The Industrial Cycle and the Collapse of the Gold Pool in March 1968

Industrial cycles normally last about 10 years—give or take a year or two. The second industrial cycle after World War II began with the 1957-58 global recession. Given the fact that the industrial cycle lasts about 10 years, we would normally expect the next global downturn to occur around 1967. And indeed 1966-67 saw not only the “mini-recession” in the United States but the recession of 1966-67 in West Germany.

However, in 1967 the U.S. government and the Federal Reserve System were determined to avoid a recession on anything like the scale of the recession a decade earlier. As I explained in last week’s post, the bourgeois Keynesian economists believed that they understood the workings of the capitalist economy well enough to develop the “tools” that would allow the capitalists governments and central banks to avoid full-scale recessions in the future. Indeed in 1967, the U.S. economy escaped with only a “mini-recession.”

But just as the Keynesians were celebrating their final victory over the industrial cycle and its crises, there came the March 1968 run on gold, which led to the collapse of the London Gold Pool. The U.S. government and Federal Reserve System, seeking to stave off the complete collapse of the dollar-gold exchange standard, felt obliged to take deflationary measures. The fed funds rate, which on October 25, 1967, had fallen to as low as 2.00 percent, rose to 5.13 percent on March 15, 1968, the day the gold pool collapsed.

As the Federal Reserve System’s deflationary measures took effect, the fed funds rate rose to as high as 10.50 percent during the summer of 1969. Long-term interest rose too, if to a lesser extent. On September 6, 1967, the rate on U.S. government 10-year bonds fell to 5.20, still well above the level of around 4 percent that prevailed during the first half of the 1960s—not to speak of the less than 2.5 percent rate at which Truman had expected to finance the Korean War.

On December 29, 1969, the yield on the long-term government bond hit 8.05 percent. With interest rates, both long term and short term, at such high levels, the demand for gold bullion was finally broken, and the dollar price of gold fell to around $35 an ounce by 1970. For the moment, the dollar-gold exchange standard had been saved.

Restrictive fiscal policy

As I explained last week, the March 1968 gold pool crisis forced the Johnson administration to rescind its decision made weeks before to grant Westmoreland’s request for hundreds of thousands more troops to serve in the war against Vietnam. The hope was that the decision to not send more troops would mean a smaller U.S. balance of payments deficit, and some of the pressure would be taken off the U.S. dollar—and U.S. interest rates. In 1969, the investment tax credit, a measure designed to encourage capital investment—expanded capitalist reproduction—was repealed. The aim was to reduce the demand for credit used to finance capital investment.

Government deficit spending was also ended momentarily as the U.S. federal government moved to balance its budget. The hope was that by ending government long-term borrowing, if only briefly, the rise in interest rates, especially long-term interest rates, would be minimized. This would, it was hoped, avoid a credit crunch like that of 1966-67, or at least reduce it. In this way, the extent of the economic downturn that would follow the move to the higher interest rates necessary to save the Bretton Woods dollar-gold exchange system would be lessened.

The recession of 1969-70

The combination of these deflationary measures pushed the U.S. economy into the first “official” National Bureau of Economic Research downturn since the recession of 1960-61. However, the recession of 1969-70 was a rather mild one as capitalist recessions go. Unemployment rose considerably but not as much as it had in 1957-58.

After the supply of credit on the U.S. domestic credit markets began to dry up, the Federal Reserve rapidly reversed direction, and “expansionary policies” were resumed. If this shift had not quickly taken place, the U.S. economy would have experienced the sharpest downturn since the 1930s with collapsing prices, profits, industrial production and employment.

That this true is shown by the near-panic conditions on U.S. money markets in the spring of 1970, which were similar to the seizing up of credit that preceded the global collapse of industrial production, employment, and world trade in the fall and winter of 2008-09. If events had been allowed to take this course in 1970, unemployment would have increased much faster than it had in 1957-58, when there had been no such “panic,” at least among the large industrial and commercial corporations.

The quick move to expansionary policies meant that the 1970 recession turned out to be a “shallow” saucer-type recession. (1) A slow recovery began in 1971—saucer-type recessions tend to be followed by slow recoveries. So it appeared that Keynesian economics had scored another victory, though not as impressive as the apparent victory in 1966-67, when an “official” recession as defined by NBER had been avoided altogether.

The July-August 1971 international monetary crisis

But again the victory was to prove illusionary. In July-August, a new and this time fatal crisis of the dollar-gold exchange system erupted. On August 15, 1971, U.S. President Richard M. Nixon ended the convertibility of the dollar into gold once and for all.

Officially, a new series of fixed exchange rates were soon announced, and a new slightly higher official dollar price of gold was established. But the official price of gold now meant nothing. The U.S. dollar was inconvertible into gold, not only for ordinary people—that had long been the case—but for governments and central banks as well. The only dollar price of gold that mattered now was the one on the open market.

There was to be one more agreement to establish yet another schedule of fixed exchanged rates, and there was another meaningless rise in in the “official” dollar price of gold. But these new international monetary agreements quickly collapsed. Soon the Bretton Woods System based on fixed exchange rates was declared dead. Instead, currencies were free to float against one another, though governments continued to intervene in the currency markets by buying and selling currencies in order to manipulate these ever changing exchange rates. This “system,” with the dollar continuing to serve as the main reserve currency, continues to the present day.

Keynesians delighted by end of the dollar-gold exchange standard

As I mentioned last week, Keynesians were delighted, convinced that gold had finally been “demonetized” for all practical purposes. With gold “officially” dethroned, the policies of the Federal Reserve System and the fiscal policies of the government could finally concentrate on achieving “full employment”—as defined by the bourgeois economists. Freed of the need to worry about defending either their gold reserves or a fixed dollar price of gold, the central banks would be free to lower interest rates to whatever level was necessary to ensure “full employment” with “stable prices”—meaning the desired level of inflation.

Nixon’s other moves on August 15, 1971

Nixon announced two other moves to deal with the plunging value of the U.S. dollar. One, he announced a “temporary” 10 percent surcharge on imports. This was a threat to close access to the U.S. market that had been granted to the European and Japanese capitalists after 1945 in exchange for giving up any attempt to compete with the United States politically and militarily.

But Nixon could not really go very far down this road. To do so would have given the European and Japanese imperialists an incentive to rebel against the American empire. In addition, if the closing of the U.S. market had led to mass unemployment in either Western Europe and or Japan, this could have resulted in the radicalization of the European working class at a time when the Soviet Union and its East European allies with their planned economies still existed.

In addition, the shooting war against Vietnam was still raging. Nixon’s moves were at most designed to give the U.S. government some bargaining power in negotiating cartel agreements with the West European and Japanese capitalists—for example, limiting imports of Japanese cars to certain levels. (2)

Wage and price controls

Much more important were the wage price controls that Nixon announced. Here, too, Nixon, though very much a right-wing Republican, followed Keynesian theory and not the ideas of Milton Friedman—later to be called “neo-liberalism”—that were to be embraced by his successors.

In the posts that I devoted to the theories of John Maynard Keynes (The Ideas of John Maynard Keynes), I explained that according to Keynes the general price level is governed by the level of money wages. As prices began to rise from 1965 onward, the Keynesian economists advocated so-called “incomes policies” to limit wage increases.

The trade unions would agree to hold back wage increases to the level of the increase in labor productivity as reported by the capitalist governments. Or what comes to exactly the same thing, the unions would agree not to use their full market power to raise wages as high as market conditions permitted. If wage increases were limited to productivity increases, then—according to the bourgeois economists of the Keynesian school—price increases would slow down. The Keynesian economists claimed that, since real wages as opposed to money wages are determined by “productivity,” real wages would not be affected.

And, they explained, the workers would benefit from “wage restraint” in another way. The Keynesian economists claimed that with inflation controlled through “incomes policies,” the Federal Reserve System—and the other central banks—would be free to follow “expansionary polices,” and recession and mass unemployment would be avoided.

As inflation kept accelerating, however, the Keynesians blamed the unions for failing to practice “wage-restraint.” The Keynesian economists and the capitalist media described the accelerating inflation as a “wage-price spiral,” though in reality it was a “price-wage” spiral. More and more Keynesian economists advocated compulsory wage and price controls to halt inflation. This would mean that the capitalist government would set the levels of both prices and wages. (3) Wages are, after all, simply the price of a particular commodity—labor power.

Since the controls would be compulsory, the unions would then have to go along with the wage freeze. The only other alternative would be to openly fight the government, which was something that unions, especially those in the the United States, were ill prepared to do. Especially since the New Deal, the U.S. union leadership had increasingly tended to rely on the government as opposed to the union consciousness, solidarity and militancy of their members.

Wage and price controls fail to prevent accelerating inflation

The only alternative to wage and price controls, the Keynesians argued, would be a rise in interest rates sufficient to cause a recession with its associated unemployment. According to Keynesian theory, a recession of sufficient severity would end inflation. As unemployment rose, the balance of forces on the labor market would swing sharply in favor of the bosses, and the rise in money wages would taper off. This would, the Keynesians claimed, finally cause inflation to slow down or cease.

But this would be achieved only through mass unemployment, with all the suffering that goes with it. However, if the unions agreed to moderate wages “voluntarily,” or if the moderation of wage increases were part of a system of government-enforced mandatory wage and price controls, inflation could be capped without recession and mass unemployment. Or so the Keynesians promised.

In the United States, this seemed reasonable to many workers who were uneducated in Marxist theory. (4) Indeed, in a socialist society the setting of wages and prices would be part of the economic plan. But the economic laws of socialism are not those of capitalism. Under capitalism, any wage and price controls are a trap for the unwary sellers of the commodity labor power.

The Keynesian economists pointed to the example of World War II as an example of successful mandatory wage and price controls. But how did the wage and price controls really work during World War II? In a situation where prices are lower than the level necessary to equalize supply with demand, such as was the case during World War II, a price freeze paralyzes the mechanism that under capitalism reduces demand to the supply—a rise in prices. The result will be shortages and government rationing.

While rationing can ensure a fairer distribution of scarce commodities than high prices that only the rich can afford to pay, it goes against the grain of capitalism. In such a “shortage economy,” capitalists tend to hold commodities off the “legal markets.” Instead, they offer commodities in the more or less illegal so-called “black markets” at much higher prices. (5) The high prices on the “illegal” markets” reduce demand to the supply.

The longer price controls are in effect, the more they will tend to break down as commodities become increasingly unavailable at legal prices and can only be obtained illegally at much higher prices. Eventually, prices controls are abandoned and official prices rise rapidly to levels that balance supply and demand once again. The “black markets” disappear. If the trade unions are unable to win wage increases, the result will be a sharp decline in real wages.

Wage and price controls combined with currency depreciation

As the 1970s progressed, inflation increasingly reflected not so much excess demand at existing prices—as had been the case in the mid-1960s—but rather the depreciation of the U.S. dollar and other paper currencies against gold. Many modern Marxists to the contrary, paper currency cannot represent value—abstract human labor—directly.

As I explained in my second post on money (From Money as Universal Equivalent to Money as Currency), and as Marx explained much better than I can in the first three chapters of volume I of “Capital” and elsewhere, paper money can only represent value indirectly through the mediation of a money commodity. This is the real function of the dollar—or other currency—price of gold.

The gold market establishes exactly how much gold a dollar—or other paper currency—represents in terms of a standard of weight such as a troy ounce—the unit in which the quantity of the use value of the commodity gold is measured. In turn, depending on the ever-changing conditions of production in the gold mining and refining industries, a given quantity—weight—of gold will represent a definite amount of abstract human labor.

And unlike the abstract human labor embodied in non-money commodities, the abstract human labor embodied in a given quantity of gold is directly social. That is, the abstract human labor that is necessary to produce a given quantity of gold does not have to be exchanged for another commodity to demonstrate that it forms a part of the social labor of society. (See the first three chapters of volume I of “Capital” for a full examination of this extremely subtle, little understood, but absolutely vital point.)

Suppose a commodity—let’s say a radio of a given make and quality—is selling at its value. Assume the radio is selling for $35 each. And assume the dollar price of gold on the open market is $35 an ounce, which was the case in 1970. In this case, it will take exactly the same amount of abstract human labor to produce a radio of a specific quality as it takes to mine and refine an ounce of gold of a certain fineness.

Now, assuming everything else is unchanged, let’s say the dollar price of gold rises to $70 an ounce. If the radio continues to sell for $35, the economic real price of the radio—or what comes to exactly the same thing, the price of the radio in terms of gold—will not be one ounce of gold for the radio, but rather one-half ounce of gold.

Under these conditions, the radio will be realizing only half of its value in terms of the use value of the money commodity that measures the values of all other commodities. But sooner or later, the market corrects this imbalance. If the dollar price of gold remains at $70 an ounce—all things remaining equal—the price of the radio will rise sooner or later to $70. (6)

So, the more the price of a paper currency such as the U.S. dollar rises against gold, and the longer the higher dollar price of gold persists, the higher will be the rate of inflation in terms of that currency. These inflationary pressures will last until once again commodity prices are more or less in line with underlying labor values as measured in terms of weights of gold.

Now, what happens if the paper currency price of gold is allowed to soar on the open market while the capitalist government tries to freeze prices and wages? The capitalists respond to the attempt of the government to force them to sell their commodities at economically real prices that are below the actual value of the commodities involved by withdrawing commodities from the legal market. This situation leads to shortages at official prices and so-called “black markets” where commodities can be obtained only at much higher prices.

The workers as sellers of the commodity labor power should do all they can to raise wages in terms of a depreciating currency just as the capitalists do with the prices of their commodities under the same circumstances. When the government allows the currency to depreciate—as measured by the price of gold in terms of that currency—while telling the workers not to demand higher wages in the name of fighting inflation, it is the job of the unions to do everything they can to defeat the wage controls and raise the price of their members’ labor power.

If the workers don’t do this, prices—the Keynesians notwithstanding—will still rise in terms of the depreciating currency. If this happens, wages both in terms of gold—real money—and in terms of purchasing power—real wages—will fall. The result will be a rise in the ratio of unpaid to paid labor. The rate of exploitation of the workers by the capitalists will rise.

When Nixon announced his controls, the dollar price of gold—that is, the amount of gold measured in terms of weight that a dollar really represented in the sphere of circulation—was already between $42 and $43 an ounce. That dollar already represented markedly less gold than it had when Roosevelt established the $35 an ounce dollar price of gold in 1934. In August 1973, the dollar price of gold rose to over $67. That is, the dollar had already lost almost half of its gold value since the days of Roosevelt.

Sure enough, shortages began to appear throughout the economy and commodities were increasingly sold illegally at much higher prices on the “black market.” Unlike during World War II, no rationing system had been established. Working-class people and others with low incomes were especially hard hit by this “concealed inflation.” Things weren’t helped by the failure of the U.S. trade unions to launch a broad struggle against the wage controls. The collapse of the price controls was rapidly approaching.

Did the 1973 oil embargo and price increases cause the inflation?

Keynesian economists blamed the failure of their prediction that the wage and price controls program would halt inflation (7) not on the their false economic theory—if they did that they would have ceased to be Keynesian economists—but instead on the dramatic rise in oil prices that followed the so-called Yom Kipper war between zionist-apartheid Israel and Arab countries. (8)

At that time, the Arab countries announced a boycott of the United States and its satellite imperialist powers, which were supporting Israel against the Arab countries. This short-lived boycott led to gasoline shortages in the imperialist countries and was soon followed by sharply higher oil prices in terms of dollars and other depreciated paper currencies.

The Keynesian economists, forgetting their theory that changes in the general price level are caused by changes in money wages, blamed the rise in prices on the sharp increase in the price of oil and the OPEC “oil cartel.” However, today it is clear that the real reason for the rise in oil prices was the accelerating decline of the U.S. dollar—the currency in which oil prices are quoted—against gold. If the U.S. government had not wanted the dollar price of oil to rise, it should have preserved the gold value of the dollar.

“This [the depreciation of the dollar against gold—SW] led,” Wikipedia writes, “to the ‘Oil Shock’ of the mid-seventies. In the years after 1971, OPEC was slow to readjust prices to reflect this depreciation [of the dollar—SW]. From 1947-1967 the price of oil in U.S. dollars had risen by less than two percent per year. Until the Oil Shock, the price remained fairly stable versus other currencies and commodities, but suddenly became extremely volatile thereafter. OPEC ministers had not developed the institutional mechanisms to update prices rapidly enough to keep up with changing market conditions, so their real incomes lagged for several years. [The depreciation of the dollar hit the OPEC countries very hard when they failed to quickly increase the dollar price of oil as the dollar depreciated against gold, just like the real wages of the workers in the U.S. fell when the unions failed to fight for higher wages in dollar terms when the dollar began its plunge against gold—SW]. The substantial price increases of 1973-74 largely caught up their incomes to Bretton Woods levels in terms of other commodities such as gold [emphasis added—SW].”

In other words, OPEC’s readjustment upward in the dollar price of oil, far from causing the inflation as the Keynesian economists and the capitalist media falsely claimed at the time, was a purely defensive move in reaction to he devaluation of the U.S. dollar against gold.

It seems that the commodity oil is more sensitive to changes in the value of the paper currency it is quoted in—the U.S. dollar—than almost any other commodity. Since oil as the basic source of energy is so important to the modern world capitalist economy, it is especially sensitive to changes in the gold value of the U.S. dollar. This close connection is confirmed by movements of the dollar price of oil between of 2004 and 2008, when there was no oil embargo.

We can confirm this by looking at changes in both the dollar price of gold and the price of oil from September 2004 to the summer of 2008. At the beginning of September 2004, just slightly more than five year ago, the dollar price of gold was $400, while the price of oil was being quoted at a little more than $40 an barrel. On August 6, 2007—just before the latest economic crisis began—the dollar price of gold rose to $651.50, while the price of a barrel of oil had risen to $69.14. Therefore, as the dollar lost gold value, the dollar price of oil more or less tracked the declining value of the dollar against gold. (9)

After U.S. and world credit markets suddenly froze in August 2007, speculators assumed that the U.S. Federal Reserve System would flood the banking system with reserves—that is, its dollar-denominated token money—in an attempt to stave off the severe recession that seemed to be—and as we now know actually was—impending.

In anticipation of the radical explosion in the quantity of dollar “token money”—”paper” dollars—speculators drove up the price of gold to over $900—and briefly over $1,000—at times during the year 2008. Not surprisingly, the price of oil soared too, despite signs the U.S. and world economy were approaching a recessionary downturn. Indeed, even our friends at the NBER now say that U.S. economy entered a “contraction” in December 2007, just a few months after the initial August 2007 credit market panic.

Despite the slowing economy—which all things remaining equal would be expected to lead to lower oil prices—the dollar price of oil reached $147 in July 2008. This despite the fact that the Federal Reserve Board had not yet in fact greatly expanded the quantity of token money. I will examine this more closely in a few weeks when I examine the crisis of 2007-09. But I think these movements in the price of oil shed considerable light on the role of oil price increases during the 1970s.

To put things in perspective, if the dollar price of gold had risen as much over the last three years as it did between 1970 and 1973, the gold price would be around—give or take a bit—$1,800. And if the deflationary collapse of the world economy that occurred between the late summer of 2008 and the summer of 2009 had not yet occurred, isn’t it likely that oil prices would be substantially higher today than they were in July 2008 just before last year’s deflationary panic hit?

The effect on wages and politics

The failure of trade unions to fight Nixon’s wage controls therefore did nothing to moderate the inflation caused by the plunge of the dollar’s gold value. While the official price levels were held back for awhile by the wage and price controls, shortages and “black markets” multiplied as the dollar plunged against gold. It wasn’t long before this partially concealed inflation broke out into the open.

The failure of the unions to demand wage increases in line with the soaring cost of living did not stop the inflation as the Keynesian economists claimed it would, nor as we will see did this prevent the recession and soaring unemployment that was to quickly follow. What the wage price controls did achieve was to lower the real wages of the American workers.

To this day, the real hourly wages of U.S. workers have never again risen to the levels that prevailed in 1973, despite a huge increase in labor productivity of U.S. workers over that period. Contrary to the theories of the bourgeois economists, real wages did not increase with labor productivity. Instead, in the United States they fell as labor productivity rose. As I have already explained, the unions were greatly undermined as a result, and this helped turn U.S. and world politics sharply to right. The way was prepared for the rise of Ronald Reagan a few years later.

Inflation breaks out into the open

The wage price controls imposed in August 1971 combined with easy money policies by the Federal Reserve System created soaring demand, a wave of shortages and at first a sharp rise in industrial production. Officially, the producer price index rose “only” a little more more 7 percent in 1972. The sharp rise in industrial production along with suppressed inflation—momentarily artificially suppressed by the wage and price controls—combined with the approaching withdrawal of U.S. forces from the war against Vietnam enabled Nixon to win a landslide re-election victory against his opponent, the liberal Democrat George McGovern. But as the fall of the dollar against gold accelerated, the price controls crumbled. Inflation broke out into the open.

In 1973, the rate of inflation in the U.S. economy as measured by the producers price index rose above 17 percent! The index rose by a similar amount in 1974—a far cry from the mere 3.5 percent rise in the producer price index that was considered so alarming back in 1965!

Nixon’s Keynesian wage and price control program had failed miserably as an anti-inflation program, though it was all too successful in lowering the living standards of the American workers.

Inflation turns into stagflation

What was really happening was a new form of financial panic. Traditionally, in the days before Keynesian economic policies, the sellers of commodities would often panic when a crisis hit and dump their commodities on the market at greatly depreciated prices. In the days of the international gold standard, the devaluation of the currency against gold was considered unthinkable, so there was no panic as far as currency values in terms of gold were concerned.

In 1973-74, the panic took a different form. The sellers of commodities weren’t all that concerned that their creditors would demand repayment forcing them to raise cash at almost any price. Keynesian government and Federal Reserve policies would keep up demand and maintain the flow of credit, or so it was believed.

Rather, in the “Keynesian world” it was the owners of currency—and currency-denominated financial assets—money capitalists—who panicked. Fearing that the dollar and the other paper currencies were about to lose the bulk of their value, the money capitalists stampeded into the gold market—and for awhile into the oil and other commodity markets.

Back in the 19th century, Marx noted that a panicky move into banknotes—currency convertible into gold—had largely replaced moves to hoard gold itself that had occurred in “former times.” (10) In 1973-74, the “former times” returned—thanks to Keynesian economics—and gold itself rather than currency was once again the object of hoarding.

The result, not surprisingly, was a sharp rise in commodity prices—not just oil—in terms of dollars, if not gold. The market was attempting to raise all commodity prices to match the suddenly sharply reduced gold value of the dollar and other paper currencies. But the market couldn’t actually succeed in this endeavor, because though the Federal Reserve System was increasing the quantity of dollar token money—the monetary base—it was not doing so at the rate that the dollar was now depreciating. In terms of the gold that the monetary base and the broader money supply represented, and in terms of real purchasing power, the monetary base and with it the broader money supply was contracting.

Keynesian economics bankrupt

The Keynesian economists had relied on the belief that inflation and recession are opposite states of the economy that could not occur at the same time. But what if economic stagnation and inflation coincided? That is exactly what confronted the U.S.—and world—capitalist economies in 1973-74.

Since prices in terms of depreciating currency were rising faster than the central banks were printing it, interest rates soared and credit froze. Credit-sensitive industries such as construction and automobiles fell into sharp recession. But there were also big movements into oil and many other primary commodities as the capitalists sought to rid themselves of dollar—and other currency—denominated assets.

This maintained the demand for these classes of commodities at the expense of demand for other commodities such as autos and houses. The overall result was that monetarily effective demand was stagnant, real wages were rapidly declining, and interest rates were rising sharply. Stagflation had arrived.

If the Federal Reserve Board had moved to increase the rate of growth of the monetary base—token, or paper, money—to the actual level of price increases in a bid to stave off recession, the panicky move out of paper currencies and into “hard gold money” and critical primary commodities such as oil would only have accelerated. The printing presses of the governments and central banks would have found themselves in a race with the skyrocketing general price level—in terms of paper money.

In this type of panic, if they doubled the monetary base, for example—like they did during the more traditional type of panic in the fall of 2008—prices might have jumped not two-fold but four-fold in a very short period of time. The rate of inflation would have increased geometrically.

If the central banks had attempted to keep up with the rising general price level in terms of their plunging currencies, they would have had to keep the printing presses turning ever faster. This is exactly how runaway inflation and even hyper-inflation leading to complete collapse of the currency, such as occurred in Germany in 1923, develops. (11)

The only way to avoid this ultimate economic catastrophe within the framework of the capitalist system was to allow interest rates to rise enough to finally break the demand for gold. If the Federal Reserve System and the other central banks kept the rate of growth of their token money below the rate of increase in the currency price of gold—which they began to do in this period—and the general price level, interest rates would rise sharply—which they in fact did. At some point, the demand for gold would be broken and inflation would start to taper off. But this meant abandoning all hope of avoiding a severe recession. The Keynesian nostrums were fast melting away in the inflationary storm.

Where the Keynesians went wrong

Keynes, remember, had conceded that crises of generalized overproduction were possible in a capitalist economy. But he denied they were inevitable. In reality, due to the basic contradiction of the capitalist mode of production—the contradiction between socialized production and the continued private appropriation of the product—crises of generalized overproduction on a periodic basis are not only possible, they are inevitable once capitalist production has developed to a certain point. Capitalist production can only exist as the expanded reproduction of capital. And the expanded reproduction of capital if it is to continue means periodic crises of generalized overproduction.

The inflationary panic of 1973-74 showed the limits of Keynesian “expansionary policies” that attempted to suppress the symptoms of contradictions of capitalist production—periodic crises of generalized overproduction—while retaining the capitalist mode of production itself with all its contradictions.

Statistics that are kindly made available by the U.S. Federal Reserve System itself tell the story. On July 24, 1974, the fed funds rate hit the then unheard of level of 14.19 percent! That was the level that proved necessary to finally break the back of the demand for gold and halt acceleration of the rate of inflation.

Long-term interest rates tell a similar story. On August 15, 1971, the rate of interest that the U.S. government had to pay on 10-year bonds was 6.41 percent. In August 1971, when Nixon finally killed what was left of the international dollar-gold exchange standard, the fed funds rate stood at 5.63 percent. But with the end of the last remnants of the international gold standard, the Fed was now free—or so the Keynesians imagined—to drive down interest rates to a level that would ensure “full employment”—meaning the level of unemployment that in the judgment of the Fed leadership represented the best interests of the capitalist system.

Gold would no longer get in the way. The Keynesians were fooling themselves. In fact, gold got in the way under the “fiat” monetary system far more brutally than it had ever got in the way under any form of the gold standard. The figures tell the story.

In February 1972, the fed funds rate fell as low 3.13 percent fueling a strong surge in industrial production. The consequent “prosperity” helped re-elect President Nixon by a landslide in the November 1972 U.S. presidential elections. There was no repeat of 1960, when a recessionary dip in the economy helped ruin “Tricky Dick’s” first try for the White House. So far so good. But by July 1973, the fed fund’s rate rose above 13 percent for several days, and it was often above 10 percent for the rest of the year.

The long-term interest rate rose too, though like is always the case during crises, not quite as much as short-term interest rates. It was soon above 6 percent again and during 1973 rose for awhile above 7 percent, hitting 7.20 percent on September 14, 1973. The Fed, determined to compensate for the oil boycott and the sharp rise in the price of oil, then drove the long-term interest rate back below 7 percent.

But the growing panicky demand for gold soon undid the Fed’s “Keynesian” moves to lower interest rates. By February 1974, the long-term interest rate was back above 7 percent again. On August 26, 1974, long-term interest rates ratcheted to 8.16 percent. As is typical, long-term interest rates are more stable than short-term interest rates, but their movements, too, pointed relentlessly upward.

As interest rates soared, the demand for gold was finally broken. Remember, if interest rates rise high enough, the demand for gold will always be broken. But it now took considerably more than the 19th century’s 6 percent to “draw gold from the moon.” On December 30, 1974, the dollar price of gold hit $195.25. After that, the dollar price of gold began to decline. Or what comes to exactly the same thing, the depreciation of the dollar for the time being was halted.

Though it was very shaky, the dollar had been stabilized, even as it turned out only briefly. As soon as the shaky stabilization of the dollar occurred, recession hit with full force by the fall of 1974 and continued through the following winter. Industrial production and employment plunged and unemployment soared. The rate of decline was sharper than had been the case in 1957-58.

Back in August 1971, the Keynesians claimed that Nixon’s wage and price controls would end the problem of accelerating inflation without recession. But Keynesian policies had not only brought soaring inflation and lower real wages, they had completely failed to stave off recession. The only “achievement” was to lower the living standards of the wage earners. In every other respect, Keynesian policies had failed across the board.

No full industrial cycle in the mid-1970s

Industrial production peaked out in the fall of 1973 only four years after it had peaked out in 1969. The four-year period between the fall of 1969 and the fall of 1973 does not constitute a full industrial cycle. The crisis of overproduction that was already heralded by the credit-crunch and mini-recession of 1966-67, then by the collapse of the gold pool in March 1968, and the recessionary dip in the economy in 1969-70 now broke out into the open as a sudden glut of unsold inventories appeared in warehouses in the fall of 1974. This led to the usual results: the collapse of industrial production and employment not only in industry but throughout the economy. Like is the case will all general crises of overproduction, the crisis unfolded on the scale of the entire world market.

Resemblances to 1957 and 1960-61

In some ways, the 1974-75 collapse resembled the second dip of the double dip recession of 1957-61. The recession of 1957-58 was followed by the secondary recession of 1960-61 when the Fed eased “too rapidly” and gold began to flow out of Fort Knox. Or perhaps it was a triple dip if we take the 1966-67 “mini-recession” as the first dip. But unlike was the case in 1957-61 when the secondary recession of 1960-61 was milder than the primary recession of 1957-58, the recession of 1974-75 was much worse than the recession of 1969-70, not to mention the “mini-recession” of 1966-67.

Though economic indicators began to rise again in the spring of 1975, the economic crisis was still far from over. More dips were coming before the U.S. and world capitalist economy finally emerged from the crisis in the early 1980s.

I will examine these final “dips” and how United States and world capitalism finally did emerge from the crisis in next week’s post.


1 If you make a graph of industrial production through the recession and the subsequent recovery, some recessions resemble saucers and others the letter V. In a saucer-shaped recession the graph of industrial production declines modestly and then stays at a depressed level for a year or so. It then resumes its rise at a modest rate.

In a so-called V-type recession, the graph of industrial production declines abruptly and then rises at a similar rate as when it fell. The more the recession resembles a V, the sharper the inventory liquidation—the liquidation of commodity capital—is. If the inventory liquidation is minimal, the subsequent rebound fueled by inventory rebuilding also tends to be minimal.

The fact that the 1970 recession was saucer-shaped indicates that industrial and commercial capitalists panicked even less than they had in 1957-58. They were confident that the Federal Reserve System and the government would quickly come to their rescue.

2 The United States over the years had also pressured Japanese and later South Korean automobile corporations to build plants in the United States. During World War II, U.S. auto plants had been converted to the production of tanks and war planes. The existence of a huge automobile industry was important for the relatively easy U.S. victory in World War II. In the event of a major future war, the U.S. government could if necessary seize Japanese and South Korean-owned auto plants in the United States and again use them to produce tanks and planes.

If, however, the domestic U.S. auto industry collapses completely—it came very close to doing so during the 2007-09 crisis, and there were no foreign-owned auto plants in the U.S—the U.S. would be in a far weaker position in the event of a new major war, such as a new war among the imperialist powers. The U.S. government, therefore, insists as a condition for being allowed to import autos to the U.S. home market that foreign automobile corporations build a certain quantity of autos within the United States itself.

3 In an unplanned capitalist economy, it is impossible for the government—or anybody else—to plan prices and wages for very long, because it is exactly the fluctuations of prices and wages—the latter being just the price of the commodity labor power—that regulates production under the capitalist system.

4 In the United States, almost no workers had even an elementary education in Marxist theory. For the most part, the U.S. trade union leadership was openly pro-capitalist and anti-Marxist. Insomuch as any economic theory predominated in the U.S. trade union movement it was Keynesian theory. As a result of this lack of even a basic education in Marxist economic theory, most trade union workers in the United States did not understand the need to struggle against the wage and price controls.

5 The word “black” is often used negatively in modern language. Perhaps this is because dark-skinned people were used as slaves during capitalism’s rise and today tend to be the most super-exploited workers.

6 Many years ago, when I tried to explain this, I was often asked, doesn’t this presuppose that the capitalists have a knowledge of the real nature of labor value and price? In fact, there is no necessity for the capitalists to have a conscious knowledge of the economic laws that ultimately govern their behavior.

What the capitalists do know through long experience is that the “price of gold” is an excellent indicator of whether the rate of inflation is rising or falling. If the “price of gold” indicates that inflation is sharply accelerating, they act accordingly. This is why the “price of gold” is one of the most-watched economic indicators by practical everyday traders, despite the teachings of bourgeois economists who insist that gold today is “just another commodity” and has little importance. The individual capitalists do not have to understand why the “price of gold” is such a good inflation indicator, they just know it is. It the job of Marxist economic science to explain why it is.

7 From the viewpoint of the capitalists, however, Nixon’s wage and price controls, though doomed to quickly collapse, were not a complete failure, since the price of the most important commodity of all—labor power—was indeed held down. The result was an increase in the rate and mass of surplus value and thus profits. And that is no small matter for the capitalists.

8 In October 1973, the government of Egyptian President Anwar Sadat launched a short-lived military offensive against the Israeli forces occupying Egypt’s Sinai Peninsula. It soon became apparent that the real reason for the Sadat offensive was to prepare the way for his government’s open alliance with the United States against the anti-imperialist Soviet Union and his recognition of zionist-apartheid Israel. The losers were the dispossessed Palestinian people.

9 The price of oil fell sharply against both gold and the dollar in the fall of 2008 just like the prices of other primary commodities did as well. There is no economic law that dictates the price of oil is unchanging in terms of gold. On the contrary. But whenever the U.S. dollar falls sharply against gold, a sharp rise in the price of oil in terms of the dollar can be expected. At least this has been the case since 1973.

10 In pre-capitalist times, and in the early days of capitalism, wealthy individuals often hoarded their wealth in the form of gold bullion, coins, plate or jewelry. But as capitalism developed and stable banknote currencies were developed, first the commercial banks, then the central banks, and finally in some cases government treasuries took over this hoarding function. Since the end of the London Gold Pool in March 1968, however, this historical trend has gone into reverse and the world’s gold supplies are increasingly being de-centralized into the hands of private hoarders once again. This is another one of the “achievements” of Keynesian economics.

11 Germany was not facing a crisis of generalized overproduction in 1923. However, the capitalist world was facing a crisis of generalized overproduction in 1973-74, even if it took an unfamiliar form thanks to Keynesian economic policies. A hyper-inflation growing out of a Keynesian attempt to stave off a crisis of overproduction is theoretically the most intense form of capitalist crisis of overproduction that can occur. If this ever happens in the real world, it would mean that all bank accounts, bonds (both government and private), and all money that is not in the form of gold would be wiped out.

It would be the most extreme form of the shift from a credit system to a monetary system that occurs in every capitalist crisis of overproduction to some extent. In a hypothetical hyper-inflationary crisis of overproduction, only gold would be able to function as money, and credit would be completely wiped out. It would bear the same relationship to an “ordinary” crisis of overproduction that a generalized nuclear war would bear to an “ordinary” world war fought with conventional weapons.


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