal Reserve Banks — called reserves — continue to grow rapidly.
The resulting flood of cash is now disrupting the money market by checking the recent rise in long-term interest rates while lowering the already near-zero shorter-term rates. Since interest rates equalize the demand and supply of gold, the lowering of interest rates is now threatening to renew last year’s depreciation of the dollar against gold. That weakening of the dollar has been partially reversed by the recent sharp rise in long-term interest rates.
Any renewed depreciation of the U.S. dollar against gold once again raises the specter of a new wave of accelerated inflation. Already, price increases at both the wholesale and retail level have accelerated. In March, retail prices according to official government estimates rose 0.6%. If this were to continue for a year, the cost of living would rise 7.5%. The rise in the U.S. government’s producer price index, which if not reversed will soon be reflected in consumer prices, rose by 1%. At an annualized rate, this would come to 12.7%. If the rise in producer prices spreads to the retail sector, it will mean a rise in the cost of living not seen since the stagflation crisis of more than 40 years ago.
Federal Reserve officials say that the current surge of inflation is “temporary,” reflecting supply disruptions caused by the COVID-19 shutdowns. The situation is compared to a surge in prices that occurred at the beginning of the Korean War. Back then, the outbreak of hot war in Korea led to widespread speculation that it was simply the opening battle of a full-scale hot war between the United States and the Soviet Union. This led to a wave of panic buying in anticipation of widespread wartime shortages. But as soon as fears of an all-out war faded, the panic-buying stopped and prices stabilized. The Fed and the Biden administration hope the same thing will happen as vaccinations spread and COVID shutdown-caused shortages are overcome by surging production.
However, if the injections of huge amounts of dollars into the U.S. and world economy causes demand for gold bullion to soar leading to a resumption of the depreciation of the dollar we saw last year, there is no reason to think dollar-denominated prices will stabilize after a few months, any more than they did in the 1970s. In that case, the current inflationary wave will turn into a new stagflation crisis.
A new stagflation crisis, however, won’t occur immediately. Over the next few quarters, the current massive injection of dollars will almost certainly cause the U.S. economy to expand at a rate not seen since the Reagan-era post-stagflation snap-back recovery of 1983-84. The hope of the policymakers in the Biden administration and the Fed — and the hope of progressives as well — is that this “snap-back surge,” which always follows a steep economic decline, will develop into a much stronger upswing in the industrial cycle than the one following the Great Recession of 2007-09.
Capitalist propagandists, led by Reuters and Yahoo News, are already writing about the coming “Great Boom” as though it has already happened — even though the latest figures show there are still 8 million fewer people working in the U.S. than in February 2020. To say the least, we are some distance from the new period of prosperity that the Fed, the Biden administration, and progressives count on.
As fears of inflation turning into stagflation rise, Republicans and some macroeconomists like Larry Summers are saying the current “stimulus” program is already going too far and should be dialed down. Federal Reserve Chief Jerome Powell — himself no radical — and former Fed chief and current U.S. Secretary of Treasury Janet Yellen counter that it is far too early to dial back the stimulus. Powell and Yellen fear that if it is cut off prematurely, the recovery will peter out with many millions in the U.S. still unemployed.
Let’s wait, the Biden and Fed policymakers say, until the multiplier and accelerator effects fully kick in, perhaps sometime in 2023. Powell and Yellen hope that the U.S. economy will then have returned to what they — not the working class — define as full employment. Only then do Powell and Yellen believe that it will be possible to gradually withdraw the stimulus without the U.S. and world capitalist economies returning to the slow-growth pattern following the crisis of 2007-09 in the base case, or a new recession in the worst case.
Yellen, Powell, and other policymakers are concerned about the failure of the U.S. economy to gain much momentum after the Great Recession of 2007-09. It seems that policymakers concluded that the stimulus policies launched after the crisis of 2008 were too small and withdrawn too quickly. They want to avoid making the same mistake again.
Yellen and Powell expect that until the economy returns to what they define as full employment, perhaps sometime in 2023, inflation should not be much of a problem. The idea that inflation and economic stagnation cannot occur at the same time was the traditional position of Keynes-inspired macro-economics before the 1970s stagflation. Powell, Yellen, and other Biden administration policymakers hope a 1970s-style stagflation will not return and undercut their Keynesian playbook once again.
The economists and stabilization policy
The neoclassical marginalist school of economics has since the end of the 19th century dominated the economics profession. It insists that the capitalist economy is naturally extremely stable. Unless there is a violent “outside shock,” these economists insist, the capitalist economy will operate at levels close to “full employment.” Even if there is a violent outside shock — such as the COVID-19 pandemic — they insist that the capitalist economy will rapidly return to “full employment” as long as the government does not interfere.
The strong form of Say’s law — that there can never be a general glut of commodities — is built into the foundation of neoclassical economics. After all, neoclassical economics is the study of scarcity and not overproduction. According to traditional neoclassical theory, government stabilization policies much beyond tweaking the central bank’s (re)discount rate are not needed because the capitalist economy is already stable as long as the government does not interfere. Any attempt to stimulate the economy by increasing monetarily effective demand, the neoclassical economists insist, will merely cause inflation since the economy is already at “full employment.”
Between the Depression, when modern Keynesian economics was developed, and the stagflation crisis of the 1970s, Keynesian economists believed that high rates of inflation and economic stagnation could not occur at the same time. Today, Keynesian and post-Keynesian economists are once again returning to that position, treating the 1970s as a freak occurrence (5) that is unlikely to recur.
Keynesian economists insist that inflation can only become a problem when the economy is in the vicinity of “full employment.” Unlike the pure neoclassical economists that dominated bourgeois economics between the late 19th century and the Depression, the first generation of Keynesian economists who had grown up during the Depression knew that unemployment of both workers and machines was very much a feature of real-world capitalism.
If inflation did develop, the Keynesian economists insisted, it was because the government or the central bank had attempted to increase demand once “full employment” was achieved. Keynesian economists traditionally are more worried about the serious prolonged unemployment of both workers and machines caused by the government and central bank’s failure to create enough monetarily effective demand than they are about inflation. This is why Keynesians are widely considered to be allies of progressives and the trade unions.
The most important of the faulty policies, Keynes believed, was the gold standard. It required that the monetary authority, usually the central bank, but sometimes the Treasury, redeem currency on the demand of its bearer in a fixed amount of gold in the form of either bullion or coins. This policy, Keynes and his followers believed, often forced the central bank and government to follow deflationary policies leading to depression.
Keynes, however, was well aware that his belief that the government and central bank under capitalism can expand monetarily effective demand until “full employment” is achieved depends on the non-commodity character of money. This is why Keynesians and progressives are enemies of the gold standard.
But what if the economic laws of capitalism require that money must be a commodity that is produced in a decentralized way by industrial capitalists for their own private profit? This was indeed Marx’s view. (6) If Marx was right, it means that neither the central bank — nor any other capitalist “monetary authority” — will be able to control interest rates and the level of effective monetary demand. That is so because one of the crucial variables necessary to do so, the quantity of money measured in terms of purchasing power, is out of the hands of the government and the monetary authority.
Marx and Engels, who rejected any theory of “non-commodity money,” believed that in highly developed capitalism crises of the periodic general overproduction of commodities is not only possible but inevitable, regardless of the fiscal and monetary policies of the government. Marx and Engels, therefore, rejected all forms — both the strong and the weak — of Say’s law.
Keynes’s ‘Babylonian madness‘
Perhaps Keynes had doubts about the possibilities of “non-commodity” money. This is why he went through a period described by biographers as the “Babylonian madness.” Keynes tried to prove that money arose in Babylonia — ancient Iraq — not through the production and exchange of commodities but rather through the action of the state. The view that money is a product of the state, and not the market, has since the early 20th century been called chartalism.
Modern chartalists say that since money is a product of state power, it is a grave mistake for the government to use as money a commodity such as gold. If the government uses a commodity as money, it will not be able to control the quantity of money and therefore the level of interest rates and the level of monetarily effective demand. Keynes, perhaps in a way that lesser economists were not, was well aware that his contention that the problem of periodic general overproduction crises could be overcome under capitalism depended on the possibility of establishing non-commodity money.
Modern Monetary Theory, now emerging as the favorite economic theory of the non-Marxist left, teaches that central governments of the most powerful capitalist states can create enough purchasing power to ensure that virtually all the commodities produced by the industrial capitalists can find buyers at profitable prices if the governments fully exercise their power to create monetarily effective demand.
Neoclassical economics and gold
Pre-Keynesian neoclassical economists, in contrast, held to the strong form of Say’s law and were not that interested in monetary policy. From the neoclassical point of view, the gold standard had the advantage of preventing inflationary policies by central banks and discouraging capitalist governments from following “socialist” policies designed to improve the condition of the working class — for example, unemployment insurance systems and welfare. In the absence of a “socialist” government policy of concessions to the working class and the absence of trade unions, neoclassical theory insisted that a capitalist economy based on “perfect competition” will quickly move to and stay in a state of “general equilibrium” where there is virtually no “involuntary” unemployment.
Beyond discouraging “socialist” policies, the gold standard wasn’t that important to the neoclassical economists. According to neoclassical economics and the quantity theory of money that goes with it, monetary policy only affects nominal wages and prices and not output and employment.
As a result of the 1930s Depression, neoclassical economics was largely discredited, especially among the younger generation of economists some of whom were showing interest in the Marxist alternative. What good was an economic theory, many of these economists were asking, that during the greatest crisis of mass unemployment in capitalist history “proved” that voluntary unemployment was impossible?
Keynes wrote his “General Theory” not to overthrow neoclassical economics but rather to salvage as much as possible from it. He concluded that “full employment” was only one of many possible “equilibrium” states. According to Keynes, a capitalist economy could be in a state of equilibrium at virtually any combination of employment and unemployment. Indeed, Keynes believed that as capitalist society grew richer and capital less scarce, the rate of profit (called by Keynes the “marginal efficiency of capital”) would decline. As a result, the capitalist economy would increasingly reach equilibrium with high levels of unemployment. In Keynesian economics, the economy is in a state of equilibrium — neither expanding nor contracting — when the rate of profit on new investment expected by capitalists is equal to the long-term rate of interest.
Keynes agreed with neoclassical economics that capital yielded its owner a profit because it was a scarce “factor of production.” In a society where capital ceased to be scarce, the entrepreneur would still earn a high wage since entrepreneurial labor would still be scarce relative to other types of labor. But once capital ceased to be scarce, the rate of profit would fall to zero making it impossible for any person to live off the interest of capital.
The idle money capitalist Keynes predicted would within 30 years — in the 1960s — disappear because both the rate of profit on capital and the rate of interest on loan money would have fallen to zero. At that time, the capitalist economy would be in a full-employment equilibrium at a zero rate of profit and a zero rate of interest.
However, Keynes believed that on the way to this capitalist paradise a problem would arise. As the rate of profit approached zero, it would become increasingly difficult to lower the rate of interest to the point where the rate of interest equaled the rate of profit at full employment. Instead, interest rates and profits would tend to equalize at a point of considerable unemployment of both workers and machines.
As population growth slowed, which Keynes as an admirer of Malthus (7) believed it would, it would have to stabilize at some point. With capital becoming less and less scarce and the rate of profit already falling towards zero, population growth would cease altogether and the rate of profit would fall to zero. This, according to Keynes, didn’t mean that the private ownership of the means of production would have to end. He considered some of what Marxists would consider profit represented “the wage of the entrepreneur” — the active capitalist. Relatively high wages of entrepreneurs — though not as high as before — would to some extent continue to be the case, Keynes believed, thanks to the continuing scarcity of entrepreneurial labor relative to other types of labor.
However, in the Keynesian capitalist paradise, since the scarcity of goods would have been overcome, there would be no need for any further economic growth. Under these conditions, according to him, nobody would be able to live off the proceeds of the mere ownership of capital. Everyone capable of working would have to have some kind of job.
This, Keynes believed, would be the final capitalist answer to the socialist critique of capitalism. The splitting up of society into a class of non-workers and workers — which in Keynes’s definition includes active capitalists as workers but not idle capitalists living off interest — would, contrary to Marx, end without abolishing private ownership of the means of production.
It should be noted that Keynes’s logic here is rooted not in classical political economy, still less in Marx, but rather in neoclassical economics itself. The process by which the idle capitalist would disappear was called by Keynes the “euthanasia of the rentier.”
Members of wealthy families, Keynes believed, would as their flow of dividends and interest payments gradually dried up find pleasant jobs as professors, writers, scientists, and civil servants — as many of them such as Keynes himself was already doing. Then, Keynes believed, the neoclassical concept of an economy of general equilibrium at full employment would finally come into its own.
Keynes concluded that the major mistake made by the neoclassical economists was analyzing only one case of general equilibrium, the case that corresponded to “full employment.” The neoclassical economists — called the classical economists by Keynes — had developed a special theory of economics without realizing that their theory had to be supplemented by a general theory. In the “General Theory,” (8) Keynes believed he was completing neoclassical theory, not overthrowing it, by analyzing other possible states of general equilibrium that happened to correspond to combinations of employment and unemployment short of full employment.
The neoclassical reaction against Keynes
Most established neoclassical theorists did not like Keynes’s proposed “completion” of their theory, while some young economists on the left were drawing socialist conclusions from his critique of the neoclassical theory. The neoclassicals answered Keynes by claiming that if the capitalist economy was not in a state of “full employment” (zero “voluntary unemployment”), prices of commodities including the price of labor — wages — would continue to fall until all markets cleared including the labor market.
As prices and wages fell, the neoclassical economists held, the real money supply — the purchasing power of the total money supply — would increase no matter what the monetary policy of the monetary authority was. The expansion of the real money supply would cause the interest rate to fall until it reached the level that was consistent with full employment. Therefore, the diehard neoclassical economists claimed, even if the government and central bank did nothing to “stimulate” the economy, full employment would inevitably return, since it was the only possible equilibrium position beyond which all further change stops. Keynes, retreating somewhat before the neoclassical criticism, proclaimed that “in the long run we are all dead.” Keynes might well have said that in a Depression like the 1930s the “Bolsheviks will get us all” before full employment returns.
The falling tendency of the rate of profit and the economists
During the Cold War, it became known to the neoclassical economists that Marx had also believed in a tendency of the rate of profit to fall and that this connected to Marx’s view that capitalism was only a stage in the history of production. Before Keynes, neoclassical economics had predicted that the rate of interest (profit) would fall as capital grew less scarce. Therefore, though they put forward different reasons, Adam Smith, David Ricardo, Karl Marx, and the neoclassical economists (9) all agreed the historical trend of the rate of profit was downward.
But after World War II, neoclassical economists began to deny that there was any prospect that the shortage of capital would disappear. Material human needs, the economists argued are infinite. The scarcity of the factors of production including capital and therefore interest on capital are thus eternal. However, the neoclassical economists didn’t want to say that the rate of profit had a tendency to rise because that might play into “Communist propaganda.” So they settled on the claim that the rate of profit is essentially fixed over time.
The split between macroeconomics and microeconomics
By the Cold War era, bourgeois economics had split into microeconomics and macroeconomics. Microeconomics is the study of an economy based on perfect competition in a state of timeless general equilibrium. The modern discipline of microeconomics is essentially the same thing as what was simply called “economics” between the “marginalist revolution” of the late 19th century and Keynes. Over the years, microeconomics has become increasingly mathematical and abstruse.
The real function of microeconomic economics is ideological. Economists when they advocate policies that happen to be in the interests of the capitalist class — such as opposing trade unions, minimum wage laws, rent control, unemployment insurance, medical care as a human right, and welfare payments — proclaim that we do not defend one class or another. We, they claim, are only advocating what is in the general interests of all members of society. (10)
Modern bourgeois macroeconomics claims to be built on the foundations of neoclassical microeconomics. However, macroeconomics concedes (to use platonic terminology) that when the perfection of general equilibrium is “copied” into this corrupt world of matter, imperfections inevitably arise. To the extent these imperfections arise, the macroeconomists believe, the free market must be supplemented by a government “stabilization policy” designed to smooth the “business cycle” and encourage the greatest possible rate of economic growth.
How the left lost the battle of ideas in the 1970s
In preparing these posts, I listened to many YouTube videos on economics. In one such video, Anwar Shaikh explains that he was amazed as a young man when he heard a “progressive economist,” presumably favorable to the working class, supporting government wage controls in the name of stopping inflation, while right-wing neoclassical economists — popularly called “monetarists” in those days — opposed them.
The (in)famous neoclassical economist Milton Friedman was a leader of the neoclassical “counterrevolution” against Keynes. To achieve his aim of restoring economics to something like it was before Keynes, Friedman had to first explain away the Great Depression of the 1930s. He did this by blaming the Federal Reserve Board, a “government body” that had “allowed” the money supply to contract by one-third, for causing the Depression. Therefore, Friedman claimed, it was government interference and not the natural operations of the capitalist economy that had caused the Depression. Hadn’t traditional neoclassical economics always warned against the danger of such interference?
Friedman also developed an analysis of the unfolding crisis of stagflation in the 1970s, which featured both high rates of unemployment and inflation, based on his earlier work of explaining away the Depression. Like other neoclassical economists, Friedman assumed that the normal state of the capitalist economy is “full employment” both of machines and workers. If there were no unions, no minimum wage laws, no welfare, and so on, Friedman held, there would be virtually no unemployment.
However, according to Friedman, since unions and minimum wage laws do exist, there is a certain natural rate below which unemployment cannot fall for very long. For example, if the value of a potential worker’s product is $10 an hour but the minimum wage is $15, the worker will not able to find a job even if our worker is willing to work for $10 an hour. The same thing would be true if unions are strong enough to enforce a $15-an-hour wage. In this case, according to Friedman and other neoclassical economists, it is collective bargaining that is responsible for unemployment. Instead of collective bargaining, Friedman and the neoclassical economists support individual bargaining between workers and their bosses. In other words, there should be no unions.
If these policies were followed, Friedman applying the theories of neoclassical economics “proved” that the natural rate of unemployment would fall to virtually zero. For example, a worker who was capable of producing only $10 worth of value per hour and was willing to work for a $10-an-hour job would now find work. Though this is indeed a poverty wage, Friedman and other neoclassical economists claimed such workers will through experience be able to improve their skills so in time the value created by an hour of their labor will rise above the poverty level and so also will their wage. They might even able to go to the university and become neoclassical economists like Milton Friedman.
Another problem, according to Friedman and other neoclassical economists, with well-meaning “socialist” policies is that they encourage “voluntary” unemployment. For example, if our potential worker’s labor can produce only $10 of value per hour of labor but can get that amount on welfare without working, the worker has no incentive to get a job. The worker will then quite “rationally” choose “leisure” with poverty over labor at a poverty-level wage. While this is a “rational choice,” it is not a good choice, according to Friedman and other neoclassical economists, because our potential worker will never acquire the skills allowing an escape from poverty.
However, if the welfare payments are eliminated, or at least reduced, the worker will be obliged to accept a job at a poverty wage of $10 an hour rather than face even worse poverty or outright starvation. The worker is still “free to choose,” according to Friedman, but now will make a much better choice and accept the job at poverty wages. Now employed, these workers will then be able to improve their skills. As their skills grow, the value that their labor produces will rise, and eventually, they will rise out of poverty. Therefore, according to Friedman and neoclassical economics in general, well-meaning “socialist policies” far from eliminating poverty are the cause of poverty.
The ability, according to Friedman, of the capitalist economy to grow over time is the sum of the rate of the growth in productivity of labor and the rate of growth of the working class. Suppose the rate of growth of productivity is 2% a year and the pool of workers increases at a rate of 2%. In that case, the economy will be able to grow at a rate of 4%. Friedman assumed that the rate of growth of the economy is stable over time. If we, however, get rid of government “socialist policies” and trade unions, the supply of workers will grow faster. If the rate of growth of the working populations rises to 3% and the rate of growth of labor productivity remains unchanged at 2%, the rate of economic growth will rise to 5%.
Like other neoclassical economists, Friedman held to the quantity theory of money, but he modified it slightly. If the economy can grow 4% a year and if the monetary authority increases the money supply at a rate of 4% a year, the economy will grow at 4% a year with no inflation or deflation. However, if the monetary authority increases the quantity of money at a rate of 6% a year, the rate of inflation will be the rate of growth of the money supply minus the rate of growth of output, in this case, 4%. Therefore, prices will increase at a 2% rate.
Friedman defined money as the sum of paper notes, coins (token money) plus checking accounts — bank-created credit money — which makes up the bulk of the “money supply.” How can the monetary authority control the quantity of money when the bulk of what Friedman defined as money is created by the profit-driven, privately owned banking system? Friedman had to assume that as long as there is no outside shock such as an incorrect monetary policy, the velocity of circulation of money will remain stable.
Friedman then assumed using the general neoclassical economic theory that the capitalist economy is naturally extremely stable that the ratio between high-powered money that the monetary authority creates — paper money, coins, and the deposits of the commercial banks at the central bank — and the credit money created by the commercial banks through their loans is also stable.
In this case, and only in this case, if the central bank increases the quantity of high-powered money that it directly controls at a rate of 4% in a given year, the commercial banks will increase the quantity of the credit money they create at a rate of 4% as well. Assuming that the velocity of circulation is also stable, as Friedman indeed claimed it was, monetarily effective demand will increase at a rate of 4% per year. There might still be some year-to-year fluctuations in economic growth since the rate of growth in productivity and the rate of growth of the working population will vary. However, Friedman assumed that these fluctuations will be minor.
Friedman and the quantity theory of money
Friedman agreed with the classical quantity theory of money, used by Ricardo and later the neoclassical economists, that the ratio between the rate of growth of the total quantity of commodities in circulation, on one side, and the total quantity of money, on the other, changes only the general price level and the level of nominal money but not of output or real wages. But, Friedman added, that is true in the “long run,” not necessarily in the “short run.”
Unlike the pure quantity theory of money, Friedman claimed that there was a lag between a change in the rate of growth in the quantity of money and a change in the rate of change of prices and wages. If the rate of change in the quantity of money is stable — and this Friedman believed could be arranged by the monetary authority — everything would proceed smoothly.
Therefore, Friedman insisted that money was neutral in the long run but far from neutral in the short run if the monetary authority allowed the rate of growth of money to vary. Then the rate of growth of the quantity of money in the short run would indeed have drastic effects on the real economy — employment and production.
Friedman, therefore, held to a stronger form of Says law than his Keynesian opponents but he did not fully return to the strong form of Say’s law held by Ricardo and the pre-Keynes neoclassical economists. What Friedman did was make bourgeois economics as much as possible like it was before Keynes while retaining his explanation for the Great Depression. Since Friedman, more extreme neoclassical economists have gone even further toward fully restoring pre-Keynesian neoclassical economics.
Friedman’s explanation of 1970s stagflation
Assume, Friedman reasoned, that the natural rate of unemployment is 4%. The government quite reasonably wants to reduce the unemployment rate and poverty it represents. There are two ways, Friedman reasons, for the government to do this. The method Friedman recommended was to get rid of all “socialist policies” and bust the unions.
The second method the government might attempt is a Keynesian-style stimulus policy that involves an increase in the rate of growth of the money supply. If the economy had been growing at 4% with 2% inflation before the stimulus, this will mean, using Friedman’s modified quantity theory of money, that the money supply has been increasing at a rate of 6% a year. Assume the government attempts to lower unemployment below its natural rate and a “Keynesian” government increases the rate of growth of the money supply beyond 6% a year.
At first, according to Friedman, this would seem to work. Workers won’t immediately realize the nominal wages that the bosses are offering now represent a lower real wage. Using 1970s dollar price levels, a potential worker who refused to work for anything less than $5 an hour before (though their labor could only produce $3 an hour and therefore are “voluntarily unemployed”) will now enter the labor force because the bosses are now willing to hire them for $5. The rate of growth of people willing to work at a given real wage will rise because the workers won’t immediately realize that the higher money wages the bosses are now offering represent the same real wage they considered too low before. As a result of this deception, economic growth will accelerate and unemployment will decline.
But soon the workers catch on and begin to demand more than $5 an hour in wages. However, according to Friedman and the neoclassical economists, since their labor doesn’t create that much value when measured in terms of the now devalued dollars, the bosses can’t afford to hire them at the money wages workers are now demanding because if they do they will lose money. As a result, these workers once again withdraw from the labor force returning them to the cycle of “voluntary” unemployment and poverty.
Economic growth that had first accelerated due to an increase in the number of workers willing to work at the going wage soon falls back to the previous level as the rate of growth of the number of workers willing to work at the going wage slows. Unemployment and the poverty that goes with it then return to their previous natural levels. But inflation has now risen to a new and higher level. The stimulus that seemed to succeed at first fails.
Faced again by rising unemployment and poverty, the government launches a stronger stimulus program. Though again its seems to work at first, it fails once workers become aware of how much inflation has eroded their real wages, and the stimulus again fails. But this time inflation is at a still higher level. This cycle repeats until inflation rises to intolerable levels. Then the only way, according to Friedman, to end inflation is to reduce the rate of growth of the money supply.
Things now go into reverse. As inflation falls, workers are unaware that their real wages are no longer being eroded as much by inflation as before. They mistakenly demand wage increases that according to neoclassical economics the bosses cannot meet without losing money. According to Friedman, workers’ refusal to work at wages that the bosses can afford causes unemployment to temporarily rise above its natural rate, driving the economy into recession. But inflation fades away. Once the workers realize that their wages are no longer being eroded by inflation, they are willing once again to work for wages that the bosses can afford. The economy then recovers and unemployment falls back to its natural rate.
If the government still wants to reduce unemployment and poverty, it must follow, according to Friedman’s neoclassical economic theories, the policy it should have followed in the first place, reducing or eliminating unemployment insurance, abolishing or weakening minimum wage laws, slashing welfare, and busting unions. Then, Friedman and the neoclassical economists assure us, everybody — capitalist and worker alike — will be better off.
What did happen in the 1970s?
The basic formula for profit is M—C—M’. This means that profit equals M’— M. Notice that profit is measured in terms of money. It is not measured in terms of surplus product, nor can it be directly measured in terms of labor value. If profit could be measured directly in terms of value, there would be no difference between surplus value embodied in still unsold commodities and profit. Therefore, profit, though it is the form of surplus value, is not the same thing as surplus value, as we already saw when discussing the transformation problem. Profit must always be measured in terms of the use value of the money commodity.
To return to Fred Moseley’s question, if non-commodity money is possible, profit can be measured in terms of non-commodity money. But if non-commodity money is not possible, then it must be measured in terms of the use value of whatever commodity serves as money, which happens to be gold bullion measured by some unit of weight.
Fifty years ago the Bretton Woods dollar-gold exchange system collapsed. This system was based on the convertibility of the U.S. dollar into gold at a fixed rate of one troy ounce of gold for every $35 presented to the U.S. Treasury. This rate of exchange defined the U.S. dollar as 1/35th of a troy ounce of gold bullion. After the New Deal, U.S. citizens were banned from owning monetary gold but foreigners, especially foreign central banks and governments, were able to present dollars to the U.S. Treasury and redeem them for gold bullion. Similarly, foreigners who owned gold bullion could sell it to the U.S. Treasury for dollars at the same rate.
The core of the Bretton Woods system, established at an international conference held in Bretton Woods, New Hampshire, in 1944, was the international convertibility of the U.S. dollar into gold at a fixed rate. While the dollar was backed by gold, the currencies of other countries were backed by U.S. dollars. The dollar reserves of other imperialist countries began to grow at a faster rate than U.S. gold reserves as they began to run trade surpluses with the U.S. once their economies recovered after World War II.
Though the Bretton Woods system contained provisions to devalue or revalue currencies other than the dollar, there was no provision to devalue the dollar itself against gold. The U.S. under Bretton Woods was expected to hold the gold value of the dollar stable just as Great Britain had maintained the gold value of the British pound between 1819 and 1914.
The first real crisis of overproduction after World War II occurred in 1957-58. It revealed the contradictions that doomed the Bretton Woods system. The Federal Reserve System responded by quickly lowering interest rates, which provoked the first serious external gold drain that the U.S. had experienced since 1931. To counter the gold drain, the Federal Reserve was obliged to again raise interest rates, which caused the U.S. economy to fall back into recession in 1960-1961.
In response to this crisis, in 1962 the U.S. got the other imperialist central banks, especially the Bank of England, the Bank of France, and the West German central bank, to pool their gold reserves behind the U.S. dollar — much of which was stored for “safekeeping” in a vault under the Federal Reserve Bank of New York. When the dollar price of gold rose on the free market above $35, these central banks would sell gold for U.S. dollars for $35. When the dollar price of gold fell below $35, the central banks would purchase gold with U.S. dollars once again raising the dollar price of gold to $35.
But the “gold pool” could only buy time. The basic problem was that the production of gold was not keeping pace with the rapid expansion of the number of commodities circulating on the world market. This situation showed that the real problem that undermined the Bretton Woods system was that the market prices of most commodities were above their prices of production. To equalize the demand for gold with its supply, interest rates had to rise. And rise they did.
However, interest rates could not rise forever because the rate of interest cannot be above the rate of profit for long. If the interest rate equals the rate of profit, the incentive to produce surplus value is destroyed. If the rate of interest on government bonds is 10%, what capitalist would take the risk involved in producing and selling commodities if they didn’t think they could make a profit greater than 10%? Therefore, the very fact that interest rates were rising from industrial cycle to industrial cycle showed that the accelerated rate of economic growth after World War II was only temporary.
The only thing that could have prolonged the period of accelerated capitalist economic growth would have been a major geographical gold discovery comparable in scale to the gold discoveries of 1848 and 1851 or the Alaskan-Canadian gold rush of the 1890s. Combined with the invention of the cyanide process, this reduced the value of gold while expanding its quantity. Back then, the cheapening of gold translated into sharp rises in the prices of production of commodities relative to market prices. This was followed by a series of powerful economic booms during which the demand for most commodities exceeded their supply at current prices. As a result, prices rose at a rate of about 3% per year between 1896 and 1913.
However, there were no gold discoveries on the scale of 1848-51 or 1896 after World War II. By the end of the 1960s, the dollars that represented the huge amount of gold produced during the Depression and to a lesser extent during World War II were now fully absorbed into circulation. Gold production was simply not great enough to maintain the ongoing rate of economic growth. This showed the market prices of commodities were too high relative to their prices of production. Once the huge dollar-gold glut whose origin was in the Depression itself was absorbed into circulation by the late 1960s, the period of accelerated economic growth was over.
However, governments, especially the U.S. government, tried to save the postwar boom. To do this, government and central bank policymakers attempted to establish paper currency, especially the U.S. dollar, as non-commodity money in place of gold bullion. If only this could be done, the real economy could operate much as the Keynesian mathematical diagrams of the late 1930s operated, which assumed that money was non-commodity money created by the capitalist state and not by the profit-driven gold mining and refining companies.
Economists, of both the Keynesian and Friedman “monetarist” persuasions, believed that gold would be demonetized if the world’s governments stopped treating it as money. Gold bullion would then be “just another commodity” and a not very important one at that. Applying the marginalist — that is the scarcity theory of value — economists predicted that the dollar price of gold would fall once gold was “demonetized” because the demand for gold as money would end. This would leave gold with relatively few remaining use values. Relative to its remaining use values, gold, the marginalists believed, would be less scarce relative to the subjectively determined need for it by individual consumers.
Here we had a rare experiment in economics where Marx’s theory of value, which includes the form of value — the necessity for money to be a commodity — was pitted against the marginalist theory of value as well as the MELT (monetary equivalent of labor time) version of labor value, which holds that money does not have to be a commodity. If either the marginalist or the MELT theory of value was true, the experiment in establishing non-commodity money on a world scale would succeed and the “boom” would be saved. But if Marx was right, it would fail.
Progressives, who hold an intermediate position in politics between Marxist advocates of proletarian revolution on their left and the advocates of capitalist class rule on their right, were counting on the successful establishment of non-commodity money because it would mean the policy of major concessions to the working class in the imperialist countries that had marked the post-World War II years could continue.
The most important question as far as capitalist production is concerned is the nature of profit. If the attempt to establish non-commodity money had been successful, the continuation of positive dollar profits should have been able to keep the post-World War II period of accelerated growth going. But if Marx were right, negative profits in terms of gold bullion despite the continuation of positive dollar profits would lead to a major economic crisis.
As the 1970s began, there were far more powerful workers’ organizations in the world than exist today. The most powerful of these was the Soviet state and its ruling party, the Communist Party of the Soviet Union. But there were also large Communist Parties in some of the imperialist countries. The largest of these was the Italian Communist Party. The labor-based Social Democratic parties were far more powerful than they are today. The trade unions, including the U.S. AFL-CIO labor federation, had many more members and exercised far greater power than they do now. Today, the Soviet state no longer exists, while the Communist Party of the Soviet Union lost state power and is now split up into much smaller opposition parties. The once large and powerful Italian Communist Party has ceased to exist.
What all these workers’ organizations had in common was that their leaderships had completely abandoned, or in the case of the U.S. AFL-CIO never had, the perspective of transforming capitalism into socialism on a world scale. While the Soviet leadership put its hopes on long-term “peaceful coexistence” with imperialism, the workers’ organizations in the capitalist world assumed that Keynesian policies maintaining more or less “full employment” would continue. The leaders of the Italian Communist Party, which went farther down this road than most other Communist parties, called for a “historic compromise” between the capitalist and working classes. When in the 1970s a crisis of capitalism once again put the transformation of world capitalism into socialism on the agenda, the workers’ leaderships of the time put their faith, not in socialism but in the continued success of Keynesian stimulus policies.
Golden profits collapse in the 1970s
Fifty years have passed since the attempt to establish non-commodity money began and the results are in. During the decade of the 1970s, the hoarding of gold, except for a few types of collectibles, was the most “profitable” investment. But hoarding gold, leaving aside storage costs, yields a rate of profit of exactly zero.
The fact that in dollar terms holding gold was the most “profitable” investment shows that, when calculated in terms of gold, profits in the 1970s were strongly negative. Golden profits were negative not because the rate of surplus value was negative. Indeed, in real terms and value terms, wages were falling throughout the decade, which shows that the rate of surplus value far from falling was rising sharply. If it were true that gold was no longer money and the U.S. dollar was now established as non-commodity money in its place, the fact that the rate of profit was negative in terms of gold would not have mattered any more than it matters that profits are strongly negative today if calculated in terms of bitcoin.
Even if the capitalists of the 1970s didn’t realize that they “should” be calculating profits in gold rather than in U.S. dollars — and its satellite currencies — an increasing number of capitalists moved some of their capital into gold because capital “invested” in gold yielded higher dollar profits than virtually all other alternative investments. Capital always moves from areas of lower profitability to higher profitability.
As “investments” in gold bullion kept outperforming almost every other type of investment, demand for gold bullion — the liquidity preference for gold — kept climbing. One result was a rise in the dollar prices of commodities other than gold, though, with the exception perhaps of oil, the rise in commodity prices lagged far behind the rise in the dollar price of gold.
One commodity that particularly lagged in its relationship to the rising dollar price of gold was the commodity labor power. This did not prevent Keynesian economists during the 1970s from advising unions to practice “moderation” in their wage demands to “halt inflation.” If only unions would moderate their wage demands, the Keynesian economists predicted, price increases would moderate. According to them, prices are determined by wages. If prices moderated, the Keynesians explained, there would be no need for “tight money” policies by the Federal Reserve System and other central banks, and recession would be avoided.
However, the capitalists kept attempting to raise dollar commodity prices in line with the sharply falling value of the dollar and the other currencies linked to it. I call this “currency-devaluation inflation.” Since prices were rising more rapidly than the quantity of U.S. dollars was increasing, interest rates rose to ever higher levels where the supply and demand for gold would be equalized. Despite the continuation of “expansionary policies” by the central banks, the money market tended to tighten slowing down economic growth and increasing unemployment.
Trade union leaders and their progressive advisers whose economic thinking followed Keynes rather the Marx hoped that “wage moderation” would halt inflation without the “tight money” policies that Milton Friedman and his “monetarists” advocated. The Keynesians as did Friedman understood that “tight money”would indeed mean a return to mass unemployment.
Unfortunately, however, Friedman’s claim that only “tight money policies” could end the relentless acceleration of inflation was correct (assuming the continuation of capitalist production) even if the reasons he gave for this conclusion were wrong. Therefore, the Communist, Social Democratic, and trade union leaders who wrongly denied that tight money policies was the only way out of the inflation were doomed to lose the struggle of ideas to the reactionary Friedman and his “monetarist” supporters.
The result was that the working class was thrown back on all fronts across the globe. The greatest danger that confronts newly minted socialists who aspire to become the new leadership of the working class is that they will fail to learn the lessons of the past and repeat the same mistakes their predecessors made half a century ago. When a new crisis develops, if the same mistakes that were made by working-class leaders in the 1970s are repeated, the results will be even more disastrous than they were a half century ago.
Next month, I want to examine some important questions dealing with the circulation of money raised by Pichit Likitkijsomboon of Thammasat University in Thailand, in his contribution to Moseley’s anthology. Likitkijsomboon is critical of what he calls Marx’s “non-quantity theory of money.”
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1 In the United States, the complex division of powers between the federal and state governments, and within the states between the state and local governments, enables the capitalist class to pit different state and local governments against one another. If one state adopts anti-union “right to work laws,” or cuts taxes on the capitalists and regulations for business, businesses in other states threaten to move to those states unless their state governments adopt similar policies.
This “race to the bottom” among state and local governments has also operated when it comes to the question of COVID reopening. If one state or locality lifts or weakens measures necessary to slow the spread of the pandemic, other states and localities come under pressure to do the same or risk the flight of business to those states and localities that do.
This factor, even more than Donald Trump’s ultra “pro-business” stance, along with the absence of health care as a human right, explains the miserable performance of the U.S. during the pandemic even as compared to most other capitalist countries. (back)
2 These numbers are the absolute minimum because many COVID-caused deaths were attributed to other causes. (back)
3 Many of the COVID vaccines use messenger RNA technology. Instead of using a weakened or dead form of the virus, like traditional vaccines have done, these new vaccines use a form of RNA that in nature moves from the nucleus into the cytoplasm of the cell where it assembles amino acids into proteins necessary for the operation of the cell. Messenger RNA vaccines use RNA that encode for the proteins that the COVID-19 virus needs to enter the cell. When the vaccine is injected into the body, the messenger RNA enters the cytoplasm of the body’s cells and combines amino acids into the proteins that the COVID virus uses to enter cells.
The cells then secrete this protein into the bloodstream, which causes the body to produce antibodies to destroy what the immune system sees as an invading protein. If the real virus then appears, these antibodies attack and destroy it. If the virus mutates, it is possible using today’s bio-engineering technology to tweak the vaccine RNA code so that when it enters the body’s cells, the cells produce the new “mutant” proteins that will cause the immune system to produce anti-bodies that will destroy the new strain of the virus.
This new technology means that from a purely technical point of view we can deal with future pandemics far better than we have been able to in the past. (back)
4 The fact that the credit system had become extremely inflated because of the “financialization” that followed the stagflation crisis of the 1970s, and that the industrial cycle was at its critical point when the COVID pandemic struck, greatly magnified the economic impact of the COVID-19 pandemic. (back)
5 Keynesian economists attributed the high inflation rates of the 1970s to the actions of the “Arab oil sheikhs” who used the OPEC cartel to artificially raise oil prices, and the strength of the trade unions, which used their “excessive power” to drive up wages obliging the industrial capitalists to raise prices. Today, Keynesian and post-Keynesian economists point out that the trade unions — and many of the oppressed countries — are in a much weaker position than they were in the 1970s. Therefore, they insist that inflation in today’s world is “not a danger” today and won’t become one until genuine “full employment” raises wages. Stagflation, Keynesian and post-Keynesian economists insist, is not a serious danger. (back)
6 One of our readers, Boffy, quotes Marx’s prediction in his “Critique of the Gotha Program” that during the first stage of communism — a future stage of production where the division of society into classes has ended, and with it all commodity production — people will be paid according to the amount of labor they perform. They will, Marx predicted, receive certificates indicating that they have performed a certain quantity of labor and will be entitled to withdraw a proportional quantity of products from the common store once certain deductions have been made to meet the common expenses of society — education and medical care, provide for an insurance fund, and provide a fund for the further expansion of production. Boffy believes that Marx here foresaw the coming of “non-commodity money.”
Since there is no commodity production in even the first stage of communist society, there is no commodity money. If we want to call the certificates — most likely some form of electronic bookkeeping — “money” — and I don’t think this is a scientific use of the term — then this would be an example of non-commodity money. However, I am not analyzing an economy of a society that has reached the first stage of communism, where labor is already directly social, in these posts but today’s capitalist economy. As long as capitalist production continues, money must remain a commodity. (back)
7 Malthus claimed that as the production of the means of subsistence increased the population would grow at an even faster rate. Only periodic famines would prevent the population from exceeding the means of subsistence. Therefore, according to Malthus, no matter how much the population increased the great mass of the people would always live in extreme poverty. According to Malthusian theory, any attempt by the state to ease the poverty of the people would only cause the population to grow and bring the inevitable famine that much sooner.
However, since the time of Malthus, the history of many countries has shown that the higher the standard of living of the population is the slower is the growth of the population. This is the exact opposite of what Malthus claimed. Keynes, therefore, unlike Malthus believed that it would be possible to create a society of abundance for all without abolishing the private ownership of the means of production. This makes Keynes the favorite economist of middle-class reformers who wish to defuse the antagonism between the capitalist class and the working class through a policy of concessions to the working class while retaining the capitalist ownership of the means of production. (back)
8 Keynes’s concept of a general theory as opposed to a special theory was doubtless inspired by Albert Einstein. In his special theory of relativity, Einstein analyzed objects in motion without dealing with acceleration. Later, Einstein worked in acceleration, which led to his theory of general relativity, which forms the basis of the modern theory of gravitation.
Keynes by way of analogy saw traditional neoclassical marginalist theory as a special theory of economics that dealt only with an economy in equilibrium at “full employment.” In his “General Theory,” Keynes saw himself as expanding neoclassical marginalist theory to deal with capitalist economies that are in equilibrium at all possible combinations of unemployment and employment. (back)
9 Adam Smith believed that as capital grew more plentiful the rate of profit would decline. Smith’s theory of the falling rate of profit brought about by the increasing abundance of capital was also accepted by the pre-Keynes neoclassical economists and Keynes himself.
Ricardo rejected Smith’s theory of the falling rate of profit. However, Ricardo believed that a growing shortage of fertile land would drive up the value and thus the price of agricultural produce causing what Marx would later call the rate of surplus value to fall while diverting ever more of the remaining surplus value from profit to ground rent. This would, Ricardo believed, cause the rate of profit of capital to fall by causing the rent on land to increase. To postpone this outcome as long as possible, Ricardo advocated the repeal of the Corn Laws, which protected the ground rents of British landlords.
Marx rejected Adam Smith’s — and the neoclassical marginalists’ and Keynes’s — theory of the falling rate of profit. But Marx developed his theory of the falling tendency of the rate of profit based on the rise of the ratio of constant capital, which does not produce surplus value, to variable capital — the workers’ labor power that has been sold to the industrial capitalists — which alone produces surplus value. Unlike Keynes, Marx never predicted that the rate of profit would fall to zero. (back)
10 Neoclassical economists — and Austrian economists — sometimes claim that they are especially concerned about the working class. They oppose trade unions, minimum-wage laws, health care as a human right, unemployment insurance, and welfare payments because they allegedly harm the working class by causing unemployment and a “culture of welfare dependency and poverty.” (back)
A Critique of Crisis Theory 