The Dollar Empire and the ‘Great Moderation’
During the “Great Moderation,” the United States became increasingly dependent on imports to maintain its standard of living. When we talk about the standard of living of a nation, we should always be careful to distinguish between the standards of living of the different classes and strata of the population.
The decaying U.S. industrial base and the consequent absolute decline in the level of factory employment during the Great Moderation devastated the standard of living of factory workers. Those industrial workers who did maintain their jobs often had to accept wage cuts and worsening working conditions. This was particularly true for the young generation of factory workers. The unions often accepted two-tier contracts that protected the wages and benefits of older workers at the expense of those of new young workers.
The younger workers who found factory jobs during the Great Moderation were lucky. Many young workers, especially workers of color in the inner cities often couldn’t find any jobs—let alone factory jobs. If they could, it was usually in low-wage, non-unionized “service” establishments such as MacDonald’s or Walmart. It is significant that the biggest U.S. corporation in terms of revenues is not an industrial giant such as U.S. Steel, as it was early in the 20th century, or General Motors, at mid-century, but rather a trading company, Walmart.
The growing mass of more or less permanently unemployed, or at most marginally employed, youth has encouraged the growth of inner-city street gangs engaged in the drug trade. This has swollen the U.S. prison population. At any given time, there are now considerably more than 2 million people, disproportionality young people of color, in U.S. prisons and jails. Many more people pass through jails or prisons in the course of a year, or are in other respects “in the system,” fighting criminal charges, on parole or on probation.
It remains important, however, for the U.S. ruling class to maintain a large percentage of the population in a relatively comfortable “middle-class” lifestyle. This is a key difference between the United States as the world’s leading imperialist country and an oppressed “third world” country.
This “middle class” is a large and socially motley group. A declining percentage is made up of the traditional “petty bourgeoisie” of independent farmers—now only a few hundred thousand people at most—and small shop owners. A much larger group is made up of franchise owners, doctors, lawyers, accountants, hardware and software engineers, system administrators, corporate managers, government functionaries, university professors, and other professionals.
Unlike the traditional “petty bourgeoisie” of farmers and small shopkeepers, with the exception of the “franchisers” and doctors and lawyers engaged in private practice, most of these people work for salaries. Like classical proletarians, they sell their labor power to a capitalist or the government on a weekly, bi-weekly or monthly basis in exchange for a definite sum of money.
Unlike classical proletarians who have no significant income beyond their wages, they can frequently build up considerable savings in the form of certificates of deposit, mutual and money market funds, IRAs and so on. This gives them a return in the form of dividends and interest income that supplements their salaries.
At the upper end, this “new middle class” shades off into the small money capitalists who can if they wish live entirely off their dividends and interest income. (1) At the lower end, it shades off into the proletariat, who are entirely dependent on their wages.
Most widespread form of small property—home ownership
The most widespread form of small property ownership in the imperialist countries today is home ownership. There are two forms of home ownership that must be distinguished. One form is the home on wheels called a trailer or a mobile home. Mobile home owners generally live in so-called trailer parks, where they have to rent the land on which the trailer or mobile home is located. Rising land prices mean higher rents, and just as is the case with apartment renters, are very harmful for trailer or mobile home owners. In addition, trailers or mobile homes are often death traps for their residents during violent windstorms such as hurricanes and tornadoes, which affect large areas of the United States.
Mobile homes or trailers are simply commodities whose use value is to produce shelter for their owners. They do not entitle their owners to any share of the total surplus value produced by the global working class and have no meaningful chance of appreciation. Indeed, even if repaired they will depreciate just like any other commodity that wears out over time.
In the southern United States especially, those people who own trailers are often referred to as “trailer trash.” (2) That is, they are proletarians who do not own any property that entitles them to a share of surplus value. These people are in no way part of the “middle class” or petty bourgeoisie but rather are classical proletarians who are forced to earn their living by selling the only commodity they have to sell, their labor power. (3) The position of a trailer owner is essentially the same as an apartment renter.
The other type of homeowners own homes built on a definite plot of land. (4) This homeowner not only owns the means of shelter but the land on which the shelter is built. Unlike the house proper, the land can rise in value when the ground rent rises. A homeowner can realize the rent that is yielded by the land on which the home is built in various ways.
The homeowner might, for example, rent out some of the rooms in the home to one or more renters. If a homeowner rents out a room at a rent of $600 a month, the homeowner realizes a rental income of $7,200 a year. Not enough to live on, but a nice supplement to a salary.
If the rent on the land increases, which it often does, the homeowner can realize the increased rental yield by selling the home at a higher price than he or she paid for it. While renters and trailer owners are hurt by rising rents, homeowners benefit from them.
From now on, when I use the term “homeowner,” I mean a person who owns not simply a means of shelter but the land on which the means of shelter is built. The evils of widespread homeownership flow not from the ownership of the means of shelter by those who live in them but in the large-scale petty ownership of land.
Even ownership of a tiny amount of land entitles its owners to a slice—small but real—of the surplus value produced by the global working class, especially the working class located in the oppressed countries. If, for example, U.S. corporations can increase their exploitation of workers in oppressed countries and become more profitable as a result, this will tend to increase the value of the land on which houses are built—in the United States or some other imperialist country—where the corporation maintains its headquarters. The increased exploitation of the workers in oppressed countries will mean higher home prices for U.S. homeowners.
In this way, homeowners—though they are not capitalists by any means—share in the super-exploitation of workers in oppressed countries, even if this share amounts to only a few crumbs. It therefore undermines the solidarity of the U.S. working class or the working class of other imperialist countries with the workers of oppressed countries.
How homeowners benefit from rising land prices
Virtually all homeowners purchase homes through mortgages—on credit. If they are lucky over time, they repay their mortgages and build up “equity” in their homes. The equity is defined as the price of the home, including the land on which it is built, minus the value of the unpaid balance on the mortgage or mortgages.
The home equity can rise for two reasons: One, the homeowner is slowly paying back the mortgage loan. When the mortgage loan (or loans) are fully repaid, the home equity equals the entire price of the home—the means of shelter plus the land on which it is built. Second, the home equity will increase when land prices rise. Unlike trailer owners and renters, homeowners benefit from rising land prices through a rise in their home equity.
Banks and other financial institutions are willing to loan money to homeowners in the form of second and third mortgages, with the home equity as collateral. Such a loan once again reduces the home equity of the homeowner but puts money in their hands that can be used to purchase commodities. Known as home equity loans, before the 2007-09 panic they were the fastest growing category of consumer credit in the United States. This is a form of consumer credit that, unlike credit cards, is denied to both renters and trailer owners.
U.S. government encourages homeownership among workers
Starting in the late 1930s, initially in response the rise of the CIO and to combat the growing radicalization of the American working class, the U.S. government has followed a policy of encouraging widespread homeownership. This has included not only “white collar” workers and small business people, but also the better-paid factory workers and other relatively well paid “blue color” workers.
The government began to redirect to a certain extent the flow of credit into the home mortgage market for the specific purpose of increasing homeownership. The Democratic Party more than the Republican Party has championed homeownership in the United States. Owning a home—and the land under it—is described as the “American dream,” implying that if you don’t own “your home” you are going to be excluded from the American dream—that is, from the benefits of living in the world’s leading imperialist power that exploits the peoples of the entire world.
Starting with the Roosevelt administration, the government created the companies now known as Fanny Mae (Federal National Mortgage Association), Ginny Mae (Government National Mortgage Association) and Freddy Mac (Federal Home Loan Mortgage Corporation). (5)
Later, these companies were privatized, though they were still seen as closely linked—as their names imply—to the government. For example, it was widely assumed that the government would back the securities issued by Ginny Mae, Fanny Mae and Freddie Mac even though they were not formally government obligations.
As a result, they could borrow at lower interest rates than other corporations because it was assumed that the full credit of the federal government stood behind them. During the recent panic, it became clear that they were in fact insolvent, and they are now under de facto government ownership once again. The assumption that the credit of the United States government stands behind their securities proved to be correct.
These outfits do not grant mortgage credit directly. Instead, a banker or other money lender grants a mortgage to either a would-be homeowner or a home equity loan to an existing homeowner. The original lender, instead of collecting monthly mortgage payments, sells the mortgages to another financial institution.
This is where Fanny Mae, Ginny Mae and Freddie Mac come in. They buy up mortgages from the initial lenders. In this way, the quantity of the total credit available for mortgages is artificially increased. This is designed to inflate the numbers of homeowners and keep home prices rising. This benefits existing homeowners but hurts renters and trailer owners by increasing the rents they must pay.
Homeowners—who in their great majority are otherwise workers who depend on their wages or salaries—are encouraged to “build wealth” in their homes. “Building wealth” in the home does not mean increasing the value of the home by improving it through the application of labor—something that many workers like to do. It means the rise in the value of the land on which the home is built. Why, for example, fight for single-payer health care if by the time you reach retirement age, the land under your home will grow into a considerable “nest egg” that will allow you to meet the expenses of old age and then some?
Of course, only homeowners benefit from this wealth, not renters or trailer owners. For the latter, the growing wealth in homes simply means higher rental expenses. Also, since higher land prices depend on a “favorable business climate”—high business profits—homeowners are encouraged to side with the bosses against the trade unions. If strong trade unions are organized in an area, the bosses argue, high wages will cause businesses to flee to lower-wage areas, causing local land prices and with it home equity values to fall. (6)
In this way, the U.S. government detaches the upper level of the working class, including a section of the “blue collar” workers, from the rest of the working class—renters and trailer owners. (7)
The policy of encouraging the ownership of petty plots of land under homes also encourages racism, which further divides the U.S. working class. First, people of color, particularly African Americans, are most likely to be renters, not homeowners. To them, appreciating home equity values simply mean higher monthly rent expenses.
In the United States, even after the end of the legal “Jim Crow” segregation in the South, what is called residential segregation is widespread. This is true in all parts of the United States, not only the former slave-owning and Jim Crow South. Certain neighborhoods are for whites, others for African Americans, and still others for Latinos.
If the “racial character” of a neighborhood changes, homeowners of the departing “race” are under great pressure to sell their homes, putting downward pressure on their prices. Therefore, homeowners—especially white homeowners—have a material interest in defending the “racial” character of their neighborhoods. Even one African American or Latino on the block could be the first step toward the neighborhood changing from a white to an African American or Latino neighborhood.
This further divides the U.S. working class and helps render it politically impotent. With the increasing “non-white” immigration from Muslim countries, a similar situation is developing in Europe.
Homeownership and the dollar
The period of a “strong dollar,” which characterized most of the Great Moderation, led to falling interest rates and rising land prices. (8) As land prices rose, so did home equity values. Banks and other money lenders eagerly made loans to homeowners against the rising equity in their homes.
The homeowners used the money they got in loans to purchase commodities that were increasingly produced abroad. As long as the dollar remained “strong” and money poured into the United States, the home equity loans could always be repaid by new home equity loans as land prices and home equities continued to climb. The whole system of widespread U.S. homeownership by “middle-class working people” turned into a giant Ponzi scheme.
This process gained momentum during the 1997 “Asian crisis” as money capital fleeing the oppressed countries poured into the United States. As U.S. interest rates plunged, land prices soared and mortgage credit ballooned. Bill Clinton boasted of the “record levels of homeownership—the growing Ponzi scheme—as one the greatest “achievements” of his administration. The process continued into the Bush administration. But like all Ponzi schemes, it was doomed to collapse sooner or later. (9)
During most of the 20th century, the political stability of capitalist rule in the United States depended on the productivity of the vast American industrial machine. An hour of concrete labor of the average American worker counted for considerably more than an hour of abstract human labor on the world market. (10) This was not because American workers were more skilled but because they on average worked with much more powerful machinery than the workers of other countries.
As a result, the U.S. industrial capitalists could afford to pay considerably higher wages than the industrial capitalists in other countries and still realize a super-profit. The result was a very large but relatively well paid and consequently privileged and politically conservative strata of factory workers. The political conservatism of the U.S. factory—and other—workers was the biggest obstacle the struggle for socialism faced during the 20th century. (11)
But by the beginning of the 21st century, the stability of the rule of the U.S. capitalist class depended increasingly on maintaining the growing Ponzi scheme in land prices and the consequent rise in home equity values. If the large home-owning “middle class” lost their homes and their access to home equity loans, the U.S. social structure would come to resemble that of a “third world” country.
On the top, there would be a small class of very rich capitalists who would still have a standard of living far exceeding that of the ruling class of any former epoch. There would be only a “small middle class” and a huge mass of impoverished working people. This huge mass could potentially find a leader in the remaining strata of factory workers who, unlike their 20th-century predecessors, would have nothing to lose.
Consequently, the U.S. government, as the executive committee of the U.S. capitalist ruling class—whether led by the Bush administration yesterday, the Obama administration today, or Obama’s successor tomorrow—is working night and day to somehow keep the dollar system afloat. Since it is on the front line in this struggle, this has increased the importance of the Federal Reserve System within the U.S. government.
All governments of all nations engaged in world trade tied to the dollar system and to U.S. imperialism
Under the dollar system, governments of countries that run large trade surpluses with the United States—and most countries run trade surpluses with the United States to some extent—such as China are obliged to maintain the large dollar reserves they accumulate in the form of U.S. Treasury securities. Just before the panic began in 2007, the Chinese and other governments were moving to invest some of their reserves in mortgage-backed securities in order to increase the low yields they earned on the U.S. Treasuries. In this way, they supported the value of the dollar and maintained the U.S. market, which is a vital outlet for the increasing volume of commodities their growing industries produce.
If the gold value of the dollar were to violently collapse, they would not only lose much of their markets in the United States, but they would see their foreign reserves go up in smoke. This would, in turn, undermine their domestic currency and credit systems, and thus their home markets.
After the “Volcker shock,” the United States did everything in its power to encourage other countries to sell off their gold reserves in favor of dollar reserves. The United States put great pressure on the emerging trading nations such as China to put their reserves in U.S. dollars as opposed to building up their gold reserves—the traditional form of central bank reserve assets.
In this way, the currency and credit systems of the emerging trading nations are held hostage to the U.S. dollar. The result is that today only the United States and some of the Western European countries maintain significant gold reserves. Both Japan and China have very small gold reserves, though there is some indication that China—but not U.S.-occupied Japan—has been attempting to increase its still very modest gold reserves. The United States is doing everything it can to discourage this trend.
The logic of the dollar system is that the United States needs to keep the dollar system going in order to prevent a major social crisis at home, while other countries need to keep the dollar system going in order to maintain their foreign markets and prevent their own foreign currency reserves and domestic currency and credit systems from going up in smoke. This ties all governments of all nations engaged in world trade to the dollar system and thus to U.S. imperialism.
This is true of not only U.S.-occupied imperialist satellites like Japan, but even the government of the People’s Republic of China. A violent collapse of the gold value of the dollar would immediately produce a crisis in China’s drive for industrialization and modernization, which has been making such giant strides over the last several decades. This is why the Chinese central bank has felt compelled to continue to purchase dollars, even though this helps finance the U.S. wars in the Middle East that threaten China’s access to oil. China wants the dollar system to end, but it wants it to be phased out gradually without an acute crisis.
Along these lines, the Chinese central bank has proposed that the dollar standard be gradually phased out in favor of a new international reserve currency that would be collectively administrated by the world’s trading nations. Ironically, this is somewhat similar to the proposal of John Maynard Keynes at the Bretton Woods Conference of 1944. The U.S. turned down Keynes then, and it shows no more enthusiasm for China’s somewhat similar proposal today.
If such a democratically administrated reserve currency existed, China might say to the United States: We will vote to give you the loans in the new international reserve currency you need if you agree to allow Taiwan to be peacefully reunited with China, withdraw the Seventh Fleet from the western Pacific, remove your troops from South Korea and Japan, and end your special “security treaty” with Japan.
Needless to say, the United States has no intention of agreeing to a reform in the international monetary system that would permit anything like this. Instead, it is doing everything it can to save the existing dollar system. It is doing so even at the risk of a sudden violent collapse of the dollar system that could cause a global economic crisis not only worse than the crisis we have been passing through but even worse than the super-crisis of 1929-33. (12)
The evolution of Bretton Woods II
The evolution of Bretton Woods II can be traced in the history of the dollar price of gold from the end of the Volcker shock in 1983 through the panic of 2007-09 and its aftermath.
In February 1983, as the United States and the world were just emerging from the Volcker shock, the dollar price of gold briefly closed above $500 an ounce. As Bretton Woods II took effect, a downward trend in the dollar price of gold set in. By December 1983, the dollar price of gold dipped below $380 an ounce. In March 1985, as the “super-dollar” was peaking, the price of gold briefly dipped below $290. At this point, however, the flood of imports into the United States was reaching such a level that the Reagan administration took fright and along with the satellite imperialisms engineered a kind of controlled devaluation of the dollar.
In December 1987, the the dollar price of gold rose briefly above $490 an ounce. At this level, Bretton Woods II was clearly coming under strain. If the dollar had continued its downward trend, not only would the stagflation of the 1970s have returned but the entire dollar system would be brought into question. As it was, Reagan’s dollar devaluation, limited and temporary as it was led to a crisis in the U.S. mortgage, real estate and home construction industries that was a kind of dress rehearsal for the much more serious crisis in this sector that began in 2006-07.
The reality is that any move to devalue the U.S. dollar to any significant extent soon shakes the whole homeownership mortgage credit pyramid, which is now the backbone of the stability of capitalist rule in the United States.
Even before Ronald Reagan finished his second and final term in the White House, the administration was forced to back off from its dollar devaluation policy. By early 1989, the dollar price of gold had again fallen below $400 an ounce. During the early and mid-1990s, the dollar gold price quickly fell back whenever it reached $400.
The liquidation of the Soviet Union in 1990-91 had a financial side, in the form of the dumping of Soviet gold reserves, as well as a political and economic side. By holding down the dollar price of gold, the dumping of Soviet gold helped finance the 1991 Gulf war against Iraq. Six years later came the “Asian crisis.” This crisis ripped through the oppressed nations that now included the former Soviet Union and the Eastern European countries. These events drove the dollar price gold further downward.
In 1998, Russia was forced to declare state bankruptcy. The crisis quickly spread to the U.S. credit markets when Long Term Capital Management faced collapse in 1998 threatening to trigger a violent worldwide economic crisis. But in late 1998, the dollar was a “strong currency.” The flight of capital from the “third world”—including now Russia—further strengthened the dollar. Shortly after the Asian crisis began, the dollar price of gold fell below $300 an ounce and stayed for the most part below $300 an ounce for about five years.
The “strong dollar” enabled the Fed to bail out Long-Term Capital Management in September 1998 in a way that allowed an orderly liquidation the following year without a prolonged credit market crisis. The Fed was able to create the large amounts of dollar token money necessary to do this without the dollar depreciating. The ability of the central banks of the United States and its satellite imperialist countries to sharply lower interest rates delayed the spread of the recession to the imperialist countries for several years and enabled them to contain the crisis without a really deep recession in the imperialist countries.
Recession finally reaches the United States
In August 1999, the dollar price of gold fell below $253 an ounce, the lowest dollar gold price of the entire post-Volcker shock era. However, at the end of that year the dollar began to weaken as some of the money capital that had fled to the safety of the imperialist countries at the peak of the crisis returned to the “third world.” By late 1999, the dollar price of gold rose briefly back above $300 an ounce before falling back. This set the stage for the recession—in greatly moderated form—to finally spread to the imperialist countries the following year.
However, since the weakening of the dollar at the end of 1999 was very slight, the boom in mortgage credit and housing construction continued with no interruption right through the recession that followed. While factory workers were losing jobs at an accelerated rate as a result of the recession, mortgage credit remained abundant, and land prices and with them home equity values kept rising.
The dollar price of gold remained generally below $300 an ounce well into 2002. However, after that it began to rise again hitting $400 by 2003. From then through the summer of 2008, with some fluctuations, the trend of the dollar price of gold was upward. In December 2005, the dollar price of gold rose above $500 an ounce. Not since the days of the Volcker shock had the dollar price of gold been so high. The implicit promise of Bretton Woods II to keep the gold value of the dollar—the dollar price of gold—within a certain range was broken. For the first time in many years, the dollar system suddenly looked shaky.
The situation worsened further during 2006 as the dollar price of gold rose above $600, and the boom in mortgage credit, home prices, and residential construction began to show signs of peaking. The worldwide industrial cycle was once again approaching its peak.
In early August 2007, the dollar price of gold was above $660 an ounce. As the dollar price of gold rose, so did the price of oil and other primary commodity prices. In September 2004, the price of oil was around $40 barrel. By the eve of the initial credit market crisis in August 2007, the price of oil had risen above $70.
As had been the case in the 1970s, a fall in the dollar against gold duly led to offsetting rises in the prices of internationally traded primary commodities. Despite pious wishes and claims to the contrary, gold had in no sense lost its role as the measure of the value of commodities during the Great Moderation. The rising prices of raw materials was pointing to a major wave of inflation, rising interest rates, and contracting credit including mortgage credit.
Unlike during the 1970s, the United States was now a debtor and not a creditor nation. In the 1970s, the mighty U.S. industrial machine, though under pressure, was still intact. Another important difference was that during the 1970s the main holders of U.S. dollar reserves were the two main defeated axis powers, Japan and West Germany, both occupied countries. But in 2007, while U.S.-occupied Japan was the second largest holder of U.S. dollar reserves, the largest holder was the Peoples Republic of China.
As I explained above, the Peoples Republic of China has no desire to see the dollar system violently collapse. Indeed, it has suggested that the dollar system be replaced gradually in a way that would not disrupt the world economy. However, China would be expected to defend its national interests much more strongly if the dollar system did begin to collapse than would U.S.-occupied Japan or Germany.
Why did the dollar price of gold start to rise again?
By the beginning of the 21st century, the long rise in world gold production that marked the last two decades of the 20th century came to an end. A gradual but persistent decline in world gold production then set in. The main reason for this decline—besides the gradual rise of commodity prices in terms of gold—was a virtual collapse of gold production in South Africa.
The South African mines that had long dominated world gold production are nearing exhaustion. It is possible that if the prices of commodities in terms of gold declines sharply in the coming years, it might become possible for the capitalist mining companies to dig deeper and revive South African gold production. But even as it is, South African gold miners have to work facing hellishly high temperatures as they dig out the gold located miles underground. Virtually all the gold located nearer to the surface is gone. Given these unfavorable changes in the natural conditions of production, gold production in South Africa became increasingly unprofitable in the final years of the 20th century.
Rising value of gold
While there have been gold discoveries in other parts of the world—and the possibility of re-opening old gold mines—they were not sufficient to fully offset the growing collapse of the South African gold mining industry at prevailing commodity prices. Real money—gold—was therefore undergoing a significant upward revaluation. On the scale of the entire world market, the amount of abstract human labor necessary to produce a troy ounce of gold was rising relative to the amount of human labor necessary to produce a given quantity of almost any other commodity.
If the world was still on the gold standard, an era of falling living costs would be setting in. But the central bankers such as the Federal Reserve System’s Ben Bernanke believed—and still believe—that it was their duty to prevent a fall in prices of commodities measured in terms of the paper currency they issue, come what may.
Instead, they promise to keep prices rising at an annual rate of between 1 percent and 3 percent. They can’t prevent prices measured in terms of gold from falling, however.
If the value of gold rises relative to most other commodities, it means the cost of mining gold also rises. This causes a fall in the rate of profit in the gold producing industry relative to that in other industries. Capital then flows out of the gold producing industry causing the production of gold to decline.
Declining gold production will tend to raise interest rates, raise the currency price of gold—devalue the currency—and contract effective monetary demand, lowering the prices of commodities in terms of gold. In this way commodity prices in terms of gold—real money—will be brought back into line with the underlying labor values expressed in terms of weights of gold—prices.
With the value of gold rising and its production declining at the existing price levels, the only way that a fall in the general price level could be avoided was through a major new devaluation of the dollar and the other paper currencies linked to it under the dollar system.
The money capitalists, therefore, had every reason to expect a new massive devaluation of the dollar and other paper currencies. They reacted by increasing their demand for gold, sending the dollar price of gold upward. In moving to protect themselves against the devaluation of the dollar and the other paper currencies, the money capitalist were bringing about the very devaluation they feared. That is exactly how the market works.
However, the leaders of the Federal Reserve System knew that if they allowed the dollar to plunge like it did in the 1970s, what was left of Bretton Woods II would not only be shattered, inflation would soar and credit, especially mortgage credit, would contract within the United States and indeed worldwide. This would lead to rising home foreclosures, falling home equity values—at least home equity values after inflation—growing impoverishment, and even homelessness among former “middle-class American homeowners.” This would destroy the internal political equilibrium of the United States.
So the Fed felt that it could neither pursue an old-fashioned pre-Keynesian policy of deflation—the traditional way of dealing with declining gold production—or a 1970s-style strategy of attempting to “stimulate the economy” by “running the printing presses.” Those kinds of policies had backfired big time back in the 1970s, as I have explained in earlier posts, discrediting the then-dominant school of Keynesian economics.
The Federal Reserve’s strategy
In the years preceding the outbreak of the crisis in August 2007, the Federal Reserve Board had been gradually slowing the rate of growth of the quantity of dollar token money it created. Instead, the Federal Reserve System, first under Alan Greenspan and then his successor, Ben Bernanke, a former Yale professor of economics, relied on “de-regulation” and “financial innovation” to find ways of continuing to inflate the total supply of credit—particularly mortgage credit—on top of an increasingly stagnant quantity of dollar token money.
At least in public, both Greenspan and then Bernanke denied that there was a housing bubble and claimed that the housing boom instead reflected the “amazing strength” of the information-based “post-industrial” U.S. economy. In contrast, however, Greenspan’s predecessor as Federal Reserve chief, Paul Volcker, had been for some years expressing growing alarm about the unfolding situation.
In August 2007 as it became clear that a colossal amount of “sub-prime” and other mortgages had been granted by swindling money lenders to would-be homeowners that could not possibly be repaid, the U.S. credit markets and then world credit markets began to seize up. Many secondary securities—called derivatives—that were based on these largely un-payable mortgages had been sold to leading Wall Street investment banks such as Bear Stearns, Merrill Lynch and Lehman Brothers. These banks, in turn, issued “innovative securities” based on their portfolios of increasingly un-payable mortgages that were sold to large investors such as insurance companies.
Like is the case with any chain, the chain of credit broke at its weakest link—the sub-prime mortgages. In public, Bernanke claimed that the Fed was successfully “containing the crisis” much as the credit market crisis that had followed the Long Term Capital Management near collapse in September 1998 had been contained. But this time, the Fed did not have the weapon of a “strong dollar” that had made it possible for it to stave off a general panic in the credit markets in 1998.
Remember, during the 1998 crisis the dollar price of gold bullion was below $300 an ounce. In August 2007, it was above $660 a troy ounce. And while the United States was already a debtor nation in 1998, it was now much deeper in debt both absolutely and relative to its GDP than it was in 1998. And while in 1998 gold production had been strongly rising for almost 20 years, in 2007 it had been drifting lower for the better part of a decade.
Under these conditions, if the Fed had simply flooded the banking system with freshly created dollar token money—its traditional reaction to threatened panics—the dollar would have entered a free fall sending commodity prices in terms of dollars soaring. The dollar system would have been brought to the very brink of collapse—and possibly over the brink. Interest rates would have soared, and the mortgage credit market with all the consequences I examined above would have been left in shambles.
However, if the Fed did not flood the banking system with reserves, the dollar system would be saved but at the price of an old-time panic and deep depression. The entire Ponzi scheme that the “great American middle class” now rested on would more or less deflate. The United States would face a social crisis far worse than that of the Depression decade when its mighty industrial base, though temporarily paralyzed by the super-crisis, remained fully intact.
This was all the more true true because the entire modern credit system was based on the expectation that the Fed would always intervene to prevent any collapse in the general price level. Bernanke himself had promised at the beginning of the decade he would do just that. (13)
The money capitalists took Bernanke at his word and acted accordingly. As soon as the credit-market seized up in August 2007, they began to dump the dollar big time. This sent the dollar price of gold, and oil as well as other primary commodities, soaring.
But the Bernanke Fed tried to outsmart the market. As expected, the Fed soon announced that it would drive down the federal funds rate. But instead of flooding the banking system with newly created dollar token money reserves by purchasing short-term government securities, the Federal Reserve System turned to a method it had not used on a large scale since the super-crisis days of 1929-33—discounting.
But the kind of discounting that the Bernanke Fed carried out would have outraged old-time central bankers. The Fed began to buy up “mortgage-backed securities” from the investment banks on a large scale. When the Bears Stearns investment bank faced collapse in March 2008, the Fed exchanged government securities in its portfolio for Bear Stearns’ “toxic mortgages” in order to facilitate the forced merger of the “venerable” Wall Street investment bank into the giant J.P. Morgan-Chase universal bank. (14)
But at the same time, the Fed was largely offsetting the increase in the dollar token money that it was creating through its discounts by selling off its portfolio of U.S. Treasuries. Contrary to the expectations of the market, the Fed did not balloon the supply of dollar token money after the initial panic in August 2007.
Between August 1, 2007, and August 1, 2008, the dollar monetary base grew by a little more 2 percent. This was in sharp contrast to the 10 percent rate of growth of the monetary base that the Fed had maintained during most of the much milder turn-of-the-century economic crisis when the dollar price of gold had been below $300 an ounce.
During the first 11 months of the crisis, the Fed resembled a person trying to lift both feet off the ground at the same time. It was forcing down the federal funds rate in an attempt to prevent an old-style deflationary banking panic while on the other hand it was holding the rate of growth of the token money it was creating to a snail’s pace in order to prevent a new inflationary panicky flight from the dollar into gold and commodities.
Prices react to the Fed moves
The result was a sharp rise in the dollar price of gold and a startling leap in primary commodity prices and in producer prices in general. After the Fed’s arranged merger of the investment bank Bears Stearns with J.P. Morgan-Chase in March 2008, the price of gold bullion spiked briefly for the first time above $1,000 an ounce. During the month of July 2008, dollar gold bullion prices were often above $950 an ounce. This depreciation of the dollar occurred despite the low rate of growth of the quantity of token money. It was the worst of both worlds. The dollar was depreciating, but its quantity was barely increasing.
Primary commodity prices such as but not only oil quickly reacted to the plunge in the dollar’s gold value—and not the lack of growth of the quantity of dollars. The market was making a mockery of the teachings of Milton Friedman. Instead, it was obeying quite different laws, the economic laws explored by Karl Marx.
For example, the dollar price of oil rose from just over $70 a barrel in August 2007 to over $145 11 months later in July 2008. Unlike in 1973-74, there was no oil embargo, nor was there anything like the revolution in Iran in 1979 to blame this time. True, the Bush administration and Israel were making threats to attack Iran, but the U.S. government only had itself to blame for that.
Nor was it only the oil price that was rising. Between August 2007 and July 2008, U.S. producer prices rose by more than 19 percent over an 11-month period. This exceeded the rates of inflation registered by this index during the worst of the inflationary crises of either 1973-74 or 1979-80. True, consumer prices didn’t rise as much as they did during the 1970s, but they soon would have soared if the dollar depreciation and with it these producer price increases had continued.
The market and the Fed were in effect engaged in a game of Double Dare. The market was saying to the Fed, we know that you will soon print tons of new paper dollars. Hasn’t your “helicopter Ben” promised you will never allow the general price level to decline! So we are anticipating your inflationary move in advance.
The Fed, for its part, was trying to hold firm and hold down the rate of growth of the quantity of dollar token money. It knew that if it didn’t provide the fuel for inflation in the form of a great increase in the quantity of dollar token money, inflation would be starved. Either the market or the Fed would have to blink.
The bourgeois journalists whose job it is to “explain” economic and financial developments to the “lay public” were confused. One day it seemed that the deflationary 1930s were returning. The next day it was the inflationary 1970s all over again. But weren’t the deflationary 1930s and the inflationary 1970s opposite states of the economy? How could the economy be in one state on one day and the opposite state the next?
If the economic journalists referred back to their old college economic text books, they would find no answers there. This was the case whether the textbooks reflected Keynesian or Friedmanite economics. Nor did they receive much enlightenment if they called up the bourgeois “economic experts” in person. The “experts” were just as confused as the journalists and the lay public.
The second panic
With the dramatic rise in dollar commodity prices, the quantity of dollar token money both in terms of gold and in terms of the dollar’s real purchasing power was shrinking rapidly. Something had to give and give it did. Starting in August 2008, both the price of oil and the producer price level began to plunge. An old-fashioned panic was on.
Just like in the days of old, panic-stricken capitalists began to dump commodities such as oil that they had purchased on credit on the expectation that their prices would continue to soar. In an attempt to stave off bankruptcy, they were forced to sell commodities at almost any price to raise cash to meet their debts and stave off bankruptcy—often unsuccessfully. From August 2008 onward, prices in terms of dollars reversed direction and started to plunge.
Some numbers tell the story
Between July 2008 and March 2009, the U.S. producer price index fell more than 18 percent. The price of oil, which was as high as $147 in July 2008, plunged to below $35 a barrel in December, just five months later! These swings of dollar-denominated commodity prices were beyond wild.
The dollar is again king
As panic engulfed the world market in the fall of 2008, the dollar was again king, much as it had been during the milder and far more limited panic that started in 1997. When the dollar suddenly became a “strong currency” in the fall of 2008, some Marxists were surprised. Why did the dollar suddenly become a strong currency when it had seemed so weak just weeks before?
But this is no mystery for those who know the history of crises. Though the dollar system had been shaken, especially during the 11 months between the initial panic in August 2007 and July 2008, the dollar system had not collapsed. Since everywhere there was a demand for payment in cash and cash still meant—and means—dollars, the demand for dollars, which had been plunging, suddenly reversed course and soared. Many speculators who had bought gold on credit now had to dump it as the dollar price of gold suddenly—and for many speculators unexpectedly—began to decline.
At the height of the panic on November 13, 2008, the dollar price of gold dropped to $713.50. This drop, however, was far more modest than the drop of the dollar price of oil, for example, underlying the monetary nature of the commodity gold as opposed to the non-monetary nature of the commodity oil.
This showed that the “strong” gold speculators, those who held the bullion outright rather than on credit, were not selling gold. The panic was pushing the dollar up against gold due to the dollar’s role as the main means of payment on the world market. However, looking beyond the immediate panic, its long-term prospects still seemed—and seems—dismal. Why is this?
The Fed blinks
In the “double dare” game between the market and the Fed, it was the Fed that now blinked. It used the extraordinary demand for dollars caused by the panic to flood the market with dollar token money. Within a couple of months, the quantity of dollar token money almost doubled. With the demand for dollars as a means of payments so high, the Fed could now meet this demand without precipitating the massive flight out of the dollar into gold that would bring down the dollar system. If, in contrast, the Fed had attempted to flood the market with dollar token in order to stave off the full-scale panic before it hit in the fall of 2008, the dollar system might not have survived.
This panic had a disastrous effect in the form of plunging industrial production and employment, not only in industry but in many “service industries” as well, along with the contraction of world trade. The crisis soon spread throughout the world. Home prices, which had been falling since 2006 despite the threatened inflation, now plunged faster, and foreclosure rates soared. Many “middle-class homeowners” were indeed losing their homes, and in some cases were—and are—faced with unemployment and homelessness at the same time.
But as bad as this panic was, it was for U.S. imperialism in particular and for the world economy in general the only way to avoid a much worse panic. That would be a panicky flight out of the dollar and into gold that would bring down the entire U.S. dollar-based world empire. For the moment the autumn 2008 panic had saved the dollar system.
After the panic
A combination of an extraordinary rise in the demand for dollars as a result of the panic, a sudden sharp fall in the dollar prices of commodities—leading to a fall in the general price level—a contraction in the quantity of real capital, both commodity capital and productive capital, as factories were shut down and inventories sold off, reduced the ratio of real capital to gold. This enabled the rate of interest, especially short-term interest rates, but briefly long-term interest on U.S. government bonds, to fall to levels not seen since the days of the late Depression and its aftermath.
At the same time there was a doubling of the quantity of dollar token money. During the first 11 months of the crisis—August 2007 to July 2008—the real—in terms of purchasing power—quantity of dollar token money was contracting rapidly. Now the quantity of dollar token money in real terms was soaring.
Because the Fed succeeded in preventing a general run on the banks, unlike in 1931-33, the banks did not have to dump their portfolios of government bonds on the market. Government bonds were considered as “good as dollars” and the dollar was king. The result was that the rate of interest on 10-year government bonds fell to 2.08 percent on December 18, 2008, even lower than during the Depression and its aftermath.
If these long-term interest rates could only last, there would be every prospect of a huge rise in the profit of enterprise, once economic recovery—which could be years and years in the future—finally arrived. However, to achieve this the Fed would have had to allow the deflationary process to continue, limiting itself to at most trying to keep it “orderly.”
But by doubling the monetary base in a period of a few months, the Fed had no intention of allowing this. It had not been able to prevent a brief fall in the general price level, but it was determined, just as Bernanke had promised, to print whatever amount of money was necessary to prevent the fall in prices from continuing.
By June 8, 2009, as the panic ebbed the rate of interest on 10-year government bonds was back up to 3.91 percent. (15) The Federal Reserve System, determined to halt the decline in the cost of living and prevent a prolonged depression, has been trying very hard to drive the long-term rate of interest back down again. It even announced a program to directly purchase long-term government bonds for its own portfolio, a program that is now being wound up. In recent weeks, the rate on 10-year government bonds has fallen as low as 3.2 percent
An examination of the quantity of dollar token money—the so-called monetary base figures provided by the Federal Reserve Bank of St. Louis—shows that the total quantity of dollar token money has begun rising sharply once again in recent weeks. While this has momentarily held down long-term interest rates, it has done so at the price of allowing gold bullion to soar above $1,050. As former Cuban President Fidel Castro has again pointed out, never has a “dollar” represented less gold—real money—than it does today.
Over the last few weeks, the rate of interest on 10-year government bonds, which largely governs mortgage interest rates, has climbed back to over 3.4 percent. The professional economists who sit on the Federal Reserve Board and the Open Market Committee seem to have a tough time learning the lesson that an increase in the quantity of token money does not have the same effect as an increase in the quantity of metallic money when it comes to the rate of interest.
As the aftershocks of the panic, though still considerable, gradually fade—assuming that they continue to do so—the extraordinary demand for dollars fades with it, causing the dollar to once again weaken against gold and commodities. The price of oil has already risen above $80 a barrel once again.
Will the coming Northern Hemisphere winter find the price of oil above $100 a barrel before winter turns into spring? How will the unemployed—still waiting for the capitalists to stop eliminating jobs and resume hiring—in the United States now officially at 15.1 million and rising—be able to heat their homes?
And as the experience of all the years since 1971 demonstrate, if the once again “weak dollar” continues, it won’t be long before the still huge and only partially deflated Ponzi scheme that is the U.S. mortgage, real-estate, and residential construction market—and the economy in general—is hit by a new crisis.
The U.S. dollar empire—at least in the financial sense—has never been shakier than it is today. And if the dollar should strengthen—without the help of a renewed panic? In that case, the crisis would be postponed. But a crisis postponed is not a crisis averted. Indeed, the postponement of the crisis would make the crisis all the worse when it finally arrives.
And so I get to the present, that magical point at which the past where we know what happened turns into the future where we don’t know what will happen. The present is also that point in time that divides what we cannot change into the future where we can—though to paraphrase Marx, not under the circumstances of our own choosing—affect what is yet to be.
This is the point where the study of history turns into the making of history. Or as Marx put it in the famous eleventh of his “Theses on Feuerbach”: The point is not to explain the world—in our specific case understanding the laws that govern periodic crises of overproduction that periodically affect the capitalist mode of production—but to change the laws. In our case, to abolish the very subject of our inquiry, the crises themselves by abolishing the capitalist system that breeds them.
In the last series of posts, I have been exploring whether capitalist production in addition to being subject to the 10-year—give or take a year or so—industrial cycle, and the shorter so-called “Kitchen inventory cycle,” is also subject to a “long cycle” consisting of several 10-year cycles.
I have examined the concrete history of the capitalist economy from the panic that broke out in London in the fall of 1847 all the way to the panic that hit New York—and the rest of the world—in the fall of 2008. This comes to exactly 161 years of concrete capitalist history. The time has come to finally draw some conclusions about the existence or absence of a “long cycle” in capitalist production. That will be the subject of the next post, the final post in the “long cycle” series.
After that will come the final series of posts, the posts on the so-called “breakdown” theory. This is the part of Marxist theory that examines the ultimate limits and fate of the capitalist mode of production.
1 Imperialism has a tendency to convert the entire population of the imperialist countries into money capitalists. Today, it seems you cannot drive a block or check out a web page without seeing the latest stock market quotes being flashed at you! This tendency can never reach its logical conclusion. If it did, there would be nobody to work in those areas of the economy that cannot be shifted abroad. There would be no one to work in malls, no mechanics to service automobiles, nobody to flip burgers at the local MacDonald’s, no construction workers to build the new houses and malls, and so on.
2 The use of the word “trash” reflects the contempt in which those who have no property whatsoever in either land or capital, and are therefore entirely dependent on wages, are held in the property-minded United States.
4 Homes in this sense need not only be buildings used for the residences of single families. They include apartments in large multi-family buildings that are sold rather than rented. The owners of these “condos” are comparable to other homeowners rather than renters or trailer owners. When land prices rise, the values of “condos” rise with them, just like the values of single-family homes do.
5 Fanny Mae, Ginny Mae and Freddie Mac are organized as three corporations rather than one to emphasize their supposed private nature. They are supposed to be three privately owned corporations in the same line of business that are competing with one another, though in reality they are closely linked to the U.S. government. The widespread perception in the financial markets that their debts would be treated as though they were debts of the U.S. government proved to be correct. The lower the rate that Fanny, Freddie and Ginny Mae can borrow, the more they can inflate the level of homeownership.
6 An example of the disastrous political consequences of widespread homeownership is the case of Proposition 13 in California. California once had one of the finest public university and educations systems outside of the Soviet bloc. In 1978, however, large landowning real-estate interests succeeded in getting Proposition 13 passed. Its aim was to slash the state taxes paid by the large landowning interests—called property taxes—that were used in part to finance California’s excellent educational system.
These large landowners posed as champions of California’s large mass of of homeowners, who owned only tiny amounts of land but who did stand to benefit in the short run from the lower property taxes that would result from passage of Proposition 13. The result is that today California is near the bottom in the United States in the amount of money spent per pupil. Skyrocketing tuition costs have put a college education out of reach for increasing numbers of working-class families. Far less is spent on educating Californians than in locking them up in the state’s huge overcrowded prison system.
7 The Republican Party is historically the party of the industrial and commercial capitalists, both large and small. Today the smaller industrial and commercial capitalists still form an important part of the base of the Republican party. Since homeownership reduces the mobility of the working class and puts upward pressure on money wages—wages must be higher to cover the costs of homeownership—the smaller industrial and commercial capitalists tend to oppose government programs that encourage homeownership. Unlike the large industrial corporations, they cannot shift their operations abroad in search of “cheap labor.” As a result, the Republican Party gives less support in words to government programs that encourage homeownership, though the Republican Party when it is in office has maintained the Democratic Party’s policies that encourage widespread homeownership.
In reality, homeowners are far more likely to vote for Republican candidates than renters or trailer owners and to support Republican-backed causes such as Proposition 13 than renters or trailer owners. In practice, despite somewhat different rhetoric by politicians of the two parties, the policy of encouraging widespread homeownership is in effect a bipartisan one.
8 Unimproved land that is not created by human labor is not a commodity in the strict sense, and has no value. However, rent-bearing land does provide its owner a flow of income when rented out. Assuming rents remain unchanged, the price of land will vary inversely with the rate of interest.
Let’s assumes that a given plot of land yields its owner $100 a year when it is rented out. If the rate of interest is 5 percent, the price of the plot of land will be ($100/.05) = $2,000. If the rate of interest falls from 5 percent to 2.5 percent, all else remaining unchanged, the price of our plot of land will rise to ($100/.025) = $4,000. The falling rate of interest that characterized the “strong dollar” of the Great Moderation put strong upward pressure on land prices, and therefore home equity values. This in turn encouraged mortgage loans and homeownership. The rising interest rates associated with a “weak dollar” has the opposite effect.
12 The central bank of the People’s Republic of China proposed that the IMF issue more Special Drawing Rights, which would gradually replace the dollar as the main international reserve currency. This implies that internationally traded commodities such as oil and consequently international debts would be priced in SDRs—a form of credit money created by the International Monetary Fund for use by governments only—which are valued in terms of a market basket of currencies rather than in U.S. dollars alone. If primary commodities and foreign debts were denominated in a market basket of currencies as opposed to U.S. dollars, the ability of United States to pay its debts in the “currency it issues itself” would be considerably reduced.
Under the dollar system, the U.S. Federal Reserve System functions in effect as the world’s central bank. It is the sole bank of issue of the currency that functions as world money—the U.S. dollar. Though all countries are affected by monetary policies adopted by the U.S. Federal Reserve Board, they have absolutely no voice in determining the Fed’s policies.
The logic of China’s proposal would be to shift the function of world central bank from the Federal Reserve Board to the International Monetary Fund, which in the future would be run democratically by all the trading nations. It goes without saying that Washington has given its thumbs down to China’s proposal. It is very much determined to safeguard the role of the Fed as the world’s sole de facto central bank.
13 During the “strong dollar recession” episode at the turn of the century, there were fears that the U.S. general price level in terms of dollars might actually decline. This is what happened in Japan starting in the late 1990s, when the general price level in terms of yen began a gradual but prolonged decline amidst Japan’s prolonged economic stagnation. What would happen, some financial journalists asked, if the federal funds rate fell to almost zero?
No problem, Bernanke explained, the Fed would use its “printing press” to print as much money as necessary to prevent prices from falling. Paraphrasing John Maynard Keynes, Bernanke explained that if necessary the Fed could drop newly printed paper money from helicopters. This earned Bernanke the nickname “helicopter Ben” among “hard money” right-wing “gold bugs.” When the August 2007 panic began, most market speculators did not believe that the Bernanke-led Fed would allow the general price level to decline. Instead, it was widely assumed that the Fed would flood the banking system with whatever quantity of newly created dollar token money was necessary to halt the panic and keep commodity prices rising.
14 Traditionally in Britain and the United States, investment banking—underwriting new securities issues—and commercial banking have been separate, as opposed to the “German model,” in which the same corporations engage in both investment and commercial banking. Banks that carry out both investment and commercial banking operations are known as “universal banks.” For years, the U.S. financial press boasted of the alleged superiority of the U.S. system of separate investment and commercial banking. In the wake of the crisis of 2007-09 in the United States, both investment and commercial banking are now throughly unified in the hands of gigantic universal banks. This became legally possible thanks to the Depression-era Glass-Steagall Act being overturned in 1999 under Democratic President Bill Clinton.
15 While the real supply of dollar token money contracted sharply between the outbreak of the initial crisis in August 2007 and July 2008, it exploded dramatically from the fall of 2008 onward due to the Fed moves to flood the U.S. banking system with newly created token money on a scale never before seen in
the history of the United States. Not only did the absolute quantity of dollar token money double, the prices of many commodities plunged further expanding the real quantity of dollar token money. The result was a collapse in interest rates and the gradual fading away of the panic during the course of 2009.
However, unlike in the days of Marx, when giving the Bank of England the mere authority to increase the amount of banknotes beyond the amount of gold that the bank had in its vaults was sufficient to break panics, the Fed in 2008-09 actually had to more than double the quantity of the token money it issues in order to break the panic.