Are Marx and Keynes Compatible? Pt 5

Keynesian economists blame their failure on the trade unions

Keynesian economists in general—and some Marxists influenced by them—blame the failure of the Keynesian policies of the 1970s on the trade unions. (1) Basing themselves on Keynes, they falsely blame the inflation of the 1970s not on the inflationary monetary policies of the central banks that were so strongly supported by Keynesian economists at the time but on the trade unions.

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

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

Fiscal Keynesianism

Left-wing Keynesians, and Keynesian Marxists like John Bellamy Foster who greatly admire Keynes’s work, hold that the failures of the 1970s were caused by the reliance on monetary policies to carry out “stabilization policy” as opposed to fiscal polices. If the governments had fought the recessionary trend that set in after the 1960s boom by increasing government spending instead of implementing inflationary monetary policies, the economists hold, the postwar prosperity could have been saved and the inflation and financialization—and finally the “Great Recession” of 2007-09—that the policies led to would have been avoided.

Most Keynesian economists hold that it is deficit spending that increases demand, economic growth and employment. Mainstream Keynesian theory holds that extra demand is created by the difference between what the government takes in in current taxes—taxes that, all things remaining equal, reduce demand—and what the government spends. When spending exceeds current taxation, the Keynesians argue, an extra demand is created. In turn, this extra demand is magnified perhaps three to five times over by the multiplier and accelerator effects.

As the state and its dependents spend what would otherwise be hoarded money and employment rises, this leads to more hiring and spending. This is the multiplier effect. The absorption of excess capacity due to the multiplier effect leads to a rise in investment on the part of industrial capitalists. The rise in investment generated by an initial rise in spending for consumer goods is called by the (bourgeois) economists the “accelerator effect.”

Therefore, Keynesian theory holds that a relatively small initial increase in demand created through government deficit spending through the combined multiplier and accelerator effects sets in motion a far greater increase in “monetarily effective demand” that leads to “full recovery” with a return to “near to full employment.” The policy of creating an initially modest rise in demand through increased government deficits with the hope of achieving a far greater increase in demand is sometimes referred to as “priming the pump.”

The Monthly Review School goes further than the Keynesians themselves go, as I explained last week, by claiming that government spending even if it is financed entirely by current taxation increases total monetarily effective demand by the exact amount of money that the government spends. If Sweezy and Baran’s “Monopoly Capital” were correct on this point, the advantage of increased government spending financed out of current taxation is that the dangers associated with an increased public debt and a rising burden of future taxation can be avoided.

Therefore, “Monopoly Capital” implies, and Foster seems to believe, that full employment can be achieved without abolishing capitalism if only the government is willing to increase its spending up to the level that fully “absorbs the surplus.” The Monthly Review School looks forward to a new “New Deal” that would actually follow such a policy, though after their hopes were briefly raised by the election of Democrat Barack Obama and the election of a solidly Democratic Congress in the 2008 U.S. elections, they now seem to have become quite pessimistic about such a “New Deal” in the foreseeable future.

Contradictions of fiscal Keynesianism

But such fiscal Keynesianism has its own contradictions. In “Monopoly Capital,” Baran and Sweezy predicted that the giant corporations would press for increased taxes on themselves so that the huge “potential surplus” that they “generate” through their monopoly pricing power could be “absorbed”—therefore solving the problem of realizing “the surplus.” Or what comes to the same thing, Baran and Sweezy held that the potential surplus generated through monopoly pricing power would be transformed into actual monopoly super-profits by having the government tax it away and then return the money by buying either directly or through its dependents the commodities produced by the monopolies at monopoly prices.

However, in the 50 years since “Monopoly Capital” was written, the giant corporations have not followed the course that its authors predicted. Instead, they have succeeded in winning one tax cut after another.

Why have the monopoly capitalists, which certainly dominate the U.S. government as well as the governments of the satellite imperialist countries, failed to follow the policies that “Monopoly Capital” predicted they would? Is it because the men—and in recent years a very few women—who run the corporations are blinded by their ideology? Or maybe the problem is that they have not read “Monopoly Capital” and fail to understand their true interests.

Can increased government spending financed out of current taxation solve the problem of the chronic inability of the market to grow as fast as production and thus provide what the Belgian Marxist economist Ernest Mandel (1923-1995) called a “replacement market”? Where monetary Keynesianism has clearly failed, could fiscal Keynesianism succeed?

First, let’s examine the case where taxes are financed out of wages. By that I mean that not only do taxes fall only on wages, but I also assume that the workers are unable to win rises in pre-tax wages that would shift at least some of the tax burden back on capital. Since the workers have to spend all their wages in order to live, it is hard to see how taxing wages will increase overall demand. Workers, as Keynes himself realized, have little choice but to spend their wages income right away. Therefore, the effects of taxing wages will be simply a redistribution of purchasing power from the workers to the state and its dependents.

But what if profits are taxed instead of wages, like all progressives including the Monthly Review School and all other Marxists advocate? Let’s assume that taxes fall entirely on profits. Any taxes that hit wages are transferred back to capital by rises in before-tax wages that offset the taxes. In order to draw the conclusions that Baran and Sweezy drew, we have to assume that (1) the taxed capitalists would have hoarded the entire taxed profit if it had not been taxed; and (2) that the reduced, after-tax rate of profit will have no adverse impact on capitalist investment.

If the monopoly corporations believe that the rate of profit on additional investment will be so low that they prefer to hoard the profits in money form, wouldn’t they hoard a portion of the untaxed profit? The after-tax rate of profit—which is, after all, what matters to the capitalists—would still be below the already “inadequate” pre-tax rate of profit from the viewpoint of the monopoly corporate capitalists.

Capitalist production is production for profit

What Baran and Sweezy have forgotten is that industrial corporations are not interested in producing commodities for the sake of selling them, but are only interested in producing and selling commodities to the extent that it enables them to “earn” a higher profit than they would have earned in the form of interest—if they had not produced and sold the commodities. Capitalist production is production for profit and only for profit.

If government spending is financed out of current taxation on profits, the capitalists as a whole will in effect be paying the state or its dependents to purchase their commodities. The result of this transaction is a reduction of profits for the social capital and reduced incentive to produce commodities. Any stimulation of particular corporations or groups of corporations, such as the “military-industrial complex,” will be more than offset by the depressive effects of taxation on the industrial corporations as a whole.

This is realized by mainstream Keynesian economists if not by Baran and Sweezy. Therefore, expanding government spending that is financed out of current taxation will, all things remaining equal, lead to stagnation not growth.

How can government spending financed out of current taxation stimulate economic growth and employment?

There are situations, however, where increased spending by the government that is entirely financed out of current taxation on profits (or from the viewpoint of the capitalists, even better on wages) can increase profits and thus economic growth and employment in a capitalist economy.

For example, if the government spends the money on transportation projects such as canals, railways, highways, ports and so on that private capital is not itself willing to undertake—or is willing to undertake only if part of the expense is undertaken by the government through subsidizing private corporations—the turnover rate of capital and with it the variable portion of capital that alone produces surplus value is increased.

The result of the increase in the turnover rate of variable capital will raise the rate of profit in a given time period. In this case, government spending can indeed increase the annual rate of profit and thus investment and economic growth and with it the demand for labor power. The shortening of the turnover period of (variable) capital achieved by improved means of transportation will then more than pay for the expenses of taxation.

This is why the champions of industrial capitalism in 19th-century United States such as Abraham Lincoln and his Whig Party (and later the new Republican Party) championed what were called “internal improvements”—government spending on means of transportation, often through the quite scandalous subsidization of corporate-owned transportation companies.

As always, however, a rise in economic growth and therefore a faster growth in employment and lower unemployment will be achieved only if the increased mass of surplus value is actually realized in money form. If, however, a capitalist economy already has more means of transportation than it can use for profit-making purposes, spending taxes on additional means of transportation will have none of these favorable effects.

When politicians representing the industrial capitalists, such as the 19th-century Whig and Republican parties, advocated increased government spending on “internal improvements,” they were dealing with the problems of a young, rapidly expanding capitalism, not the stagnating capitalism that concerned Keynes and his followers.

The same analysis can be applied to government spending on education. If an expanding capitalist economy suffers from a lack of educated skilled workers, government spending on education, even if it is entirely financed out of current taxes on profits, can pay for itself from the viewpoint of the capitalists by providing an increased pool of needed qualified labor powers. Indeed, such taxes will pay for themselves all the more since by increasing the supply of skilled labor powers, the wages of skilled labor will be driven downward, still further increasing the production of surplus value.

However, if the problem is not a lack of skilled labor power necessary to produce surplus value but rather the inability to realize surplus value that has already been produced—or could be produced if the existing supply of skilled labor were fully employed—increased spending on education financed at least partially out of profits will only reduce the profits appropriated by the capitalists, not increase them. This is why spending on education is under attack in the United States and Europe today.

The ‘Treasury view’

In contrast to the Monthly Review School, most Keynesian economists, including Keynes himself, claimed it was deficit spending that was the key to lifting an economy out of depression. The view of anti-Keynesian bourgeois economists—sometimes known as the “Treasury view” after the British treasury officials who opposed the proposals of former Liberal Prime Minister Lloyd George and Keynes for large-scale deficit spending to combat Britain’s 1920s unemployment crisis—was that increased government deficit spending would not stimulate spending overall, since increased state borrowing would be exactly offset by reduced private borrowing and spending.

Fallacy of the Treasury view

While the Treasury view is more or less true in a boom, it is not true in a depression. In a depression, there are not only considerable idle productive forces, including of course unemployed workers, there are also hoards of cash lying idle in the banks. While the first point is widely understood, the latter is often ignored. Keynesians and many Marxists who have not fully understood Marx’s perfected theory of value believe that if there is not enough money, the “monetary authority” can simply print any additional money necessary as long as there are idle productive forces and workers. As we saw in our examination of monetary Keynesianism, this is not true.

However, this does not change the fact that under post-crisis depression conditions, there are considerable hoards of idle cash. Therefore, under these circumstances the government can increase its borrowing with very little immediate impact on long-term interest rates. This explains the seeming paradox that the more depressed the capitalist economy is, the larger the deficits the government can run without causing long-term interest rates to rise and therefore cancel out the stimulative effects of “deficit spending.”

Deficit spending can take two forms. The government can merely cut taxes—the policy favored by reactionaries—or it can increase spending—the policy favored by progressives in the hope that the government will use the borrowed funds in ways that will aid the workers and their allies among other oppressed people.

For example, the government can spend on payments to the unemployed, direct employment by the government of the unemployed, public housing and education. The capitalist government can also increase its spending for war purposes—that is, follow a policy of “military Keynesianism.” A policy of cutting taxes favored by reactionaries allegedly to increase economic growth was called “supply-side economics” in the 1980s by the supporters of Ronald Reagan.

However, cutting taxes on the rich and corporations does little good during and in the aftermath of a crisis of overproduction, because profits are too low to create prosperity not because too much surplus value is being appropriated by the government in the form of taxes but because the value, including the surplus value, contained in commodities cannot be realized due to a lack of monetarily effective demand.

Instead of tax cuts for the rich and the corporations, progressives urge that spending be increased without cutting taxes. This they hold will increase demand for commodities either directly through increased state expenditures or indirectly through the increased purchasing power of the dependents of the state.

Progressives advocate increasing deficit spending on social programs that help the workers and the oppressed—not the military—so that social problems caused by mass unemployment and the lack of “adequate effective demand” for commodities that causes unemployment can be dealt with simultaneously.

Contradictions of deficit spending

However, deficit spending is not the magic remedy for the tendency of production to grow faster than the market that Keynesian economists believe it to be. First, deficit spending merely postpones an increase in taxation because government debts have to either be repaid or, more realistically, the interest payments coming due on government bonds have to be serviced.

The danger is that the part of the budget of the central government that goes to paying the debts due wealthy owners of government bonds will grow at the expense of any help the unemployed workers or other oppressed sections of the population enjoy. The more deficit spending the government engages in during a depression, the higher the burden of the public debt—the one part of national wealth that really belongs to the nation, as Marx ironically put it—will be in the future.

In addition, even if depression-time deficit spending does not raise long-term interest rates while the depression lasts, it does increase the mass of outstanding debt that exists on the money market when economic recovery sets in. This will tend to cause long-term interest rates to start rising earlier and faster than would be the case in the absence of such debt. This not only will shorten the boom but contains the risk that unemployment at the peak of the next boom will be higher than it would be in the absence of deficit spending.

Deficit spending powerless to prevent outbreak of crisis

It should be noted here that Keynesian-style deficit spending is completely powerless to prevent the outbreak of the crisis. On the eve of the crisis, there is a growing shortage of loan money, not the glut of loan money that characterizes the post-crisis depression period. If the government attempts to increase deficit spending to prevent a looming crisis, the effect will be increased competition for the already too-small supply of credit between the government, consumers and business. This will drive an already high rate of interest higher and cut off loans to a portion of either the commercial or industrial capitalists or to consumers—for example, would-be home buyers.

Keynesians of all types believe that this problem can be dealt with by having the “monetary authority” print more money. But as we already saw, this is exactly what the state or its monetary authority cannot do without incurring all the contradictions of monetary Keynesianism. Therefore, deficit spending by the central government can at best shorten the period of depression.

The period of depression as a rule will only be shortened by deficit spending if it begins after the crisis-recession has already “bottomed out.” In this case, there will be no reduction in the intensity of the crisis itself. But if the state deliberately increases its deficit spending during the crisis, it risks intensifying the crisis.

This is exactly what happened during the crisis of 2007-09. As recession set in after the initial panic of August 2007, U.S. President George W. Bush negotiated a “stimulative plan” with the Democratic Congress designed to pump $168 billion worth of purchasing power into the economy through tax rebates. However, the tax rebates had to be financed through increased government borrowing. The result was that $168 billion of additional government debt was thrown at credit markets that were already reeling from the developing crisis.

Just five months after the first rebate checks were mailed out by the U.S. Treasury, the Lehman Brothers investment bank collapsed triggering full-scale financial panic. The 2008 panic, intensified all the more by the increased federal borrowing necessary to finance the $168 billion tax rebate program, caused a massive contraction of credit and purchasing power, which transformed what had been only a “mild recession” into the Great Recession. This was the exact opposite of what Bush’s tax rebate program, inspired by Keynesian economics, was attempting to achieve.

But even if increased deficit spending during a recession-crisis does not
actually intensify the crisis like it did in 2008, it will tend to increase the duration of the depression-stagnation phase that follows the crisis, as occurred in the post World War II era when this policy was implemented.

After World War II, business came to expect that the governments would engage in large-scale deficit spending in time of recession and their aftermaths. In effect, governments said to the industrial and commercial corporations, don’t panic and sell off your inventories of commodities at lower prices. The banks were told that “the Fed” would increase their reserves and if necessary bail them out. The government said to the banks don’t press your debtor industrial and commercial corporations to pay off their debts by selling off their overproduced inventories at drastically reduced prices like you used to do in the old days. Instead, “roll over” their debts and allow the debtors to pay them off gradually.

The introduction of government-sponsored deposit insurance in the U.S. after the 1929-33 super-crisis made runs on the banks less likely and also encouraged the banks to roll over debts due them rather than demand immediate repayment that would force industrial and commercial corporations to raise cash by slashing prices.

Therefore, deficit spending combined with government-sponsored deposit insurance helped make the early post-World War II recessions (2) less intense than many pre-World War II recessions had been—even leaving aside the special case of the super-crisis of 1929-33. But it also encouraged corporations to hold on to their inventories and instead sell them off gradually at high prices. Instead of slashing prices to get rid of overproduced commodities, they simply held down production and employment until the overproduced commodities were liquidated at high prices.

In the “old days,” financial panic would force a rapid reduction of inventories—contraction of commodity capital—followed by a rapid recovery as depleted inventories had to be rebuilt when the panic passed. After a sharp but relatively brief crisis, the economy would stage a powerful recovery. Such strong recoveries were no longer seen in the U.S. (or Britain) after World War II.

Dampening the amplitude of the industrial cycle in order to dampen workers’ struggles

Conservative pro-business neo-Keynesians believe, not without reason, that milder recessions and weaker recoveries are preferable from the viewpoint of the capitalist class these economists defend, because the reduction of the amplitude of the industrial cycle tends to dampen the struggles of the workers. Before World War II, and especially in pre-Federal Reserve days, when a violent recession occurred that was followed by a strong recovery, U.S. workers would be able to use the strong post-recession rebound in business and consequent sharp rise in hiring to first win back what they had lost during the recession and then use the existing momentum to win additional gains.

The main contradiction of deficit spending

Remember, one of the basic functions of the crisis-depression phase of the industrial cycle is that by lowering commodity prices, the profitability of gold production is increased both absolutely and relative to other branches of production. During periods of deflationary depression, more of the labor of society is utilized producing money material and less time is spent producing non-monetary commodities.

The increase in the rate of growth of the quantity of money material, combined with the rise in the purchasing power of the existing money material brought on by the fall in prices, makes possible the sudden expansion of the market that ends the depression and ushers in the next period of economic prosperity. Therefore, any temporary success that Keynesian fiscal policies have in reducing the amplitude of the industrial cycle undermines the growth of the market by postponing the needed fall of inflated prices back to—and for a while below—their values. The seeds are thus planted for a return to sharper crises.

After World War II, the general price level continued to creep upward over a series of “dampened” industrial cycles. By the late 1960s, this upward creep of the general price level was destroying the profitability of gold production. A commodity that is not profitable to produce under capitalism will not be produced even if the commodity in question is the money commodity. Therefore, any success in maintaining high prices—without currency devaluation—will undermine the long-term ability of the market to grow. Sooner or later, this must lead to a return of sharper crises.

Fiscal Keynesianism dependent on monetary Keynesianism

At should already be apparent, fiscal Keynesianism is dependent on monetary Keynesianism. Therefore, just as monetary Keynesianism is doomed to fail in the long run, so is fiscal Keynesianism. We have seen that at the peak of the industrial cycle, there is a shortage of loan money and money capital as well as the means of circulation in general. The general money famine, as Engels described it in “Socialism Utopian and Scientific,” causes credit to vanish just when it is most needed.

As the industrial cycle peaks, the combined purchasing power of the capitalists and the workers, plus the hangers-on of the capitalists—persons who live off surplus value, including the state—is insufficient to purchase the total mass of commodities at their value that is being produced by the industrial capitalists. At this point in the cycle, any move by the state to increase its expenditures, whether this is financed by current taxes or by borrowing, will reduce the purchasing power of the capitalists and/or the workers.

Once the peak of the cycle has passed, the capitalists and indebted non-capitalist consumers start paying off their debts and rebuilding their cash reserves. As the crisis and depression progresses, this idle mountain of hoarded cash gets larger and larger. The larger the idle cash hoard becomes, the greater the borrowing power of the government. However, if the government engages in massive borrowing “prematurely” before a sufficient idle cash reserve has been accumulated, the crisis will simply break out again after a short interval, and there will be a “double-dip” recession.

Therefore, in order to make sure the recovery when it arrives is “sustainable,” the government is under pressure to refrain from too much “premature” deficit spending.

Some economic history

Let’s look at the concrete economic history of the 20th century to see how these contradictions worked themselves out in practice.

On the eve of World War I, all economic indicators were pointing toward a serious depression. Prices had been in a strong upswing since 1896, and this rise in prices had by reducing the profitability of gold production all but halted the growth in the production of money material. The stagnation of gold production was a sure sign that prices as expressed in gold were rising above the values of commodities. The gap between the ability of the industrial capitalists to increase production and the ability of the market to grow was, after a period of exceptional growth of the world market, again widening. Indeed, a recession had begun in 1913 in the United States and Europe and was deepening in the summer of 1914.

War economy replaces depression

The war economy with its massive deficit spending quickly liquidated this developing depression. The depression was replaced by a war economy. While tens of thousands of workers in uniform died in the trenches, the problem of unemployment vanished. Industries converted to war production and the unemployed who were not absorbed into the military were largely shifted to war production. The reserve industrial army of the unemployed gave way to the literal armies. Instead of facing the hardships of unemployment, the workers were slaughtering each other in the trenches. After the war, Keynes claimed that the success of the war economy in eliminating the developing unemployment crisis proved that deficit spending could solve the problem of unemployment in peacetime as well.

Contradictions of war economy

The war disrupted the entire process of capitalist expanded reproduction. In some countries, such as Germany, an acute shortage of raw material caused production to decline sharply—much more than it had as a result of any pre-war crisis—even if there was no unemployment. Industrial capitalists found a shortage of elements of constant capital, not only of raw and auxiliary materials but of new machines.

Instead of replacing and expanding their real capital, the world’s industrial capitalists were replacing their real capital with fictitious capital in the form of government bonds. Much of the potential variable part of this real capital—sold labor power—was perishing in the trenches. The capitalists did not expect the war to last “too long.” As the war began in August 1914, the slogan was that the boys would be home “before the leaves fall.”

The capitalists in the warring nations hoped the victory of their own countries would mean that their government bonds would be repaid in good money—at the expense of the defeated countries. The capitalists in the losing capitalist countries—such as Germany and Austria—indeed saw the value of their government bonds largely or completely wiped out due to the postwar inflation, while the purchasers of war bonds in the victorious countries, especially the U.S., were enriched.

The mass destruction of real capital meant that instead of overproduction the war economy brought acute shortages of commodities. Commodity prices therefore soared not only in terms of depreciated paper currencies but in terms of actual money material—gold bullion. This had two effects. It greatly reduced the purchasing power of the world supply of existing gold bullion while greatly reducing the profitability of the world’s gold mines. Gold production already stagnating on the eve of the war slumped sharply as prices soared during, and for a while after, the war.

World War I, therefore, created a huge, and up to the present historically unmatched, gap between the prices and the values of commodities. Commodity prices, which were already dangerously inflated on the eve of the war, more than doubled. This huge gap between prices and values could never have been “achieved” in a peacetime economy, since a crisis of overproduction would have inevitably intervened well before such a wide gap between prices and values developed.

Once the war was over, therefore, the gap between the ability of the industrial capitalists to increase production and the ability of the market to grow dramatically widened due to a drop in both the purchasing power and production of money material. As long as the war continued, however, the ability to produce commodities was not increasing as under normal capitalist expanded production; it was declining. Therefore, the greatly reduced ability of the market to grow was not a problem as the war raged.

In 1920, in order to avoid hyperinflation, governments and central banks—with the exception of defeated Germany—adopted sharply deflationary polices that brought inflation to a screeching halt. (3) This caused a sharp drop in prices and a sharp if brief recession in production and employment. However, since there was little real overproduction—world industrial production was no higher in 1920 than it had been in 1913, which marked the peak of the last pre-World War I economic boom—the world capitalist economy ran out of inventories well before prices had fallen enough to restore even the already inadequate pre-war level of gold production. Though the deflation of 1920-21 halted its sharp decline, gold production remained well below the already inadequate level that had prevailed in 1913. (4)

As result of the reduced purchasing power of gold compared to 1913 due to the still high price level, combined with the low level of gold production, when the world economy did begin to recover from the war destruction and the brief postwar recession of 1920-21, there were far fewer reserves of idle cash than usual to finance a recovery. Therefore, the economy had to depend on credit to an unusual extent. When the resulting credit bubble and associated swindling began to collapse starting in 1929, it led to a massive debt deflation that transformed the cyclical U.S.-centered recession that began in 1929 into the super-crisis of 1929-33, which ushered in the Great Depression.

Therefore, contrary to Keynes, the war economy with the huge deficit spending of 1914-1918 did after all not prevent the depression and associated unemployment crisis that was developing in the 1910s. It merely postponed the depression and unemployment by 15 years in the United States. Less-favored European countries began to experience a grave unemployment crisis as soon as inflation was halted—in 1920 in Britain and 1923 in Germany. What would have been a more or less 19th-century-type depression during the 1910s was transformed into the Depression with a capital “D” of the 1930s with all its grave consequences.

Did World War II bring prosperity?

But Keynesians and Keynesian Marxists argue that World War II with its even more massive deficit spending—and destruction and death—finally ended the Depression and brought a return to prosperity. In fact, the condition of the world economy and the world market were virtually the opposite of those that prevailed on the eve of the World War I.

World II broke out after an economic crisis and resulting Depression had occurred that was qualitatively worse then any other crisis-depression in the entire history of capitalism. The huge gap that World War I had caused between prices and values was finally reversed by the super-crisis of 1929-33.

The plunging prices brought about by the Depression increased the purchasing power of gold and the profitability of gold production causing gold production to rise to the highest level in history up to that time. This combined with the lingering Depression, reinforced by the 1937-38 recession, kept investment at very low levels throughout the Depression decade, leading to the building up of by far the largest idle cash hoard—centered in the United States—that the world had ever seen. Economic conditions were the exact opposite of the situation that prevailed when World War I broke out.

This unprecedented buildup of idle cash in the banks—especially in the United States—was the “liquidity trap,” as the Keynesians call it, of the 1930s. The world market was therefore primed for the greatest “sudden expansion” in its history. None of this owed anything to either World War II, which was yet to occur, or the “Keynesian revolution” in economic policy except to the extent that the deficit-financed World War I war economy made the Depression with a capital “D” possible in the first place.

Indeed, an examination of economic data shows that the U.S. economy was entering a strong upswing on the eve of World War II, the exact opposite of the situation that prevailed on the eve of World War I when the U.S. economy was sinking into depression. This fact is somewhat obscured by the artificially induced Roosevelt recession of 1937-38 that managed to prolong the Depression by several years. (5) However, the Roosevelt recession had been over for more than a year when war broke out in Europe on September 1, 1939.

Therefore, World War II replaced what would have been a strong rebound from the Great Depression disaster—largely caused by the aftermath of the World War I war economy—with a new war economy. True, this war economy reduced unemployment much faster than any “peacetime” economic boom would have—though at the price of killing off the newly “employed” workers in uniform by the millions. The most destructive war in history also made possible the reconstruction boom in Europe and Japan after the war, which would not have occurred if “peace” had broken out at the end of the 1930s instead of war.

In other ways, however, the war economy actually limited the postwar boom. Like in World War I, rising prices in terms of gold reduced the purchasing power of money material and discouraged gold production. The 1941 level of gold production was not to be exceeded before the late 1950s, though gold production remained above pre-Depression levels.

As was the case in the World War I war economy, overproduction was suppressed during the war. For example, in the U.S., the country least affected by the war economy, automobile production was suspended completely during the war as the auto factories shifted to the production of tanks and warplanes. Naturally, there was no question of an overproduction of automobiles when the war ended.

But there was still a price to pay for the war. Instead of entering the postwar boom with prices well below the values of commodities—which was the case on the eve of the war—the world capitalist economy entered the postwar boom with prices more or less equal to values. This was still far better than the unprecedented inflation of prices over values that existed after World War I, but it was far worse than the situation that would have prevailed if the war had been avoided. The war, however, did not completely cancel out the forces that were working in the direction of a massive expansion of the post-Depression economy.

In the immediate aftermath of the war, the economy of the U.S.—which had most of the world’s gold reserves—emerged from the war with a greatly increased (federal) government debt but with virtually no business or consumer debt. The U.S still possessed a massive hoard of idle cash that was available for investing and loaning to Europe and Japan once the war ended. Unlike after World War I, the conditions that had been put in place for a “sudden expansion of the market” still existed even though they were weakened by the wartime price inflation and its negative effects on the purchasing power of money and gold production.

Overall, if the war had been avoided the strong upswing in gold production that was still climbing in 1941 would have continued for a while, while prices would have been much lower relative to labor values at the start of the boom. This would have meant that the production of money material would have been higher in the early stages of the boom. In addition to a higher level of production, the money material would have had a higher purchasing power without the World War II inflation. Working in the opposite direction, there would have been no postwar reconstruction boom, though there still would have been a need for a massive replacement and renewal of capital run down during the Depression decade.

On balance, it seems likely that economic growth over time would have been greater if World War II had been avoided. Just like World War I had not been able to prevent the depression that was developing in the 1910s but merely postponed it for 15 years and turned it into the Depression with a capital “D”, World War II merely replaced the post-Depression boom due in the 1940s with a war economy followed by a reconstruction boom. After that, the “peacetime” boom that was due for the 1940s and 1950s was moved to the 1950s and 1960s.

The duration of the boom and the amount of wealth that was actually created by the post-World War II boom net the destruction that occurred during the war—not to speak of the loss of human lives—was, however, on balance almost certainly reduced by World War II and not increased by it.

None of this prevented the Keynesian economists from taking credit for the post-World War II boom. Economic textbooks written after the war explained that depressions were something that “used to occur” but were now a thing of the past due to the success of Keynesian “stabilization policies.”

Unfortunately, many, perhaps most, Marxists—and not only those of the Monthly Review School—echoed these arguments, claiming that the high level of expenditures on arms was responsible for the postwar prosperity. This implied that the workers actually had an interest in war economy—within certain limits—since the alternative would have been a return of the mass unemployment of the Depression years. In the early postwar years, the Depression was still a vivid memory.

Keynes replaces Marx in the post-World War II workers’ movement

The reformists in the workers’ movement openly replaced Marx with Keynes. Many Marxists honestly confusing Keynesianism with Marxism—especially the argument that war and massive military spending brings prosperity—also often repeated Keynesian arguments without realizing they were in effect advocating Keynes not Marx. What we saw was a major penetration of bourgeois ideology into the workers’ movement where Keynesian economics increasingly replaced Marxist economics. This helped pave the way for the disasters that were to occur in the final years of the 20th century.

While Keynes agreed with Marx against the original marginalists that capitalism left to its own devices was a very unstable system prone to deep depressions—which makes Keynes sound very radical—he also held in contradiction to Marx that correct government policies could bring permanent economic prosperity with “near to full employment” within the framework of capitalism.

Therefore, like the non-Marxist progressives, “Keynesianized” Marxists—or Marxists who confused Keynesian economics with Marxist economics—were disarmed when acute economic crises returned in somewhat different forms in the 1970s and early 1980s. A now throughly Keynesianized left was thus thrown back when Keynesian economics was discredited in practice during the 1970s and early 1980s. The followers of Milton Friedman took the initiative and global politics shifted sharply to the right.

Coming up

I had originally planned to end this series on Keynes by examining how the workers’ movement can fight the current unemployment crisis, which shows no signs of ending. However, I have decided to postpone this to the following month in the light of Monthly Review‘s decision to publish two of the letters written by Paul Baran and Paul Sweezy when they were working on “Monopoly Capital” a half century ago.

Over the next month, I urge all readers of this blog to read these letters, which are now available free online or in printed form in the December 2010 edition of Monthly Review. The editors of Monthly Review must be commended for publishing these letters, which shed much light on the development of economic thought during the 20th century. These two letters will be the subject of next month’s reply.


1 A sorry example of this is “The Political Economy of Post-crisis Global Capitalism,” by Duncan Foley. (Paper prepared for the Economy and Society Conference at the University of Chicago, December 3-5, 2010)

2 In the pre-1914 era, recessions were more violent in the U.S. than in Europe because the U.S. lacked a central bank that could soften panics and reduce bank runs. The result was that the amplitude of the industrial cycle in the U.S. was greater than was the case in Britain and other European countries, though overall economic growth was greater in the U.S. than in Europe. However, unlike in the era of the “Keynesian” stabilization policies that followed World War II, there was no attempt by governments or the central banks of the pre-1914 era to stop the general price level from falling when economic conditions favored such a fall. Such a policy would not have been compatible with the international gold standard.

3 Inflation continued in Germany in 1920-21. The German inflation escalated to hyperinflation in 1923, which was then halted by the stabilization of the German mark. After the inflation ended, Germany like Britain entered a period of much higher unemployment than had been experienced before 1914. Things got drastically worse when the super-crisis hit—which actually began in Germany in 1928 and didn’t bottom out in that country until the summer of 1932. The beginning of economic recovery in 1932 came too late to prevent Hitler from coming to power in January 1933.

4 At the peak of the post-World War I industrial cycle in 1929, gold production, though it had recovered somewhat from its low point in 1922, was still well below the 1913 level even though world commodity prices and production were higher than had been the case in 1913. More money was needed as a means of circulation but less new money material was being produced to back the increased means of circulation.

This led to a considerable inflation of credit that increasingly replaced money in circulation during the prosperity, such as it was, of the 1920s. When the boom was replaced by recession in 1929, the result was a debt deflation centered in the United States that transformed the normal cyclical recession into the super-crisis of 1929-33, which represented the first phase of the Depression of the 1930s.

5 A traditional crisis begins when a drain of gold or foreign exchange reserves, or under a paper money system a sharp decline in the value of the currency, obliges the central bank to raise interest rates, which triggers the crisis. In 1937, the U.S. was facing the exact opposite of a gold drain. Instead of a drain on gold reserves, the U.S. was “experiencing a huge accumulation of gold in the U.S. Treasury and consequent explosion of reserves in the U.S. banking system.

This explosion of U.S. gold and banking reserves was due to both increased world gold production and the flight of money capital to the United States ahead of World War II. Officials of the Roosevelt government and the Federal Reserve System feared that this explosion of gold and bank reserves would lead to a runaway boom.
Contrary to historical mythology that no end to the Depression was in sight during the 1930s, the economic boom that finally occurred after World War II was therefore clearly coming into view as early as the mid-1930s.

Fearing the prospect of a runaway boom, the Roosevelt administration and the U.S. Federal Reserve System adopted a sharply deflationary fiscal and monetary policy. As regards fiscal policy, the regressive Social Security tax on wages had been introduced but there were as yet no Social Security payments. In addition, pointing to the rapidly increasing index of industrial production that had reached the levels of 1929 combined with falling unemployment, the administration moved to end the WPA public works programs that had directly employed a portion of the unemployed workers. For many young workers growing up in the Depression years, these WPA jobs were the only employment they had known.

As regards monetary policy, the Federal Reserve System did not raise its (re)discount rate, which was very low. However, it did raise bank reserve requirements, and the U.S. Treasury adopted a policy of sterilization of the gold inflow. For every dollar of gold that flowed into the U.S. Treasury, the U.S. sold a dollar of government bonds on the open market without spending the proceeds, which brought the rapid growth in bank reserves to a sudden halt.

Between them, the Roosevelt administration and the U.S. Federal Reserve System withdrew huge amounts of currency from circulation and then hoarded it in the U.S. Treasury. The result was the brief but violent recession of 1937-1938 that caused industrial production to plunge and unemployment to once again soar. In early 1938, alarmed by the violence of the recession that the administration’s own policies had created, both the Roosevelt administration and the Federal Reserve System reversed their sharply deflationary policies.

As soon as this was done, the strong recovery from the super-crisis of 1929-33 resumed, though now from a much lower level. The effect of the strongly deflationary policies of 1937 was to artificially extend the Depression by several years.

Though the capitalist government and its monetary authority cannot prevent economic crises, it does have the power to create an artificial economic crisis by withdrawing currency from circulation if it wants to. In those days, progressives including the U.S. Communist Party, which strongly supported the New Deal as part of the Communist International’s “anti-fascist Popular Front policy,” were not inclined to make many criticisms of the Roosevelt administration.

Both the economic and political situation led to a widespread belief among
young economists who were coming under the influence of Keynes that U.S. and world capitalism had entered into a stage of “secular stagnation” that could only be counteracted by ever bigger doses of government spending in the future.

Why did the the Roosevelt administration follow such vicious recessionary policies in 1937-38? Officially, the reason was that the U.S. economy fueled by the unprecedented expansion of bank reserves was moving into a runaway boom that would end in new 1929-33 type super-crisis or worse. But in reality, the U.S. economy even at the height of the “prosperity” of 1937 was still a year or so away from a real boom. Unemployment was still in double digits as it was calculated in those days, corporate investment was still very low, and industrial production though rising rapidly was still barely above the level that had first been reached in 1929, eight years earlier.

One reason that suggests itself was the rapidly spreading unionization drive in basic—and other—industries. The period immediately preceding the Roosevelt recession were the years of the rise of the CIO and the sit-down strikes. Whether this was the conscious intention of the New Deal-era policymakers or not, the unionization drive that had been gaining tremendous momentum, where millions of U.S. workers were feeling their power as a class for the first time, was thrown back in the face of what in effect was a massive government-organized lockout.

The U.S. trade union movement has never to this day regained the momentum it had in 1937. Even today, however, progressive historians still under the influence of the myth of Roosevelt’s “progressive pro-labor New Deal,” as we see in the case of even a man as intelligent as John Bellamy Foster, are not particularly interested in pursuing this line of inquiry.

Second, it is possible that the administration hoped to attract even more gold to the U.S.—though they claimed that they were alarmed by the gold inflow—at the expense of Germany, which unlike the U.S. was facing a problem of inadequate gold reserves that it needed to finance its pre-war arms build up. In the wake of the Roosevelt recession, the flow of gold from Europe to the U.S. greatly increased. Hitler solved the problem of the pressure on Germany’s gold reserves created by the artificially engineered “Roosevelt recession” of 1937-1938 by annexing Austria. This considerably increased Germany’s gold reserves, since Austrian gold reserves were now combined with Germany’s. Europe was brought to the brink of war, which broke out in September 1939, a little more than a year later.


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