Crises Real and Artificial, and Why a New ‘New Deal’ is Not Feasible
I had originally planned to answer questions by Mike on exchange rates, which were partially taken up in my critique of an article by Dean Baker. While the factors that determine exchange rates are an important question in economics, especially for the theory of world trade, events over the last few weeks dictate that my reply to Mike’s questions be postponed.
These events include the threatened default of the U.S. government on its debt payments, the decision of the Obama administration to accept a compromise that includes no tax increases for the rich, a wave of panic selling on Wall Street and other world stock exchanges, a new plunge of the dollar against gold, the downgrading of the U.S. debt from AAA to AA+ by Standard and Poor’s, and a rare split vote by the Federal Reserve’s Open Market Committee on what to do next concerning the Federal Reserve’s monetary policy.
Any one of these events would probably have necessitated the decision to postpone the reply to Mike’s questions on exchange rates. However, the events of the last few weeks are closely intertwined with and relate to questions that this blog has been examining since its inception in the January following the late 2008 panic. In order to keep this reply within reasonable limits, I will concentrate on the question of the debt of the U.S. federal government and the threatened default by that government.
Debt default crisis a political and not a true financial crisis
Since World War I, the maximum debt that the U.S. government could carry has been determined by law. Every so often as the maximum debt limit was approached, Congress routinely voted to raise the debt limit. But this year the Republican-controlled House balked. The Republican majority threatened to refuse to raise the debt ceiling unless the Obama administration agreed not to raise taxes on the rich and corporations or even close tax loopholes that have often enabled the rich and corporations to pay no taxes at all.
The U.S. Treasury warned that if the debt limit was not raised by August 2, it would not have enough cash on hand to pay all its bills coming due, forcing it to default. The crisis was purely a legal and political one, since the U.S. government has been having no trouble recently selling its notes and bonds. Indeed, the federal government was able to sell them at prices that yielded some of the lowest interest rates it has ever had to pay. This would hardly be the case if there was a real threat of a federal default.
The media were taking the default threat seriously, but the markets—the capitalists in the know—were not. The markets were right. Over the weekend of July 30-August 1, the Democratic and Republican parties came up with a deal that raised the debt limit and averted the “danger” that the U.S. government would run out of money and default on payments on its huge debt.
As reported by the media, the Democratic Obama administration wanted to balance cuts in the federal budget including cuts in so-called entitlements—mostly Social Security pensions for retirees and the government Medicare health insurance program for those over 65—with some tax increases for the wealthy and closing of some tax loopholes. It was reported that Obama wanted to raise the age for Social Security and Medicare payments from the current age of 65 to 67, as well as weaken cost-of-living protection that adjusts for inflation the benefits Social Security recipients receive. The idea was that depending on the future rate of inflation the Social Security benefits retirees would receive in real terms—the amount of commodities that the pensions could actually buy—would be progressively lowered.
The Republican Party, while it had no problems with cuts in federal spending (including entitlements)—the military excepted—insisted that there be absolutely no tax increases or other revenue raising measures. They wouldn’t even accept closing tax loopholes that frequently allow wealthy individuals and profitable corporations to pay no federal income taxes whatsoever. Rather than accept any raises in taxes on the corporations and the rich, the capitalist media claimed the Republican Party—especially its “Tea Party” extreme right wing—was willing to allow the U.S. government to default on its debt obligations.
Media pundits warned that if the U.S. Treasury actually defaulted on its debt payments, the U.S. government would lose its “no-risk” AAA credit rating, which would cause the rate of interest at which the U.S. government could borrow to soar, leading to a new panic on Wall Street and in the credit markets worse than the one that occurred in late 2008 after Lehman Brothers investment bank collapsed.
The collapse of a major investment bank was a disaster, but the default of the U.S. Treasury would be practically the end of the financial world as we know it. By implication, the threatened U.S. government default if it materialized would replace the current stagnation with an economic collapse that would surpass even the super-crisis of 1929-33.
It was exactly these dire threats whipped up by the media that allowed the Obama administration to accept an agreement to reduce planned federal spending by trillions of dollars over the next decade without any increases in taxes on the rich or corporations. He could say, in effect, to the Democratic Party “progressive” wing: “Look I do not really like this deal. I believe that we should have closed tax loopholes and raised taxes for the rich and corporations to help reduce the federal budget deficit somewhat. But though the current deal is not perfect, it is far better than a full-scale economic collapse. Considering the refusal of the Republicans to compromise, I simply had no alternative.”
Announcement of specific cuts postponed
Besides the default blackmail, the deal was made more tolerable because it did not include any actual immediate cuts. Instead, it set up a committee—dubbed by the media a “super-congress”—divided equally between six Democrats and six Republicans charged with recommending specific cuts in November.
If the “super-congress” does not reach an agreement by then, automatic across-the-board spending cuts will kick in. These will include the military but exempt Social Security and Medicaid but not the Medicare health insurance program for seniors. The Medicare cuts would directly affect only the medical providers—hospitals and doctors—but not patients.
However, nothing in this deal precludes an agreement among the Democrats and Republicans to cut Social Security and Medicare in November, and it seems highly likely that an agreement will be reached by the November deadline. But like the recent debt default “crisis,” it may well go down to the wire.
A likely argument will be that with our solders dying in Afghanistan, the “terrorists” still resisting in Iraq, and dictators like Syria’s Assad and Libya’s Gaddafi “defying the international community by shooting down their own people” we cannot afford to cut the military. Instead, we will have to raise the age at which people become eligible for Social Security from 65 to 67 and change the formula used to calculate cost-of-living increases for benefits.
Any other course would play into the hands of the “rogue dictators” and the terrorists undermining “national security” at a critical time in the “war on terror.”
In practice, a lot of the cuts will be made not by the federal government at all but by state and local governments. State and local governments depend on federal financial aid to finance various programs including unemployment insurance. The state and local governments, when they make cuts, explain that they are running out of money. Unlike the federal government, they have no power to issue currency of their own and limited authority to borrow money.
They explain that unless the public employee unions are willing to accept drastic cuts in wages and retirement pensions, they will either have to cut programs for schools, close down senior centers and libraries, or reduce or end other city services. The officials even hold public meetings and present charts of revenues and expenses and challenge members of the audience to suggest alternative cuts to those that are being proposed.
The idea is to pit “the public” that is outraged by specific cuts in city services against the public employee unions that are resisting proposed wage and benefit reductions. Instead of blaming the capitalists who are really responsible for the crisis, blame is shifted onto the unions that “refuse to make sacrifices in this time of crisis.” The lesson? To be effective, any struggle against cutbacks in the U.S. must be centralized and aim its fire at the government in Washington.
Why there was never any real chance of default
Along with the political power of the rich who are the principal creditors of the U.S. government, the nature of the present international monetary system virtually guaranteed that the U.S. government would not in fact default on the debts it owes in U.S dollars, which the U.S. Treasury prints. Indeed, if you have a U.S. dollar bill handy, you will see that it is actually signed by the U.S. Secretary of the Treasury. (1) Under the dollar system, foreign governments hold their reserves largely in U.S. government securities instead of gold to back up their own currencies.
U.S. government securities are payable in the dollars that the U.S. Treasury prints, and the Federal Reserve System, which is closely intertwined with the U.S. Treasury, issues. U.S. government securities can be quickly converted into actual U.S. dollar currency on world debt markets and are therefore considered to be virtually equivalent to cash—Federal Reserve Notes.
Governments and corporations that operate on a world market basis are obliged to hold U.S. government securities as reserves as long as the prices of the key primary commodities—oil and wheat, for example—are quoted in terms of U.S. dollars. Because key primary commodity prices such as the price of oil are denominated in U.S. dollars, the great bulk of world market debts are also denominated in U.S. dollars. This is the essence of the dollar system.
Whenever global credit is shaken for whatever reason, there is a rush into the U.S. dollar, which enables the U.S. Federal Reserve to increase the quantity of token dollars it issues. The global character of the dollar system is shown by the fact that the majority of Federal Reserve Notes—green paper dollars—circulate outside of the U.S.
If the U.S. government actually refused to pay the interest or principle on its debts, the convertibility between U.S. government securities and Federal Reserve Notes would—depending on the extent of the default—be broken. Governments and corporations are “rewarded” for holding their reserves in dollars—actually, interest-bearing short-term U.S. government securities—rather than in gold, actual money material, by the interest they “earn” on the Treasury notes. Gold, in contrast, yields no interest to its owner and incurs storage costs.
If the U.S. refused to pay its debts, governments and corporations would have to choose between holding actual Federal Reserves Notes, which like gold do not yield interest to their owner, and holding gold. True, unlike Federal Reserve Notes gold can never depreciate against itself. Federal Reserve Notes can also appreciate against gold, which happens whenever the dollar price of gold declines.
If the U.S. Treasury defaulted on its debt, the Federal Reserve System would be under great pressure to follow a monetary policy that would actually lower the dollar price of gold. It would need to keep the rate of growth of the dollar monetary base below the rate of growth of the quantity of gold bullion. This would be the equivalent of paying interest on Federal Reserve Notes, since they would be gaining in gold value.
If the Federal Reserve did not do this, or put the U.S. dollar back on the gold standard, huge amounts of dollars would be dumped on the market, the dollar price of gold would soar, and the dollar system would start to unravel. Pressure would mount to start quoting the prices of primary commodities in gold rather than in U.S. dollars. If primary commodity prices were to start being quoted in gold rather than U.S. dollars, the U.S. dollar empire would fall.
This is why those in the know on Wall Street, unlike the mass media, never took the default threat seriously.
U.S. government debt downgraded by Standard and Poor’s
But after the debt agreement was reached that averted the never-real threat of default, the Standard and Poor’s debt rating service downgraded the U.S. government debt from AAA to AA+. Why did this powerful Wall Street company do this if there was no real threat of a debt default?
On the Internet, progressives have noted that this same Standard and Poor’s gave AAA ratings to mortgage-backed securities before the crisis began in August 2007. Does S&P really believe that there is a greater danger of default on U.S. government securities than there was on mortgage-backed securities in 2007? No, but S&P knew exactly what it was doing.
Wall Street knows that while the idea of “cheap government” and lower taxes is popular in the abstract, cuts in spending, especially cuts in “entitlement programs,” are extremely unpopular in the concrete. As a result, politicians like to vote for tax cuts but do not like to cut entitlements. The financiers behind S&P are afraid that the politicians of both the Democratic and Republican parties will attempt to shy away from actual “entitlement” reductions while allowing deficit spending to continue, further destabilizing the already highly unstable financial markets.
Let’s examine Standard and Poor’s stated justification for the move to lower the rating on U.S. federal debt:
“We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements [emphasis added—SW], or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.”
Government debts and the swings of the industrial cycle
First, is the U.S. facing a long-term problem with the federal debt even if it can pay its debts in its own currency? Within the industrial cycle, an increase in government debt in the period leading up to the period of transition from boom to recession will worsen the “credit crunch” for the industrial and commercial capitalists and for consumers. At this stage in the industrial cycle, loan money is in short supply relative to the demand for it. Any increase in the debt of the central government simply redirects scarce loan money into government bonds and away from the rest of the economy.
This is why standard textbook “stabilization theory” holds that the central government should run surpluses in the period leading up to the recession. The danger is not that the central government will default, it is that a “money crunch” in the private sector will further intensify the approaching recession.
As the recession develops, however, demand for credit by the private sector dries up as both businesses and consumers slash their spending. The industrial and commercial capitalists accumulate huge sums of money in their bank accounts that will later on finance the next economic upswing. Keynesian stabilization theory advocates that the central government run a deficit at this point when the “private sector” is awash in cash but not yet spending its money.
The idea is to “prime the pump” to get the recovery going. Once the recovery is underway, deficit spending is to be gradually reduced, and once the boom proper begins, the central government is expected to run a surplus.
If the government runs deficits that are “too large” during the recession, however, the danger is that the mass of government debt on the market will cause interest rates to rise faster than they would otherwise once economic recovery takes hold and thereby limit the extent of upswing.
Remember, the cyclical crises that confront capitalism are crises of overproduction. If the crisis is ended “prematurely,” before all the surplus commodities and means of production have been destroyed, the upswing will be undermined and the next crisis will either break out earlier or be more severe when it does occur, or some combination of both.
In this case, the next crisis will have to clean up not only the new overproduction of the upswing but the “left over” overproduction of the preceding cycle. This is why Keynesian stabilization polices backfire after one or two industrial cycles and tend to reduce economic growth in the long run.
Does the U.S. government face a long-term debt problem?
Leaving aside the question of the fluctuations of the industrial cycle, isn’t it true that the U.S. government faces a long-term threat of bankruptcy if it continues to run deficits in the trillions? Even if the mounting federal debt doesn’t lead to a default in terms of U.S. dollars, won’t it lead to runaway inflation at some point in the future?
Right-wing economists and politicians claim that it is deficit-spending by the central government that creates inflation. If the government would only live within its means and run budget surpluses, inflation would go away, they say. This has been one of the key themes of the U.S. Republican Party since the New Deal days.
One of the things that distinguishes the right wing of the bourgeois political establishment from its left wing is that the right is always warning about the dangers of inflation while the bourgeois left plays down the danger of inflation and even sometimes argues that “a little more inflation” would be a good thing. In order to maintain our independence from the entire bourgeois political spectrum—its left wing as well as its right wing—we need to be clear about the real relationship between government deficit spending and inflation.
The relationship between deficit spending and inflation
If the ratio of the government’s debt to the Gross Domestic Product keeps rising, the government will at some point find it increasingly difficult to borrow. The rate of interest it has to pay on its debt will rise, which then further drives up the government’s debt as more money is borrowed to pay the rising interest. A vicious cycle sets in. History indicates that governments in such a position sooner or later resort to the printing press.
They either have the central bank buy up government bonds, or the government simply pays its debts in paper money declared “legal tender for all debts, public and private.” Runaway inflation develops and the industrial and commercial capitalists increasingly withhold their commodities from the market rather than exchange them for the collapsing currency. In the end, the government is forced to halt inflation, issue a new stabilized currency and bring its expenditures back in line with its tax revenue, or is bailed out by far richer countries, or a combination of the two.
Is the U.S. today facing a debt crisis?
At about 65 percent of the GDP, the total debt of the U.S. federal government held by the public is still well below the level where government deficits would trigger such a crisis. Bourgeois economists say that the “danger” level is about 100 percent, though experience indicates that the debt-to-GDP ratio can often rise well above that level, at least for a time, without a crisis.
The fact that interest rates on U.S. government bonds have been around 3 percent since the “Great Recession”—and are now well below that level—shows that we are still far from the point where the debt of the U.S. government will create a problem. For example, the ratio of debt to GDP remains below the levels that prevailed immediately after World War II. And we know that the debt burden incurred by the U.S. in World War II did not trigger a collapse of the dollar and runaway inflation. Despite the large debt the U.S. government incurred in fighting World War II, the U.S. economy experienced great capitalist prosperity for the first 25 years after the war.
It is not unusual for governments to incur huge increases in the public debt, and the ratio of the public debt to GDP, in times of all-out war. In the normal course of development, once the extraordinary expenditures of the war ends, the debt is then gradually retired.
After World War II, however, the U.S. embarked on a path of global empire and continued high military spending in “peacetime.” In addition, the U.S. fought two major shooting wars against Korea and Vietnam and carried out many other lesser military interventions.
On top of that, the prevailing Keynesian economic doctrines encouraged deficit spending in times of recession or higher-than-average unemployment.
Didn’t all this deficit spending cause the federal debt to soar to dangerous levels? Actually, it did not. The ratio of total U.S. federal government debt to GDP as a percentage kept falling from well above 100 percent in 1946 to below 50 percent around 1980. So despite the claims of right-wing politicians and economists, the U.S. was actually moving away from an inflationary crisis caused by the rising debt of the federal government in the decades after World War II.
Since 1980, however, this trend has reversed, and the general trend has been for the federal debt to rise relative to GDP—though the ratio did fall during the Clinton boom of the 1990s. If the upward trend continues, at some point many years in the future the U.S. will face an inflationary crisis caused by the public debt.
S&P, the Republicans and the leading Democrats are arguing that the federal government must cut Social Security benefits as well as unemployment insurance and Medicare to avoid such a future crisis many years from today. The much bigger problem for the U.S. economy is the huge size of the private debt—corporate and consumer. However, it is only the debt of the federal government that seems to concern the Washington politicians, including the Obama administration.
But why can’t the U.S. simply return to the situation that prevailed between the end of World War II and 1980 when it ran a world empire; fought the “Cold War,” which involved massive “peacetime” military expenditures; fought two big wars, against Korea and Vietnam; and continued to occupy its two main opponents in World War II—(West) Germany, including West Berlin, and Japan—in the bargain? It was exactly during these years that the U.S. government created the Medicare health insurance program for people over 65 and launched the “Great Society” programs under Lyndon Johnson. Yet despite all this “reckless spending,” it still managed to progressively reduce the ratio of the debt of the federal government to GDP!
James Galbraith’s utopian view
A leading progressive economist, James Galbraith, has written a paper that has been issued by the Levy Economics Institute, entitled “Is the Federal Debt Unsustainable?” Galbraith is the son of the well-known progressive—but not Marxist—economist John Kenneth Galbraith. James Galbraith in his article argues that the U.S. can indeed return to such a situation where the ratio of the debt to GDP, if it does not actually fall like it did after World War II, can at least be stabilized at a level that is still below the ratio that prevailed immediately after World War II.
Galbraith’s argument would be considerably stronger if he proposed a reduction to the U.S. military down to the level that would actually be necessary to defend the United States. (2) It is very hard to see how any foreign country could invade or attack the U.S. homeland in the foreseeable future. Indeed, no foreign country has landed troops in the U.S. or even bombarded the U.S. mainland since Britain did during the War of 1812.
For example, Galbraith could have proposed that the U.S. end the wars against Iraq, Afghanistan and Libya. None of these countries can remotely dream of launching an attack on the U.S. He could also have proposed that the U.S. finally end its costly de facto occupations of Germany and Japan more than 65 years after these countries surrendered in 1945. Again, it is hard to see how either Germany or Japan could menace the U.S. homeland leaving aside a completely suicidal nuclear attack. Even at the height of their power, neither imperial Japan nor Nazi Germany were able to attack the U.S. mainland.
Since Galbraith fails to propose serious reductions in military spending, the main cause of the chronic budget deficits of the U.S. government, how then does he propose to halt the growth of the ratio of the debt of the U.S. government to GDP? First, Galbraith faults the Congressional Budget Office for assuming a 2.5 percent real growth, 2 percent inflation and 2 percent real interest rate on the debt of the federal government.
Instead, Galbraith makes alternative assumptions of 3 percent real growth and interest rates on the federal government’s debt that are below the rate of inflation. That is, he assumes negative real interest rates on the debt of the U.S. federal government.
Making these assumptions, Galbraith calculates that it should be possible to halt the rate of growth of the ratio of federal debt to GDP before it exceeds the level that prevailed right after World War II, perhaps at a level slightly over 100 percent. Galbraith figures that as long as the federal debt ceases to grow relative to GDP, it can in absolute terms grow forever.
The Galbraith article is valuable insomuch as it shows the crucial role that interest payments on government bonds paid to the rich and super-rich play in increasing the size of the federal debt.
The biggest problem in Galbraith’s demonstration is its assumption of continued low—and actually negative—real interest rates on government debt as a permanent condition. How can Galbraith be so confident that the interest rate on government securities will remain low?
Galbraith assumes that the government through the Federal Reserve System controls the short-term interest rate—defined as interest on loans of less than one year. If long-term interest rates rise, Galbraith proposes that the U.S. Treasury simply borrow short term rather than long term. However, if over the long term the Federal Reserve cannot maintain short-term interest rates below the rate of inflation, Galbraith’s entire mathematical demonstration collapses.
Galbraith completely fails to understand what determines the rate of interest. In this blog, I devoted a good deal of space to examining this question and will not repeat the explanation here.
I will say this much. Even bourgeois economists concede that the Federal Reserve System cannot control the long-term interest rate. But these economists often claim that the Fed can control short-term interest rates. For example, doesn’t it announce targets for the federal funds rate—a short-term interest rate—after every board meeting? However, though the yield curve—the ratio between long-term and short-term interest rates—can vary, ultimately low short-term interest rates are not compatible with high long-term interest rates.
If long-term rates rise sufficiently above short-term interest rates, to levels exceeding the increased risk of long-term versus short-term lending, the money capitalists will sell short-term securities and buy long-term bonds, evening out the “yield curve” once again. For example, if the rate of interest of long-term bonds—maturities of more than a year—rise above 15 percent—like they did at the height of the 1970s stagflation—the federal government will not be able to borrow short-term at say 2 percent unless the Federal Reserve System is willing to buy all the notes issued by the Treasury. However, if that happens, the government is printing money and not borrowing it.
But as long as the Federal Reserve can avoid the kind of inflation that developed in the 1970s, shouldn’t it be able to hold interest rates low like Galbraith assumes?
If the Fed wants to maintain low interest rates over time, it will have to abandon its policy—sometimes called inflation targeting—of never allowing the cost of living to decline. Low interest rates were not maintained under the international gold standard by keeping the general price level more or less unchanged from year to year. That did not happen during the gold standard years nor could it ever under the capitalist mode of production.
What did happen under the gold standard was that the general price level sometimes rose and sometimes fell as prices fluctuated around the labor values—or more strictly the prices of production—of commodities. It was a fluctuating general price level—not a stable price level—that over time enabled the capitalist system under the international gold standard to avoid stagflation and financialization and thus keep interest rates low over time.
Therefore, to maintain the low interest rate environment that Galbraith is counting on would ironically require an end to Keynesian stabilization policies of “inflation targeting” and probably a return to the gold standard. If this were done, interest rates would remain relatively low, though even then it would be impossible to maintain negative real interest rates all the time. The reason is that nominal interest rates would remain positive during the inevitable periods of falling prices.
Galbraith’s assumptions about interest rates are therefore completely utopian. Once his utopian assumptions about interest rates are removed, Galbraith’s article actually demonstrates the opposite of what he is trying to prove. Or what comes to the same thing, U.S. economic growth would have to be higher than the 3 percent he assumes to keep the ratio of the federal debt to GDP stable under his assumptions.
The current tendency of the ratio of the U.S. federal debt to GDP to rise is a consequence of the period of very high interest rates that followed the Volcker shock, which I have explored elsewhere in this blog, and the increasingly slow growth of the U.S. economy combined with a series of tax cuts for the rich and the corporations—all in the name of boosting U.S. economic growth—that began with the so-called Kennedy-Johnson tax cut in 1964.
The rising federal debt to GDP ratio is not the cause of the decline of American capitalism, it is one of the consequences of the decline of American capitalism.
Deficits and inflation
The common denominator in all runaway inflations (3) is an explosion of the quantity of token money relative to the available quantity of real money material—precious metals in the form of bullion. In pre-capitalist times, if the gold and silver in the king’s treasury was low, the government would mint coins of the same denomination but containing smaller and smaller amounts of precious metal. As the quantity of coins of a given denomination grew faster than the quantity of bullion available, the price of bullion in terms of these depreciated coins rose.
And as the coinage became depreciated as measured by the price of bullion in terms of coins, the general level of commodity prices measured in terms of the debased coins rose. This led to a vicious circle where inflation drove up the government’s costs, which caused the government to debase the coinage still further. The inflation continued until the government finally reduced its expenditures—unless the situation was relieved by a rise in the quantity of bullion in the government’s treasury, perhaps as a result of military conquests or the discovery of rich new mines.
The same thing has happened under capitalism as well. The only difference is that since the invention of paper and the printing press, it has become possible to increase the quantity of token money at a much faster rate than it was in pre-capitalist times. This is why modern capitalist inflations are worse than ancient or medieval inflations were. However, it doesn’t really matter why the quantity of token money grows faster than the quantity of bullion. Any increase in the quantity of token money that is not matched by a comparable growth in the quantity of bullion—money material—will lead sooner or later to the depreciation of the token money leading to inflation.
However, the government does not have to be running deficits in order for a serious and even runaway inflation to occur. If the quantity of token money grows much faster for whatever reason than the quantity of real money material—gold bullion under modern conditions—the result will still be runaway inflation.
Today, inflation—a rate of growth of token money faster than the growth rate of gold bullion—can arise not only due to government budget deficits but out of the policy of the monetary authorities of preventing any fall in the cost of living in an attempt to prevent deep downturns in the industrial cycle.
When he ran for president in 1980, Ronald Reagan misrepresented the cause of the inflationary crisis that was then affecting the U.S. and other capitalist countries. Reagan claimed, just like the right-wing economists and politicians do today, that inflation was the result of the government spending more money than it was taking in—the classic cause of inflation in pre-capitalist times.
What Reagan forgot to mention is that while the debt of the U.S. government was increasing in absolute terms, it had been on a general downward trend relative to U.S. GDP since World War II ended 35 years earlier. The U.S. inflation of the 1970s, contrary to Reagan, was not caused by “excessive government spending and borrowing” but by the attempts of the Federal Reserve System to fight the cyclical overproduction crisis of the 1970s by expanding the quantity of token money at a much faster rate than the quantity of gold bullion was growing.
The economists of the day, which included not only Keynesian economists on the “left” but Milton Friedman on the “right,” believed that if the Federal Reserve System kept expanding the quantity of token money a serious economic depression would be avoided.
Ironically, Reagan’s own record as president shows how false the analysis that he presented during his successful run for the presidency in 1980 was. It was under the right-wing Republican Reagan administration that the downward trend of the federal deficit to GDP ratio reversed itself upward. Under his administration, deficits soared as Reagan and Congress cut taxes for the rich and vastly increased military expenditures in an attempt, which unfortunately was successful, to provoke a political crisis in the Soviet Union.
If federal deficits and excessive government spending were the real causes of the 1970s inflation as Reagan claimed, inflation would have vastly accelerated under his administration. Instead, the opposite happened. In reality, the only thing that the U.S. inflation crisis of the 1970s had in common with pre-capitalist inflations was that there was a rapid growth in the quantity of token money relative to the quantity of real money—gold bullion.
But the cause of the rapid growth of token money was not that the U.S. government was printing money to finance its deficits, but because it was facing a major crisis of overproduction, which it thought it could cure if only it kept the general price level in terms of dollars rising by continually devaluing the dollar against real money—gold.
No pre-capitalist government had to confront a crisis of the generalized overproduction of commodities. However, the inflationary crisis did manage to provoke a crisis in government financing as a secondary effect. In the fall of 1979, the U.S. government did actually face a plunging market for government bonds. But the crisis in the government bond market was the result of a general flight of money capitalists into “hard assets,” especially gold. Today, we are again seeing the dollar price of gold rise persistently, though not yet to the same degree that it did between August 1979 and January 1980, when it rose from below $300 to $875 per ounce.
What the money capitalists feared in late 1979 was that the Federal Reserve Board would attempt to prevent the federal funds rate from rising by increasing at an accelerating rate the rate of growth of the quantity of token money. But Volcker refused to do this and instead caused interest rates to soar. The dollar began to recover against gold and U.S. bonds began their long-term bull market.
However, the Volcker shock was too little and too late to prevent interest rates, both nominal and real, from rising to record levels and triggering “financialization”—the explosion of private debt, as I have explained elsewhere in this blog.
If today the Federal Reserve System reverses its policies of never allowing the cost of living to fall and allows deflation to proceed by resisting calls for QE3 (a third round of “quantitative easing”), and in the future holds the long-term rate of growth of dollar token money to the rate of growth in the quantity of gold bullion, we will no doubt experience a very deep depression, perhaps deeper and longer than the Depression of the 1930s. But the current low interest rates will be “locked in” for years to come even if the ratio of the debt to GDP rises considerably.
But if, as seems far more likely, the Bernanke Fed continues to allow the quantity of U.S. dollar token money to grow much faster than the rate of growth of gold bullion in a last desperate bid to stave off a much deeper depression, it will be only a matter of time before inflation explodes and U.S. government bonds start to crash and we will have “Volcker shock II”—almost certainly far worse than the 1979-82 “Volcker shock I.”
If this comes to pass, the bourgeois right will claim that the crisis was caused by “our” refusal to end the policy of “spend, tax and borrow” and to cut “entitlements,” when in reality its real cause will be the attempt to stave off the effects of capitalist overproduction—a crisis caused by the existence of a capitalist class—by inflating the quantity of dollar token money relative to the rate of growth of the total quantity of gold bullion.
How does Standard and Poor’s propose to deal with the budget problem?
S&P proposes to deal with the federal debt problem by saving American capitalism—if it can be saved at all—by reversing U.S. capitalism’s decline. And how do they propose to do that? Certainly not by the utopian interest rate policies of James Galbraith or still more tax cuts. Both Democratic and Republican administrations have carried out tax cut after tax cut for the rich and corporations in hopes of reversing the long-term decline of American capitalism, but these measures have failed miserably, though at times normal upturns of the industrial cycle have been falsely attributed to such cuts.
The real-world financiers that stand behind Standard and Poor’s undoubtedly understand the working of financial markets and interest rates a great deal better than James Galbraith or right-wing economists and politicians who claim that cutting taxes on the rich are sufficient to revive the fortunes of American capitalism. The S&P financiers do not have the luxury of engaging in such fantasies. They have to deal with capitalism as it is.
To understand why S&P takes the stand it does, we have to look at the basic nature of the capitalist wage system. Under capitalism, the population is divided into two primary classes: the capitalists, who own the means of production, and the workers, who have nothing to sell but their labor power in order to live. Ideally, from the viewpoint of the bosses, the workers should have no other income beyond the money they receive in weekly wages that they receive in return for selling their labor power—their ability to work—that they put at the disposal of the capitalists. The workers are then forced to perform unpaid labor above and beyond the value of their labor power—for the capitalists. This unpaid labor when it becomes embodied in the commodities that the capitalists sell—or try to sell—becomes what Marx called surplus value. Surplus value is the ultimate source of all non-wage income—the incomes of the remaining small commodity producers excepted.
Of course, ever since wage workers were forced to sell their labor power to the pioneering capitalists, the working class has been forced to struggle against this inhuman “doctrine” of capital. The struggle against capital has ranged from isolated strikes and protests to the socialist October Revolution of 1917 in Russia. And through centuries of struggle, the workers have forced the capitalist class to accept some responsibility for supporting retired workers who can no longer—or at least certainly do not want to—produce surplus value. As a result of centuries of struggle, workers can look forward to a few years at the end of their lives when they can enjoy life without “clocking in” in order to perform more unpaid labor so that millionaires and billionaires can live in luxury without having to work at all.
But the capitalists are by their very role as agents of the capitalist mode of production driven by the elemental economic laws that govern capitalism to take back concessions they have been forced to make to the working class. In the face of any weakening of the workers’ struggles, cut-throat competition obliges the capitalists to take back all the concessions they can and once again drive wages down toward the bare biological minimum.
This is the real reason why the U.S. capitalists are launching an attack on Social Security, unemployment insurance and Medicare and not the nonexistent crisis of the self-financing Social Security system.
Over the last 30 years, a large part of capitalist industry has relocated to China, India, smaller Asian countries and other countries where the value of labor power is for historical reasons much lower than it is in the United States, U.S.-occupied Europe, Australia, New Zealand and U.S.-occupied Japan. This has proven to be a very profitable arrangement for the U.S. capitalists as seen by their recent stellar profit reports. But it is extremely dangerous for the interests of U.S. imperialism as a whole. This is especially true as regards China, because in 1949 as Mao-Zedong put it, “China stood up.” Nothing has been the same since.
Many Marxists are disappointed by the fact that in recent decades the Chinese economy has developed along increasingly capitalist lines. Why the Chinese Revolution has developed in this direction as opposed to the socialist direction that most Marxists assumed it would after 1949 is a question that would take us far beyond the scope of this blog. But we cannot ignore reality. The growth of capitalism in China has included a very cruel exploitation of Chinese workers by both imperialist corporations and the increasingly wealthy and assertive Chinese capitalist class—though for now the Chinese capitalists are still content to remain the junior partners of the U.S. empire.
But the basic conquests of the Chinese Revolution remain intact. In a backward, overwhelmingly pre-capitalist country like China was in 1949, the growth of industrial capitalism is historically progressive though not as progressive as the building of socialism would be. Except for Taiwan, China remains off limits to U.S. military and political power. With its large defensive military and limited but real nuclear deterrent, an invasion of China by the U.S. military seems out of the question.
Therefore, the U.S. exploits China economically but does not control it either politically or militarily. Instead, U.S. capitalism is becoming ever more dependent on the Chinese working class that is producing ever greater amounts of surplus value that is showing up on the “bottom line” in U.S. corporate reports. How long will the increasingly assertive Chinese capitalist class be willing to share the surplus value that it is wringing out of the Chinese working class along with the U.S. capitalists?
And even more importantly, how long will the Chinese workers be willing to keep on producing the huge and ever-growing amounts of surplus value for both the Chinese capitalists and the capitalists of the U.S. and its imperialist satellites in Europe, Australia, New Zealand and Japan? The rapid growth in the demand for the commodity labor power in China is putting upward pressure on wages, though Chinese wages are still very low. If rising wages, and a rising organic composition of capital that the rise in wages encourages, lead to a fall in the rate of profit on capital invested in China, Chinese capitalists will be less willing and indeed less able to share profits with the U.S. capitalists.
And what would happen if the Chinese workers assert their right to actually own and manage the rapidly expanding means of production in China? In that case, the huge amounts of surplus value that is showing up in the stellar earnings reports issued by U.S. corporations would vanish.
The role of the current slowdown in the rate of growth of the world market
It is now pretty clear that the world capitalist market is passing through one its periodic prolonged phases of reduced growth that have marked the history of capitalism since the 19th century. In contrast, between 1945 and 1970 the world market was in a phase of accelerated expansion that was really part of the aftermath of the Great Depression. Under these conditions, the U.S. could tolerate the rapid growth of industry in Western Europe and Japan, because even if the share of U.S. industrial capitalists in the world market necessarily shrank, the absolute size of the markets available to them was still expanding.
This was all the more tolerable because in the final analysis to the extent that capitalist industry was shifting out of the United States, it was shifting to U.S.-occupied and controlled countries such as West Germany and Japan. How different conditions are today.
Not only is the world market growing much more slowly than in the “golden” post-World War II years, but increasingly industrialization is spreading not only to China but to a lesser extent India, which the U.S. can hardly occupy and control the way it controls such relatively small countries as Germany and Japan.
American imperialism can therefore tolerate less and less the continued “de-industrialization” of the U.S. economy—its increasing dependence on the surplus value produced by workers of other countries. If the de-industrialization of the U.S. economy is not reversed, it will be only a matter of time before the U.S. empire falls, reducing the U.S. to a producer of raw materials that are exchanged against consumer goods produced in other countries like was the case before the rise of America’s industrial might in the 19th century. (4)
This would mean a dramatic decline in the profits of U.S. corporations and no doubt the bankruptcy of many, perhaps most, of them. The owners of the stocks and bonds of these corporations will lose huge amounts of their capital when the U.S. empire falls. Therefore, the U.S. capitalists have no choice but to move to dramatically increase the rate of surplus value—that is, the ratio of paid to unpaid labor at home.
If they can do this successfully, the capitalists behind S&P hope—assuming the world market grows fast enough, which is another question altogether—that the rate of U.S. economic growth will accelerate between the inevitable crises of overproduction—perhaps beyond the 3 percent that James Galbraith assumes, and then the rate of growth of the ratio of federal debt to GDP can be paid down.
But social insurance, especially unemployment insurance, stand in the way. Imagine if there was no unemployment insurance and you faced immediate starvation as soon as you exhausted any savings you had managed to accumulate. You would be forced to take a job at virtually any wage. This is exactly the situation that S&P wants and that U.S. capitalists need. And now we come to the real reason why S&P downgraded the U.S. debt.
Standard and Poor’s is saying to the politicians in Washington, you are playing the same old games. You refuse to raise taxes, and you still shy away from what really needs to be done. You must abolish—or at the very least drastically weaken—social insurance, not because it is too “expensive” but because it stands in the way of the radical rise in the rate of surplus value we—the capitalists—need.
This time things have to be different. We are no longer living in the days of Franklin Roosevelt, when America had built up the greatest industrial machine to extract surplus value from the workers at home that the world had ever seen. Nor is it even the time of Ronald Reagan, when budget cuts could be targeted towards only the most oppressed sections of the working class, sparing the “middle class” of highly paid privileged workers. It is time, S&P is saying, to draw blood before the U.S. workers get organized and the spirit of Madison, Wisconsin, re-emerges and spreads.
Indeed, it is long past due for the U.S. workers to begin to fight back. But this time, unlike the 1930s, the perspective cannot be for a new “New Deal.” The New Deal was possible because American imperialism was at the peak of its industrial power relative to its capitalist rivals. That world is gone forever. Instead, the aim has to be the abolition of the capitalist system of wage labor once and for all.
1 Though the U.S. Secretary of the Treasury prints the dollars, they are actually issued through one of the 12 Federal Reserve banks that constitute the U.S. Federal Reserve System. As late as the 1960s, the Treasury issued a certain quantity of currency directly. These bills were officially called United States Notes, but in all other respects they were identical to the Federal Reserve Notes that are issued through the Federal Reserve banks.
2 Marxists should not make such a demand. Instead, our slogan should be “not one penny for this government.” This slogan is sometimes misunderstood as a pacifist slogan for “unilateral disarmament.” But it is nothing of the kind. What the slogan really aims to do is to underline the point that Karl Liebnecht, the great German socialist and friend of Rosa Luxemburg, made when World I broke out.
Liebnecht explained that “the main enemy is at home.” Whatever the capitalist class and its spokespersons may claim, the function of the huge repressive machinery, including the military and the “intelligence community,” is to act as the last line of defense against the working class. In the United States, this means that our main enemy is not a foreign “dictator” like Gaddafi or Assad or “terrorists” like the late Osama bin Laden, or the even the rising capitalists of India, China or Brazil. It is the capitalist class right here at home.
That is why we demand no money for this—that is, the capitalist—government even if the military budget was reduced to the level where it was only large enough to defend the actual territory of the United States. After a workers’ government is established in the United States, if there are still capitalist governments in other parts of the world that could menace the North American workers’ republic, we would of course need to maintain a military to defend our workers’ republic.
Hopefully this will not be the case and it would be possible to abolish militarism—even working-class militarism—once and for all. In any event, this will become possible only after capitalist class rule has been replaced by the rule of the workers throughout the world. However, as a bourgeois progressive, Galbraith has no notion that “our own” capitalist class is the main enemy. He believes that through enlightened Keynesian-inspired policies, capitalism can be made to work for the benefit of the U.S. workers and capitalist alike.
It is therefore worth noting that progressive James Galbraith fails to call for the reduction of the U.S. military to the level necessary to defend the current bourgeois republic in North America, like was the case as late as the 1930s. If this were done, it would be much easier to reduce federal spending to the levels that could actually make it possible to establish a “sinking fund” to gradually retire the entire federal debt while safeguarding and expanding Social Security including Medicare—and indeed expand Medicare for all Americans—safeguard the unemployment fund and launch desperately needed public works.
However, Galbraith takes for granted the continuation of the U.S. world empire that was established as a result of the U.S. victory in World War II—the main historical achievement of Franklin D. Roosevelt—and that requires huge and costly military expenditures to maintain. It is within this framework of a still very powerful but declining U.S. empire that Galbraith is attempting to find a way to arrest the growth of the ratio of the federal debt to GDP.
3 Rising prices have also been caused both in pre-capitalist and capitalist times by the actual devaluation of money material—that is, by a faster growth in the productivity of labor in gold or silver mining and refining than was the case in most other commodity-producing industries. But compared to the possibilities of debasing coinage, not to speak of paper money, the rise in prices caused by the devaluation of the precious metals has been relatively slow.