The development of the credit system splits profit—total surplus value—less rent into two parts, interest and profit of enterprise. (1) What determines the division of the relative shares of interest and profit of enterprise?
Suppose the rate of profit is 10 percent. Unless all the profit goes to interest, the rate of interest cannot be higher than 10 percent. (2) Indeed, the rate of interest in the long run cannot be as high as 10 percent, because at a 10 percent rate of interest there will be no additional profit from carrying out an industrial or commercial enterprise. Therefore, an interest rate of 10 percent, assuming a rate of profit of 10 percent, will destroy the incentive to produce surplus value. And without production of surplus value, there is neither ground rent, interest nor profit of enterprise.
Therefore, the rate of profit establishes an upper limit to the rate of interest. But what then determines the lower limit? The rate of interest cannot fall to zero, because if it did the money capitalist would turn miser. There would be no advantage in loaning money. Why take a risk of not being paid back, or being paid back in devalued currency, for no “reward” whatsoever?
At an interest rate of zero, the money capitalist will simply hoard money in the form of bullion and gold coins. Therefore, the rate of interest must be somewhere above zero but below the the total rate of profit. It is quite possible to have a low rate of interest with a high rate of profit, though it is not possible to have a high rate of interest with a low rate of profit.
No natural rate of interest
Many bourgeois economists, especially those of the neoliberal school such as Milton Friedman, claim that there is a “natural rate of interest.” (3) The rate of interest is supposed to be determined by the “scarcity of capital.” Marx, in contrast, explained that there is no such thing as a “natural rate of interest.” Instead, within the broad limits of just above zero and just below the rate of profit, the rate of interest is determined by the competition between the money capitalists on one side and the industrial and commercial capitalists on the other.
If the competition swings in favor of the money capitalists, the rate of interest rises, and if the competition favors the industrial and commercial capitalists, the rate of interest falls. Assuming the rate of profit remains unchanged, the profit of enterprise will move inversely to the rate of interest. The profit of enterprise and the rate of interest can rise at the same time only if the rate of profit itself rises.
But what determines the relative strengths of the money capitalists on one side and the industrial and commercial capitalists on the other? The most important factor is the quantity of real capital relative to the quantity of money. But by quantity of money, what form of money am I referring to?
Over the last three weeks, I have shown that there are three forms of money: metallic money—actual money material, whether in the form of bullion or coins; token money, called by the bourgeois economists today “fiat money”; and credit money.
But in the strict sense, only metallic money such as gold bullion is real money. Token money merely represents real money in circulation, and credit money consists of IOUs payable in some other form of money that can be used as a money substitute in making purchases and payments. The relative strength of the money capitalists versus the commercial and industrial capitalists is therefore largely determined by the quantity of real money—that is, metallic money—relative to the quantity of real capital. (4)
If the quantity of real capital grows relative to the quantity of metallic money, the rate of interest will tend to rise. If, in contrast, the rate of growth of metallic money is greater than the growth of real capital, the rate of interest will tend to fall.
This law is illustrated by the behavior of the rate of interest in the course of the industrial cycle. During the boom, when capitalist expanded reproduction is in a flourishing state, the growth rate of real capital is high relative to the growth of metallic money. This is the fundamental reason why interest rates rise during periods of prosperity.
During the crisis, on the other hand, the quantity of real capital contracts—inventories are liquidated and unprofitable factories are destroyed, and the value of much of the fixed capital that remains is “written down.” But the growth of metallic money—the world gold hoard—keeps on expanding as gold continues to be produced. Gold bullion is not, after all, consumed, and therefore is not destroyed, but simply keeps piling up as capitalism develops. Therefore, during the downward phase of the industrial cycle, the rate of interest declines.
Interest rates and credit money at the peak of the industrial cycle
As the industrial cycle peaks, the “quality” of credit money deteriorates. The mass of credit money becomes vastly inflated relative to the underlying mass of metallic and token money. Therefore, during the industrial cycle the expansion in the quantity of credit money goes hand in hand with a gradual rise in the rate of interest. However, as the crisis takes hold, and real capital begins to contract relative to metallic money, which continues to grow, there is a tendency for the supply of credit money to contract. As this process unfolds, the rate of interest tends to fall.
Depreciation of token money and its effects on the rate of interest
A factor that can raise the rate of interest independently of the stage of the industrial cycle is the depreciation of token money. Rising gold prices in terms of token money are usually followed by rising interest rates, while declining prices of gold bullion in terms of token money—the appreciation of the token money—is generally followed by a decline in interest rates.
If the monetary authority allows the token money to depreciate creating expectations of continuing depreciation in the future, the money capitalists will defend themselves by demanding a higher rate of interest. And they have the power to collectively enforce their will. This collective money power is greater than the powers of the central banks. (5) Therefore, everything else remaining equal, the greater the expectation of future devaluation of the token currency against gold, the higher will be the rate of interest. If on the other hand, there are expectations of an increase of the gold value of the token currency, the rate of interest, all else remaining equal, will fall.
How the Asian crisis of 1997 lowered interest rates in imperialist countries
When the so-called “Asian crisis” (6) broke out in 1997, there was a flight of capital from many Asian, Latin American and other “third world” countries into the imperialist currencies, especially the U.S. dollar. This led to an appreciation of the imperialist currencies against gold. Each dollar represented more gold in circulation than it did before the crisis began. The price of gold in terms of U.S. dollars dropped well below $300 an ounce. Just like last fall, cash was king, and cash was the U.S. dollar. This was followed by a sharp drop in the rate of interest in the imperialist countries, especially the United States and Japan, starting in 1997 and extending into the early years of the current decade.
Central banks and the rate of interest
We all have read articles in the newspapers “explaining” that the central bank “sets” the rate of interest. Yet the central bank controls neither the quantity of metallic money, the quantity of real capital, nor the rate of profit. Therefore, the ability of the central banks to influence interest rates is far less than the “lay” public—and many economists—believe.
What today’s central banks really control is not the rate of interest but the quantity of token money, measured not in terms of real money—gold—but in terms of dollars, pounds, euros and so on. As the bourgeois media “explains,” they can create “any amount of money they wish” in terms of dollars, pounds, euros and so on. But what good does that do if this money loses its purchasing power even faster than it is printed?
True, the central banks generally raise the interest rate during economic booms. But this is exactly the natural tendency of interest rates during economic upswings. Therefore, when they raise interest rates during a boom, they are simply following the tendency of the market, not determining it.
Similarly, when the central banks lower interest rates during recessions, they are following the market, since interest rates naturally fall during recessions for reasons that I examined above. (7)
Therefore, the appearance is created that the central banks are raising interest rates as the economy booms and lowering interest rates when recession hits. In reality, it is the changes in the phases of the industrial cycle that are determining the policies of the central banks, not the other way around.
What happens if the central bank in a bid to keep “the boom” going tries to force the rate of interest down—or at least prevent it from rising—by flooding the money market with newly issued token money? (8)
In order to isolate the effects of such an attempt, I will assume that before the attempt is made the rate of interest is in equilibrium—that is, tending neither upward nor downward. (9)
For example, assume the rate of profit is 10 percent while the rate of interest is 5 percent. The profit of enterprise is therefore 5 percent. If things are in equilibrium like I am assuming here, the money capitalists will keep the percentage of gold in their portfolios constant. I also will assume that the level of gold production is such that the total quantity of gold money is growing at the same rate as other forms of capital. Just enough gold is coming out of the mines to keep the total gold in the money capitalists’ portfolios growing at a rate that keeps the percentage of gold in these portfolios at exactly 1 percent. To further simplify, I will assume that there is a single world currency. As far as the currency is concerned, the world is a single capitalist nation.
Now suppose the central bank decides to force the rate of interest down to 4 percent. In order to lower the rate of interest, the central bank increases the rate of growth of the token money it is issuing. For example, it starts buying government bonds, which causes the rate of interest to fall from 5 percent to 4 percent. The profit of enterprise will rise from 5 percent to 6 percent.
Perhaps the central bank is attempting to increase profitable investment opportunities, defined as investments that the industrial capitalists believe with good reason will exceed the rate of interest. If the rate of interest falls to 4 percent, profitable fields of investment by definition are now any investment that the industrial capitalists expect to yield more than 4 percent.
In reality, industrial capitalists will as a rule only make new investments when the expected profit of enterprise is average or higher. Under our assumptions, this “hurdle” rate will be 6 percent.
However, if the average rate of profit falls, the industrial capitalists will accept the lower rate as long as it still exceeds the rate of interest. If the average rate of profit falls to the level of the average rate of interest, industrial capitalists will only invest in those exceptionally profitable areas where the rate of profit can be expected to exceed the rate of interest. All else remaining equal, therefore, the lower the rate of interest the more the fields for new industrial investments.
But by forcing down the rate of interest from 5 percent to 4 percent, the central bank has broken the previous equilibrium. At 4 percent, the money capitalists collectively wish to increase the percentage of gold they hold in their portfolios relative to bonds, stocks and so on that ultimately more or less reflect the value of the underlying real capital. They attempt to increase the percentage of their portfolios that consists of gold.
Suppose initially the rate of interest falls from 5 percent to 4 percent because of the central bank’s move to increase the quantity of token money. The money capitalists collectively figure that they should now hold, say, 2 percent of their assets in gold rather than the 1 percent that satisfied them at 5 percent. They therefore start buying gold bullion on the open market. The money capitalists will do this for two reasons:
First, the 4 percent rate of interest is below the previous equilibrium level, which was 5 percent, reducing the “opportunity cost” of this ultimate insurance against loss of capital.
Second, the confidence of the money capitalists in the token money will be shaken, since the increased demand for gold causes its token money price to rise and therefore the token money to be devalued. They fear that the token money will be further devalued in the future. They therefore will demand an interest rate of, say, 6 percent to compensate them for the increased risk of further devaluation.
As the price of bullion rises in terms of the token money, token money prices of primary commodities such as oil, copper, grains and so on start to rise. (10) The velocity of circulation will increase and more credit money will be created through increased bank loans that are necessary to finance the higher level of prices in terms of the token currency.
More of the reserves of token money must be mobilized to support this new higher price level. While the central bank is attempting to increase the size of the hoards of token money held by the banks, their reserves, the rise in prices works in the direction of reducing the size of these hoards relative to the needs of circulation once again.
As a result, the interest rate is forced up on the open market until it reaches the new equilibrium level that under our assumptions is 6 percent. At this point, the supply of and demand for gold will again be equal. The money capitalists will now be satisfied with the percentage of their total assets they hold in the form of gold in their own portfolios.
But from the central bank’s viewpoint, the operation will have backfired. They set out to lower interest rates and ended up with higher rates, the exact opposite of what they were trying to achieve. Instead of lowering interest rates from 5 percent to 4 percent, interest rates have risen from 5 percent to 6 percent. The profit of enterprise, instead of rising from 5 percent to 6 percent, once the dust settles has fallen from 5 percent to 4 percent.
Defending real wages
Here I assumed that workers are successful in defending their real wages. In order to do this, the workers must be well organized in trade unions, the trade unions must see through all the arguments that the bourgeois economists advance, and understand that wages in terms of a depreciating currency must be raised as prices in terms of the depreciating currency increase.
I also assume that the trade unions retain the freedom of striking—that is, there are no enforceable laws that limit the ability of the unions to strike whenever it is necessary to defend their members’ standard of living. This must be true whether the attacks on the workers’ standard of living come from individual bosses or from a move by the government and its “monetary authority” to devalue the currency in which wages are paid.
These are under today’s conditions, and indeed historically, highly unrealistic assumptions. Currency devaluations that lower the amount of gold—real money—that a given dollar, pound, euro and so on represents cut wages in terms of real money, whenever currencies devalue against gold. They also cut real wages whenever such currency devaluations provoke a rise in the price of commodities in terms of the devalued currency that is not compensated by an offsetting rise in wages in terms of the devalued currency. Wages, the price of the commodity labor power, are all too often the last price to respond to changes in the value of the currency.
In the long run, however, wages will eventually reflect such changes. If they did not, wages would fall so far below the value of labor power that labor power would not be fully reproduced. But it depends on the organization of the workers how long it takes for wages to fully reflect changes in the value of the currency.
To the extent wages are not promptly raised in terms of devalued currency to offset the effects of these devaluations on wages, currency devaluations function as a general wage cut. The rate of surplus value, the ratio of unpaid to paid labor, will then rise, and all else remaining equal so will the rate of profit. (11)
Returning to the above example, suppose the rate of profit rises from 10 percent to 12 percent due to the wage-cutting effects of the currency devaluation. In this case, the profit of enterprise will actually rise. Assuming that the new equilibrium interest rate is 6 percent, the profit of enterprise instead of falling from 5 percent to 4 percent will rise to 6 percent.
The workers will then be hit at two ends. They will not only end up with lower real wages but will also face higher interest rates on mortgages, credit card balances, and other consumer loans. In this post, when I talk about interest, I mean the portion of the total profit that goes to the money capitalists as opposed to the industrial and commercial capitalists. But the rates of interest that worker-consumers pay—the portion of wages that the providers of consumer credit get to pocket—is linked to the interest rates the most creditworthy industrial and commercial capitalists pay. This is sometimes called the “prime rate.”
Any rise in the interest rates the industrial and commercial capitalists pay is reflected in a rise in the interest rates that the workers will pay on consumer loans. Therefore, the workers will not only have lower real wages but will have to hand over a greater percentage of those wages to the money lenders as well, further lowering real wages. Therefore, if the living standard of the workers is to be fully protected from the effects of currency devaluations, not only must wages in terms of the devalued currency be increased to compensate for the rise in commodity prices in terms of the devalued currency, but they must be further increased to make up for the higher rate of interest on consumer loans.
Interest rates during the last century
The history of interest rates during the last century illustrates the operation of the economic laws that govern the rate of interest. The Great Depression of 1929-40 followed by the war economy of 1940-5 meant that for nearly 16 years the normal process of expanded reproduction was at a virtually complete standstill.
While the accumulation of real capital came to a halt for 16 years, the accumulation of money capital continued apace. Indeed, for reasons I will explain when I examine the industrial cycle, the rate of accumulation of money capital actually accelerated—gold production rose considerably—as the accumulation of real capital became negative. The result was the accumulation of a huge hoard of idle money, mostly in the form of a huge expansion of bank reserves. Interest rates fell to record lows. (12)
Immediately after World War II, interest rates were extremely low, around 2 percent on long-term U.S. Treasury bonds. Profits, on the other hand, were very high. (13) The lion’s share of the total profit was going to the industrial and commercial capitalists, not the money capitalists.
All this encouraged the “spirit of enterprise.” The capitalists had a strong incentive once again to function as industrial and commercial capitalists and not as mere money capitalists. After its 16-year hiatus, all this helped the process of expanded capitalist reproduction to flourish once again. (14)
The post-World War II boom was on. Gold production increased but rather slowly for reasons I will examine in later posts. Or what comes to exactly the same thing, the accumulation of money capital after speeding up during Depression was now proceeding at a slower rate. As a result, interest rates reversed direction and began to rise.
Because interest rates relative to the total profit were so low to start with, they could gradually rise for some time after the war without immediately threatening the post-World War II prosperity. However, interest rates could not keep on rising indefinitely unless the rate of profit itself was rising at a rate that offset the negative effects of rising interest rates on the profit of enterprise.
But the tendency of the rate of profit after World War II was in the opposite direction. As capitalist industry once again boomed, the demand for the commodity labor power was high and unions were generally much stronger than they had been in earlier decades. This, combined with technological progress now dubbed “automation,” meant a renewed rise in the organic composition capital. All this put downward pressure on the rate of profit. Therefore, the gradually rising rate of interest was on a long-term path toward collision with the gradually declining rate of profit.
By the Vietnam War era, things were coming to a head. The U.S. administration of Lyndon Johnson and the Federal Reserve System were trying to find a way to halt the long-term rise in interest rates that had marked the post-Depression, post-World War II economy. As the Fed struggled to keep interest rates below their rising equilibrium levels, gold was flowing out of Fort Knox both into the European central banks and into private hoards.
In earlier times, the Fed would have allowed interest rates to rise to their equilibrium level. Eventually, financial panic and economic crisis followed by depression and falling prices would have lowered interest rates once again. As happened during the “big Depression” of the 1930s, real capital would have contracted while the rise in the world’s monetary gold hoard would have continued to grow, and, for reasons we will examine in the series of posts beginning next week, would indeed have accelerated. Interest rates would have fallen once again until the world economy—assuming capitalism still existed—had recovered from the new depression. A low rate of interest combined with a high rate of profit would have been restored once again returning capitalist expanded reproduction to a “sound” basis. The cycle would then have repeated itself.
But the U.S. government resisted this development. Partially, it did this to finance the Vietnam War, but more fundamentally because it feared that a major new depression would radicalize the U.S. and world working class. Therefore, the U.S. suspended what was left of the convertibility of the U.S. dollar into gold, preventing any further depletion of the Fort Knox gold hoard.
This process was formally completed when U.S. President Richard Nixon announced in August 1971 the U.S. government was repudiating its promise that it had made under the Bretton Woods system to exchange gold for dollars at a rate of $35 per ounce. This “bold move” by Nixon was hailed by virtually the entire academic economic profession, including the followers of Keynes, as well as Milton Friedman, who was then an economics professor at the University of Chicago.
The Nixon administration, the Fed and the economists all figured that, having freed themselves from the need to maintain gold convertibility of the dollar at a fixed rate, they would be able to halt the rise in interest rates by simply printing whatever amount of paper dollars was necessary. The price of gold in terms of dollars and primary commodity prices in dollar terms began to soar. This was followed by soaring interest rates. The price of gold rose from $35 in 1970 to $875 at its peak in January 1980.
Gradually, the high primary commodity prices in terms of dollars worked through to the retail level, though for reasons I will examine elsewhere they still did not fully reflect the dollar’s depreciation. As the Fed continued to crank out more token money—measured in dollars—and inflation accelerated, interest rates were at record levels and rising.
At first, the bourgeois economists explained that it was only nominal interest rates, not “real” interest rates—that is, interest rates in terms of commodities—that were rising. The Friedmanites claimed that as soon as inflation stopped, real interest rates would fall back to their “natural” level of 3 percent or so.
When Washington finally halted the depreciation of the dollar during the 1979-1982 Volcker shock, interest rates indeed peaked, but they proved very slow to decline. The money capitalists were still afraid the depreciation of the dollar could resume at any time, especially since Washington refused to move toward the restoration of the international gold standard in any form. Far from rapidly falling back to their alleged natural levels, interest rates only very slowly declined over the following decades.
This prolonged period of very high interest rates led to large-scale “de-industrialization” and “financialization” as many industrial corporations preferred to invest in interest-bearing securities rather than carry out new industrial investment. The industrial capitalists were transforming themselves into money capitalists just as Marx explained they would under such circumstances. Through “de-industrialization” and “financialization,” economic laws were forcing interest rates back below the the rate of profit, restoring a positive profit of enterprise.
Because the confidence in the dollar and the other paper currencies had been so throughly undermined by the 1970s inflation and the failure to restore the international gold standard, it took several decades for interest rates to return to anything like historically normal levels.
It seems highly likely that in the end more real wealth was destroyed and labor squandered over a period of several decades than would have been the case if the 1970s inflation had been avoided and an old-fashioned deflationary depression had occurred instead. Such a deflationary depression would probably have been followed by a strong industrial upswing.
Instead, there were two severe recessions, which differed from classical depressions in the sense that prices—in terms of devalued currency—rose rather than fell. True, these downturns did not approach the extreme levels of the early 1930s debacle, but then no other depression has either. So far, the Depression of the 1930s is unique in the history of capitalism. In the United States, however, official unemployment soared to over 10 percent before the prolonged economic crisis of the 1970s and early 1980s—with ups and downs within it—finally bottomed out at the end of 1982.
When economic conditions finally began to improve starting in 1983, unemployment, like interest rates, declined very slowly. Unlike the periods that followed the deflationary depressions of old, the economic crisis of the 1970s and early 1980s was not followed by a “great boom” but only the “Great Moderation.”
The pattern was similar in the countries of Western Europe. Not only did official unemployment rise to double digit levels in many countries, it has never again fallen back to the levels that prevailed from the middle 1950s through the 1960s. The picture in Japan is similar.
Nor is this trend confined to the imperialist countries. In Latin America, for example, economic growth has never returned to the levels that prevailed during the 1960s. Only the developing countries of Asia, especially China, have bucked the trend.
Extraordinary growth of token money
Last week, I explained that the Obama administration and the Fed policy of engaging in huge government spending financed by printing press token money provided by the Fed is risking the collapse of the dollar system, because private capitalists might start quoting prices and loans in terms of gold rather than dollars. It was partly to avoid this danger that the Fed kept the growth in the supply of token money low right up until the panic of last fall finally forced their hand.
But even if the dollar system survives, there is another danger. The current unheard-of growth rates in the supply of token money created by the Fed and other central banks could well unleash a new wave of 1970s-style inflation. Indeed, this time the inflation rates might be higher once the current cyclical downturn ends, given the extraordinary rates of growth of token money that we have seen since last fall.
If this threatening tidal wave of inflation becomes a reality, interest rates will also began to rise rapidly, first in nominal terms but also, when inflation is finally ended, in real or commodity terms as well as in economically real gold terms. Inflation will eventually end unless the paper currencies are completely destroyed, and even then inflation will end because only gold would then be acceptable as a means of purchase and payment.
Assuming this threatening inflation does develop, what will be the level of interest rates once it is finally halted? One thing we know, in the long run interest rates will once again have to fall below the rate of profit to restore a positive profit of enterprise. If this does not happen, capitalism will not be able to continue.
With the U.S. government now heavily indebted and highly dependent on its continued ability to borrow money at the low interest rates of recent years, a return to interest rates even approaching those of the early 1980s would have disastrous effects for U.S. imperialism. The Federal Reserve System attempted to avoid this danger by holding down the rate it was creating new token money until last fall.
In his February 2004 speech on the “Great Moderation,” Federal Reserve Board of Governors member and now chairman Ben Bernanke gave some of the rationale for the Fed’s policies in the period immediately preceding last fall’s panic:
“I will try to support my view,” he said, “that the policies of the late 1960s and 1970s were particularly inefficient.” Determined to avoid the “inefficient” policies of the late 1960s and early 70s, the Federal Reserve System this time was determined to reduce the growth rate of the supply of token money to a low level and keep it there. According to the theories of Milton Friedman, this would allow the underlying stability of the capitalist system to show itself without being undermined by an unstable monetary environment.
Even when the initial panic of August 2007 hit, the Fed stuck to its guns. It barely accelerated the rate of growth of its token money during the year that followed. With rare exceptions, the bourgeois economists who specialize in predicting the rate of growth of the GDP down to the decimal point predicted at most a “slowdown,” or at the very worst a “mild recession,” for the first half of 2008 followed by a gradual recovery in the second half.
If the recession had remained “mild” and recovery took hold by the second half of 2008, or even a little later, everything would have worked out dandy as far as the Fed was concerned. Interest rates would have fallen further, and the “Great Moderation” would have continued. This is what the Fed was counting on.
Instead, panic erupted and the U.S. and world capitalist economy plunged into, using Fed-speak, a “severe contraction.” It was now impossible to maintain the “stable monetary environment” that Friedman advocated. If the Fed had kept the rate of growth of token money at a “slow and stable rate,” the supply of credit money would have violently contracted and Depression with a capital “D” probably combined with mass starvation would have occurred for reasons I explained last week.
Instead, the Fed under Bernanke’s leadership has pushed up the rate of growth of the token money it creates to levels far beyond those of the late 1960s and 1970s, when “monetary policy” turned out to be “particularly inefficient.” In the coming years, we will see out how “efficient” or “inefficient” today’s “monetary policy” will turn out to be.
Interest rates can’t just keep rising
As I explained above, interest rates cannot in the long run simply keep rising. They are constrained by the rate of profit. Interest rates can for certain periods rise above the rate of profit, but this destroys the very incentive to produce surplus value. The result is de-industrialization, “financialization” and economic stagnation that finally forces interest rates back below the rate of profit, restoring a positive profit of enterprise.
This threat of massive inflation brought about by the explosion in the supply of token money created by the Fed since last fall, with all its consequences, is perhaps the more likely danger confronting us over the next few years, rather than a simple repeat of the deflationary crisis of 1929-33.
For example, instead of a “healthy” cyclical expansion lasting the usual seven or eight years, a short inflationary boom develops lasting only a few years. The dollar soon plummets against gold, and inflation accelerates even further. Interest rates follow leading to a new and perhaps far worse crash as the Fed finally hits the “brakes” on the creation of token money in a bid to save the dollar system. (15) The resulting global depression sends unemployment well into the double digits in most of world if it isn’t already there.
Under those conditions, a “stimulus program” will not be on the agenda. Instead, the government, whether controlled by Democrats or Republicans—or Social Democrats, Greens, Christian Democrats, Labor, Tories or other parties elsewhere—will initiate a neo-Reaganite, neo-Thatcherite austerity policy that might make the times of Ronnie and the “Iron Lady” seem like the good all days. Therefore, the “Keynesian” cure with the Fed’s support that the Democratic administration of Barack Obama is attempting for the current depression might turn out to be even worse than the disease. (16)
The Republican Party in the United States seems to be betting that something like this will happen. The GOP did not actually block the stimulus program—three “moderate” Republicans agreed to support it in the Senate at the last minute. This is what happens when the U.S. ruling class really wants a particular bill to pass. Enough “moderates” from the “opposition” party are always found to vote for it. After all, the hopes of the capitalist classes both in the United States and across the globe of avoiding a major social crisis in the coming years depend on quickly overcoming the current crisis. But what if it doesn’t work? This is where the Republicans come in.
With the exception of the three Republican “moderates,” all the other Senate Republicans and all Republicans in the House voted against Obama’s program, frustrating the hopes of the new president of getting “bipartisan” support for his anti-crisis program. The Republicans are positioning themselves to reap the benefit if the Obama stimulus program goes up in inflationary smoke.
If this indeed comes to pass, the GOP figures they will then return to office under the banner of Ronald Reagan and Milton Friedman. They will argue that Reagan’s medicine got us out of the crisis of the 1970s and it will work again this time. If this happens, the hopes of many liberals and leftists for a new era of progressive social reforms will turn into a neo-Reaganite, neo-Friedmanite nightmare. (16)
This is one of the reasons why Marxists must not make the mistake of hitching our wagon to Keynesian economics. Keynesian economics led to Friedmanite reaction once before. It could well do so again.
The three types of money
I have explained that three types of money—metallic money, token money and credit money—follow quite different laws. Now let’s sum up by examining what happens if the quantity of each of these types of money grows at an excessive rate.
In examining the effects of an increase in the quantity of metallic money, I assume that the quantity of metallic money increases rapidly but the value of money remains unchanged. For example, this might happen if new gold mines of the same richness—but not greater—than the mines that are already in production were discovered. Or what comes to exactly the same thing, there is a considerable increase in the quantity of gold but a given quantity of gold still takes the same amount of labor on average to produce as it took previously. In this way, we can isolate the effects of changes in the quantity of gold.
Metallic money is the money commodity that in terms of its use value measures the values of all other commodities. Like other commodities, the money commodity is produced by private industrial capitalists whose aim is the highest profit possible.
Is it even possible for the money commodity to be produced in excessive quantity? No. An increase in the quantity of metallic money, all else remaining unchanged, will mean a fall in the rate of interest. More of the total profit will go to the industrial and commercial capitalists and less will go to the idle money capitalists. The profit of enterprise will rise.
With more gold being produced, the central banks will, all else remaining equal, be able to issue additional token money without the token money depreciating. If this additional token money cannot for whatever reason be fully absorbed in circulation, it will accumulate in the form of hoards in the banks—that is, in the form of vault cash and “excess reserves” on deposit with the central bank. Or what comes to exactly the same thing, bank reserves will rise.
Rising reserves of idle cash in the banks translates into a fall in the rate of interest and a rise in the profit of enterprise. This will tempt a portion of the money capitalists to transform themselves into industrial or commercial capitalists. The “spirit of enterprise” will be encouraged. A rise in the quantity of metallic money therefore forms the material basis for an expansion of the market. To what extent this actually happens, however, depends on other factors that I will examine in coming posts.
Unlike metallic money, which is produced by for-profit industrial capitalists, token money is issued by the state “monetary authority.” If the monetary authority over-issues the token money, it depreciates. First, the price of gold bullion in terms of the token money rises leading to a rise in the prices of primary commodities. If the the over-issue of the token money persists, these higher primary commodity prices gradually cause wholesale prices and finally retail prices to rise.
This inflation is actually the market’s way of forcing up the rate of interest, not only in nominal terms but eventually in real terms—as well as in gold terms—up to the level that satisfies the money capitalists. If the “monetary authority” continues to over-issue its token money, it will increasingly discredit itself and with it the token money it issues. This will mean that the money capitalists will demand higher interest rates than before, further driving up the rate of interest. We saw just such a process unfold during the 1970s and early 1980s.
In addition to the immediate consequences of inflation, the over-issue of token money means a rise in the rate of interest when inflation finally ends and, all other things remaining equal, a fall in the profit of enterprise.
In the most extreme cases of the over-issue of token money, such as occurred in Germany in 1923, hyper-inflation results, and the currency loses virtually all value and becomes worthless. This destroys credit and makes its restoration very difficult. Germany’s hyper-inflation was one of the reasons why the economic crisis of 1929-32 was much worse in Germany than in most other capitalist countries.
Credit money issued by a state monetary authority
Credit money can be issued by a state or state-backed “monetary authority.” In this case, the currency is convertible into gold at some fixed rate, whether in the form of bullion or coin. This is the system that prevailed when Marx wrote “Capital” and is known as the “gold standard,” or if silver functions as the money commodity, the silver standard.
Unlike a private capitalist, however, the main aim of the monetary authority in this type of system—the Bank of England in Marx’s day, for example—is not profit but the stabilization of the value of the currency in terms of gold. It achieves this by exchanging its currency for a fixed amount of gold on demand. Under a gold standard, the monetary authority must therefore retain a fund in the form of gold to meet any demands to exchange currency for gold. The type of currency consists of promissory notes on the monetary authority payable in gold.
If the monetary authority then over-issues its credit money, more and more of the notes will be presented to the monetary authority for payment in gold. The monetary authority will therefore suffer a loss of the gold that serves as its reserve fund. If the monetary authority wants to maintain the gold standard, it must then reduce the quantity of its notes in circulation. This will result in a rise in interest rates and a fall—all else remaining equal—in the profit of enterprise.
If the monetary authority is unwilling to do this, it will be forced to suspend the convertibility of its notes into gold, thereby transforming its notes into token money. It can do this very easily, because all the conditions that are needed for issuing of token money are already at hand. The monetary authority already has a monopoly on the issue of the notes, it is directly backed up by the state power, and its aim is not profit but stability both of the value of currency in terms of gold and, to the extent it is possible under capitalism, of the economy in general.
Therefore, the conversion of state-issued credit money into token money requires little more than a stroke of a pen. Over the last century, all credit money issued by the state monetary authorities has been converted into token money. Today, therefore, all state-issued currency follows the laws of token money, not of credit money.
Credit money issued by private capitalists
This type of credit money is issued by private for-profit capitalists, usually commercial banks. Remember, credit money is simply an IOU that can be transferred from person to person to make purchases or settle debts. It must be payable in some other type of money—metallic money, convertible-into-gold banknotes or state-issued token money. Unlike the case with token money, or convertible-into-gold currency issued by a state or state-backed monetary authority, there is more than one issuer, and the aim of the issuers is the maximization of profit. Unlike the case with token money, the only real limit on the quantity that is issued is the prospect of the bankruptcy of the over-issuer.
Therefore, unlike the case with state-issued convertible-into-gold currency, this type of currency cannot be transformed into token money. (18) Any attempt to do so on a large scale would mean a huge increase in the quantity of token currency that would lead to the complete discrediting of such a currency with all the consequence that I have explored above.
Short of this, the over-issue of such credit money ends in financial panic and bank runs leading to destruction of a portion of this credit money and the failure of some of its issuers.
Basis of split between the real economy and the monetary economy
I began these posts by examining crisis theories based on underconsumption, falling rate of profit, and disproportionate production, which largely ignore money. Instead, all these theories look to the “real economy” to explain crises. Over the last four weeks, in contrast, I have examined how the the split between the real economy and the monetary economy is actually rooted in the most basic contradiction of commodity production, the dual nature of the commodity as a use value and an exchange value.
This has led us on to an examination of the various forms of money, prices, credit and interest rates. Since as far as I know no Marxists attribute crises to monetary factors alone, I have not critiqued any actual Marxist crisis theory here. Starting next week, I will construct an “ideal industrial cycle” and show how the development of all the basic contradictions of the capitalist system during an idealized industrial cycle must result in a general overproduction of commodities that ends in a crisis.
1 By interest I mean the portion of the total profit that goes to the money capitalists, including the industrial and commercial capitalists who work with their own capital and therefore act as their own money capitalists. When workers borrow money, whether in the form of mortgages, credit cards, or auto loans, the interest is paid out of wages, not profit. However, changes in the rate of interest paid by the industrial and commercial capitalists is reflected in changes in consumer loans, since the rate of interest paid by the strongest industrial and commercial capitalists form the “prime rate,” which forms the base on which the rates of interest paid by workers on consumer loans are calculated. Since loans to workers are considered much riskier than loans to powerful corporate monopolies, the rate of interest paid on such loans is considerably higher than the prime rate.
2 This is not necessarily true in the short run. On occasion, the rate of interest can not only swallow up the entire profit of enterprise but even some of the borrower’s capital. However, this cannot be sustained, because under these conditions a capitalist can make a higher profit simply lending money as opposed to engaging in an industrial or commercial enterprise. A portion of the industrial capitalists will therefore transform themselves into money capitalists. This will continue until the rate of interest once again falls well below the total rate of profit. For example, during the period of extremely high interest rates that prevailed in the wake of the inflation of the 1970s, many industrial corporations entered the “financial services business”—became money lenders— even as they were closing down and “downsizing” many of their factories.
3 Friedman supported a modified version of the quantity theory of money. According to the quantity theory, changes in the quantity of money are reflected in changes in nominal prices and wages but have no effect on real wealth. The quantity theory of money holds that while interest rates reflect an inflation “premium” during periods of inflation, real interest rates will not be affected. For example, according to the Friedmanites and other supporters of the quantity theory of money, if the money supply is expanding at such a rate that prices are expected to rise 5 percent a year and the natural rate of interest is 3 percent, then the nominal rate of interest will be 8 percent.
John Maynard Keynes in his “General Theory” revived the mercantilist theory of interest. According to this theory, which was also supported to a certain extent by Marx, changes in the quantity of money change interest rates, not prices. I will examine the theories of money and interest of Marx and Keynes in later posts. While there are a few points of contact between the two economists, there are also vast differences.
4 This is an important point. Keynes heavily counted on the ability of the monetary authority issuing the token money to set the level of interest rates by varying the quantity of its token money. However, the monetary authority will not be able to set the rate of interest if it is the variation of the quantity of metallic money that influences the rate of interest. Experience, as well as theory, has shown that indeed a token money-issuing monetary authority does not have the power over interest rates that Keynes was counting on. This point will be fully explored in the posts that follow.
5 This must not be seen as some kind of conspiracy. The money capitalists don’t get together in a room somewhere and set interest rates. Instead, each individual money capitalist simply follows what he or she perceives as his or her own individual interest. By doing this, the money capitalists collectively create the “money market,” which is far more powerful than the central banks. If the money market “wants” to increase interest rates, the central banks will be unable for very long to prevent it.
6 The Asian crisis that began with the devaluation of the currency of Thailand in 1997 led to a wave of recessions, or at least stagnation, that affected most countries of the world between 1997 and 2003. Many Asian countries, especially Indonesia and South Korea, were hit by severe recessions between 1997 and 1998. Latin American countries were affected a bit later. In some Asian countries, such as Indonesia, as well as Argentina, this crisis was fully comparable in its severity to the crisis of 1929-33 in the United States and Germany. However, the crisis didn’t approach this severity in any imperialist country or the world market as a whole. Still, recession or at least very slow growth rates did affect the United States, the European Union and Japan during the years 2000 to 2003.
Ten years later almost to the month, the next crisis broke out in the United States, in August 2007, when U.S, credit markets began to freeze up. We therefore see the outline of a typical global 10-year industrial cycle. Unlike the last crisis, however, in the current crisis severe recession hit the entire globe at the same time starting in the fall of 2008. From the perspective of the world market, the current crisis is therefore much worse than its predecessor, when the recessions occurred at different times in different countries.
A central feature of the 1997 crisis was a panicky flow of money capital from Asia, Latin America and Russia to the United States, Japan and Western Europe. This flow of money capital greatly lowered interest rates in the latter countries, both postponing the onset of recession and greatly moderating its effects in the imperialist countries when it did arrive. The consequent lowering of interest rates in the imperialist countries did much to start the boom in residential construction in the United States, whose collapse played such a central role in initiating the current crisis.
7 Through experience, the central banks, in direct opposition to the advice of John Maynard Keynes, as we will see in later posts, have learned that it’s a bad idea to try to buck the money market when it comes to setting interest rates. When they do try, they always lose and the market always wins.
10 Right after assuming office in March 1933, at the low point of the Great Depression, the new Democratic administration of Franklin Roosevelt moved to devalue the dollar. In part, this was a bid to lower the real wages of the U.S. workers, which according to the theories of the bourgeois economists then, as today, would help restore “full employment.” The workers responded to the inflationary effects of the devaluation that came on top of the devastating effects of the Depression with a wave of strikes that led to unionization of basic industry for the first time in U.S. history. The unionization wave neutralized the negative effects of the Roosevelt devaluation on the wages of U.S. workers.
However, when a much greater devaluation of the dollar occurred during the 1970s, U.S. workers—and workers in other countries, as well—failed to respond with strikes and union organization to anywhere near the same extent the U.S. workers had done back in the 1930s. As a result, real wages of U.S. workers plummeted and have never returned to the levels that prevailed in 1973.
11 As rises in primary commodity prices worked their way through the price structure during the 1970s, economists of the Keynesian school claimed that the inflation was caused by rising wages, not the currency devaluation that they so strongly supported. They therefore urged the unions to moderate their wage demands in order to stop the inflation. Unfortunately, the unions followed this advice. Inflation kept rising, real wages plummeted, and unemployment rose.
The correct way to react to a currency devaluation is to ignore the “advice” of the bourgeois economists, especially those of the Keynesian school, and meet it with union organization and strikes if necessary so as to keep nominal wages rising along with the cost of living.
12 Roosevelt’s devaluation of the U.S. dollar that occurred between 1933 and 1934 worked in the opposite direction. But it was unable to overcome the more fundamental factors pushing interest rates downward. One reason was that, unlike the devaluations of the 1970s, the devaluation of 1933-34 was viewed as a one-time event that was unlikely to be repeated.
15 This would be a new Volcker shock, similar to the one that occurred in 1979-82. In later posts I will examine this particular episode more closely. The Volcker shock is named after Paul Volcker, who was chairman of the Board of Governors of the Federal Reserve System at the time. Today Volcker, a Democrat, is a senior advisor to the Obama administration.
16 This is not the greatest danger. Especially if the dollar system and the American world empire with it collapse and the U.S. working class fails to rise to the occasion, the way could be open to the rise of something like American fascism. The possible consequences of such a development in the age of nuclear weapons hardly need to be elaborated here. That is why the struggle to revive the U.S. workers’ movement from the wreckage of the last 30 years, and indeed of the entire post-World War II period, is so important.
17 Industrial cycles are, however, full of surprises, so the above is only one possibility, not a prediction of what will happen as the current industrial cycle unfolds. Future posts will go into some of the reasons that make reliable predictions of the course of individual industrial cycles impossible.
18 During the current crisis, governments and deposit insurance funds have extended their guarantees over an increasing mass of credit money created by the commercial banks. Much of these guarantees are described as temporary and will presumably be withdrawn once the current cyclical economic crisis ends.
The danger of these guarantees is that the credit money issued by the commercial banks in the form of deposits will be increasingly transformed into de facto token money. The commercial banks would create credit money through loans and the Fed would then transform this credit money into token money by freely exchanging it for newly printed paper dollars or the electronic equivalent. In effect, the for-profit commercial banks would be able to “print money.” If this were to happen, the results would be a disastrous collapse of currencies against gold, triggering runaway inflation and exploding interest rates. This is a point that deserves closer examination, which will be done in future posts.