Reagan Reaction and the ‘Great Moderation’

After World War II, the Keynesians reformers took unjustified credit for the postwar economic upswing. Similarly, in the 1980s the extreme right-wing governments that came to power in Britain in 1979 and the United States in 1980 also took unjustified credit for the end of the protracted economic crisis of 1968-1982.

These right-wing governments attempted to take back as many concessions as possible that had been granted to the working class after World War II. At first, the policies of the new reactionary governments was called “monetarist,” but later they were called “neoliberal” for reasons that will become apparent below.

As I mentioned last week, the “monetarist,” or neoliberal,” era in the United States actually began with the appointment of Paul Volcker as chairman of the U.S. Federal Reserve Board by the Democratic administration of Jimmy Carter in August 1979. The post-World War II reformist era had been made possible by the generally expansionary economic conditions that prevailed between 1948 and 1968. The collapse of the London Gold Pool in March 1968 marked the end of the early post-World War II era of capitalist prosperity.

Attempts to relaunch the post-World War II capitalist prosperity through Keynesian methods repeatedly failed during the 1970s. This was the economic basis for the new era of reaction that was symbolized by the election of Ronald Reagan (1) in the November 1980 U.S. presidential election, as well as the rise to power of Margaret Thatcher in Britain with her “there is no alternative” slogan.

What Thatcher really meant was that there was no “Keynesian” alternative to her reactionary “monetarism” as long as the British pound was plunging in value both against gold and even against the dollar on world currency markets.

The attempt to pull Britain out of its economic decline during the 1970s through Keynesian policies had even more dismal consequences in the form of skyrocketing inflation and interest rates than similar policies had in the United States. Therefore, the non-Marxist British Labor Party and the non-Marxist British left in general, which based itself on the economics of Keynes rather than Marx, no longer represented a viable alternative to Thatcher’s policies of currency stabilization carried out at the expense of the working class for the benefit of the capitalist exploiters.

Monetarism and the Volcker shock

The Volcker shock in essence involved the radical rise in the rate of interest necessary to restore confidence in the dollar and other paper currencies. It was presented to the public, however, as the adoption of the policies of Milton Friedman, whose theories supposedly corrected the mistakes that had been made by the Keynesian economists. Back in the 1950s and 1960s, Friedman had been considered as a fringe theorist because of his opposition to Keynesian economics. But as economic conditions worsened after 1968, Friedman moved from the fringe to the mainstream.

Friedman claimed that the capitalist economy would avoid sharp swings in the industrial cycle if the rate of growth of the “money supply”—token money in the hands of the non-bank public plus bank-created credit money—were stabilized. If this were done, Friedman his supporters held, the contractions of the “money supply” that had marked the classic pre-World War II crises, on one side, and the “stagflation” of the post 1968 years with its rising prices—in terms of paper money—growing unemployment and rising interest rates, on the other, would be avoided in the future.

In contrast to Keynes, the Friedmanites also claimed that there was no need for expansionary fiscal policies such as public works programs or even extended unemployment insurance to combat the effects of mass unemployment caused by recessions. Unlike Keynes, who feared that long-term mass unemployment would turn the working class and even large sections of the middle class against the capitalist system, Friedman claimed that as long as the “money supply” kept growing at a slow but steady pace, a prolonged deep economic depression was impossible.

Unlike the Keynesians, who see unemployment as caused by a lack of monetarily effective demand for commodities, the “monetarists” claimed that the growing unemployment of the 1970s was caused by what they call the “high natural rate of unemployment.” (2) The only way to lower the “natural rate” of unemployment was to cut back social insurance, crush trade unions, repeal minimum wages laws, and so on. The more this was done, the supporters of Friedman claimed, the closer the “natural rate of unemployment” would fall towards zero.

Such policies, along with the steady rate of growth of the money supply—which required a paper money system, not a gold standard, according to Friedman—the Friedmanites claimed would end both unemployment and inflation and lower interest rates. (3)

The ‘Great Moderation’

Between 1983 and 2006, there were only two “contractions” in the the U.S. economy, according to the National Bureau of Economic Research, one in 1990-91 and another in 2001. The official statisticians claimed both were “brief and mild.”

But in reality the bourgeois economists and statisticians present a prettified picture of the 1983-2006 era. This is even more true of the economy of Western Europe than that of the United States. In many Western European countries, the official statisticians claimed that there was no actual recession in 2001 but only a period of “slow growth” between 2000 and 2003.

With hardly any recessions for a quarter of century, you would think that the 1983-2006 period would be one of great capitalist prosperity. In reality, 1983 to 2006 was an era of profound and growing decline for the economies of the United States, Western Europe—not to speak of Eastern Europe after 1989—as well as Japan.

Nor were the two major cyclical downturns of the Great Moderation, one in the early 1990s and the other between 1997 and 2003, in reality as brief and mild as bourgeois economic statisticians claim. This is especially true if you look at the world economy as a whole, not just the imperialist countries. For example, the economic crisis that began in July 1997 with the devaluation of Thai baht was both protracted and in some countries extremely severe.

In Argentina, the crisis in 2001 was arguably worse than the crisis of 1929-33 in the United States and Germany. However, no imperialist country experienced a banking or currency crisis during this downturn. The currency and banking crises and their associated deep depressions were confined to the oppressed countries in this particular economic crisis. The United States came close to a major credit crisis in September 1998, when the giant Long Term Capital Management hedge found itself on the brink of collapse and had to be bailed out by the Federal Reserve Bank of New York. U.S. credit markets briefly seized up. But unlike 2007, the credit market crisis quickly passed.

Though the period between 1983 and 2006 saw dramatic gains in stock markets, there were at least two major stock market crashes. One was the short-lived stock market panic of 1987, and the other saw the U.S. NASDAQ high-tech stock index lose more than half its value during the the so-called “” crash that started in March 2000. In contrast to the 1948-1968 period, which saw few currency and banking crises, the global financial system was far less stable during the Great Moderation.

Still, compared to the super-crisis of 1929-33 and the “stagflation crises” of the 1968-1982 period, which threatened on two occasions—1973-74 and even more in 1979-80—to bring down the currency and credit system of the entire capitalist world, the Great Moderation of 1983-2006 was an era of relative stability.

And despite the stock market crash of 1987 and the turn of the century crash, the era saw the greatest boom in both stocks and bonds in the history of the capitalist world. If you were a money capitalist—like most the “opinion makers and financial experts” who write for the capitalist press are, the period of 1983-2006 was the greatest period of prosperity that the world had ever seen.

No great boom in the real economy

However, if you look at the “real economy”—especially the sphere of factory employment—you get a quite different story. A look at the trend of factory employment in the United States, the leading capitalist country, tells the story. (4) From the war of American independence at the end of the 18th century—which marks the birth of industrial capitalism in the United States—to 1979 with cyclical ups and downs, factory employment showed a secular upward trend. True, since factory employment is very sensitive to changes in the industrial cycle, such employment dipped during periods of crises and lesser recessions, but it always rose to new highs when economic growth resumed.

This held good even for the super-crisis and the Depression of the 1930s. After the Depression ended, factory employment rose well above the levels of the 1920s and stayed there. It did show a fall from the extraordinary high level of the World War II war economy, when workers who were not in uniform were pressed into the factories to make means of destruction. But after the “reconversion crisis” of 1945, factory employment resumed its secular rise, falling during recessions but rising more during expansions than it fell in the preceding recessions.

After World War II in the United States and other highly industrialized capitalist countries, the percentage of factory workers as a percentage of all workers declined. This reflected a dramatic decline in the farm population in the United States and other imperialist countries. Historically as capitalism developed, the number of factory workers grew relative to the small farmers or peasants but dropped relative to the broadly defined “service workers” category.

As long as the number of small farmers or peasants formed a large percentage of the population, the number of factory workers grew relative to the entire population, but once the small farmer-peasant portion of the population fell below a certain level, the percentage of factory workers in the total population started to decline relative to the percentage of service workers. (5)) But even after this happened, the number of factory workers continued to rise in absolute terms, falling temporarily only during recessions.

However, since 1979, despite there being only two official NBER “contractions” in the U.S. economy and perhaps one official recession in many European countries, over the 23-year period from 1983 to 2006, factory employment has fallen more during recessions than it has risen during expansions. For example, in the United States the three official NBER “expansions,” two of which are the longest expansions of record, factory employment eroded during expansions and plunged during the two official periods of contraction. (6)

Indeed, long stretches of the NBER “expansions” were characterized by falling factory employment. Factory employment behaved during much of the period of NBER “expansions” of the Great Moderation more like it used to during NBER “contractions.” During the final official expansion of the Great Moderation—2001 to 2007—factory employment increased only for a very small fraction of the expansion. Across the expansion, U.S. factory employment declined considerably. This is even true if we take the more realistic dates of mid-2003 to mid-2007 for the last upswing of the industrial cycle of the Great Moderation.

As a result, even before the crisis that started in 2007 began official employment in manufacturing was the lowest since the late 1940s. Already before the outbreak of the latest crisis, the entire growth in factory employment that had occurred during the post-World War II prosperity had been wiped out.

If we use the criteria of total factory employment, the recession that began with the Volcker shock in 1979, despite some fluctuations, has never ended but has continued to deepen. The 30-year and counting recession in U.S. factory employment stands in the sharpest contrast to the unparalleled performance of U.S. and world stock and bond markets between 1982 and 2007!

These trends were not unique to imperialist countries. The economy of Latin America has generally experienced slower growth than it did before the Volcker shock. Indeed, some countries such as Argentina that have often been described as “semi-industrialized” have experienced drastic economic decline. Africa remained throughout the Great Moderation an economic disaster area.

The rise of China

The great exception to the semi-stagnation of the Great Moderation was Asia, where in some countries economic growth since 1983 has been considerable and in a few dramatic. This has been especially true of China since Deng Xiaoping opened up China to outside capitalist investment and began to encourage the expansion of Chinese-owned capitalist enterprises as well after 1978.

The growth of capitalist industry and exploitation has been nothing short of spectacular. As a result, the China that has just celebrated the 60th anniversary of its great revolution is not only unrecognizable compared to China of 1949, but even the China of a decade ago. (7)

The dismal performance of the “real economy” between 1983 and 2006—China and a few other mostly Asian countries excepted—forced the capitalist media to boast about not the “unparalleled boom” like they did in past periods of long-term capitalist upswing, but only about the “great moderation.”

In long-term capitalist upswings of the past, such as the mid-Victorian boom between 1848 and 1873, the years from 1896 to 1913, and after World War II 1948 to 1968, factory employment grew in many countries. True, output always grew much faster than the growth in factory employment due to the rising productivity of labor that characterizes the entire history of capitalism. But before 1979, while industrial production grew much faster than factory employment, due to rise in the productivity of labor—and the growth in the organic composition of capital—factory employment had always grown in absolute terms.

While the growth of labor productivity has been considerable over the last 30 years, and as a result the performance of factory output has certainly not been as dismal as factory employment, there is no indication that the growth in the productivity of labor as been faster since 1979 than it was in the pre-1979 era. Certainly there is not enough of a difference to account for the decline in factory employment that has occurred in so many capitalist countries.

Clearly the Volcker shock that began under Democrat Jimmy Carter in 1979 marked a major watershed in modern economic history, perhaps in the long run more important than the year 1929 that saw the beginning of the super-crisis.

Why did factory employment decline?

I could explain the post-1979 decline of factory employment as due to the “decline of capitalism.” But this is no real explanation. It’s like saying that factory employment in the United States and the other imperialist countries dropped because the number of factory workers declined in those countries.

What we as Marxist economic scientists have to answer is why this unprecedented prolonged decline in factory employment occurred? And will factory employment continue to decline once the present economic depression runs it course.

What I say below is of necessity tentative, since I am exploring a new phenomena in the history of capitalism. In the past, many Marxists and even more so bourgeois economists, have gone astray by proclaiming relatively prolonged but ultimately temporary deviations from the long-term path of capitalist development as permanent, only to be confounded when capitalism resumed its “normal” path.

Like is always the case when we confront a new phenomena, we should always “consult” Marx. Marx was not a religious prophet who had a lifeline to the almighty. But he often gives us valuable clues that help us analyze new phenomena in capitalist development and decay.

There are many reasons to suspect the long-term decline in factory employment that has occurred in so many capitalist countries is closely related to two other phenomena that have characterized the last 30 years. One is financialization—what John Bellamy Foster of “Monthly Review” has called the rise of “monopoly finance capital.”

Closely connected to this has been the rise of the dollar standard, which replaced the old dollar-gold exchange standard of the early post-World War II era. This week I will examine financialization, and next week I will examine the evolution of the dollar-gold exchange standard of the Bretton Woods system into the current dollar-centered international monetary system. Both are crucial in my opinion in understanding the current condition of the world capitalist economy and its future evolution.

The aftermath of the crisis of 1968-82—the rise of ‘financialization’

The U.S. and world economies at the end of the prolonged crisis of 1968-1982 differed in one important sense from the situation that followed a traditional capitalist economic crisis. Typically in the wake of a major economic crisis, the rates of interest, both short term and long term, are lower than they were were before the crisis.

This was particularly true in the wake of the Depression of the 1930s. The very low long-term interest rate played an important role in launching the post-World War II protracted capitalist prosperity. Due to the protracted breakdown of expanded reproduction as a result of the Depression and World War II, combined with rising gold production during the 1930s, interest rates, both long term and short term, were at the lowest levels in the history of capitalism up to that time. These low interest rates combined with a high rate of profit were the conditions that made possible the postwar capitalist prosperity.

A low long-term interest rate encourages a portion of the money capitalists to become industrial or commercial capitalists. In referring to industrial and commercial capitalists, I am not simply referring to individual money capitalists who might be tempted to try their luck by becoming industrial and commercial capitalists, though this does play a role. Since the end of the 19th century, the world capitalist economy has been increasingly dominated by corporations—associations of money capitalists—that act as individual industrial and commercial capitalists. (8)

Individual holders of shares in industrial and commercial corporations can be said to function as money capitalists insofar as they invest money capital M in the shares with the expectation of “earning” a return in the form of dividends and or capital gains, thereby realizing an augmented money capital M’. The difference between M’ and M is equivalent to the accrued interest “earned” by holders of corporate bonds.

The main difference between the two types of “moneyed” capital is that the return on shares is variable whereas the return on corporate bonds is fixed.

While there are pure “money capitalists,” there are no pure industrial or commercial capitalists. Marx explained that every industrial and commercial capitalist is also a money capitalist. We can see why this is so if we look at the basic formula of industrial capital M—C—P—C’—M’.

The process always begins with M. Unless our industrial capitalist is working entirely with borrowed capital, our industrial capitalist must also be a money capitalist—an owner of capital in the form of money. This is why the industrial capitalist is “entitled” not only to the profit of enterprise but also to interest on his or her own—but not on borrowed—capital.

Even in the unlikely event that our industrial capitalist is working entirely with borrowed capital, if the business is successful we would expect our industrial capitalist to transform some of the M’–M—profit—into capital during the next expanded cycle of production. He or she will thus become the owner of this new capital in the form of money and will thus to that extent become a money capitalist.

The same is true of commercial capitalists. There the cycle of commercial or trading capital is expressed by the formula M—C—M’ where C is commodity capital. The trading capitalist begins with a sum of money—money capital—and then proceeds to transform it into commodity capital. He or she buys the commodities at a price that does not fully realize the surplus value embodied in them, and then proceeds to sell them at a price that does fully realize the surplus value the commodity capital contains.

In this way, the commercial capitalist gets his or her slice of the surplus value that was produced by the unpaid labor of the working class. Therefore, the trading capitalist is also to a certain extent a money capitalist, except in the case where the trading capitalist is working with entirely borrowed capital.

This becomes even truer as industrial capitalism evolves into corporate-dominated monopoly capitalism. Modern non-financial corporations—industrial and commercial corporations—are very careful never to allow any cash they have on hand to lie idle. If they cannot immediately transform idle cash on hand into productive capital in the case of industrial corporations, or into commodity capital in the case of commercial corporations, they invest it in various interest-bearing securities.

By doing this they act as money capitalists, not industrial and commercial capitalists. Everything remaining equal, the more that capitalist production and trade fall under the control of large corporations the more the industrial and commercial capitalists will function as money capitalists as well as commercial or industrial capitalists.

The extent to which “non-financial” corporations act as money capitalists as opposed to industrial and or commercial capitalists varies with the stage of the industrial cycle and the rate of interest. If business is stagnant, for example, corporations will tend to increasingly invest their growing cash revenues that due to the stagnant state of business cannot be immediately transformed into productive or commodity capital in conservative low-yielding securities such as government bonds or short-term government Treasury notes.

If, however, business is expanding vigorously—that is, the process of capitalist expanded reproduction is proceeding with great vigor—the “non-financial” corporations quickly transform any money that passes through their hands into productive or commodity capital.

Profit, interest and the profit of enterprise

Another factor that determines to what extent the corporations—and non-corporate capitalists—act as industrial and commercial as opposed to money capitalists is the relationship between the rate of interest and the rate of profit. If the rate of interest is low while the rate of profit is high, any industrial or commercial corporation incurs a high “opportunity cost” if it invests its capital in low-yielding securities as opposed to investing it in its industrial or commercial business.

If it invests in low-yielding securities during periods of brisk business, it will be losing out on opportunities to appropriate the profit of enterprise. Under these conditions, industrial and commercial businesses will be able to transform their money capital into real—productive or commodity—capital. They will hold only the smallest possible balances of money—or interest-bearing—capital as possible. If they don’t do this, they will incur large “opportunity costs” in terms of the profit of enterprise not obtained.

High rate of profit and high rate of interest

But what about a situation where both the rate of profit and the rate of interest are high? Suppose the rate of profit is high but all of the high profit goes to interest and not the profit of enterprise. Assume the rate of long-term interest is 12 percent and the rate of profit is also 12 percent. Though the rate of profit is a high 12 percent, the profit of enterprise is 0 percent.

In this situation, it makes no sense for an industrial capitalist to borrow money at 12 percent if he or she only expects to make a profit of 12 percent. If the industrial capitalist works with borrowed capital under these conditions, that capitalist will realize no profit at all.

But even if working entirely with his or her own capital, if the industrial capitalist expects to make only a 12 percent rate of profit, it would be much less risky to let the business decay and invest cash revenues in government bonds or other low-risk long-term securities.

As Marx explained, in the long run the rate of interest must be lower than the rate of profit. If it isn’t, industrial capital decays as the production of surplus value grinds gradually to a halt. But if such a process unfolds, it will unleash the forces that will inevitably reduce the rate of interest over time until once again the rate of interest is again below the rate of profit, restoring a positive profit of enterprise.

This in a nutshell is Marx’s theory of interest.

Last week, I explained that the capitalist economy cannot exist for very long in a situation where the rate of profit in terms of gold is negative. Or what comes to exactly the same thing, it cannot exist in a situation where simply hoarding gold is more “profitable” than industrial investment.

It is also true that capitalism cannot exist in the long run in a situation where the rate of interest is not below the rate of profit. If the rate of interest is equal to or higher than the rate of profit, the very incentive to produce surplus value is destroyed. Real capital will contract, but the very contraction of real capital will bring about a fall in the rate of interest until it is once again below the rate of profit.

The long shadow of Keynesian economic polices

I think it is now pretty obvious that the Keynesian economic polices of the 1950s and 1960s, though they did for awhile reduce the intensity of cyclical crises, caused severe long-term damage to the capitalist economy that extended far beyond the Volcker shock.

It was, after all, the Keynesian economic policies that preceded the Volcker shock, and not the Volcker shock itself that was responsible for the long reign of high interest rates. This is shown by the fact that from the end of World War II to the Volcker shock, interest rates kept rising on a secular basis, but after the Volcker shock, both long-term and short-term interest rates have been declining.

The dollar paper money standard

While interest rates finally began to fall after the Volcker shock, they remained far above the historical levels for an extremely prolonged time. In the wake of the Volcker shock, currencies were stabilized, but the money capitalists wondered how long the stabilization would last.

The U.S. government quickly rejected suggestions to restore the gold standard—notwithstanding the fact that President Reagan was said to personally favor it. Instead, the administration limited itself to allowing American citizens to own monetary gold, and resumed the coining of gold bullion produced in the United States at a mint price of $50 an ounce.

However, since the mint price of these new gold coins was far below the market price of gold bullion, these coins, though they are formally legal tender, are used for hoarding only. Commodity prices and debts continued to be expressed in terms of “legal tender” paper dollars and not the new gold dollar.

Both Keynesians and Friedmanites opposed to a new gold standard

And the bourgeois economists—not only the Keynesians, who were now much reduced in numbers and influence, but also the “monetarist” followers of Milton Friedman—continued to believe that prices should never be allowed to actually fall.

The new consensus among the bourgeois economists that developed in the wake of the Volcker shock was that the Keynesians had gone much too far in the late 1960s and the 1970s in believing that it would be possible to eliminate the “business cycle”—industrial cycle—through government deficits financed by paper money created by the “monetary authorities.” In the future, the aim of “stabilization policy” should not be to eliminate the “business cycle” but to simply control it and keep it within “moderate limits.”

According to the consensus view that developed in the years of the Great Moderation—except for the “Austrian school,” which is not taken seriously in policy-making circles—in the past under the gold standard, the “monetary authorities” had not been able to create sufficient money to prevent the business cycle from leading periodically to deflation, panics and severe depressions.

In the 1970s, the new gospel went, the governments and “monetary authorities” had gone to the opposite extreme, believing that they could eliminate the “business cycle” altogether if only they issued money in sufficient quantity. This had caused the “monetary authorities” to balloon the “money supply,” which brought the capitalist economy to the brink of runaway inflation and disaster. In the future, a middle cause should be followed that would avoid both extremes.

The early postwar promises that in the future, capitalism would experience permanent “full employment” if only it was given another chance were, in effect, withdrawn.

However, without the “discipline” of a revived gold standard in some form, the money capitalists feared that the devaluation of the paper currencies would resume sooner or later. There had been brief “stabilizations” of the dollar between 1968 and 1982, after all, but hadn’t the devaluations quickly resumed? Why would it be any different in the future? After all, hasn’t the whole history of currency since the coining of money metals was invented about 2,500 years ago been the history of the debasements of these currencies, with brief intermissions of stabilization, such as the international gold standard of 1870-1914?

After currencies were pushed to the brink of collapse during the 1970s causing severe losses for the money capitalists, the money capitalists were reluctant to lend money accept at very high rates of interest. If the “monetary authorities” tried to force down these high rate of interest by flooding the money market with newly created token money, the money capitalists would respond by dumping their paper assets for “hard money” in the form of gold.

As a result, especially early in the Great Moderation, long-term interest rates were so high that there was little room for a positive profit of enterprise.

Marx foresaw ‘financialization’

In volume III of “Capital,” Marx imagined just such a situation where the rate of interest was equal to the entire rate of profit. Or what comes to exactly the same thing, the profit of enterprise is zero. What would happen? he asks.

In such a situation, Marx explained, a portion of the industrial and commercial capitalists would convert themselves into money capitalists. This would once again lower the long-term rate of interest to below the rate of profit, allowing a positive profit of enterprise to re-appear.

In a nutshell, Marx anticipated the whole phenomenon of “financialization” that was lurking a century or more in the future. (9)

Marx’s comments were brief, since there was no such phenomenon in his day. Under the gold standard, interest could only very briefly if at all swallow up the entire profit and then only under conditions of extreme financial panic that by its very nature was very short-lived.

As I explained in previous posts, such financial panics in Britain in Marx’s day were quickly ended by temporarily suspending the law that prevented the Bank of England from issuing banknotes much beyond its gold reserves. Marx never had a chance to examine a situation of prolonged high interest rates such as followed the Volcker shock.

Now, unlike Marx, we can examine such a situation as it unfolded—not in the pages of “Capital” but in real life. The extremely high rate of interest tempted the leaders of “corporate America,” and capitalists in other countries as well, to enter the “financial services business”—that is, to make money by lending it out at interest as opposed to acting as industrial or commercial capitalists.

The formula of interest-bearing capital is simply M—M’. Production and indeed commodities themselves drop from view. It seems that money is literally breeding money, as though money itself was a living organism.

The big capitalist corporations increasingly transformed themselves into collective money capitalists following the Volcker shock. The real industrial economy entered into decay—de-industrialization. As corporations that had previously been mostly industrial or commercial companies began to buy and hold interest-bearing securities of various types, the demand for these securities progressively rose. As the demand for interest-bearing securities rose, the rate of interest on them slowly but relentlessly declined.

Where did the money come from to buy all those securities?

But where did the money come from to buy the huge quantities of securities, derivatives and financial instruments that drove the rate of interest relentlessly lower as financialization proceeded? As I have demonstrated in these posts, it could not ultimately come from the “monetary authorities.”

The new money that finally lowered interest rates came not from the “monetary authorities” but from where new money has always come—the labor of the workers employed in the industry that produces money material. And this industry—the gold mining industry—starting in the 1970s—had suddenly become very profitable once again both relatively and absolutely.

Professor Friedman falls on his face

The 1980s turned out to be a bad decade for Milton Friedman. After the Volcker shock, Friedman looked at the rate of growth of the “money supply” and once again predicted accelerating inflation, just like he had correctly done throughout out the 1970s.

But this time the Chicago University professor fell on his face. The rising “money supply” instead of driving up inflation began to accumulate into hoards in the banks rather than being burned up in the form of sharply higher prices. As this process proceeded, the supply and demand for money could be equalized at gradually lower rates of interest.

What was really happening was that the quantity of metallic money was growing substantially faster than it had grown in the 1970s. And as I explained in a previous post, the effect of an increase in the quantity of metallic money, all other things remaining equal, is to lower interest rates.

This rise in gold production, which made the economic stabilization of capitalism, no matter how shaky, possible after the Volcker shock, was no accident. It was the working out of the law of value of commodities, which over the long run equalizes prices with their underlying values, though only through the deviation of prices from their labor values in the short run.

The dramatic fall of commodity prices in terms of gold that was concealed behind the accelerating rise of prices in terms of depreciating paper currency during the 1970s had made the gold mining and refining industries fabulously profitable. Capital, always in search of the highest profits possible, flowed into the gold producing industry.

As a result, gold production steadily increased from the early 1980s to the turn of the century. The resulting rise in the quantity of metallic money helped make possible a decline in the rate of interest without a new Volcker shock during the years of the Great Moderation.

To the bourgeois economists, who have no understanding of value, profit, prices or interest rates—they are barred from such an understanding by their rejection of the law of labor value and surplus value—it seemed as though the Keynesian world had to some extent returned. Once again, the “monetary authorities” had regained their ability to lower interest rates, if only at a painfully slow rate.

The consensus among the bourgeois economists began to form that the 1970s had been some kind of aberration caused by the gross abuse of Keynesian economics between the Vietnam War era and the Volcker shock. The Keynesian medicine could be used in an emergency, which hopefully would never occur, but it would have to be used with caution. An overdose would be disastrous.

Therefore Friedman’s quantity theory of money—monetarism—became increasingly discredited in university circles. However, this was not explained to the “lay public.”

Whatever happened to ‘monetarism’?

The University of Chicago professor’s insistence that what was good for the capitalist class corresponded to the interests of society—no social insurance, no trade unions, no rent control, no minimum wage laws—was simply too good to give up, even if his “monetary theory”—his supposedly great discovery— had proven to be nonsense.

The term “monetarism,” therefore, quietly disappeared and was replaced by “neoliberalism.” It was, after all, possible to advocate cuts in—and even the abolition of—social insurance, trade unions, minimum wage laws, and so on without advocating a fixed rate of growth of the “money supply.” And Friedman, who did have a great gift of making vulgar neoclassical marginalist economics appear plausible to the lay public, continued to be a useful icon of reaction even if his alleged “scientific discovery” was no longer taken seriously.

Next week, I will take a closer look at the dollar system, and how this “international monetary system” paved the way for the panic of 2007-09.


1 The election of the extreme right-wing former movie actor Ronald Reagan to the presidency of the United States is often attributed to the so-called Iran hostage crisis. However, the complete failure of the Keynesian—until August 1979—economic policies of the Carter administration, which ended with the soaring interest rates and skyrocketing unemployment of the Volcker shock, pretty much ensured Carter’s defeat. If it weren’t for the prolonged economic crisis that had been raging since 1968, combined with the ongoing Volcker shock, a Republican candidate as right wing as Ronald Reagan would have likely shared the fate of Barry Goldwater in 1964.

2 Remember, the late 19th-century marginalists had claimed that as long as there is free competition in all markets, especially the labor market, any prolonged unemployment represented “voluntary unemployment.” If there was clearly involuntary unemployment anyway, the marginalists blamed the trade unions, which kept wages from falling to the marginal product of the labor of the unemployed. The marginalists “defended” the unemployed against not the capitalists who were the real cause of unemployment but the trade unions.

Friedman claimed that attempts to drive the level of unemployment below the “high prevailing natural rate”—which he claimed was caused by the trade unions, unemployment and social insurance in general, minimum-wage laws, and so on—through Keynesian measures such as lowering interest rates by increasing the rate of growth of the money supply and deficit government spending were doomed to fail. At most, unemployment would fall temporarily below its “natural rate,” but soon inflation would rise and unemployment would rise back to its natural level. The result was the stagflation of the 1970s.

Friedman’s theory of “stagflation” was false. For example, while there are natural prices—prices of production—that market prices fluctuate around, there is no “natural rate of unemployment” that the actual rate of unemployment fluctuates around. However, Friedman had a theory of stagflation, which he developed by extending the ideas of “orthodox marginalism,” even if it was a false theory. That was more than the Keynesians had. The result was that the “Keynesian left” had no real answer to Friedman.

3 Remember, both Keynes and Friedman shared a common hostility to gold standards. Both economists advocated paper money systems.

4 The category of factory workers should not be confused with the category of productive or industrial workers who produce surplus value. While the rising productivity of labor that marks the capitalist mode of production makes possible an increase in the numbers of “unproductive” workers who do not produce surplus value, many workers who are not employed in manufacturing proper do in fact produce surplus value. This includes workers in mining and construction. It also includes workers in transportation, since as Marx explained the labor that changes the place in space of a commodity increases its value. After all, a commodity cannot be consumed if it is not brought to the consumer.

Many workers employed in wholesale and retail trade—for example, warehouse workers, as well as workers who stock the shelves in retail establishments, produce surplus value. The same is true of workers in “service establishments” such as MacDonald hamburger flippers. A MacDonald hamburger is just as much a commodity as an ingot of steel or an automobile. The decline in the number of factory workers during the Great Moderation of 1983-2006 therefore does not mean that there was a decline in the total number of surplus value-producing workers.

However, the workers who are concentrated in great numbers in giant factories have been historically the most union conscious and class conscious part of the working class and thus the natural leaders of the rest of the working class. The decline of the large concentrations of factory workers in so many countries during the Great Moderation undoubtedly greatly weakened the trade unions and the working class-based political parties. This contributed to the sharp swing to right in world politics that marked the Great Moderation.

5 It is in the interests of the capitalists and their hired statisticians to play down the potential strength of the working class in order to demoralize their class enemy. They therefore invent categories such as blue collar versus white collar, service workers, and more recently “information workers.” They then lump the most diverse categories of workers together. Such categories are meant to hide more than they reveal and must be approached with the greatest caution by Marxists.

6 The phenomena of so-called jobless recoveries where not only the total amount of factory employment but total employment of all kinds declines reflects at least in part the attempt of capitalist statisticians to make recessions disappear by using indices of economic growth such as the Gross Domestic Product—GDP—that are designed to overstate economic growth and as much as possible hide recessions. If the phases of the industrial cycle were more realistically measured, some of this paradox of jobless recoveries would disappear.

The NBER in its own way has admitted this. During most of the 2000-2003 period, the U.S. Commerce Department kept on reporting tiny but positive increases in the real GDP despite numerous signs that the U.S. economy was in recession, including a prolonged drop in the total amount of workers—not just factory workers—employed. When the NBER finally decided there had been only an eight-month period of actual “contraction” that already had ceased by the end of 2001, they answered criticism by pointing out that the Commerce Department’s real GDP data implied only about an eight-month period of actual decline in this index.

After August 2007 and through much of 2008, the Commerce Department also reported tiny but, with the exception of the fourth quarter of 2007, positive gains in GDP. Overall, if we are to believe the U.S. Commerce Department, the real GDP continued to grow through the first half of 2008. However, the NBER announced that an official NBER “contraction” began in December 2007 despite the alleged growth in the real GDP over much of the following year. Therefore, the NBER itself in effect admitted that the official real GDP figures released by the U.S. Commerce Department do not in fact measure real economic growth.

However, a decline in factory employment that lasts for a period of 30 years is a new phenomenon. It is not very likely that we have simply been experiencing a 30-year-long downturn in the industrial cycle. How long the trend of declining factory employment will continue in the United States and other countries and what are its limits will prove to be is another question entirely.

7 Marxists in the West understandably have been extremely disappointed by the growth of capitalist economic relations in China and now Vietnam that has occurred under the rule of their respective Communist parties. Naturally, Western Marxists had expected these countries to build socialist economies under the rule of the Communist parties.

However, we should not underestimate the tremendous historical significance of the rapid industrialization of these countries that in the case of Vietnam was a French colony and in the case of China was the classical semi-colony not so long ago. Today, China in particular offers major economic competition to North American, West European and Japanese capitalists, who have long monopolized the world market.

A few decades ago, both China and Vietnam had only tiny working classes and very little industry. In the case of Vietnam, much of the industry—as well as the agriculture that the country did have—was systematically destroyed by U.S. bombing and chemical warfare. Today, China has the largest factory work force in the world, and many factory workers are now concentrated in gigantic factories employing tens of thousands of workers.

Vietnam seems to be heading in the same direction. In the years to come, the factory workers of both China and Vietnam will be able to play a crucial role in the evolution of the global class struggle between the working class and the capitalist exploiters. They have the potential to provide crucial relief for the now shrunken factory work forces of North America, Europe, the former Soviet Union, Eastern Europe and parts of Latin America.

It is a great mistake, in my opinion, to lump together the rapid growth of industry and the factory proletariat that we have seen in China and Vietnam with the disastrous consequences of the restoration of capitalism in the former Soviet Union and the Eastern European countries. We can’t forget that the victorious revolutionary parties in China and Vietnam were confronted by the basic tasks of the bourgeois-democratic revolution and not the socialist revolution that a victorious revolutionary party will face when it comes to power in an advanced capitalist country.

In the former Soviet Union and Eastern Europe, in contrast, counter-revolutionary parties came to power that were determined to restore capitalist economic relations, even if this meant the destruction of the huge industrial machine that was both owned by and built by generations of workers. Today, the economy of Russia depends on the exchange of raw materials—for example, oil—for consumer goods, the classic colonial and semi-colonial relationship.

It is this colonial exchange of raw materials for consumer goods that China and now Vietnam are leaving behind. In contrast, the current government of Russia is attempting to resist the takeover of its natural resources by U.S. and other imperialist monopolies. If the imperialist monopolies gain control of Russia’s natural resources, there will be a lot fewer consumer goods for those few Russian citizens who have benefited from the counterrevolutions of the 1980s and 1990s. However, the Russian government is not attempting to restore Russia as a major industrial power, not even on a capitalist basis.

8 Under U.S. law, corporations are treated as legal persons. That is, the law treats an industrial or commercial corporation as though it were a “person”—an individual money, industrial or commercial capitalist.

9 This is not to say that Marx “predicted” financialization. But so deep were his insights into the workings of the capitalist economy that he was able to at times imagine situations that would become reality only far in the future. In contrast, even when today’s economists have noted financialization, they have not been able to explain why it has occurred.

One thought on “Reagan Reaction and the ‘Great Moderation’

  1. I find Chris Harman’s account of financialization much more convincing:

    Also I think it’s a mistake to equate absolute or relative factory employment figures with whether or not the economy is in recession. We have NOT had 3-4 decades of recession. Mechanization and outsourcing to other countries with cheaper wages are what underpins the fall in factory employment. Why employ 100 workers when you can get the same or more from just 50?

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