From the 1974-75 Recession to the ‘Volcker Shock’

As I explained last week, the devaluation of the U.S. dollar in terms of gold had temporarily halted by the end of 1974. After peaking at $195.25 an ounce on December 30, 1974, the dollar price of gold had fallen to $104.00 on August 31, 1976.

As a result, during 1975 the rate of U.S. inflation as measured by the government producer price index was “only” about 4.4 percent. Still, the official producer price index rose more in the recession-depression year of 1975 than it had in the inflationary boom year of 1965. This despite a slump that was considerably worse than that of 1957-58.

The U.S. workers—and workers in other capitalist countries—were hit in two ways. One, workers’ living standards were lowered by the rising cost of living in terms of the devalued currency their wages were paid in. In a more traditional type recession-depression, the cost of living would have been expected to fall.

Second, just like was the case in a traditional crisis-depression, wages were under downward pressure from the high rate of unemployment. In the case of U.S. workers, this was on top of the disastrous—for U.S. workers—wage and price controls that had been imposed by the Nixon administration.

Keynesians plead ‘special circumstances’

Neither the U.S. government nor the Federal Reserve System was quite ready yet to ditch the Keynesian economics that dominated “macro-economics” up to that time. As I explained last week, the Keynesian economists pleaded special circumstances in order to explain away the inflationary economic crisis of 1974-75.

The Keynesian economists claimed that the Arab oil boycott of late 1973 and early 1974 followed by the sharp rise in the price of oil carried out by the “OPEC cartel” had caused prices in general to soar. This inflation, in turn, reduced real purchasing power, which led to the severe recession of 1974-75. Indeed, the capitalist media and most economists of the time described the recession of 1974-75 as “oil-induced.”

The Keynesians economists overlooked the fact that the global oil industry had long been dominated by the “seven sisters” international oil cartel, which OPEC was now challenging. (1) Why was the oil cartel of the oil-producing oppressed nations inflationary, while the oil cartel of the big oil corporations owned by American and European capitalists was not?

Perhaps due to the continued high unemployment left over from the 1974-75 recession, continuing if reduced inflation, as well as the aftermath of the Watergate scandal that had swept the Nixon administration away, the Democratic candidate for president, Jimmy Carter, managed to defeat the unelected Republican president Gerald Ford in the 1976 U.S. presidential election. (2) The new Democratic administration wanted to continue the traditional Keynesian policies. After all, Keynesian policies had worked reasonably well before 1968. Why wouldn’t they work again in the future?

As previously mentioned, by late August 1976, the dollar price of gold had fallen back to $104.00 an ounce. This was achieved at least in part by renewed U.S. gold sales on the open market, designed to discourage speculation in gold. The fact that these sales were deemed necessary shows that the broader economic crisis that had begun with the collapse of the London Gold Pool in March 1968 had not been overcome. This was the case notwithstanding the rise in industrial production and the reduction in the rate of inflation that became apparent from the spring of 1975 onwards.

However, even before the U.S. presidential election of November 1976, the dollar had resumed its decline against gold. This was a very bad omen for the new Democratic administration of Jimmy Carter. At first, however, the renewed decline of the dollar was modest. It wasn’t until July 1978 that the dollar price of gold rose above the $195.15 level first reached on December 30, 1974. Soon after this happened, the whole “recovery” that had begun in the spring of 1975 began to unravel. The chronic crisis that the U.S. and world economies had faced since March 1968 was about to become acute once more.

In 1976, as a result of what proved to be a short-lived partial recovery in the dollar’s value against gold, the producer price index rose just 4.84 percent, only slightly higher than the rise that occurred during the crisis-depression year of 1975. The federal funds rate, which had risen to as high as 14.33 percent during the crisis in 1974, fell back to 4.72 on January 23, 1976.

The ability of the Federal Reserve System to lower the federal funds rate to the relatively low level of 4.72 without the dollar price of gold soaring was a sign that the acute monetary crisis of 1973-74 had been eased, though only at the price of the deep industrial slump of 1974-75.

Long-term interest rates remain stubbornly high

However, long-term interest rates fell far less than the federal funds rate. The rate that the federal government had to pay on 10-year bonds hit 8.13 percent in September 1974. On September 16, 1975, the rate for these bonds hit 8.59 percent, a bad sign for the economic “recovery” that had begun the previous spring. On December 28, 1976, reflecting the rise in the gold value of the dollar, the interest rate on “10-year governments” fell to a still historically high level of 6.84 percent.

This showed that the money capitalists still lacked long-term confidence in the dollar. They feared—and as it turned out, correctly—that the massive devaluation of the dollar would soon resume. The stubbornly high rate of interest was particularly alarming for Keynesian economists.

Remember, Keynes in his “General Theory” had counted heavily on the alleged ability of the “monetary authority” under a paper money system to lower long-term interest rates by increasing the supply of token money. Just as an increase in the quantity of gold money, all else remaining equal, will lower long-term interest rates, Keynes hoped that an increase in the quantity of token money—not metallic money—created by the “monetary authorities” would also lower interest rates.

Keynes made the mistake—fatal to his conclusions—that token money would follow the same laws as metallic money. However, as I explained in my second post on money, token money follows quite different laws than gold money. What happened next provided a classic illustration of this. (3)

Soon after the dollar resumed its decline against gold, long-term interest rates began to rise once more. By the summer of 1979 with the dollar price of gold hovering around $300—well above the high point reached in the crisis year of 1974—long-term interest rates were around 9 percent, higher than they had been at any stage during the crisis of 1974-75. (4)

Inevitably, by 1978 the rate of inflation as measured by the U.S. producer price index accelerated once again, rising by more than 10 percent that year. It was becoming clear to both the men (5) on Wall Street and in Washington that something was very wrong with Keynesian economics.

In August 1979, U.S. President Jimmy Carter appointed fellow Democrat Paul Volcker as chairman of the Board of Governors of the Federal Reserve System. Volcker, who had been head of the Federal Reserve Bank of New York, the Federal Reserve Bank closest to Wall Street, was—and is—highly respected in top Wall Street and Federal Reserve System circles. It wasn’t long before the new Fed chief faced a major crisis.

The crisis of 1979-80

At the time of Volcker’s appointment in August, the dollar price of gold—the measure of the dollar’s growing depreciation against gold—was fluctuating around $300 or a little less. On January 21, 1980, gold was quoted at $850 a troy ounce at the afternoon London gold market fixing. (6) In intra-day trading, the dollar price of gold hit $875 before falling back. That is, the U.S. dollar had lost considerably more than half its gold value within a period of only five months.

In August 1979, one dollar had represented 1/300th of an ounce of gold, or a little more on some days, while on January 21, 1980, the dollar represented only 1/850th of an ounce of gold. It was becoming clear to the leaders of the Federal Reserve Board that a drastic change in polices were necessary if U.S. and world capitalism was to avoid a disaster far worse than even the super-crisis of 1929-33.

Paul Volcker, Milton Friedman and the crisis

The immediate problem that Volcker faced was similar to the problem that the U.S. and world capitalist economies had faced in 1973-1974. But now the situation was far more serious. By giving Keynesian economics “one more chance” and following “expansionary policies,” the Federal Reserve System had dealt a mighty blow to what remained of the confidence that the world’s money capitalists held in the U.S. dollar—then as it still is today the main reserve currency of the capitalist world. (7)

Confidence in the U.S. dollar was collapsing as money capitalists dumped dollar-denominated assets and shifted to gold or primary commodities such as oil. It seemed that the world capitalist economy was on the brink of its first global runaway inflation in its history.

While many capitalist countries have experienced runaway inflation or even hyper-inflation, runaway inflation has never hit the central or reserve currency. If the dollar succumbed to runaway inflation, it would drag down every other capitalist currency with it. If this ever happens while the dollar remains the reserve currency, the result will certainly be the worst crisis—not excepting the super-crisis of 1929-33—by far in the history of capitalism. (8)

After the German mark collapsed in 1923, the German currency and credit system had been stabilized by massive loans from the United States. But if the dollar had gone the way of the German mark, who would make the loans to the United States to re-establish a functioning currency and credit system?

It was the threat of just such a nightmare crisis that Paul Volcker faced shortly after he assumed office.

The immediate task before the Volcker Fed was to break the panicky demand for gold. And under capitalism, there is only one way to do this. Interest rates would have to rise and rise drastically and then stay at extremely high levels for an extended period of time. Any further delay, even a delay of a few weeks—or even days—would mean that interest rates would have to rise considerably more and stay up all the longer to break the abnormal demand for gold. If this were not done, the necessary degree of confidence in the dollar as a national and world currency, without which the modern capitalist economy could not function, would not be restored.

The political problem

The problem facing Volcker and his colleagues at the Federal Reserve Board was not really technical. Under a paper money system, it is not that hard for a capitalist central bank like the U.S. Federal Reserve System to raise interest rates when confidence in the currency plunges. All the central bank has to do is to slow the rate of growth of its creation of token money, or simply refrain from increasing it. The real problem facing Volcker and his colleagues at the Fed was political.

High interest rates are extremely unpopular among people of virtually all classes except for the money capitalists. If the Fed had announced that much higher interest rates were necessary—which they certainly were—and then proceeded to take the actions necessary to raise them, there would have been a huge public outcry. The demand would have been raised for Congress and President Carter to oust Volcker and take direct command of the Fed. (9)

Instead, the ruling group in the United States—this was before Reagan’s election—made the decision to dump Keynes and instead embrace the theories of Milton Friedman. By dumping Keynes, the Reagan era of “neo-liberalism” in a very real sense was already beginning even though Reagan’s actual election was still more than a year in the future.

In contrast to Keynes and to the central bankers themselves, who are after all practical people, as I explained in earlier posts, Friedman advocated a slow, steady rate of growth of the money supply, which he defined as cash that was not deposited in the banks plus the credit money—checking account deposits—created through bank loans.

As I explained in earlier posts, Friedman dogmatically insisted that the capitalist economy was extremely stable, abstracting the quantity of money. All the real instability—the inflations, booms and busts—that mark the actual history of capitalism, Friedman insisted, were caused by a single variable—the quantity of money. The University of Chicago professor then went on to treat the quantity of money as though it was external to the capitalist system.

Under the gold standard, according to this arch-reactionary University of Chicago economics professor, changes in the quantity of money were determined by changes in the balance of payments and globally by the level of gold production. That is why Friedman supported Nixon’s decision to finally end the dollar’s limited convertibility into gold in August 1971 while denouncing the rest of Nixon’s “anti-inflation program.”

But Friedman complained that the Federal Reserve Board, as a “government” agency, was doing a lousy job of keeping the rate of growth of the “money supply” stable. In the early 1930s, the Fed had allowed the money supply to contract by one-third, allegedly bringing on the Great Depression. In the 1970s, it was making the opposite mistake and was allowing the money supply to soar. The cycles of booms and busts, Friedman held, would virtually disappear if only the central banks would finally follow his advice and stabilize the rate of growth of the “money supply.”

Since capitalist central banks under a paper money system only really control the quantity of token money it issues—the monetary base—Friedman’s theory comes down to the claim that the ratio between the broader money supply (cash plus credit money) and token money is stable, or at most changes only very gradually over long periods of time. It also depends on the turnover of money—the velocity of circulation—also being stable.

But the concrete history of capitalism shows that neither the ratio of the broader money supply to the monetary base or the velocity of circulation of the currency is stable. Even if these variables are somewhat stable over periods of decades, they are certainly not stable over the course of the industrial cycle.

During crises, as I have already demonstrated, the quantity of credit money contracts sharply relative to the monetary base, and the velocity of circulation slows dramatically. The classic demonstration of this occurred during the super-crisis of 1929-33. The rate of growth of the monetary base accelerated just as the Friedman-defined “money supply” began to contract rapidly in 1931. This is all illustrated in the concrete statistical data that is found in the back of Friedman and Schwartz’s own “Monetary History.”

The crisis that we have been passing through also illustrates these basic economic laws. During the fall-winter of 2008-09, though the Fed doubled the “monetary base,” the broader money supply grew much more slowly, while the velocity of circulation declined sharply.

During booms, in contrast, the supply of credit money expands rapidly relative to the monetary base as demand for bank loans soars, and the velocity of circulation of the currency accelerates. Far from being the cause of the industrial—or business—cycle, fluctuations in the “money supply” as defined by Friedman are the consequences of the cycle. Friedman built his entire theory of inherent capitalist stability on this fallacy—inverting cause and effect.

As a practical macro-economist and banker—not an ideologue—the Democrat Volcker knew full well that Friedman’s theories were nonsense. Volcker had only contempt for Friedman as an economic theorist who had spent his entire adult life as a professor and unlike Volcker had never actually worked in either a commercial or a central bank. Volcker had done both. However, as it turned out, Friedman was very useful politically.

Friedman had his uses

During the 1970s, Friedman wrote a popular economic column that appeared in Newsweek magazine, where he was paired off against the conservative pro-business “neo-Keynesian” Paul Samuelson. As the decade of the 1970s wore on and inflation kept on accelerating, Friedman’s “common sense” claim that inflation would not go away until the rate of growth of the “money supply” was reduced, as he explained in popular language in his Newsweek column, made him appear to be some sort of economic genius compared to the blundering Keynesians.

In contrast to the Keynesians, Friedman kept predicting—correctly—that inflation would accelerate and that accelerating inflation would not solve the growing unemployment crisis. And the University of Chicago professor kept on being vindicated on these points by the course of events as the decade wore on.

Therefore, the Federal Reserve System shortly after Volcker’s appointment decided that instead of announcing that they were going to raise interest rates sharply—which was their real policy—they would announce that from now on the “quantity of money” would be targeted, as opposed to interest rates such as the federal funds rate. The Federal Reserve leadership could then explain that since they no longer targeted interest rates, they could do nothing about the skyrocketing rate of interest.

The ‘Volcker shock’ takes effect

As the “Volcker shock” unfolded over the next three years, unemployment soared, credit-sensitive industries such as residential construction and automobiles plunged into deep depression, and much of basic industry—especially that of the older capitalist countries such as the United States and Britain, collapsed. The “rust belt” was born as much of the U.S. steel industry—which had been the backbone of the huge U.S. industrial machine—was shut down and the plants literary demolished.

Unlike the case during the Depression, when plants idled by the super-crisis were reopened as that crisis passed, this time the plants were closed for good. The same process was unfolding in Britain, the birthplace of modern industry, under the government of Margaret Thatcher.

In the United States, whole cities that had been built around heavy industry such as Buffalo, New York, were devastated. As the old U.S. steel industry that was centered in Pittsburgh, Pennsylvania, all but died, the United Steel Workers union, which had represented the workers who for generations had worked in these plants, was largely wiped out. Today, a generation later, the United Steel Workers of America is only a shadow of its former self.

African Americans especially hard hit by the Volcker shock

Especially from World War I onward, African Americans were able to get jobs—though they were the worst and most dangerous jobs—in heavy industry. Escaping from the dying sharecrop economy of the old Jim Crow South, they were able with the rise of the Congress of Industrial Organizations to gain experience in union organization—though unfortunately the new CIO unions were far from free of racism. But at least the CIO, for all its defects, gave the African American workers an arena in which to fight.

The experience gained by the African American working class in the unions prepared the way for the Civil Rights movement of the 1950s and 1960s. But the “Volcker shock” slammed the door that had been opened for African Americans—and poor people of other races and nationalities as well—that the CIO had opened. The results a generation later are ruined cities, working-class youth—especially working-class youth of color—who have never had a job, the rise of urban youth gangs that live off the drug trade, and a soaring prison population that is now well above 2 million and rising.

Paul Volcker quickly became one of the most hated men in America. “Volcker’s Fed,” Wikipedia writes, “also elicited the strongest political attacks and most widespread protests in the history of the Federal Reserve (unlike any protests experienced since 1922), due to the effects of the high interest rates on the construction and farming sectors, culminating in indebted farmers driving their tractors onto C Street NW and blockading the Eccles Building.”

But he was and is well respected on Wall Street. Today, much to the chagrin of the liberal-progressive wing of the U.S. Democratic party, he serves as a senior economic advisor to President Barack Obama. Naturally, many well-meaning progressives wonder: What is this Wall Street favorite, the hated chief organizer of the Volcker shock, which destroyed the chances of several generations of working-class youth—especially African Americans youth—doing in the administration of the liberal first African American U.S. president.

Was there an alternative to Volcker’s policies?

In volume III of “Capital,” Marx wrote: “For the sake of a few millions of money many millions of commodities must therefore be sacrificed. This is inevitable under capitalist production and constitutes one of its beauties.”

In other words, the Bank of England, in order to save a few millions in gold in its vaults, had to sacrifice much of the wealth of the nation. And Marx described this ironically as one of the “beauties” of the capitalist system.

The founder of scientific socialism, however, did not denounce the Bank of England for doing this in the way U.S. progressives denounced Paul Volcker for doing exactly the same thing. Instead, Marx was using the irony that was characteristic of him to explain how under the capitalist mode of production the Bank of England had no real choice. And that as long as the capitalist system lasted, so would this “beauty”—along with the other “beauties” of the capitalist system.

Unlike Marx, the Keynesian economists—many no doubt well-meaning reformers—believed that there must be a way of removing this “beauty” from capitalist system. But the crises of the 1970s—even more than the super-crisis of 1929-33 and even than the crisis of 2007-09—demonstrate the need to periodically sacrifice the wealth of the nation—and the lives of the workers—in order to save the gold bars in the vaults of the central banks, or the gold value of the currency under a paper money system.

It is a built-in feature of the capitalist system. You cannot get rid of this necessary “beauty” without the transformation of the capitalist system into socialism. This was the conclusion of the greatest economic scientist of all times, Karl Marx. And Marx’s finding was confirmed in practice by the crisis of the 1970s and its climax—the “Volcker shock.”

Therefore, the “real barbarous relic” isn’t the role of gold within the capitalist monetary system, as Keynes claimed. Nor is gold the cross that weighs down on the backs of labor as the sliver-tongued William Jennings Bryan proclaimed. The real “barbarous relic,” the “cross” that weighs down on the backs of all those who work, is the capitalist system itself.

As long as the system whereby a few benefit from the wage labor of the many persists, the periodic sacrifice of the wealth created by exploited wage labor—and of the workers themselves—in order to safeguard wealth in the form of gold bars in the central bank or government treasury, or the gold value of the currency under paper money systems, will persist. That is the real lesson of the 1970s and the Volcker shock.

The real alternative

Under the conditions prevailing in 1979—that is, a crisis of overproduction that had long been prevented from coming to a climax as a result of repeated “Keynesian” interventions in the economy—the only alternative to the Volcker shock was to end the contradiction between the socialization of the process of production and the private appropriation of the product, which is the real cause of the periodic crises of overproduction.

In other words, the only alternative to the Volcker shock—and the “monetarist” policies in Britain presided over by Margaret Thatcher and similar policies in other capitalist countries—would have been a socialist revolution.

However, no economic crisis, no matter how severe, can bring about a socialist revolution automatically. That was true during the super-crisis of 1929-33, it was true during the 1970s, and it is true today. The socialist transformation of society must be carried out as a conscious act of liberation by the working class. For many reasons that are far beyond the scope of these posts, neither the U.S. working class nor the global working class in 1979 was anywhere near the level of organization and class consciousness that would have been necessary to carry out such a revolution.

Given this political reality—and of course our job as Marxists is to change this political reality—there really was no alternative to the Volcker shock. Many well-meaning liberals and progressives who want to avoid the dangers of revolutions and the excesses that often accompany them—and unfortunately many Marxists—have described Volcker’s policies as a mistake.

According to them, Volcker and the Federal Reserve System should have expanded the quantity of token money to the extent that was necessary to prevent the already extremely high interest rates of August 1979 from rising further. This they claim would have avoided the Volcker shock.

Exactly how the collapse of the dollar and the other capitalist currencies would have been avoided is something they fail to explain. If the progressives are correct, then Paul Volcker is one of the greatest criminals in history. Yet far from being treated as a criminal, he is serving in the current liberal Democratic administration, and has always been a member of the Democratic Party, the party supported by virtually all American liberals and progressives.

If we claim Paul Volcker made a “mistake” when he allowed interest rates to rise as high as they did, what we are really doing is to cover up the realities of the capitalist system. This is, of course, exactly what the professional bourgeois economists are paid to do, whether they are Austrians, traditional neoclassical marginalists, Keynesians, or Friedmanites.

However when Marxists prettify the capitalist system—through the failure to fully appreciate and understand the economic discoveries of Marx—we are betraying our mission. Our mission is to tell the truth about the capitalist system, no matter how ugly this truth is. And the truth about capitalism is very ugly indeed!

The Volcker shock was therefore no mistake. It was necessary at the time in order to maintain the capitalist system of exploitation of wage labor in the long run. The “masters of the universe” on Wall Street know this full well, which is why they respect Paul Volcker, and this is why he is today a senior advisor to President Obama.

As Marxists, we of course despise the Paul Volckers and their ilk for devoting their considerable intelligences and talents to extending the life of the capitalist system. We must despise them for their real crime. Their real crime is the defense of the capitalist system despite all its “beauties.”

Remember, they did not create the capitalist system, and did not craft its beauties. If they had been able to design a system of exploitation from the ground up, we can assume as intelligent and sane human beings, they would have designed a more rational system. But as practical people functioning in the real world, they have no choice but to defend the capitalist system as it is, and not a more rational system of exploitation that can exist only in the minds of reactionary ideologues like Milton Friedman, or in the heads of well-meaning Keynesian reformers.

The numbers tell the story

When Paul Volcker was appointed, the the federal funds rate was already well over 10.50 percent and closing in on 11 percent. But by the end of October, the federal funds soared to over 16 percent as the Volcker Fed moved to keep the growth of bank reserves to a rate below the soaring rate of inflation and the consequent growth in the demand for credit defined in dollar terms.

Despite this, the dollar price of gold—the measure of the dollar’s depreciation against gold—continued to soar. This shows how much Keynesians policies had “succeeded” in undermining the confidence of the money capitalists in the currency. Not until January 21, 1980, did the dollar hit rock bottom.

How high would the dollar price of gold have risen—or more properly how far would the gold value of the dollar have fallen—if the onset of the Volcker shock had been postponed for a few months or even a few more weeks?

On March 14, 1980, Carter imposed credit controls—that is, restricted the ability of the commercial banks to sell securities for cash. This drove the fed funds rates even higher. On March 28 and 29, the fed funds rate soared to 19.71 percent! As the commercial banks halted bank loans, the supply of credit money—checking account deposits—and with it the “real economy” began to plunge. Since the Volcker Fed was committed to a reduced rate of growth in the money supply—not a dramatic contraction—it quickly reversed policy. President Carter quickly canceled the credit controls.

The super-high interest rates finally broke the demand for gold. On January 21, 1980, gold closed in London at $850 an ounce. Remember, it had been under $300 an ounce five months before. But right after Carter announced his credit controls, the dollar price of gold fell briefly below $500. The collapse of the dollar against gold was bought to a screeching halt.

As the credit controls were lifted, interest rates plummeted. By May 1980, the fed funds rate had fallen below 9 percent. Soon the level of economic activity, which had been falling rapidly as credit contracted, began to revive. The National Bureau for Economic Research quickly announced the “contraction” of 1980 was over and a new economic expansion was beginning. Though the recession had been sharp, it was also the shortest on record, according to the NBER and the capitalist media.

However, the extremely sharp fall in interest rates caused the demand for gold to begin to soar once again. By October 9, 1980, gold closed in London at $690.00 an ounce. The run into gold, which had been briefly halted by the sky-high interest rates and recession in the spring, was gaining momentum once again as interest rates fell. The only solution available to the Volcker Fed was to again restrict the growth of its token money, which would enable the rate interest to rise sufficiently to break the renewed rush into gold before it gained even more momentum, even if this meant that interest rates would rise above their heights of March 1980.

They also had to avoid any repetition of the mistake—and it really was a mistake—they made in the spring and summer of 1980 of easing too quickly in the face of weakening economic data. Interest rates would not only have to rise sharply again, they would have to stay up for a prolonged period.

And this is exactly what happened. By mid-December 1980, the federal funds rate was above 20 percent. By the end of December, the fed funds rate reached 22 percent, higher than they had been in March during Carter’s short-lived credit controls.

Long-term interest rates tell a similar story. On March 24, the rate of interest on 10-year U.S. government bonds hit 13.17 percent. But on September 8, 1981, long-term interest rates rose to 15.59 percent. This was the price for the “premature” easing during the summer of 1980.

With interest rate levels like these, the “recovery” the economy had begun in the summer of 1980 had no chance of lasting. This “recovery” was truly dead on arrival. By the fall of 1981, the NBER was forced to acknowledge that the “expansion” of 1980-81 had turned out to be shortest in history. It goes without saying that a one-year “expansion” does not represent a real upturn in the industrial cycle!

This time, the Volcker Fed was determined to keep interest rates up for an extended period of time, even though it would mean a severe and long recession. If the Fed eased rapidly again as recession took hold, the money capitalist would stampede back into gold with even more disastrous consequences, leading to still higher interest rates and ultimately an even deeper recession.

The rate of profit during the 1970s

It is widely understood that inflation exaggerates profits. If commodity prices rise in the period between the time that the production process is completed and the time the commodities are sold, profits will rise accordingly. However, if prices keep on rising, more money will be necessary just to carry out production on the same scale, let alone on the expanded scale that the capitalist economy requires.

Therefore, most economists assume that profits during periods of inflation are partially illusionary. Various attempts to adjust profits for the inflation of the 1970s have been made by economists, both bourgeois and Marxist.

The problem with these estimates is that their authors don’t understand that what matters in capitalist production is not “real profits” in terms of commodities—”real purchasing power”—but profits in terms of money—that is, real—gold—money. Economically real profits must always be measured in terms of the use value of the commodity that serves as money.

A capitalist deciding whether to expand his or her real capital now or rather to wait for a more favorable moment does not have a choice of holding “unchanging real purchasing power” or investing. The only choice is between holding money in some form or investing.

True, the purchasing power of money—even gold money—is a variable and not a constant. Despite this fact, the exchange values of commodities and capital are always measured in terms of money. Pure real purchasing power as some sort of mathematical constant does not and cannot exist outside of the imagination of economists and statisticians.

Indeed, during periods of crisis, the fact that the purchasing power of money is not a constant but a variable is actually an advantage to its holders, since the purchasing power of money rises. Even—and especially—during the inflationary 1970s while the purchasing power of paper money was declining, the purchasing power of gold money was increasing.

When the official currency is rapidly losing purchasing power, the capitalists can hold real money—gold—instead of the depreciating currency, but not unembodied, unchanging “purchasing power.” During the 1970s—leaving aside the production of gold itself—holding gold was more “profitable” in terms of depreciating paper currencies than practically every other “investment,” with the possible exception of holding non-reproducible works of art.

During the decade of the 1970s, misers who simply hoarded gold emerged richer than those individuals and corporations who attempted to act as capitalists—that is, to expand their capital as measured in the use value of gold. As it became evident that simply holding gold—hoarding it—was the best “investment,” more and more capital flowed into gold.

This explains why it took ever higher rates of interest to prevent the dollar and the other paper currencies linked to it from collapsing altogether. Such a situation could not be long maintained. Capitalism could not have continued if had not returned to profitability on a gold basis. Or what comes to exactly the same thing, a capitalism where simply hoarding gold is more “profitable” than actually carrying out capitalist production cannot exist for very long.

By the end of the decade, the situation where hoarding gold was far more profitable than carrying out capitalist production—the actual extraction of surplus value from the working class—could not continue. Something had to give. And it did in the form of the Volcker shock, which restored capitalism to genuine profitability as measured in terms of gold.

Therefore, during the 1970s the capitalist economy was actually operating at a loss in terms of real money—gold. This does not mean that workers were not producing surplus value any more than the massive losses of the early 1930s meant that workers weren’t producing surplus value. What it did mean was that though surplus value was being produced by the workers it wasn’t being realized in terms of real money. This was a situation that could not last. This is why the Volcker shock or an even more unpleasant shock was absolutely necessary if the capitalist system of production was to continue. (10)

What really happened during the 1970s?

As both interest rates and inflation rates soared during the 1970s, the Keynesian economists tried to comfort themselves with the thought that while nominal interest rates were climbing, the “real” rate of interest was “below” zero. Therefore, even if the “monetary authorities” couldn’t control the nominal interest rates, they could, the Keynesians argued, still control the “real rate” of interest. And, the Keynesians argued, isn’t it the real rate of interest—the rate of interest in terms of commodities, not money—that matters?

However, when inflation fell dramatically during the Volcker shock, nominal interest rates remained stubbornly high. The long-term rate of interest on government bonds, for example, didn’t fall below double-digit levels until 1985! Suddenly it wasn’t only nominal interest rates that were very high, it was “real” interest rates—interest rates in terms of commodities—that were extremely high, as well the interest in terms of real money—gold.

This was all the more ironic because Keynes had predicted that interest rates would fall toward zero as “scarcity” vanished and the rentiers would be “euthanized.” But that was not how things worked out. The era of “financialization,” when the money capitalists—Keynes’s rentiers—were to thrive like never before, was dawning.

Price, profit and gold production in the 1970s

Earlier, I explained that the growth in world gold production, which was slowing sharply in the late 1960s, started to drop in 1970 when commodity prices in terms of gold—not just paper dollars—experienced a final spike. The very—if brief—success that the government and the Federal Reserve System had in driving the dollar price of gold back to $35 an ounce without any deflation in the nominal price level meant that prices in terms of gold had now reached the highest levels since the immediate post-World War I period.

Even the slave-like conditions of apartheid that prevailed in South Africa, then the leading gold mining country, which had kept profits in the industry artificially high, could no longer keep profits high enough to prevent gold production from entering its first sustained decline since the end of World War II. (11)

When the Fed and the other central banks tried to continue to stimulate the economy by holding down the rate of interest by increasing the rate of growth of their token money under these conditions, the price of gold in terms of the various paper currencies soared. Between the 1970 and January 1980, the dollar price of gold rose from $35 an ounce to $875.

As long as there were huge reserves of idle money capital left over from the Depression, long-term interest rates were very low. Under these conditions, Keynesian economics worked well. But under the economic conditions that prevailed after the Depression and World War II, the global capitalist economy would have been expected to work well even without Keynesian economics. Without Keynesian policies, crises like the one the began in 1957 would have been sharper and cyclical swings greater, but interest rates would in the long run have been much lower, and long-term economic growth would have been higher.

As the industrial cycle resumed from 1948 onward, real capital began to expand more rapidly than the world’s supply of monetary gold. The result was a gradual tendency for interest rates to rise. Interest rates still rose in booms and fell during recessions, but they rose more in booms than fell in recessions.

But since interest rates were initially extremely low due to the Depression and the prolonged halt in expanded reproduction that lasted through World War II, interest rates were well below the rate of profit in the early postwar period. They could rise for some time before they threatened to wipe out the profit of enterprise—which forms the real incentive to produce surplus value. As long as these conditions prevailed, the Keynesian policies of weakening recessions or even postponing them by cutting interest rates and increasing demand through government deficit spending could work.

But even during the heyday of Keynesian economics, the secular rise in long-term interest rates indicated that it was only a matter of time before the efficacy of Keynesian polices would come to an end. By the end of the 1960s, as the boom fueled by the regressive Kennedy-Johnson tax cut and the Vietnam War began to rapidly raise prices in terms of gold, gold production began to stagnate and then decline.

If the rules of the gold standard in any form—including the rules of the Bretton Woods dollar-gold exchange standard—had been followed, the result would have been a classic deflationary depression. Such a depression on the backs of the workers and other toilers would have set the stage for a new series of “expansionary” industrial cycles.

The combination of falling prices that would have increased the quantity of gold money in purchasing power terms, combined with the rise in both the relative and absolute profitability of gold mining and refining industries, would have increased gold production and thus over time would have increased the quantity of gold in terms of weight as well. This would have created the conditions for a new expansion of the world market and a new upsurge in capitalist production, always assuming that the political rule of the capitalist class would have survived. (12)

In a classic depression—one without Keynesian intervention—the stagnation in the accumulation of real capital combined with rising gold production reduces the ratio of real capital to gold. That, in turn, leads to lower interest rates. More of the surplus value goes to the industrial and commercial capitalists in the form of the profit of enterprise and less to the money capitalists in the form of interest. All of this encourages a rise in investment when the economy recovers, just like it did after World War II.

The high unemployment of depression also leads to lower money wages and a rise in the rate of surplus value. Not only does a greater mass of the surplus value go to the industrial and commercial capitalists in the form of the profit of enterprise but the total mass of the surplus value also increases.

The policies of the Keynesians did change the form of the economic crises somewhat. Instead of deflation in terms of currency, there came inflation, combined with unprecedented interest rates as the money capitalists progressively lost confidence in paper currencies.

On two occasions, first in 1973-74 and then in 1979-1980, panicky flights to safety in gold led not only to extreme inflation but violent recessions that finally drove even the official unemployment rate in the United States above 10 percent by late 1982. In Western Europe, too, unemployment reached levels that were characteristic of the post-World I years rather than the “full employment” of the early post-World War II years.

While some of the “third world” countries—and also the Soviet Union, which was—Russia still is—a major oil producer—had benefited from the high prices of primary commodities during the 1970s, they were hard hit by the Volcker shock. They were squeezed between high debts they had contracted during the inflation and the falling prices of the primary commodities they sold.

From the 1970s to the ‘Great Moderation’

Many Marxists during the 1970s assumed that the inflationary conditions with frequent and increasingly severe recessions would simply continue, just as many economists both bourgeois and Marxist of an earlier generation had assumed the Depression conditions of the 1930s would continue or resume after World War II. And yet another generation of economists—especially bourgeois but many Marxists as well—had assumed that the prosperity of the 1950s and 1960s, thanks to new Keynesian economic policies, would continue indefinitely.

But the “stagflationary” conditions of the 1970s did not prove any more permanent than the Depression conditions of the 1930s or the postwar prosperity of the 1950s and 1960s had been. Indeed, the very fact that during the 1970s the capitalists could not make profits in terms of gold meant that the stagflationary conditions of that decade could not possibly have continued for much longer than they did. In fact, these conditions were brought to an abrupt end by the Volcker shock of 1979-80, giving way to a new and very different period, commonly referred to as the “Great Moderation.”

I believe that it can be safely stated that a 1970s-style stagflation lasting for much longer than a decade is economically impossible.

The level of gold production during the 1970s

As anybody who has studied the history of the 1970s knows, prices in terms of dollars—and other paper currencies—rose sharply. But though prices in terms of paper currency rose sharply, they had not risen nearly as fast as the gold value of the dollar and the other paper currencies more or less linked to it had fallen.

Therefore, already in the wake of the crisis of 1974-75, prices in terms of gold were considerably lower than they had been in 1970. If you look at the trend line in world gold production, you notice that after declining for about five years in the first half of the 1970s gold production bottomed out, though it remained depressed compared to the peak of 1970.

Ironically, the effect of the highly inflationary recession of 1974-75 on gold production was similar to effect of the highly deflationary recession of 1920-21. In 1920-21, the deflation of 1920-21 halted a sharp decline in gold production, though gold production remained depressed relative to the previous peak that occurred around 1915, until the super-crisis of 1929-33 stimulated it anew. While the recession of 1974-75 was highly inflationary in paper money terms, it was highly deflationary in terms of gold prices.

However, the decline in gold prices brought about by the 1974-75 crisis was not enough to turn gold production decisively upward. This took a new crisis within the crisis, which erupted beginning in 1979. This too brought a surge of paper money prices and a sharp deflation in terms of gold prices.

The result was that the profitability of the world gold mining and refining industry, both relative to other industries and absolutely, soared. The gold industry was the great exception to the lack of profitability of capitalist production during the 1970s. Not surprisingly, beginning with the 1979-82 crisis global gold production began a prolonged upward movement that was to continue until the turn of the 21st century.

At the beginning of the prolonged crisis in March 1968, I showed how the prices of commodities in terms of gold had risen above the underlying labor values of commodities. But by the early 1980s the prices of commodities in terms of the money commodity gold, the commodity that measures the value of all other commodities in terms of its use value, was now well below the values of those commodities.

Behind the scenes, the law of value of commodities had once again asserted itself. In this respect, the situation resembled the situation right after World War II. But in other respects, especially in terms of interest rates, the situation was the complete opposite of the early post-World War II years.

By dramatically lowering the prices of commodities in terms of gold—though of course not paper currency—the prolonged economic crisis that raged with varying degrees of intensity from March 1968 to the end of 1982 had acted as a classic depression. The paper money inflation in prices had simply hidden the deflation in terms of gold.

But in terms of the rate of interest, the division of the profit between the money capitalists on one side and the industrial and commercial capitalists on the other, the results were virtually the opposite of a classical depression.

For example, in March 1968, at the beginning of the protracted crisis that extended through the decade of the 1970s into the 1980s, the yield on 10-year government bonds was about 5.57 percent. In January 1983, at the end of the prolonged crisis, the rate of interest on 10-year bonds was hovering around 10.5 percent! It wasn’t until August 1993 before the yield on the U.S. 10-year government bonds finally fell below the levels that had prevailed in March 1968, more than a quarter of a century before.

I will examine the effects of these very high interest rates in next week’s post.


1 Basically the OPEC countries were simply claiming the ground rent yielded by oil producing land within their borders, which was of course their democratic right. Before 1973, the lion’s share not only of the profit proper but of the ground rent had gone to the seven sisters cartel.

OPEC’s ability to win a much larger share of the ground rent shows how the weakening of the U.S. dollar during the 1970s strengthened the oppressed countries relative the imperialist oppressors. The renewed strength of the dollar during the 1980s and 1990s, in contrast, strengthened the American empire in particular and imperialism in general once again. Since early in the current decade, the dollar has again declined, further weakening the U.S. empire and imperialism in relation to the oppressed countries.

2 Nixon’s first vice-president, Spiro Agnew, had been forced to resign in 1973 when it was revealed that he had received kickbacks while he was governor of Maryland. Nixon then named Gerald Ford, the Republican leader in the U.S. House of Representatives, as the new vice-president.

When Nixon was finally forced to resign in August 1974, Ford, who had been elected neither president nor vice-president, became the first completely non-elected president in U.S. history. He quickly pardoned Nixon for any and all felonies he had committed as president. This was obviously an extremely unpopular move and led inevitably to speculation that Ford and Nixon had made a deal whereby Ford pardoned Nixon in exchange for Nixon’s resignation and Ford’s ascension to the presidency.

However, a trial of Nixon would have been devastating for U.S. imperialism, since it would have revealed even more about the operations of the U.S. government and its “intelligence” agencies than were actually revealed in the course of the Watergate scandal. Ford, as a lifelong loyal servant of American imperialism, therefore had little choice but to pardon Nixon.

Ford’s defeat by Democrat Jimmy Carter was attributed by the media to the Nixon pardon, though the inflationary recession and continued high unemployment and inflation even after “recovery” had begun undoubtedly played a role, along with Watergate, in the Democratic victory in the 1976 elections.

3 This is the basic reason why Keynesian “anti-crisis policies” inevitably run into a wall in a situation of severe economic crisis. Keynes notwithstanding, under a system of paper money the “monetary authorities” cannot lower long-term interest rates at will simply by expanding the quantity of token—paper—money.

4 In his 1936 “General Theory,” Keynes admitted that the “monetary authorities” might have difficulty lowering interest rates when the long-term rate of interest was extremely low, as was the case in the 1930s. This is the famous “liquidity trap” of Keynesian economics. If the rate of interest falls towards zero, Keynes explained, it would be extremely difficult for the “monetary authorities” to lower long-term interest rates further, since after all the long-term rate of interest cannot actually fall all the way to zero. At zero interest, there is no incentive for the money capitalists to lend money. They will simply hoard it.

However, the problem in the 1970s was that interest rates were extremely high, not extremely low as is the case in a Keynesian “liquidity trap.” According to Keynesian theory, the “monetary authorities” in a situation of very high long-term interest rates should have no problem lowering them. All they have to do to achieve this, according to Keynesian theory, is to increase the quantity of token money they issue. But in the 1970s, the more token money the Federal Reserve System—and other capitalist central banks—created the higher interest rates rose.

5 In those years, all the big shots in the ruling circles in the United States were still men.

6 All dollar gold prices quoted in this post represent the London afternoon fixing. Since the long gone days of Britain’s global domination of the capitalist world, the London gold market has continued to be the leading gold market in the world.

7 The dollar was and is the currency in which the prices of all commodities that are traded on the world market are quoted. As a result, more debts are denominated in dollars by far than in any other currency. As a result, the dollar is the world’s main means of payment. This obliges governments, central banks and corporations to hold large reserves of dollar-denominated assets that can be quickly turned into actual dollars if required.

If, however, it had kept on depreciating at the rate at which it was during the 1970s, the dollar would have inevitably lost this role, probably to gold itself. The market would have forced the capitalist world to return to the gold standard. The United States, even more today than was the case in the 1970s, since it is now a debtor not a creditor, is determined to avoid this at almost any cost. I will examine this more closely in coming posts where I will deal with the dollar standard that replaced the dollar-gold exchange standard of the Bretton Woods era.

8 This should be kept in mind in understanding the Fed actions in the period leading up to and in the early stages of the crisis of 2007-09, which I will examine in the next few weeks.

9 The one area where capitalism cannot tolerate democracy, especially under a paper money system, is central banking. Democracy—that is the great majority of the people including even the industrial and commercial capitalists—would always demand lower interest rates. However, this would destroy the confidence of the money lenders—money capitalists—in the currency. If democracy—even bourgeois democracy—ever came to central banking, the money capitalists would quickly lose confidence in the currency and dump it for gold—or at least other currencies issued by independent central banks that are shielded from the democratic process. To avoid this disaster, the central banking system must be kept “independent”—that is, shielded completely from any form of democratic control.

10 Remember, the basic formula for capital is M—C—M’. Profit is measured in terms of M money, not “real purchasing power”. And money, means the money commodity, measured in terms of the weight of the precious metal that functions as the money commodity—gold. Just like economically real prices must be measured in terms of weights of gold, so economically real profits must be measured in terms of weights of gold. A situation where profits in terms of gold are negative cannot be long sustained under the capitalist mode of production.

11 Profits were artificially high because the African workers could not under the conditions of apartheid obtain the full value of their labor power.

12 Would capitalism have survived a classic depression in the 1970s? It was often said during the 1960s that capitalism would not be able to survive another depression, and certainly the capitalist class itself feared that it was so. That is why they followed Keynesian policies as long as they did in the 1970s and why today, too, they are once again attempting to shorten the current depression through the use of Keynesian policies—despite the miserable experience of the 1970s.

However, it must always be kept in mind that capitalism will not transform itself automatically into socialism, no matter how desperate the economic situation becomes. In order for capitalism to be transformed into socialism, the working class must conquer political power. If this doesn’t happen, socialism will never be achieved.

3 thoughts on “From the 1974-75 Recession to the ‘Volcker Shock’

  1. So what policies and actions were the Keynesians pushing before the Volcker shock? I didn’t see anything specific mentioned here, so I’m curious. I’m trying to study this period because I have been persuaded (by reading that currently we are in a period of stagflation, so I am curious to see what was done in the past about it in the hopes of anticipating what they are going to hit us with next.

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