Capitalist production is based on the world market. To understand the laws governing the capitalist system, one must understand those governing world trade. The orthodox or neoclassical theory of foreign trade is based on the theory of comparative advantage. [See “World Trade and the False Theory of Comparative Advantage” and “Comparative Advantage, Monopoly, Money, John Maynard Keynes, and Anwar Shaikh”]
The theory of comparative advantage holds that in national trade: the industrial capitalist with the lowest cost price when producing a commodity of a given use value and quality prevails in competition. In international trade: the capitalist with the comparative advantage prevails.
The view that different laws govern national and international trade precedes neoclassical economics. The originator of this theory is the classical British economist David Ricardo, who formulated the comparative law more clearly than neoclassical economists. This is because of his labor-based theory of value, where the value of a commodity of a given use value and quality is determined by the quantity of labor necessary to produce it.
Ricardo demonstrated that if the workers of every nation were employed only in the production fields they were best at relative to the global average, even if below the global average in every branch of production, the global productivity of labor would be maximized. If global productivity of labor is to be maximized, a nation exceeding the average must abandon those branches of production where it is least above the average. (1)
Within a nation-state, assuming equal wages, the capitalist prevails who can produce a given commodity of a given use value and quality with the least amount of human labor. (2) However, Ricardo claimed this law, called the law of absolute advantage by Anwar Shaikh, was not true in trade between capitalists in different nation-states. Instead, Ricardo advanced the view that a capitalist in one nation-state using more labor to produce a commodity would prevail, even assuming equal wages within all nations, against another nation’s capitalists using less labor under certain circumstances.
According to Ricardo, the circumstances are those capitalists producing at a higher labor productivity, whose productivity advantage in that industry is less than the average productivity advantage of another nation’s capitalists in industry as a whole (including agriculture). In that case, those capitalists who produce at a lower labor productivity can undersell capitalists producing at a higher labor productivity in another nation. From this, Ricardo and his liberal — today’s neoliberal — followers conclude that free trade is in the interests of industrially advanced nations with higher than average productivity in most branches of industry and underdeveloped nations with lower than average labor productivity.
Shaikh points out that world trade under the capitalist production mode is between capitalist firms, not nation-states. In this respect, world trade is no different from trade among capitalist firms within a nation-state. When an industrial capitalist purchases inputs for production, they can purchase them from another capitalist operating within the nation-state or in an outside state. The same is true when it comes to finding buyers for the commodities produced. Capitalists can find customers either outside their nation-state or within it.
Shaikh concludes that Ricardo and modern neoclassical economics notwithstanding, the same economic laws prevailing within the nation-state prevail with trade among capitalists of different nation-states. Many opponents of globalization or free trade point out that empirical studies give no support to the theory of comparative advantage. They say that any country wanting to industrialize on a capitalist basis should protect its industries through tariff or non-tariff barriers and impose restrictions on moving money out of the country. These are the policies recommended by mercantilist economists who dominated the pre-Adam Smith political economy.
Today’s neo-mercantilists confront claims that the policies they favor have been refuted by modern economic science. Heterodox economists respond that if perfect competition prevailed, the neoliberal economists’ opposition to neo-mercantilist policies of developing countries would be correct. They say we no longer live in the world of Ricardo and other early liberal economists. Today, powerful monopolies headquartered in the imperialist countries but operating internationally dominate world trade. They use monopoly power to impose unequal exchange on poor countries.
In Ricardian terms, monopolies are so powerful in the age of imperialism that they force countries of the Global South to exchange commodities with more hours of embodied labor time than the commodities they get from the rich countries. An hour of labor performed in the Global South exchanges for perhaps 15 minutes of labor performed in the Global North. This leads to the enrichment of Global North countries at the expense of those of the Global South.
When analyzing working class exploitation by the capitalist class, Marx explained the enrichment of the capitalists at the expense of the workers on the basis of equal exchange (of equal quantities of labor). This is the cornerstone of Marx’s theory of surplus value. Modern left-wing opponents of free trade under imperialism explain the exploitation of the Global South by the Global North on the basis of unequal exchange. It is monopoly power wielded by Global North monopolist corporations that enforce unequal exchange. Monopoly power prevents the Ricardian law of comparative advantage from operating to benefit the Global North and South alike.
Anwar Shaikh rejects this argument. He writes, “The conventional (Ricardian) theory of free trade is wrong on its own presupposed grounds of international competition precisely because real competition is very different from perfect competition [which incorporates Ricardian comparative advantage -SW]. … It is not the real world that is ‘imperfect’ because it fails to live up to conventional theory. Rather, standard theory is inadequate to the world it purports to explain.” [p. 495, “Capitalism”]
Ricardian comparative advantage and the quantity theory of money
The Ricardian claim that absolute advantage prevails in the home market and comparative advantage prevails in the world market rests on accepting the quantity theory of money. However, once we reject the quantity theory of money, no mechanism operates within an international global capitalist economy that can enforce comparative advantage.
To review, Ricardo assumed it was in the capitalists’ interest to keep money capital in circulation. Allowed to sit in a stagnant hoard, it reduces the profit rate on total capital. Ricardo assumed there was never a significant quantity of idle money in capitalist strong boxes or the banks. He figured that what was true of money capital was true of real capital as well. He assumed all capital was fully utilized. He reasoned that any change in money quantity affected only nominal prices and wages, not production or capacity utilization, which he assumed was always at 100%.
The discovery of rich new gold mines increased prices and money wages in terms of gold. But it did not accelerate economic growth or affect real wages. A reduction in the money quantity within a country lowered prices and money wages but did not reduce output, employment, or real wages. If Ricardo had been correct, comparative advantage would prevail on the world market. The problem is that the quantity theory of money is invalid.
Shaikh realizes that even if we assume no monopolies — besides the monopoly of the capitalist class in the means of production without which capitalism cannot exist — once we reject the quantity theory of money, there is no mechanism to enforce comparative advantage in international trade. This does not mean there are no monopolies. Shaikh denies there is more monopoly power now than in the days of Ricardo. That is a separate question for a future post(s).
Already clear is that the theory of money plays an essential role in the analysis of world trade. In our posts on Keynes and mercantilism, we saw that once Keynes rejected the quantity theory of money, he developed a respect for the mercantilist economists. Though Shaikh is no supporter of the quantity theory of money, he believes modern money is pure fiat money — non-commodity money. Shaikh shares this with neoclassical economists, Keynesian economists, post-Keynesian economists, supporters of Modern Monetary Theory, and most academic Marxists. To develop a correct theory of world trade, I believe we have to get rid of the idea that modern money is non-commodity money. Moreover, since the periodic cyclical crises of the relative overproduction of commodities are world market crises, we need a correct theory of both money and international trade to understand these crises. And finally, world trade raises questions involving Marx’s theory of labor value that do not arise if we examine only an individual capitalist nation-state, or to simplify as Marx sometimes did, that the entire capitalist world was a single country.
If we assume the entire world is a single country, we can assume that wages for a given type of labor power are equal throughout the world. However, this is not the case in the real world of different nation states and exploiting and exploited nations. Shaikh’s failure to grasp the nature of modern money points to a deeper problem. He has not adequately analyzed the value-creating properties of human labor. His theory of value is closer to Ricardo’s than that of Marx. I begin by analyzing the international monetary system and its function in world trade. This will take several posts. After that, we will have to deal with the darker corners of Marx’s theory of value and how it differs from Ricardo’s.
Comparative advantage, gold, and paper money
There are two versions of comparative advantage. One is for the era of the international gold standard. The other is for a system of free-floating exchange rates where no currency is convertible into gold at a fixed rate by the monetary authority — a central bank like the Bank of England. Under the British gold standard, Bank of England banknotes were payable in gold sovereigns — a British gold coin of a fixed weight — at a rate of one gold sovereign for each banknote pound. In Marx’s time, the lowest domination note was the five-pound note. An owner of a five-pound banknote could go to the nearest branch of the Bank of England and cash it in for five sovereign gold coins.
If Britain ran a deficit in its balance of payments as a result of a deficit in its balance of trade, the pound’s exchange rate fell relative to the currencies with which Britain ran a balance of trade deficit. If the exchange rate fell to a certain level — the gold point — it would cost less to absorb the cost of shipping and insuring the gold than it would to absorb the foreign exchange loss. As a result, the bank’s gold reserves would be run down. To safeguard the banknotes’ convertibility into gold, the bank was forced to reduce their quantity. According to the quantity theory of money, this should lead to a drop in nominal prices and wages in Britain.
The fall in prices would make British commodities more competitive on the world market. According to Ricardo and his followers, known as the currency school, the result would be that Britain’s trade deficit caused by prices being too high relative to world market prices would disappear as British prices fell. If Britain ran a trade surplus, this meant British prices were too low relative to world market prices. The currency school then assumed gold would flow into Britain from nations running trade deficits with it; as the quantity of gold in the bank’s vaults grew, the number of banknotes increased. The rise in the quantity of money caused by the trade surplus causes prices and wages to rise. This causes British commodities to become less competitive at home and abroad, and Britain imports more and exports less. This continues until its trade surplus goes away. Neither a trade surplus nor a trade deficit could last for long.
The currency school assumed the world supply of monetary gold is distributed in such a way that trade would balance among all trading nations. Any shift in world trade leading to surplus for some nations and deficits for others will be quickly corrected. This is because nations with lower than average productivity have less gold and, thus, less money in circulation. This causes prices in the lower productivity country to be below the value of commodities. Countries with higher-than-average labor productivity have more gold and more money in circulation. The greater amount of gold means prices of commodities are above their values.
The conclusion is that free trade, defined as the government not interfering in foreign trade through tariffs or other trade barriers, is in the interest of countries with higher than average labor productivity as well as underdeveloped countries with lower than average labor productivity. Industrially developed Britain has more gold in its central bank than any other country, but British gold is depreciated below its value. The smaller amount of gold in underdeveloped countries is appreciated above its value. In the end, everything balances out in the common interests of the developed and underdeveloped nations alike.
The modern version of comparative advantage
As I show throughout this blog, the worldwide economic crises of 1847, 1857, and 1866 showed that Ricardo’s theory was not working out in practice. [See “Ricardo’s Theory of International Trade” and “Ricardo’s Theories Challenged by the Crises of 1825 and 1837”] Modern neoclassical economists claim the mistake of their Ricardian currency school predecessors lay in their incorrect definition of money. They defined money as gold, silver, legal tender base metal coins, and Bank of England banknotes. Today’s economists include in their definition of money coins, paper currency, and checkable bank accounts, which, from the mid-19th century onward, comprise the bulk of the total circulating media within Britain. As the 19th century progressed, fewer banknotes circulated as their place was taken by checkable bank accounts.
Today the convertibility of national currencies into gold at a fixed rate by the monetary authority is gone. In the United States, you cannot go to the closest branch of your district Federal Reserve Bank and cash in your $100 bill for gold coins. The Federal Reserve Bank’s employees would explain that a $100 legal tender Federal Reserve Note is the most basic form of money there is, and it cannot be cashed in for any other form of money. The most they might do is change a worn-out Federal Reserve Note for a crisp, newly printed one. Federal Reserve notes — and legal tender base metal coins — are money not because they are made of valuable materials like gold coins, but instead, they are money by government fiat. Hence the expression fiat money.
So how does comparative advantage work under the fiat money system? Both supporters of Milton Friedman on the right and Modern Monetary Theory on the left advocate what is called a clean currency float. Governments and central banks do not attempt to maintain any particular rate of exchange between the national currency or other national currencies. Instead, exchange rates are determined by supply and demand on the open market. Neither the ministries of finance nor the central bank maintains reserves of gold or foreign currencies to back their national currencies.
Suppose the U.S. runs a balance of payments deficit due to a deficit in its balance of trade. The dollar falls against other currencies, meaning that dollars buy less foreign currency and thus fewer foreign commodities. But since foreign currencies buy more dollars than before, U.S.-made products priced in dollars become cheaper as the dollar falls in terms of these foreign currencies. As a result, U.S. products become more competitive in international markets as well as at home. U.S. exports rise as foreigners buy more U.S. products, while imports fall as Americans buy fewer foreign commodities. This continues until the trade deficit vanishes.
Suppose we have the opposite situation. The United States runs a trade surplus. This causes commodities priced in dollars to become more expensive in foreign currencies, while imports become cheaper because the dollar can buy more foreign currency. As a result, commodities become more expensive in the foreign currency while foreign commodities become cheaper in dollars, and U.S. exports decline while imports rise. The trade surplus declines and vanishes. The free market in currencies assures that currency exchange rates settle at levels that balance international trade.
The conclusion: foreign trade will balance if governments cease interfering with foreign trade and exchange rates. No country will, for very long, run either a trade surplus or a trade deficit. If a country runs chronic trade deficits (like the U.S. has done for decades) while others run chronic trade surpluses, it is because some currencies (like the dollar) are overvalued while others (like the Japanese yen or the Chinese yuan) are undervalued. If currency exchange rates are allowed to move freely, they soon find a level that will balance world trade. Then no country experiences chronic trade deficits or trade surpluses. No country sinks into debt with another country. The solution to international debt problems is to remove all trade barriers, both tariffs and non-tariffs. Governments and central banks must cease manipulating exchange rates through the sale or purchase of foreign currencies. If this is done, the law of comparative advantage will come into its own. All countries, from the most developed to the most underdeveloped, will then benefit equally from foreign trade, and the global productivity of labor is maximized.
The modern version of the theory of comparative advantage depends on the validity of the quantity theory of money. The general price level within a country, in the national currency, depends on the quantity of the national currency relative to the number of commodities within that country. While it is conceded that the prices of imported commodities in local currency will rise if the exchange rate of the national currency falls against foreign currencies or fall if the national currency rises against foreign currencies, this will have little effect on the overall national price level, which is determined by the ratio of the currency to commodities. So whether the old-fashioned gold standard or freely floating exchange rates prevail, the quantity theory of money needs to be true if the law of comparative advantage is to prevail over absolute advantage in international trade.
Shaikh is right to reject the theory of comparative advantage either for a gold standard world or our own floating currency world. But he is hindered by his acceptance of the claim that today’s money is pure fiat non-commodity money. Shaikh accepts the claim that the state has the power to transform paper notes and tokens made of worthless pieces of paper and base metals into money by pure fiat.
Whenever Shaikh senses he is on shaky ground, he turns to input-output models beloved by the followers of Piero Sraffa and other neo-Ricardians. What I will do here is formulate a theory of world trade based on Marx’s theory of value and money price as the form of value. According to Marx, money must be a commodity. He did not deny that legal tender token money with forced circulation exists. But such tokens still represent at any given point an actual quantity of gold measured by the price of gold in terms of those tokens. According to Marx’s theory of value, Shaikh’s pure fiat money cannot exist under the capitalist system. Like Keynes in the “General Theory,” Shaikh rejects the quantity theory of money without understanding that money must be a commodity. His theory of modern money is close to that of Keynes. Shaikh understands that even with a Keynesian rejection of the quantity theory of money, the theory of comparative advantage falls. There is no need to bring in monopoly to explain why comparative advantage does not work in practice. (3)
Shaikh understands that the capitalists producing a commodity of a given use value and quality at the cheapest unit price — cost price in Marx’s terminology — prevail over time in both national and international competition. Cost price is what the capitalist pays to produce a commodity, while the production price, forming the axis around which market prices fluctuate, is what society pays for the commodities. Shaikh demonstrates in “Capitalism” that production prices are approximately equal to direct prices. Shaikh uses empirical studies to demonstrate that in the real world production prices are pretty close — usually within 10% — of direct prices. Once we get rid of Shaikh’s pure fiat money we find that direct price is the quantity of gold whose value matches the value of the commodity whose value is being measured by gold.
Cost prices are determined — approximately — by the value of the commodities used up in the production of commodities plus the value of labor power. Two factors determine the cost price of a commodity. One is the quantity of labor necessary to produce a commodity. The other is the value of the wage the capitalists pay for the labor power used to produce the commodities. The lower the value of labor power, the greater the quantity of unpaid labor is relative to the paid labor. The capitalist is interested in minimizing the quantity of paid labor — wages — but maximizing the value of the unpaid labor — surplus value. Only the cost of the paid labor — labor power plus the value of the constant capital used up — enters into the cost price.
This brings us to the single most important difference between national and international trade. Even in the early 21st century, the world market has not advanced to the stage where commodities of a given use value and quality have the same social value in all countries. This is true for the most important commodity of all, the commodity labor power, which alone produces value and surplus value. To analyze world trade, we have to examine what the nation-state is and how its existence affects the value of labor power.
The nation-state
The modern nation-state is itself the product of capitalist production. It should not be confused with the nation. The nation is far older. Originally it was made up of tribes, which in turn were made up of clans. Clans were extended families. All members of a clan share a common ancestor. This was originally a maternal ancestor and later a paternal ancestor. Tribes were a group of clans who shared a more or less fictitious common ancestor many generations back. The nation began as a group of tribes tied together by this common ancestor even more generations back. The nation viewed itself as an extended family. In its original form, the nation did not include the state. The nation was not tied to any particular territory. Membership was defined by kinship, not geography. Nations could and did migrate.
With the rise of private property, the nation became divided into classes. Some classes performed labor while the ruling class lived off the surplus labor the exploited class(es) performed but whose fruits they did not get to consume. This led to the rise of the state as a special organization of armed people to hold down the classes that are forced to work in the interests of the classes that do not themselves work.
The class-divided nation settled in a definite geographical area called a city-state. The nation no longer migrated but had a fixed location. From this stage, geography rather than kinship defined what nation you belonged to — what kind of kinship can exist between the exploited and the exploiters? Great empires arose, such as the Roman Empire, in which one city-state came to dominate other city-states over a large geographical area. The largest of these empires ruled over large areas that sometimes equaled the size of a modern large nation-state. Unlike the citizens of modern nation-states, the people of these empires did not share a common language, nationality, religion, or culture.
The rise of the modern nation-state
In medieval Europe, loosely organized feudal kingdoms had internal trade barriers and different languages. Some of these kingdoms evolved — with help from the occasional revolution — into the modern capitalist nation-states of today. One language emerged that was spoken by all the people living there. A common system of weights and measurements and a common currency were established. Internal trade barriers were eliminated, establishing free trade within it, giving rise to the national market. Each nation-state was itself surrounded by tariffs and other trade barriers. Each was organized around a ruling capitalist class and became the chief weapon of the ruling capitalists in its commercial competition with other nation-states. This competition often led to shooting wars. This was the world the early economists called mercantilists.
No nation-state achieved the ideal form in which all people spoke the same language, practiced the same religion, and considered themselves part of one nation. For example, the British nation-state contained not one but four nations: England, Wales, Scotland, and Ireland. Initially, these nations spoke four different languages, but over time all nations of the British Isles adopted the English language reflecting England as the ruling nation. Today, Irish, Welsh, and Scottish nationalists are reviving their original languages. In the 20th century, the Irish established their state while the Scots, the Welsh, and the dominant English nations live in a single state. Today there is a strong Scot independence movement seeking to establish an independent nation-state.
In the 19th century, the capitalists of Britain (sometimes called England after its dominating nation), due to the adoption of steam as a motive power, achieved such a superiority in labor productivity that it found it advantageous to remove most of the trade barriers surrounding the British state. They saw the national markets of the world as a single world market.
Britain remained a capitalist nation-state with the victory of free trade in 1846 that came with the repeal of the corn laws protecting British capitalist farmers, and landlords. Britain had its national language and system of weights and measures. Not all commodities had the same value in Britain as elsewhere. While the value of gold and silver — the money commodities — were the same everywhere, other commodities had differing national values. The value of labor power was different than in Britain. Fruits and agricultural raw materials like cotton that could not be grown in Britain for climate reasons had higher value there than in the countries where they were produced — because of the cost of transporting these commodities to Britain. Britain had (and has) its own national currency, the pound sterling, and it retained the power to impose trade barriers if it is in the interests of the capitalist ruling class, as it did when Britain lost its industrial monopoly on the world market.
The labor power commodity, the most important of all, as no other commodity exists without labor power, has different values in different nations. The value of labor power is determined by the average labor power. Itconsists of two parts. One part is the value of labor power determined by the commodities biologically necessary to maintain the lives of the workers and raise a new generation. An additional moral part is determined by the history of a country and its history of class struggle. This second or moral part of the value of labor power is substantial in some countries but barely exists in others. Skilled labor power has a value that is a multiple of average labor powers.
In capitalist nation states that began as colonial settler states — such as the United States, Australia, and Canada — the aboriginal populations were partially exterminated. The survivors have been only partly absorbed into the active working proletariat of these nations. In the United States, enslaved Africans did not participate in the labor market. Their entire persons, not their labor power, were commodities that could be bought and sold on the (enslaved person) market. Since the end of chattel slavery, their descendants have been forced to participate in the labor market on disadvantaged terms.
In the colonial settler states, the white population seized land from the aboriginal population and became a class of farmers who owned the land and the means of production. The population forced to sell their labor power was small relative to the demand for it. The labor power in white colonies had a high value from the beginning, notwithstanding the initially lower productivity of labor compared to Britain. In these countries, the moral portion, added onto the value determined by bare biological subsistence, forms a significant portion of the value of labor power.
In other countries — such as Britain, Germany, and France — strong labor unions and later working-class political movements developed. This led to a higher value of labor power. Where that’s higher than average, capitalists use more constant capital than where the value is lower. National values of commodities tend to be lower in high-wage countries than in low-wage countries.
Within a capitalist nation-state, the value of labor power can vary from region to region but not as far as it can between nation-states. If it did, workers would move from low-wage to high-wage regions. Oppressed nationalities and racial groups within some nation states are paid lower wages for the same work. This is true for the descendants of enslaved Africans in the United States. As a result, the value of labor power is lower in the Southern states, not only for enslaved people’s descendants but also for white workers.
The movement of workers is more restricted between nation states (external migration from one nation-state to another) than within (internal migration from one region to another within a nation-state). Workers move from low-wage regions to those where wages are higher. In the United States, Canada, Australia, New Zealand, and Western and Northern Europe, reactionary politicians take advantage of this by keeping up a drumbeat against external migrants whom they claim bring crime and threaten the wages of the white workers. Capital moves in the opposite direction, from regions where the value of labor power is high to regions where it is lower. This process is called international labor arbitrage.
Within a capitalist nation-state where simple labor power (4) has a common national value, the ability of capitalists to drive out a rival by paying lower wages is still limited. There is a trend for the value of labor power along with all other commodities to equalize on the world market. This is far from being achieved. From the second half of the 20th century onward, capitalists have been abandoning the old industrial-high-wage countries for low-wage countries. This results in the deindustrialization of the old industrial countries where the value of labor power is relatively high and the rapid development of capitalism in some low-wage countries where the value of labor power is low.
This puts downward pressure on the value of labor power in the old countries while raising the value of labor power in newly industrialized ones. Capital on a world scale is increasingly forcing the value of labor power to the lowest level possible as determined by biological subsistence. This has been dubbed the race to the bottom.
What we have is not a fully united world market but one divided into areas fenced off by tariffs and trade barriers. While many commodities have global values, others have different national values. There are two special commodities in capitalism, the money commodity — gold bullion — and labor power. Gold has a common global value. The commodity labor power has different national values. We will explore the significance of this in coming posts.
Money and world trade
The easiest way to understand the basic principles of world trade is to begin with the assumption that the world uses gold coins as currency. Gold is mined and refined in some countries while others must exchange non-money commodities to obtain money material from gold-producing countries. Gold bullion is given to countries’ mints and coined into national currencies. If a country runs a balance-of-payments deficit due to a deficit in its balance of trade, the deficit reduces the quantity of gold — money — in that country drops. Ricardo assumed prices within the country, including the price of labor (power), would drop as the money supply shrank until the balance of trade swung back in favor of the country. This is the foundation on which Ricardo built his theory that comparative, not absolute, advantage prevails in international trade.
Within the deficit country some of the money — gold — is in circulation, while another part of the money forms a reserve hoard. This is where Ricardo’s error begins. He assumed the reserve hoard was minimal, but this was not the case. What happens is that a portion of the money in the reserve hoard has to be drawn into circulation to replace the gold currency flowing out of the country. The shrinking reserve hoard causes a tightened money market and rising interest rates.
Assuming no gold shortage on the world market, rising interest rates attract hot money seeking the highest interest rate to flow in from abroad. The money halts the decline of the domestic gold hoard. This ends a further rise in interest rates, bringing payments back into balance. The negative trade balance is compensated by an inflow of money capital from abroad. In economic terms, a negative balance on the current account is compensated by a positive balance of payments on the capital account. As long as the inflow of money capital continues, the country can import more than it exports. However, this is at the price of higher interest rates and either growing international debt, increased foreign ownership of industry and land, or a combination of both.
What happens to a country in the reverse situation? A country runs a balance of payments surplus because it runs a balance of trade surplus. Ricardo believed that as the money supply grows, nominal prices and wages rise because he (wrongly) believed that almost all of the money within a country would be in circulation. As a result, a country with a balance-of-trade-and-payments surplus is soon priced out of the world market. This continues until its trade surplus disappears. Neither trade deficits nor trade surpluses can persist for long.
The root of Ricardo’s mistake was his belief that most of the money in a country is in circulation. This is the quantity theory of money. In reality, a portion of the money supply within a country, as well as on the world market, forms a reserve hoard whose size varies with the phase of the industrial cycle. This reserve hoard can be tapped when needed for additional currency. It can be reinforced with a portion of circulating currency whenever the needs of circulation fall, making a portion redundant. Thomas Tooke and the banking school pointed this out, challenging the views of the currency school based on the quantity theory of money. During the 19th century, economists were divided between the dominant currency school that accepted the quantity theory of money and the banking school that rejected it. The currency school was close to today’s neoclassical orthodoxy that accepts a version of the theory. The banking school is close to the views of John Maynard Keynes that rejects the theory.
We can establish some basic laws of international trade that apply to every capitalist international monetary system. Countries with trade surpluses corresponding to what bourgeois economists call a surplus on the current account have offsetting deficits on the capital account. They are net exporters of money capital and emerge as international creditors. If the creditor countries do not loan out their surplus money capital, debtor countries cannot keep buying commodities in excess of the commodities they sell to the creditor countries. International creditor countries have lower domestic interest rates than debtor countries. It is easier for those in creditor countries to borrow money within that country than for those in debtor countries. Contrary to Ricardo and the currency school, some countries can run balance-of-trade surpluses for prolonged periods while others run balance-of-trade deficits. Nothing prevents international debt from building up to dangerous levels, which eventually collapses in crises.
Shaikh explains that these patterns emerge from the trade carried between individual capitalists who aim to make as much profit as possible. International trade is no more planned than trade and production within a capitalist country. As with domestic production and trade, in international trade, order emerges out of disorder. But that order is exploitative and unstable.
The nature of money and the rate of exchange
The division of the world market into separate national markets means that universal money — gold — becomes divided into national currencies. The rate one currency exchanges for another is called the exchange rate. Today, all national currencies are legal tender or fiat currencies that are not convertible into gold at a fixed rate by a national monetary authority. All currencies can be exchanged for gold at variable rates of exchange on the open market. The currency’s rate of exchange with gold is the price of gold in that currency.
The price of gold is not a real price but what Marx called an economic slang expression. Price in the scientific sense is the rate a non-money commodity that represents a quantity of abstract human labor exchanges with the money commodity, which like all commodities, also represents at any time a quantity of abstract human labor. The money commodity represents a quantity of abstract human labor that reflects the amount of labor necessary to produce it under the prevailing conditions of production. The price of a commodity is a given quantity of the use value of the money commodity measured by a unit of measurement appropriate for the use value of the commodity that functions as money.
The price of gold is a special exchange rate
The currency price of gold — for example, the price of gold in dollars — does not represent a relationship between two commodities that are both products of human labor. While a troy ounce of gold is a commodity, the dollar is an arbitrary unit of account decreed by the state. We are measuring a certain quantity of the use value of the money commodity — an ounce of gold in this example — that determines how much real money — gold — that state-created accounting unit called the currency represents in circulation at any given moment. The bullion in an old-time gold piece of a certain denomination cost society twice the quantity of labor to produce than gold in a gold piece of half the denomination of the first gold piece. In contrast, it does not cost society twice the labor or any more labor at all to print a $20 bill than it takes to print a $10 bill.
If the price of an ounce of gold equals $1,500 at a particular time, a dollar represents 1/1500 of an ounce of gold. The price of gold is not a price but a special exchange rate that anchors all other exchange rates. For example, if the exchange rate between the dollar and the British pound is $2 for £1 and the dollar price of gold is $1,500 an ounce, the British pound represents 1/750 of an ounce of gold. In economic slang, the price of gold in British pounds is £750 per ounce. When we quote the rate of exchange of the British pound as £1 for $2, we are not measuring the amount of gold a British pound represents directly, but the amount of gold a British pound represents indirectly through the mediation of the dollar. This is the essence of the dollar system that has dominated the international monetary system since the end of World War I. Under the dollar system, currencies other than the dollar express their relationship with gold not directly but through their exchange rate with the dollar.
During the infamous hyperinflation that gripped Germany in 1923, Germans were glued to the skyrocketing price of the dollar in terms of the German mark which rose by the hour. Workers paid in marks stampeded to buy the commodities they needed to stay alive (they couldn’t afford to buy anything else) before the mark price of the dollar rose so much that the paper marks they were paid wouldn’t buy the bare biological necessities. In 1923, the U.S. currency was on the gold standard. The amount of gold a dollar represented was fixed by the U.S. Treasury and Federal Reserve System at $1 equals 1/20.67 of an ounce of gold. Through the mediation of the dollar, the Germans were measuring the fast shrinking amount of real money — gold — that the paper marks they were paid represented.
Two factors determine the rate of exchange
Two factors govern changes in the exchange rate between currencies. One is the balance of payments. If a country has a positive balance of payments, more people will buy that country’s currency than sell it at current exchange rates. The exchange rate of a country with a positive balance of payments rises relative to those with a negative balance of payments. The second factor governing exchange rate changes between countries is changes in the quantity of a currency measured in currency units of account — dollars, pounds, etc. — relative to changes in the quantities of other currencies. In today’s world, with currencies not convertible into gold at fixed exchange rates, the constant fluctuations of currencies against one another are governed by a combination of these two factors. We must keep these two factors separate to understand the economic laws governing exchange rates.
If the quantity of a given currency is doubled, its exchange rate will fall by half against gold and other currencies whose quantities remain unchanged. If the quantity of dollars doubles but the quantities of other currencies remain unchanged, it takes twice as many dollars will be needed to purchase a given quantity of gold bullion, British pounds, Canadian dollars, euros, Russian rubles, Indian rupees, Chinese yuan, etc. than it took before.
The other factor causing the exchange rate between currencies to change is shifts in the balance of payments between currencies. If the balance of payments shifts in favor of a country, its currency exchange rate rises against other currencies. If the balance of payments shifts against a country, the exchange rate of its currency falls. These two factors are intertwined in the daily fluctuations in the international currency markets. Sometimes they cross each other, and other times reinforce each other.
I am going to introduce a new concept not generally found in economic writing. It is that money can flow into and out of national currencies. Most modern economists believe that modern money is non-commodity money consisting of legal tender coins and paper notes with little value in themselves, that governments declare by fiat to be money. Or maybe it is checkable bank accounts and electronic bookkeeping entries, or could it be those electronic bookkeeping entries called bitcoin and cryptocurrencies as well? There is a debate about whether bitcoin and other cryptocurrencies are money. When it comes down to it, economists who believe in non-commodity money are not sure what money is after all. What is it really?
Money is a social substance that must be represented by a physical substance.
Marx explained that gold and silver are not by nature money, but that money is by nature gold and silver. Only in the last few years have scientists begun to understand how the element gold is created in nature. Most metals heavier than iron are created when gigantic stars, more massive than our sun, reach the end of their lifetimes and start fusing atoms to create heavy metals. Scientists could not figure out how gold could be created in this way. They now realize that most gold in the universe is created when two neutron stars that are the remnants of massive stars collide. These collisions create showers of subatomic particles so intense that they fuse protons into atomic nuclei that make up the element we call gold.
Do the colliding neutron stars create any money? No. Neither gold nor any other element or compound can function as money in the absence of a society based on the production and exchange of commodities. The only such society we know of exists on our planet, though, given our present knowledge, we cannot rule out the possibility that other commodity-producing societies exist elsewhere in the universe. But we know that most of the gold in the universe is not and will never be money. Money is a social relationship of production. Like all value, money consists of abstract human labor embodied in commodities. Money’s value differs from value in general because the abstract human labor making up its value is directly social. This direct social labor is embodied in whatever commodity functions as money.
The private labors producing commodities are a discreet fraction of the total social labor to the extent that the commodities produced are exchanged for money. For this reason, the private human labor that produces gold is unlike human labor that produces other commodities because it does not have to be exchanged to demonstrate that it is a fraction of the total social labor. This is what the supporters of the Monetary Equivalent of Labor Time (MELT) and Anwar Shaikh fail to understand. We cannot treat the private labor that produces non-money commodities as social labor before the commodities it produces are exchanged for money. We must remember this to understand what money is and what it is not. That is why only human labor embodied in the money commodity can be considered money. When we talk of MELT, we treat the labor time embodied in all commodities as money, which is a mistake.
Over the last couple of centuries, reformers dreamed of establishing a currency that would represent labor directly while retaining all the other features of capitalism. Instead of being denominated in terms of dollars, pounds, etc., representing different weights of gold (or silver) and representing human labor through the mediation of the money commodity, labor money supporters propose a currency that represents quantities of labor denominated in some unit of time, for example, an hour of labor. Instead of a $1 bill, we have a one-hour note. As I have explained before, such a system would get rid of commodity money and crises of the general relative overproduction of commodities.
Advocates of labor money imagine that once a commodity is produced, the amount of labor that went into its production would be tallied up by some authority, such as a special bank. The commodity’s producer would exchange it at the bank for a note with the amount of labor that went into it printed on the note. For example, a commodity that took 100 hours of labor to produce would be exchanged for a 100-hour note. The problem is that if the value of commodities could be realized through labor money, there would be no way to determine whether the private labor expended met any actual human need. Since the economy would still be profit driven and unplanned, there would be no mechanism to establish that commodities would be in the proportions necessary to maintain production and human society.
There is another reason labor money would not work under capitalism, though the reason given above is decisive. Suppose a worker works eight hours daily with a surplus value rate of 100%. The worker would receive a note with four hours of labor printed on it representing the value of the worker’s labor power. The worker would realize they worked eight hours but were paid for only four. The unpaid labor the worker performs when the commodity labor is sold at its value, so artfully hidden under the system of commodity money, would be right out in the open.
Money is defined as a social relationship of production. It is a social substance of human labor that’s directly social, embodied in a physical money commodity, and measures the value of all other commodities in terms of its use value. The money’s social substance is represented by a physical substance that can be carried around in the form of coined gold. If a given commodity has a price in terms of the money commodity of one ounce of gold per unit and is sold for an ounce of gold, this shows that the private labor that went into producing that commodity met a social need. The private labor used showed itself through the act of sale at its value, that it was a fraction of the total social labor. The bookkeeping units we call U.S. dollars, British pounds, etc., represent money only to the extent that they can be exchanged for physical gold on the open market.
If the exchange rate of a dollar rises for whatever reason against the money commodity, the dollar price of gold falls, and the amount of money a dollar represents increases. If the exchange rate that a dollar represents falls, the dollar price of gold rises, and the dollar represents less money. What is true of the dollar is true of other capitalist currencies, whether they express their value in terms of gold directly as a currency price of gold or indirectly through their exchange rate with the dollar.
Changes in the exchange rate
As we have seen, if the dollar rises against other currencies, not because of reduced quantity but because the balance of payments is favorable to the United States, each dollar represents more money. The social substance that constitutes money flows into the dollar. Monetary authorities, governments, and economists encourage us to think dollars are money in and of themselves by state fiat, as are British pounds, European euros, Russian rubles, Chinese yuan, and Japanese yen. The fact that different currencies represent money and are exchangeable with one another at a given rate of exchange shows that money itself is not dollars, pounds, rubles, yuan, or rubles. Money is something else. It is abstract human labor embodied in a special commodity — gold — that differs from abstract human labor in non-money commodities only in the sense that it is directly social. Once this is understood, we understand that money can flow in and out of different currencies. When it flows in, the currency exchange rate rises. When it flows out, the exchange rate falls.
For example, if money flows into the dollar because the United States has a favorable balance of payments, the total quantity of dollars represents more money than before. If money flows out of the dollar, the total quantity of dollars represents less money than before.
This should be distinguished from a situation where the dollar (or other currency) exchange rate drops because its quantity has been increased or rise because it has been decreased. Let us assume the number of dollars is doubled, but all else remains unchanged. Money is neither running into nor out of the dollar. Doubling the quantity means the amount of money the total quantity of dollars represents is unchanged. Each dollar now represents half the amount of money than before.
The dollar system
Under the current world monetary system, not all currencies are created equal. The dollar is the central currency of the international monetary system. On the London gold market, the price of gold is quoted in dollars. If you follow the ups and downs of the gold market daily, you will often read something to the effect that gold fell sharply in the face of a strong dollar. In reality, money flowed out of other currencies into the dollar on that particular day. Since the quantity of dollars does not change much over a trading day, to say the dollar rose against gold means the total quantity of dollars on the world market represents more actual money — gold — than the day before. Or the dollar might be weak, its exchange rate falling against other currencies, and the dollar price of gold rise. Again, dollars as a whole represent less money than the day before because money flowed out of the dollar.
It is not always true that a strong dollar against other currencies is accompanied by a fall in the dollar price of gold, while a weak dollar is accompanied by a rise. Sometimes there is a sharp drop in the confidence capitalists have in paper money in general, not just a particular currency. Then money flees from paper currencies as a whole, as when it flows out of global stock markets, causing a crash. The dollar may hold its own or rise against other currencies and fall against gold; in this case, it is flowing out of all currencies. The total quantity of global currencies then represents less money. Or if the opposite happens and the total quantity of currencies represents more money, the dollar price of gold falls even if the dollar is not particularly strong against other currencies. Under the dollar system, a strong dollar against real money means a falling dollar price of gold, and a weak dollar means a rising dollar price of gold.
The changes in the exchange rates of the currency, both against other currencies and gold — the money material — change minute by minute. This reflects changes in the balance of payments and the number of dollars, the quantity of other currencies for which the dollar exchanges, the change in the quantity of gold being offered for the currency at any given moment, and capitalists’ confidence in the dollar-centered international monetary system in general, and in particular paper currencies.
Under a gold standard, the monetary authority’s chief responsibility is to maintain within strict limits the amount of gold a given legally defined unit of currency represents on the open market. The monetary authority doesn’t have control over the quantity of the currency — defined as legal tender currency notes and coins. Under this system, the movement of money into or out of a country manifests itself in the change in the quantity of the national currency.
The quantity of a national currency is not the same as the currency in circulation because part of the total currency must be held in reserve by commercial banks. As we know, the ratio between the quantity of currency in circulation and the quantity of money in the banks’ reserve funds can vary with the different phases of the industrial cycle. (5) The quantity of the reserve fund is higher after a crisis when commodity circulation is stagnant than during a boom. Under a system of legal tender token money — fiat money — the monetary authority has control of the quantity of currency — the legal tender currency — but loses control of how much money each unit of currency represents. The more the monetary authority has control over the number of monetary units, the less control it has over the amount of money each currency unit represents, and the more control the monetary authority has over the quantity of money that a currency unit represents, the less control it has over the total quantity.
Under a fiat system, if money flows out of the country, the total quantity of currency units does not necessarily fall; it might even rise, perhaps explosively. But the amount of money — gold — that the total quantity of narrowly defined units represent will still fall. If money flows into a currency, it might not express itself in the form of an increase in the quantity of that currency. It might instead express itself in a rise in the exchange rate of that currency and a fall in the price of gold of that currency.
To be continued
(1) Ricardo assumes here that all potential workers producing commodities traded internationally are employed. In reality, this is far from the case. (back)
(2) Ricardo assumes that wages the capitalist paid for a given type of labor (power) were equal. As a first approximation, this is a reasonable assumption for workers within a given nation. (back)
(3) Shaikh thinks Ricardo was inconsistent in his theory of value on foreign trade. Ricardo held that prices of production close to direct prices are determined by the quantity of social labor necessary to produce commodities of a given use value and given quality. He modified this on the world market with his assumption that gold — world money — is distributed among trading nations in proportions that those nations with industrial capitalists using more labor to produce commodities than average would sell them at prices below their national values on the home and global markets. Nations producing commodities with less labor would sell them at prices above their national values. Ricardo asserts that because the lesser amount of gold in nations with below-average labor productivity causes gold to appreciate above its value, while the greater amount of gold in nations with above-average labor productivity causes gold to depreciate below its value. (back)
(4) An hour of labor performed by the labor power of an average worker of average skill creates an hour of value. Value is the average, general, or abstract human labor embodied in some commodity. The more valuable labor power of skilled workers consists of multiple simple labor powers. For example, an hour of the labor of a skilled worker might create four hours of value. The market treats the labor power of a skilled worker as four simple labor powers. To calculate the value created by an hour of labor performed by this type of worker, we multiply the one hour of labor by four.
In addition to skilled workers who work with additional labor power, there are workers whose labor powers create less than an hour’s worth of value in an hour of labor. To calculate how many labor powers these disadvantaged workers work, we have to multiply their labor power with a number less than one. For example, the market might treat the labor of a particularly disadvantaged worker as equivalent to only 15 minutes of labor. To find out how much value such a worker creates in an hour of labor, we multiply the one hour by ¼, giving us a quarter of an hour or 15 minutes worth of value.
An hour of labor performed by an average worker — not any particular individual worker — creates one hour of value, no matter the skill level or the productivity of the average worker. If the labor force becomes more skilled, the amount of value created by an hour of average labor will not increase, nor will it decrease if the labor force becomes less skilled. This is a complex and controversial subject among Marxists. However, it is a very important one if we are to understand imperialism correctly. For this reason, I will devote a future post(s) in this series to examining and critiquing the work of Anwar Shaikh on this subject. (back)
(5) Or anything else that disrupts the circulation of commodities. When the COVID-19 shutdowns hit in March 2020, the banks’ reserves, as well as the reserves of currency held by private individuals, expanded as the currency fell out of circulation and accumulated in stagnant hoards. (back)
A Critique of Crisis Theory 