The Ideas of John Maynard Keynes (pt 2)

Keynes on the ‘classical’ marginalist economists

In Chapter 2 of his “General Theory of Employment, Interest and Money,” Keynes provides a summary of the theories of those he called the “classical economists.” Though Keynes uses the same terminology that Marx uses, Keynes is referring to the “classics” of marginalism, not the classical economists in Marx’s sense of the term. (1)

To Marx, the classical economists were those pre-1830 bourgeois economists who lived in a time when the contradiction between the capitalist and working classes was still underdeveloped. Therefore, the bourgeois economists were still able to analyze the laws of capitalist production scientifically, rather than merely apologetically.

Keynes’s “classical economists” were the “classics” of marginalism, especially Keynes’s own teacher Alfred Marshall (1842-1924). In his critique of the “classical” marginalist doctrine, Keynes did not dump marginalism and return to anything like classical economics in the Marxist sense. Instead, he gave marginalism a facelift so it would no longer be in such obvious contradiction with capitalist reality, especially the reality of the Depression years. Keynes’s main aim was to develop a form of marginalism that could explain the existence of persistent mass unemployment under capitalism.

Keynes’s modified marginalism was designed to serve two purposes. First, he hoped, to halt the spread of Marxist ideas among students of economics and other members of the young intelligentsia that was occurring under the impact of the Depression. This more plausible version of marginalism, Keynes hoped, would help turn the newly radicalized young intellectuals back towards a “safe” bourgeois version of economics. Second, Keynes’s revised marginalism would also provide a justification for massive government deficit spending, which he believed was necessary to combat the Depression in a way that “classical” marginalism did not.

Keynes’s critique of the marginalist theory of wages and prices

In Chapter 2 of the “General Theory,” Keynes presented the postulates of the liberal marginalist economists. These postulates are still defended today by neoliberal economists. All the quotes in this post are from Chapter 2 of Keynes’s “General Theory.”

The first postulate, and perhaps the most important postulate of traditional marginalism, is that “The wage is equal to the marginal product of labour.” “That is,” Keynes explained, “the wage of an employed person is equal to the value which would be lost if employment were to be reduced by one unit (after deducting any other costs which this reduction of output would avoid); subject, however, to the qualification that the equality may be disturbed, in accordance with certain principles, if competition and markets are imperfect.” (2)

This postulate holds that the worker’s wage is equal to the marginal product of the worker’s labor under conditions of “perfect competition”—no trade unions, no minimum wage laws and no social insurance. It assumes that the workers are not exploited by the capitalists. According to marginalism, when a new worker is hired, production will rise by a certain amount. The extra production is the marginal product produced by workers of that particular skill. As more workers of that particular skill are hired, the value of the workers’ marginal product will tend to decline, since the products that are produced with the help of the newly hired workers become more plentiful. According to marginalist theory, all else remaining equal, the price and thus the value of these products will decline. (3)

On the other hand, the more workers of a given skill are hired, the stronger the demand for labor and the higher the wage will be. This process continues until the value added by the last worker hired exactly equals the wage of the last worker. According to the marginalists, equilibrium is reached at this point. In equilibrium, therefore, workers through their labor are producing a quantity of value that is exactly equal to the value of their wages.

How the marginalist economists used mathematics to ‘refute’ Marx

This “postulate” boils down to the statement that the source of surplus value is not the unpaid labor of the working class, since the worker’s wage is equal to the value that the worker produces. What proof do the marginalists provide that this is indeed the case? And what exactly is the meaning of the word postulate?

“Postulate” is a mathematical term, and in mathematics, a subject with which Keynes was very familiar, “postulate” has a very precise meaning. It is defined by “The Basic Postulates & Theorems of Geometry” Web page as follows: “Postulates are statements that are assumed to be true without proof.”

Therefore, we see how the mathematical marginalist economists refuted Marx’s explanation of surplus value. They merely assumed without proof that surplus value is not produced by the working class.

The second “postulate” is that “the utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment.” It is assumed by the marginalists that no worker really wants to work at all. Performing labor for a capitalist boss is a definite “disutility” from the worker’s point of view. On the other hand, the money that the workers obtain in exchange for their “labor” enables the workers to buy commodities that have a definite utility for them. Indeed, without the “utility” provided by the wage, which the worker can only obtain by selling his or her “labor,” the worker couldn’t live at all. (4)

“That is to say,” Keynes explains, “the real wage of an employed person is that which is just sufficient (in the estimation of the employed persons themselves) to induce the volume of labour actually employed to be forthcoming; subject to the qualification that the equality for each individual unit of labour may be disturbed by a combination between employable units analogous to the imperfections of competition which qualify the first postulate. Disutility must be here understood to cover every kind of reason which might lead a man, or a body of men, to withhold their labour rather than accept a wage which had to them a utility below a certain minimum.”

Therefore, according to the “classical marginalists,” the worker does a kind of unconscious mathematical calculation. As long as the utility of the wage exceeds the “disutility” to the worker of working for the boss, the worker continues to work. At some point, however, the worker will decide that the disutility of working for the boss exceeds the utility provided by the extra wages the worker could earn if she continued to work. At that point, the worker says enough is enough and clocks out.

It is just as well for our economists that this statement is a postulate and therefore does not need to be proved. Anybody who has ever had a job under the capitalist system will immediately see that this “postulate” is completely divorced from reality. Suppose a worker who has actually read the marginalist economists explained to her boss that she has reached a point where the marginal disutility of her labor equals her wage for the day, and in accordance with the postulate used by the professional economists, she is clocking out.

The boss might, if he is mathematically educated, explain that the economists do not have to prove this postulate, since a postulate is a statement in mathematics that does not have to be proved. However, I, your boss, will disprove this particular postulate used by the economists for you. If you clock out now, you are fired. There are many other people out there who would be more than willing to take your job.

The second “postulate of the classical economists” is disproven whenever a boss schedules “forced” overtime”. (5) Even at “time and a half,” the worker would often be more than willing give up the overtime but cannot do so because if she refuse the overtime she will be fired. That is why it is called “forced overtime.”

Perhaps the professors who taught at Oxford or Cambridge who discovered this “postulate” might have been in a position to refuse to teach more than, say, two hours a week. In late 19th-century Britain, almost all professors, I believe, were recruited from ruling-class families who drew a large income from the rents on their families’ landed property and interest and dividends on their families’ investments.

After two hours of teaching the spoiled brats that constituted the rising generation of the ruling class the rudiments of marginalist economics, our professors would naturally prefer leisure for the rest of the week over continued teaching. Perhaps these professional economists who taught at such great institutions as Cambridge and Oxford didn’t realize that their conditions of employment were not exactly the same of those of the workers who labored in the mills, mines and fields. Unlike most professional economists, real workers had no other source of income except their wages. This postulate of marginalism, however, does provide an interesting illustration of Marx’s materialist theory of ideology. Being indeed determines consciousness.

Using these two postulates of marginalism—both at odds with reality—the marginalists proceed to construct their “proof” that, assuming “free competition” prevails in the labor market, the only kind of unemployment that can exist is either frictional or voluntary. (6) If a worker quits a job, it might take her a few days to find another one to her liking. Such a situation is an example of “frictional unemployment.”

The other type of possible unemployment is voluntary. For example, I might be able to find a job that will pay $500 a week. But I make the following calculation. While I certainly would like the commodities that I could obtain if I had an extra income of $500 a week, the utility that I would obtain from these commodities is less than the disutility of actually getting up in the morning and working for eight hours. I therefore choose leisure over work.

Indeed, voluntary unemployment was a growing phenomenon among the ruling class in Britain in the period when marginalist economics was being developed. The last quarter of the 19th century witnessed the transition from industrial capitalism based on free competition to monopoly capitalism or imperialism. Members of the capitalist class were increasingly withdrawing from the active direction of their businesses—leaving it to hired managers—and becoming transformed into mere collectors of interest and dividends. Increasingly, these members of the ruling class were indeed choosing “leisure” over any extra income they might have been able to earn directing businesses, as members of parliament; serving in the upper reaches of the military, civil service or the church; or as professors or other similar occupations that might do honor to a “gentleman.”

However demoralizing the growth of this kind of mass idleness among the members of the ruling class was, it did represent the free voluntary choice of the individuals concerned. Idleness among the working class was a different matter altogether. Unlike the idle capitalists and landowners, idleness among the working class meant poverty. Few workers would voluntarily choose the extreme poverty that the unemployed experienced in late 19th-century England rather than hold a job.

Basing itself on these two absurd postulates, marginalism “proved” that mass long-term unemployment among the working class—except perhaps in unionized industries—was simply impossible.

It was this “proof” that only voluntary and frictional unemployment could exist in a capitalist economy that Keynes challenged. After the experience of the mass unemployment of the 1920s, followed by the even higher unemployment after 1929 of the Depression itself, Keynes realized something was very wrong with the marginalist “proof.” But where did the “proof” go wrong?

The diehards of economic liberalism, especially the leaders of the Austrian school of marginalist economists such as Fredrick von Hayek and Ludwig von Mises, supported in England by Lionel Robbins, insisted that the way out of the slump was through massive wage cuts. (7)

According to these economists, if the capitalists hired the unemployed workers at the prevailing level of wages, the workers’ labor would be producing far less value than the value of the wages the bosses would be paying them. The poor capitalists would be exploited by the workers! In a free society, the capitalists simply wouldn’t put up with that.

The only way out, economists of the Hayek, Mises and Robbins schools claimed, was through major wage cuts. Once wages dropped to a level that corresponded to the actual value that the workers’ labor was capable of producing, mass unemployment would disappear. What was standing in the way, Hayek, Mises and Robbins claimed, was the power of the trade unions and “socialist” government policies that were either encouraging mass “voluntary” idleness on the part of the working class, or keeping wages so high that the capitalists couldn’t afford to hire them at the prevailing wage levels.

In his “General Theory,” Keynes rejected the claim that cutting nominal wages would eliminate unemployment. The bosses, during the Depression years, certainly knew how to take advantage of the mass unemployment. There were no lack of wage cuts. Yet contrary to the predictions of the Hayek’s, Mises’s, and Robbins’s, there was no sign that full employment was being restored. On the contrary.

Keynes by no means completely disagreed with Hayek and Company. He shared their basic marginalist assumptions. But Keynes’s marginalism was more pragmatic and flexible in the British manner, as opposed to the stringent dogmatism of the “Austrians.”

Keynes agreed with the Austrians that “real wages” must be cut in order to restore “full employment.” But he argued that cutting money wages was not the same thing as cutting real wages. According to Keynes, it was real wages that must be cut to restore full employment. “Whilst workers will usually resist a reduction of money-wages”, Keynes explained, “it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods.”

Keynes almost certainly was greatly influenced by the general strike of 1926, the greatest social and political crisis in recent British history. How could he not have been? The General Strike occurred less than a decade after the October Revolution of 1917 in Russia. Could something similar happen in Britain? This was, of course, the ultimate nightmare of all members of the British ruling class, Keynes included.

Back in the middle 1920s, the chancellor of the exchequer—Britain’s finance minister—Winston Churchill, in the face of considerable opposition within the British ruling class, including Keynes, moved to restore the convertibility of the British pound into gold at the old exchange rate. (8) Since the pound had fallen about 10 percent since the suspension of the gold convertibility in 1914, that amounted to a revaluation of the pound by about 9 percent against both gold and the U.S. dollar. (Unlike the pound, the U.S. dollar had not been devalued against gold as a result of World War I.)

The effect of this currency revaluation was to raise the price of labor power in terms of gold and the dollar about 9 percent. The bosses—especially in the declining British coal mining industry—responded by attempting to lower the wages in terms of revalued pounds by about 9 percent in order to wipe out the effects of the pound’s revaluation. The struggle against these wage cuts—in terms of revalued British pounds—led straight to the great General Strike of 1926.

But what would have happened if instead of a revaluation, the pound had been devalued? Suppose the devaluation of the pound was such that the price of commodities that the British workers consumed to reproduce their labor power rose by 10 percent in terms of pounds, while nominal pound wages had remained unchanged. Real wages would have fallen about 9 percent. Would the response of the workers have been so strong? Would the General Strike of 1926 have occurred anyway?

Keynes suspected the answer would be no. Therefore, he concluded, it is always better to avoid cutting nominal money wages, which the trade unions and workers will strongly resist. Instead, Keynes implied, the government should pursue policies that encourage the cost of living to rise. This will lower the living standard of the workers in a way that will be less obvious to them and therefore, he hoped, avoid any repetition of the “unpleasantness” of 1926 that had bought the continued rule of Keynes’s beloved capitalist class into question.

Keynes feared that lowering money wages would not lower real wages

In addition to opposing cuts in nominal wages because they provoked the trade unions and the working class, Keynes also argued that cutting nominal wages was simply ineffective when it came to actually lowering the workers’ standard of living.

“Moreover,” Keynes wrote, “the contention that the unemployment which characterizes a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts. It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing [since] wide variations are experienced in the volume of employment without any apparent change either in the minimum real demands of labour or in its productivity. Labour is not more truculent in the depression than in the boom‚ far from it. Nor is its physical productivity less. These facts from experience are a prima facie ground for questioning the adequacy of the classical analysis.”

Why, following the logic of the classical marginalist analysis, would the value that the workers’ labor was producing suddenly collapse in the early 1930s causing their wages to suddenly exceed that value? In terms of “physical productivity,” as Keynes puts it or, as the classical economists and Marx would put it, in terms of use value, the workers’ labor was capable of producing more than ever.

Indeed, the decade of the 1920s, which preceded the Depression, saw an extraordinarily rapid increase in the productivity of labor in the United States as electricity finally drove out steam as the main motive power in industry. Yet it was the United States that was hit hardest and longest by the Depression and experienced the highest levels and most persistent mass unemployment among the imperialist nations.

Great Depression or ‘Great Vacation’?

According to the classical marginalists, in the United States during the terrible year of 1932, the unemployed were “choosing leisure” rather than accept wages that would represent the value their labor was actually producing. Indeed, one wag even suggested that if the marginalist analysis is correct, the Great Depression should really be renamed the “Great Vacation.”

Indeed, this is not far from Milton Friedman’s analysis of the Depression. If the Depression was not simply a “Great Vacation,” it was at least a “Great Misunderstanding.” According to Friedman, real wages had risen as a result of the fall in prices brought on by contraction of the money supply. Therefore, when the Fed allowed the money supply to contract by one-third, the workers received a huge wage increase in real terms that was only partially counteracted by cuts in their nominal wages. The workers, not realizing how much the cost of living had fallen, were withholding their labor because they wrongly interpreted cuts in money wages as reductions in real wages.

One obvious problem with this “analysis” is that if it were true, workers should have been quitting their jobs in large numbers as the bosses moved to cut money wages, rather than being laid off as they were in reality. The implication of the “classical marginalist theory,” defended by the neoliberal Friedman, was that once the workers got sufficiently bored with the “Great Vacation” and began to realize just how much cheaper everything was, they would gladly return to work at lower money wages—but the same real wage—and “full employment” would return.

By recognizing that the Great Depression was no “Great Vacation,” Keynes was making a point that was obvious to every worker, indeed to virtually every member of the lay public who was not a trained professional economist. But Keynes was very much a trained professional economist of the marginalist school. How then could he square the marginalist analysis with the facts that were so obvious to everybody with the exception of marginalist economists?

Keynes did this by appealing to an even older economic fallacy than marginalism. This fallacy is the claim that the general price level is determined by the level of money wages. This view holds that, all things remaining equal, if wages go up, prices go up as well leaving real wages unchanged. Conversely, if wages go down, so will the general price level, also leaving real wages unchanged.

In the past, this argument had been used to “demonstrate” the futility of trade union activity. The argument was that if the unions succeeded in winning higher money wages, the workers would gain nothing from it, because the bosses would simply pass on the extra costs in the form of higher prices.

“The classical theory,” Keynes wrote, “assumes that it is always open to labour to reduce its real wage by accepting a reduction in its money-wage. The postulate that there is a tendency for the real wage to come to equality with the marginal disutility of labour clearly presumes that labour itself is in a position to decide the real wage for which it works, though not the quantity of employment forthcoming at this wage.”

In other words, the marginalists assumed that if there is serious unemployment, the workers will simply accept lower wages, resulting in lower money and real wages. This will lead, the “classical marginalists” claimed, to a speedy restoration of “full employment.”

“Now the assumption that the general level of real wages depends on the money-wage bargains between the employers and the workers, Keynes wrote, is not obviously true. Indeed it is strange that so little attempt should have been made to prove or to refute it. For it is far from being consistent with the general tenor of the classical theory, which has taught us to believe that prices are governed by marginal prime cost in terms of money and that money-wages largely govern marginal prime cost.” (9)

According to economists of the Friedman type, even the stupidity of the Federal Reserve System in “allowing” or even “causing” the one-third drop in the U.S. money supply between 1929 and 1933 would in and of itself not have been enough to cause the Depression. (10) The stupidity of the Fed had to be backed up by the stupidity of the workers in not understanding the difference between an actual fall in real wages as opposed to a mere fall in money wages.

But Keynes was arguing that workers are not so stupid. Even if the workers fully “understand” that real wages must be reduced so that they can again get work, the workers will not be able to actually lower their real wages as opposed to money wages. According to Keynes, the more money wages fall, the more prices fall. The workers are thus powerless to actually lower their real wages. In order to lower their real wages so that they can return to work, Keynes was implying that workers need the assistance of an inflationary policy on the part of the government and central bank.

The claim that “prime costs”—which are supposed to come down to wage costs—govern the general price level is not really a marginalist notion but a return to a false idea of Adam Smith that was later refuted by Ricardo. Smith had used the theory of labor value in places but in a far less consistent way than Ricardo.

Essentially, Smith assumed that commodities would exchange in proportion to the labor socially necessary to produce them under conditions of simple commodity production where wages and profits did not yet exist. But once capitalist production came into existence, it is the equalization of the rate of profit that drives capitalist production.

Capital is always flowing from industries where the rate of profit is below the average to industries where the rate of profit is above the average. Therefore, under capitalist production proper, according to Smith, the value of commodities—what Smith called “natural price”—is not really proportional to the quantity of labor socially necessary to produce them. Then what does determine the value of commodities under profit-driven capitalist production?

Smith believed that “constant capital,” to use Marx’s later terminology, could be reduced ultimately to variable capital. Commodities that are necessary to produce a given commodity other than labor (power) are themselves produced with both constant and variable capital, Smith argued. In turn, the commodities that produced these commodities other than labor power are in turn produced with both constant and variable capital. Therefore, Smith claimed, if you go back far enough, all capital consists of variable capital alone. All capital is therefore reduced to wages! A fine theory indeed.

Smith concluded that the value of a commodity is reducible to the three forms of incomes—or revenues—of capitalist society—wages, profits and rents. Therefore, Smith reasoned, if wages rise, the value and thus the price of commodities must rise with it.

Keynes in the passage quoted is actually replacing the vulgar theory of marginalism with an older vulgar theory. Changes in wages, Keynes insists, govern changes in prices. If this were true—which it isn’t—the quantity theory of money would be invalid.

I should make clear here that even if the quantity theory of money is invalid, which it indeed is, this doesn’t mean that the claim advanced by Keynes that changes in wages determine changes in prices is true. This claim will be the subject of next week’s post.

Was Keynes really a friend of the working class?

During the first deflationary years of the Great Depression, compared to the economists of the “Austrian” school and other marginalist economists, Keynes appeared more friendly to the working class. The trade unions and the working class were resisting cuts in their wages, and Keynes for his own reasons also opposed cuts in nominal wages.

The workers were trying to the extent it was possible to defend their standard of living under the extremely unfavorable conditions of the early years of the Great Depression. Keynes, on the other hand, opposed the cuts in nominal wages in part because he believed they were ineffective in lowering real wages.

But in the inflationary years that were to follow, Keynesian economists became the leading supporters of wage moderation on the part of the trade unions. During the “Great Inflation” of the 1970s, Keynesian economists, backed up by the bourgeois press, constantly talked about the “wage-price spiral.” Higher wages were raising the “cost of production”—shades of Adam Smith’s old theory—and therefore were driving up prices. The Keynesian economists called this alleged process cost-push inflation.

Keynesian economists, therefore, urged the trade unions to practice “wage moderation” and were delighted when Republican President Richard Nixon imposed wage-price controls that were mostly wage controls in practice. (11)

The Keynesian economists, who had proclaimed victory over the “business cycle” in the 1960s, claimed that prosperity could be maintained by so-called expansionary policies—large budget deficits financed by massive borrowing by the government combined with rapid increases in the quantity of token money by the central banks—without inflation rising to “intolerable” levels if the trade unions maintained wage moderation.

Unfortunately, the unions, especially in the United States, followed the advice of their mostly Keynesian and Keynesian-influenced economic advisors and went along with the wage moderation program. The result? Inflation continued to accelerate, and the U.S. economy went through the back-to-back monster recessions of 1974-75 and 1979-82.

Both the inflation rate and the official unemployment rate eventually rose into the double digits. As for real wages, measured on a hourly basis, they have never returned to the levels that prevailed in the year 1973 shortly after the controls were imposed despite the considerable growth in labor productivity over the last quarter of a century.

The failure of the trade unions to resist wage controls greatly weakened them, not only economically but politically. This weakening of the trade unions made possible the reaction of the Reagan-Thatcher years and the long reign of “neoliberalism” that followed.

This lesson must not be forgotten as the current huge expansion of public debt—dwarfing anything seen in the 1970s—backed up the monstrous expansion in the quantity of token money—also leaving far behind anything the 70s had to offer in this department—shows every sign of leading to a new upward explosion in the cost of living in the near future.

Next, I will examine the Ricardo-Marx critique of the claim that the level of wages determines the general price level.

——

1 More precisely, Keynes lumped early marginalists like Marshall together with Ricardo and Say as “classical economists.” Though Say was a contemporary of Ricardo, Marx considered Say to be a vulgar not a classical economist. However, when Keynes explained the “postulates” of the “classical economists,” he was clearly referring to the marginalist economists.

2 For example, if there are no trade unions, social insurance and minimum wages laws.

3 Unlike with the Marxist theory of value, the marginalist theory of value makes no distinction between price and value.

4 Actually the worker sells her labor power, not her labor.

5 Labor laws, at least in the United States, while mandating an eight-hour workday, allow the bosses to schedule “forced overtime,” which the workers cannot refuse under pain of being fired. However, the boss is required to pay 150 percent of the wage rate for “straight time.” This is supposed to discourage the use of “too much” overtime, and encourage the hiring of additional workers instead, though the time-and-a-half requirement is completely inadequate to deter the bosses from resorting forced overtime, particularly during periods of economic boom.

6 Again no trade unions, no minimum wages law, and no social insurance.

7 British marginalism developed in a place and time where the workers had little class consciousness. The British trade unions generally supported the Liberal Party. In those days, there was no mass working-class party in Britain. The Austrian school of marginalism developed originally in Austria, where in contrast to Britain many workers supported the then Marxist Austrian Social Democratic Party and were organized into unions led by the Social Democrats. While the British marginalists simply ignored Marx, the Austrian marginalists were obsessed with “refuting” Marx, while in their own way borrowing certain ideas from Marx when they found it to their advantage.

The Austrians marginalists specialized in demoralizing socialist intellectuals by “proving” that socialism could never work in practice and that capitalism was a truly just system that alone could deliver “economic efficiency.” For this reason, the Austrians avoided as much as possible the use of mathematics and mathematical jargon that the other schools of marginalism specialized in. Instead, the Austrians preferred verbal arguments in everyday language in order to reach “non-mathematical” intellectuals.

Today, “Austrian economics,” as it is called, is influential among right-wing “libertarian” intellectuals who find Milton Friedman too moderate. The ideas of the “Austrian economists” are so extreme, however, that they are simply not taken seriously by governmental economists and other policy makers. For example, they attack the U.S. Federal Reserve System for having followed “inflationary policies” during the Depression and urge that the Federal Reserve System and other central banks be abolished altogether.

8 The move to restore the pound to its pre-war parity against gold and the dollar was supported by the financial interests of “the City.” Essentially, the British banking interests, represented by Churchill, hoped that capitalists engaged in international commerce would once again deposit their money in the London banks as they had done before World War I. In order for them to do so, the supporters of the return to the old gold parity argued, the pound would have to return to its pre-war gold value and remain there.

However, the British industrial capitalists, who were already taking a tremendous beating during the 1920s, were horrified that their costs, particularly their wage costs, would be increased in terms of gold and the dollar. The revaluation, in addition to helping provoke the General Strike of 1926, was a failure. In 1931, just five years after the “return to gold at the pre-war parity,” the Bank of England, faced with a massive international run on its gold reserves, was forced to suspend gold payments, and the pound was massively devalued. The devaluation of the pound in 1931 proved to be the first of many that were to follow over the coming decades. Britain’s days of domination over the capitalist world were not coming back.

9 The British marginalists claimed to be continuing the classical tradition of Adam Smith and David Ricardo. However, they instinctively based themselves on everything that was vulgar in the work of Smith and Ricardo rather than what was scientific in their work. The claim that “prime costs”—reduced to “wage costs”—govern the general price level, upheld by Adam Smith and Malthus, was refuted by Ricardo. The more consistent marginalists on the Continent generally held that the general price level was determined by the quantity of money relative to commodities.

Modern supporters of this view, such as Milton Friedman, admit in their own way that changes in nominal wages do not cause changes in the general price level but merely reflect them.

Next week’s post will be devoted to examining the claim, still stubbornly maintained by the followers of Keynes, that changes in wages govern changes in price. This is particularly important at the current time as signs multiply—for example, the renewed rise in the price of oil—that a tidal wave of inflation will soon be rolling over us. If the trade unions repeat their mistakes of the 1970s and practice wage moderation in the name of fighting inflation, the economic and political results could be even more disastrous than they were in the 1970s.

10 In “A Monetary History of the United States, 1867-1960,” first published in 1963, which Friedman co-authored with fellow economist Anna Jacobson Schwartz, the authors claimed that “the Fed” by allowing the “money supply”—defined as cash plus bank deposits—to contract by one-third made the “contraction,” as Friedman and Schwartz called economic crises, far worse than it otherwise would have been.

At the time, Friedman and Schwartz did not claim more than that. But in later years, Friedman and his followers increasingly implied or stated outright that the Fed itself had not simply “allowed” but actually caused the contraction in the U.S. money supply, thereby causing the Depression, which otherwise, it is claimed, would have been entirely avoided.

11 In contrast, Milton Friedman, as a far more consistent marginalist than the Keynesians, denounced Nixon’s wage and price controls. He even went so far as to describe the right-wing Republican Nixon as the most “socialist” president in U.S. history.

When Friedman described a person as a “socialist,” this was not meant as a compliment. However, I should point out that Friedman strongly supported another part of Nixon’s program that proved highly inflationary in practice. This action—which was also supported by the Keynesian economists—was the final repudiation of the promise by the U.S. government to exchange gold for dollars at the rate of an ounce of gold for every $35 dollars presented to it by other governments and foreign central banks. Without the huge devaluation of the U.S. dollar—and other currencies—against gold during the 1970s, the inflation could not have been maintained.

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