A Marxist Guide to Capitalist Crises
“A Marxist Guide to Capitalist Crises,” an eBook created from the key posts on the Critique of Crisis Theory blog, is currently in production. We’ll be sharing the completed chapters between our regular postings.
Chapter 19: Keynes on the ‘Trade Cycle’
Keynes, throughout the “General Theory,” was concerned with explaining how his marginalist equation of “equilibrium” — marginal efficiency of capital = rate of (money) interest — could correspond to mass unemployment. The industrial cycle itself was of secondary concern for him. Nevertheless, in Chapter 22, entitled “Notes on the Trade Cycle,” Keynes does deal with the industrial cycle, or as he called it in the English manner, the “trade cycle.”
When he did deal with the industrial cycle, marginalism hindered Keynes at every step. Unlike the classical economists and Marx, the marginalists do not distinguish between use value and exchange value. As a marginalist, even if an unorthodox one, Keynes had problems explaining how commodities could be overproduced yet be “scarce” simultaneously.
Keynes, like other marginalists, tended to treat capitalism as though it were a system of production for human needs. Or, as Marx often complained about the bourgeois economists he criticized, Keynes tended to treat capitalist production for profit as though it were socialist production for human needs.
For example, Keynes assumed that as long as capitalism operated properly, the market size would be determined by the size of the total population. As a great admirer of Malthus, Keynes saw big dangers in both the growth and the lack of growth of the population.
One danger Keynes saw was absolute overpopulation, with all the accompanying Malthusian horrors. Unlike Malthus, however, Keynes was fairly optimistic that population growth could be restrained. Already in his time, the growth rate of the population was declining in the imperialist countries.
Therefore, if the population growth were restrained and eventually ceased, as Keynes was convinced it would sooner or later have to, wouldn’t this imply a halt in the never-ending expansion of the market, abstracting cyclical fluctuations, that is an essential feature of the capitalist system?
Wouldn’t the cessation of the market expansion mean chronic overproduction and growing chronic mass unemployment? Indeed, it is the tendency of population growth to slow down or even halt in the imperialist countries altogether that Keynes believed was the fundamental cause of the Great Depression.
Keynes did not believe surplus value is produced, as we saw in the last chapter. Instead, like the mercantilists and Malthus, he believed that surplus value originates in the sphere of circulation due to the scarcity of use values. Therefore, Keynes could not conceive of the contradiction between the conditions that favor the production of surplus value and those that favor the realization of surplus value.
Keynes, however, did see the fluctuation of the rate of profit, or the marginal efficiency of capital, to use Keynes’s preferred terminology, as the main factor that determines the changes in the phases of the industrial cycle:
“Now, we have been accustomed in explaining the ‘crisis’ to lay stress on the rising tendency of the rate of interest under the influence of the increased demand for money, both for trade and speculative purposes. At times, this factor may certainly play an aggravating and, occasionally, perhaps, an initiating part. But I suggest that a more typical, and often the predominant, explanation of the crisis is not primarily a rise in the rate of interest, but a sudden collapse in the marginal efficiency of capital.” (This and the following quotes from Keynes in this chapter are from Chapter 22 of the “General Theory.”)
Now, we have seen that changes in the rate and mass of profit can occur due either to changes in the amount of surplus value produced, both absolutely and relative to the existing capital or to changes in the amount of surplus value that can be realized in money form. The main problem for Marxist crisis theory is to what extent the collapse in the rate of profit that occurs at the beginning of the crisis is caused by the growing difficulties of producing surplus value versus the increasing difficulties of realizing surplus value.
Keynes, however, as we saw above, could not even pose the question, let alone answer it. He wrote: “We have seen above that marginal efficiency of capital depends, not only on the existing abundance or scarcity of capital goods and the current cost of production of capital goods, but also on current expectations as to the future yield of capital goods. In the case of durable assets it is, therefore, natural and reasonable that expectations of the future should play a dominant part in determining the scale on which new investment is deemed advisable. But, as we have seen, the basis for such expectations is very precarious. Being based on shifting and unreliable evidence, they are subject to sudden and violent changes.”
Here Keynes sees changes in the degree of scarcity of “capital goods” and, ultimately, the scarcity of the consumer goods that the “capital goods” produce as determining the rate of profit. But according to Keynes, the rate of profit is determined not only by the underlying scarcity of material use values relative to human needs but also by the changing expectations of future profits by the industrial and commercial capitalists. Keynes defines the marginal efficiency of capital as the rate of profit that capitalists expect to make. He believed that the capitalists’ expectations play a crucial role in determining the actual rate and mass of profit.
Here Keynes, in the manner so typical of vulgar economics, was adopting the view of the industrial or commercial capitalist engaged in the daily struggle of competition. For now, business is good, and demand is outstripping the supply of commodities that our industrial capitalist is producing at current prices. The rate of profit on new investment is very high. Since the human mind tends to assume that the current trend will continue, our industrial capitalist is optimistic about the future and accelerates his plans to increase the productive capacity of his factories and other productive forces.
But suddenly, as Keynes sees it, business goes sour, and the yield on existing industrial assets collapses. Instead of being wildly optimistic about the prospects for profit on the new investments, our industrial capitalist now falls into complete despair. The personal psychological depression is said to lead to general economic depression.
Keynes saw these violent psychological swings in mood among the “entrepreneurs” as the cause of the extreme instability characteristic of a highly developed capitalist economy. In contrast, Keynes believed that the expenditures on capital investment that depend on the expectations for profit on the part of the active industrial capitalists, the expenditures on articles of personal consumption and the government’s expenditures are reasonably stable.
“In conditions of laissez-faire,” Keynes wrote, “the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology [emphasis added—SW] of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.”
Is Keynes advocating that society take over the means of production so that the level of investment can be stabilized, eliminating the violent swings of the capitalist industrial cycle? By no means.
That would mean an end to the “current order of society.” Keynes most certainly did not want a planned socialist economy to replace capitalism. However, Keynes’s opposition to the “classical” marginalists and other schools of economic liberalism did lead him to see the need for large-scale intervention on the part of the capitalist state in the operations of the economy. He admitted that highly developed capitalism left to its own devices is a dangerously unstable system.
Where Marx and Keynes agreed
In this respect, he agrees with Marx and profoundly disagrees with Milton Friedman, who stubbornly insisted that capitalism was a stable system.
Paul Sweezy praised Keynes for his profound understanding of the psychology of the business world. Sweezy, I assume, was contrasting Keynes to the professors of economics at Harvard who, in the 1930s, had taught him marginalist economics during the Great Depression. Undoubtedly, Keynes was superior to these academic hacks.
While I am no expert on psychology, I assume the active industrial and commercial capitalists do experience mood swings as the market, and consequently, their profits, fluctuate wildly. Keynes, however, implied that capitalism would be stable like the classical marginalists, and later Milton Friedman claimed it was if the “psychology” of the capitalists could be changed.
Here Keynes’s view is subjective and, in the philosophical sense, idealist. The real world is not reflected in the human mind, but rather the human mind somehow creates material reality. Indeed, the entire marginalist theory of value is subjective, while Ricardo’s and Marx’s concept of labor value is objective.
In contrast to Keynes, Marx saw the changes in the minds of the active industrial and commercial capitalists as reflections of the objective contradictions of capitalist production.
Liquidity trap
According to Keynes, industrial capitalists will expand their enterprises as long as they believe that the rate of profit on their productive capital — marginal efficiency of capital — is above the prevailing rate of interest. But once the crisis or recession replaces the boom, the marginal efficiency of capital falls to or below the interest rate — indeed, profits often turn into outright losses.
Keynes wrote: “Later on a decline in the rate of interest will be a great aid to recovery and, probably, a necessary condition of it. But, for the moment, the collapse in the marginal efficiency of capital may be so complete that no practicable reduction in the rate of interest will be enough. If a reduction in the rate of interest was capable of proving an effective remedy by itself, it might be possible to achieve a recovery without the elapse of any considerable interval of time and by means more or less directly under the control of the monetary authority.”
The view that it was well within the power of the “monetary authority” to prevent violent swings in investment, production, and employment is the view of Milton Friedman and his so-called “monetarist school.” Keynes, however, drew the opposite conclusion. “But,” Keynes wrote, “in fact, this is not usually the case; and it is not so easy to revive the marginal efficiency of capital, determined, as it is, by the uncontrollable and disobedient psychology of the business world [emphasis added—SW]. It is the return of confidence, to speak in ordinary language, which is so insusceptible to control in an economy of individualistic capitalism. This is the aspect of the slump which bankers and businessmen have been right in emphasizing, and which the economists who have put their faith in a ‘purely monetary’ remedy have underestimated.”
As Keynes saw it, in a depression, the “marginal efficiency of capital” falls so low — or even becomes negative — that it becomes impossible for the “monetary authority” to lower interest rates to the point where interest rates are below the “marginal efficiency of capital.”
Once the investment of the boom collapses, it will usually be three to five years, Keynes observed, before investment begins to recover. To check massive involuntary unemployment during the three to five years following a crisis, Keynes believed that the central government should step in with massive deficit spending and thus compensate for the contraction of demand brought on by the collapse of investment — in Marxist terms, expanded reproduction — by the industrial capitalists.
Keynes understood that in a situation where the rate of profit is low or even negative, no possible lowering of the rate of interest could revive the economy. Such a situation is called by Keynesian economists a “liquidity trap.” Like Marx before him, Keynes understood that the rate of profit must rise substantially after a crisis before a new period of capitalist prosperity can set in.
A permanent liquidity trap?
Therefore, both Marx and Keynes realized that a low interest rate is a necessary but insufficient condition for a healthy recovery. The key variable that leads to recovery is not the rate of interest but the rate of profit. Marx pointed out that a “healthy” upturn in the industrial cycle requires both a low rate of interest and a rapidly rising rate of profit. Keynes would agree with Marx on that point.
In the years following the publication of the “General Theory” in 1936, the Depression dragged on, even though the already very low rate of interest fell further. Many of the more radical followers of Keynes — especially after the Roosevelt recession of 1937-38 — began to suggest that this time the “liquidity trap” was not part of a passing if unpleasantly prolonged depression phase of the industrial cycle but permanent.
The more radical of the younger generation of economists influenced by Keynes claimed that ever larger doses of government spending in the future would be necessary to avoid “secular stagnation,” which they believed a “mature” capitalist economy naturally tends toward. Here we find the origins of the Monthly Review school.
Liquidity trap a necessary phase of the industrial cycle
Keynes did not understand that a liquidity trap that follows the crisis is a necessary phase of the capitalist industrial cycle. During the liquidity trap, the accumulation of capital takes the form of the accumulation of money capital, not real capital. As a result, while the world’s supply of hoarded gold grows at an accelerated pace, the actual forces of production stagnate. At a certain point, the growing mass of idle money capital begins to burn a huge hole in the collective pockets of the capitalists. This makes possible the next “sudden expansion of the market” that brings about recovery and thus ushers in a new phase in the development of the forces of production.
Keynes’s proposals for suppressing crises
Keynes wanted to find a way to prevent the crisis from creating a liquidity trap in the first place while retaining the capitalist mode of production: “The remedy for the boom,” he wrote, “is not a higher rate of interest but a lower rate of interest!”
Keynes was saying that if the monetary authority, instead of raising interest rates during the boom — “taking away the punch bowl,” as William McChesney Martin, a former head of the U.S. Federal Reserve System, once famously put it — lowered interest rates, especially long-term interest rates, the crisis, and the liquidity trap would be avoided altogether.
Indeed, if this were possible, it would be possible for the monetary authority to stabilize the capitalist system after all, though not by the method advocated by Milton Friedman — stabilizing the growth rate of the quantity of money. This more conservative aspect of Keynes’s thought appealed to pro-business “neo-Keynesians,” as opposed to left-wing socialist Keynesians and Keynesian-Marxists.
Keynes suggested that as the “marginal efficiency” of (real) capital falls, the monetary authority should print more money—make money less scarce — causing the interest rate to fall faster than the marginal efficiency of capital. Then the investment boom would continue, and there would be no sharp collapse in the marginal efficiency of capital, no liquidity trap, and no depression with its associated massive involuntary unemployment.
While practical Keynesian economists are often seen as advocating a series of policies aiming to moderate and shorten a recession once it begins, Keynes here was more ambitious. He was suggesting that recessions with their unemployment can be abolished altogether — itself a worthy aim — without abolishing the capitalist system.
Assume we have a boom. The “scarcity” of capital goods is declining, and it is only a matter of time before the “marginal efficiency of capital will fall. If the monetary authority can lower interest rates sufficiently at this point, then the industrial capitalists will still be able to find fields of investment that, though they will yield a rate of profit lower than before, will still be at a rate above the now even lower rate of interest.
Traditionally, the central banks have followed a course opposite to the one that Keynes suggests here. Instead of lowering interest rates during a boom, they raise them. The reason for this policy — besides the need to “fight inflation” — is that the central banks must restrain the boom to limit the inevitable recession that will follow. If a general overproduction of commodities causes recessions, this makes sense within the brutal logic of the capitalist system.
Since the overproduction occurs during the boom, if you limit the overproduction of the boom by raising interest rates, the recession, which represents the forcible termination and liquidation of the boom, will be less severe than it otherwise would be.
But what happens if the monetary authority followed Keynes’s advice in the “General Theory” to expand the supply of token money to such an extent that the interest rate falls rather than rises during the boom? Wouldn’t this whip overproduction into a frenzy, leading to an even worse crash? The long practical experience of central banking has generally taught the central bankers — practical men like William McChesney Martin, head of the Federal Reserve from 1951 to 1970 — that this would happen.
However, Keynes challenged the traditional central banker view. Keynes reasoned like this: As the production of capital goods rises during the boom, the reduced scarcity of capital goods reduces the marginal efficiency of capital. What Keynes was aiming for, however, was a gradual decline in the rate of profit without the dramatic collapse in the rate of profit that occurred at the beginning of the crisis, which he believed was caused by the psychological reaction of the capitalists to rates of profits that were lower than the prevailing rates of interest. Keynes wanted to reconcile the capitalists to what he saw as the inevitable fall in the rate of profit. Instead of periodic crises with their mass unemployment, we would have a gradual long-term fall in the rate of profit as the means of production become less scarce.
The fatal flaw in Keynesian economics
Keynes, like Marx, realized that, contrary to the claims of the traditional marginalists, the rate of interest does not equalize the demand for and supply of capital, or what comes to more or less the same thing in marginalist economics, savings, and investment, but rather the total quantity of money with the demand for money.
So far, so good. The problem is that Keynes did not understand what “money” really is. Nor could he because he never broke with the marginalist theory of value that holds that the value of a commodity is not determined by the quantity of labor socially necessary to produce it but rather by its scarcity relative to subjective human needs.
In the final analysis, we have seen that money must be a commodity like gold bullion produced by human labor. The demand for commodity money — gold bullion — is equalized in the final analysis with the current quantity of the money commodity by the fluctuations in the rate of interest.
If the interest rate is “too low,” the demand for gold bullion is greater than the supply of bullion at current interest rates. If interest rates are “too high,” the demand for bullion is lower than the current supply of bullion. The problem with the Keynesian idea is that the rate of interest tends to equalize the supply and demand for metallic money, whether within a country or the world market.
Now, if under the capitalist system, we could replace commodity money with “non-commodity” money whose quantity could be controlled by a monetary authority, the monetary authority would then be in a position to lower the rate of interest by making money less scarce whenever it is necessary to do so to avoid a crisis.
However, if money must ultimately be a real commodity like gold, the monetary authority will be powerless to do this. Instead, the quantity and the rate of production of money material will be regulated by the law of value, as is the case with all commodities.
In the case where the rate of monetary growth, or what comes to the same thing, the level of gold production, is insufficient to prevent a rise in the rate of interest, no increase in the rate of growth of the token money created by the monetary authority can prevent—at least not for very long—the rate of interest from rising. If the monetary authority attempts to lower the interest rate anyway by simply printing more money, the result will be a monetary crisis in the form of a panicky run out of paper money into gold, leading to a sharp devaluation of the paper money with all its inflationary consequences.
Remember, one of the primary functions of crises is to lower the prices of commodities in terms of gold, thereby increasing the rate of profit in the gold mining and refining industries. This stimulates the production of gold, thus lowering the rate of interest. Through this mechanism, the law of value, in the long run, sees that money material is produced in sufficient quantities to keep the interest rate below the profit rate.
What would happen if crises were abolished?
If crises were abolished, prices in terms of gold would rise, even if only gradually, without limit. Sooner or later, prices would lose all connection with the actual labor value of commodities. Gold production — or whatever commodity represents money material — would halt. The rate of interest would then rise without limit.
However, this it cannot do in the real world. As soon as the rate of interest swallows up the entire profit, it wipes out the profit of enterprise. If this happens, the incentive to produce surplus value is destroyed, and a crisis can no longer be staved off. The resulting crisis again lowers the interest rate below the profit rate. This enables capitalist production to continue, but precisely at the price of a crisis. This is why, contrary to Keynes, capitalist crises cannot be abolished without abolishing capitalism itself.
Through the succession of booms and crises, not only is the rate of interest kept below the rate of profit in the long run, but commodity prices are kept in line with labor values. In effect, Keynes was trying to find a way to abolish the law of value while retaining the capitalist system. This is pure utopia.
Keynes did not understand that his proposals were utopian, nor do the professional bourgeois economists today, whether they belong to the Keynesian or, for that matter, the Friedmanite schools, which also believe that crises can be abolished within the framework of the capitalist system.
Keynesian ‘stimulus policies’ throw monkey wrenches into the mechanism that brings about recovery
An expansion of token currency that does not, in the long run, match a real expansion in the quantity of metallic money will increase rather than reduce the rate of interest. This has consequences fatal for Keynesian economics.
During the great boom of the 1960s, when the influence of Keynes was at its flood tide, there was an attempt to follow something like Keynes’s advice. The results of this experiment gave a real-life demonstration of why Keynesian suggestions for crisis-free capitalism cannot work in practice.
In the early 1960s, the Bretton Woods system — the final stage of the international gold standard — was still in effect. The cornerstone of the Bretton Woods system was the definition of the U.S. dollar as 1/35th of a troy ounce of gold, or what comes to the same thing, the dollar price of gold was fixed at $35 a troy ounce.
The Federal Reserve System and its satellite European central banks formed an agreement to buy and sell gold to keep the price of gold on the open market — not just in dealings among central banks and governments — at $35 an ounce. Under the gold pool, the central banks agreed that if the price of gold began to rise above $35 an ounce on the open market, they would sell gold; if it began to fall below $35, they would buy gold.
The crisis of 1968
In March 1968, however, the gold pool collapsed when the demand for gold at $35 an ounce became so strong that, had it continued, it would have drained all the remaining gold reserves of Fort Knox and the central banks within weeks. The immediate cause of the gold pool collapse was the decision of U.S. President Lyndon Johnson to sharply increase the number of U.S. troops in Vietnam in the wake of the “Tet Offensive” launched by the Vietnamese resistance in January 1968.
But the Tet Offensive was only the immediate cause for the collapse of the gold pool and the Bretton Woods System, not the fundamental cause. Even if the Vietnam War had not occurred, the Bretton Woods system was doomed, though the Vietnam War did move up the timing of its collapse. Why is this so?
Academic, government, and central bank economists had convinced themselves that they could avoid another prolonged deep depression if only they could prevent the general price level from falling. They reasoned that deflation not only brings on credit crises in the form of banking panics, that lead to a sudden contraction of demand. It also causes potential buyers of commodities to postpone purchases in expectation of further price declines. This results, the policy makers reasoned, in prolonged economic stagnation.
While they were powerless to prevent the purchasing power of gold from periodically rising, they saw no reason why the monetary authorities could not arrange for a gradual but permanent fall in the value of the legal-tender token money they issued. However, in the absence of a massive fall in prices in U.S. dollars as the purchasing power of gold was declining, it became inevitable that, at a certain point, the relative and absolute profitability of gold production would decline. The declining profitability of gold production would result in a growing shortage of gold as production fell, making a devaluation of the U.S. dollar and its satellite currencies inevitable.
However, such a devaluation of the U.S. dollar was in a fatal conflict with the Bretton Woods system and the gold pool, which, like any other form of the gold standard, required that the gold value of the currencies be maintained at the existing level.
The Bretton Woods system did allow for devaluations and revaluations of currencies against the U.S. dollar under certain conditions, but it made no provision for the devaluation of the U.S. dollar itself against gold.
As we have seen, however, the law of labor value does not permit permanent inflation in prices in terms of the use value of the commodity that serves as money material. If the actual relative labor value of gold bullion fell too much against other commodities leading to a permanent rise of prices in terms of bullion, gold would, like silver, be increasingly demonetized on the market and replaced by a more precious metal.
The followers of Keynes did not have any understanding of these economic laws since, to understand them, we need Marx’s law of value. Instead, following the “General Theory,” they reasoned like this. The 1960s boom meant that the number of capital goods was steadily increasing. As a result, capital goods were becoming less scarce. Sooner or later, there would be a drop in the “marginal efficiency of capital,” just as was the case after every previous capitalist economic boom.
Interest rates have to be lowered to prevent the postwar boom from collapsing. According to the logic of the “General Theory,” the boom would continue even if the marginal efficiency of capital falls as long as interest rates fall even more.
However, if the rules of the Bretton Woods system had been followed, not only would a fall in the rate of interest have been impossible, interest rates would have had to be increased sharply to reduce the exploding demand for gold bullion that had brought the Bretton Woods system to the brink of collapse.
The run on and collapse of the gold pool in March 1968 showed that the money capitalists wished to hold more gold than they did at the prevailing level of interest rates; indeed, more gold than existed in the combined vaults of the central banks, governments, and the private gold hoarders combined. Only by sharply raising the “reward” — the rate of interest that money capitalists get for not holding gold — would the demand for gold be once again lowered to the supply of gold that was available.
But due to the long postwar boom, the interest rate was already extremely high. If the central banks had raised interest rates sufficiently to bring the demand for gold back into balance with the actual supply of gold, Keynesian policymakers reasoned, the rate of interest would surely rise above the falling, or soon-to-be-falling, marginal efficiency of capital. A violent crisis would occur, and then it would be back to the liquidity trap and all that goes with it — depression and mass unemployment.
And this was in a world in which the United States was not only losing the war against Vietnam, but where the Soviet Union was still powerful, China was still in the throes of the radical phase of its great revolution, Cuba’s socialist revolution had occurred less than a decade before, and unions and labor-based political parties in the Western world were still near the peak of their post-World War II power.
To some extent, the governments and the central banks yielded to the inevitable and raised interest rates. This reduced the demand for gold to its actual supply for a time, but also began to slow down the real economy. The Keynesian policymakers were determined to prevent the “slowdown,” or “mild recession,” from turning into a major new liquidity trap and depression.
A ‘managed currency’ at last
To avoid this, Keynesian policymakers decided to abandon the gold pool and let the price rise on the free market. Keynes hated the gold standard anyway and looked forward to a “managed currency” where gold would play no role. Now, the Keynesians in the universities and policymaking circles believed it was time to put Keynes’s ideas of a managed currency into effect. With the end of gold’s “residual” role in the international monetary system, Keynesian economists believed they were removing the last obstacle to truly crisis-free capitalism.
The right-wing Republican U.S. president of the time, Richard M. Nixon, was on board with the plan to demonetize gold. Interest rates were not raised sufficiently or for a sufficient period to stabilize the gold value of the dollar and the currencies linked to it under the Bretton Woods system on the open market for very long. Government and central bank policymakers applying the marginalist theory of value, which they had learned in their “microeconomic” courses in their university days, predicted that the price of gold probably would not rise; instead, it would fall.
They reasoned that as gold was finally completely “demonetized,” it would lose its main “utility,” its “utility” as money. The market would soon be flooded with gold since, besides its monetary function, gold had relatively few other utilities or use values. The price of gold, the marginalist economist predicted, would then fall, perhaps quite sharply. This allowed for a kind of “experiment” which pitted the Marxist theory of value and price against the marginalist theory of value and price to take place in real life.
Much to the delight of the Keynesians, the last vestiges of the convertibility of the U.S. dollar into gold bullion were removed between March 1968 and August 1971. Contrary to the predictions of Keynesian and other marginalist economists, the dollar price of gold soared — using that economic slang term for the gold value of the dollar.
As each dollar represented less gold — real money — prices in terms of dollars began to rise faster than the central banks expanded the quantity of token money and faster than commercial banks could expand the supply of credit money based on the token money created by the central banks. Whenever the central banks tried to drive down interest rates — or at least check their rise — by expanding the rate of growth of their token money, the price of gold would leap upward, generating a new wave of inflation.
The Keynesian economists and the government kept hoping that the nightmare of high inflation, high unemployment, and economic stagnation, which was dubbed “stagflation,” would go away. While there were occasional minor improvements, stagflation continued to worsen.
The crisis of 1979 and the coming of the Volcker shock
In the fall of 1979, things came to a head. Alan Greenspan, the Republican economist who later became chairman of the Federal Reserve Board, explains in his memoir, “The Age of Turbulence,” that the administration of Democratic President Jimmy Carter appointed fellow Democrat Paul Volcker as chairman of the Federal Reserve Board. “He’d been Fed chairman barely two months,” Greenspan writes, “when a crisis erupted.” What was the nature of the crisis? “The interest rates on ten-year Treasury Notes leaped to nearly 11 percent on October 23. Suddenly, investors [money capitalists —SW] began to picture an oil-induced inflationary spiral leading to breakdowns in trade, a global recession, or even worse.”
A combination of a dramatic and prolonged rise in interest rates to levels never before seen in U.S. history, severe recession, and eventually, a new rise in world gold production brought on by the collapse of commodity prices in terms of gold finally stabilized the U.S. dollar. This made possible the Great Moderation — but not a new “great boom” — of 1983-2007.
But even this limited recovery only occurred once official unemployment rates had risen into double digits. As a result of the prolonged siege of astronomical interest rates, much of basic U.S. industry and British industry, where the crisis was even more acute, collapsed. The heartland of U.S. basic industry, that had dominated world industrial production for most of the 20th century was transformed into the “rust belt” and has never recovered. Keynes would have been horrified if he had lived to see it.
Interest rates were so high that it took many years for them to return to historically normal levels. The result of the extremely high interest rates dragged on — the exact opposite of what Keynes would have wanted. The result was financialization, deindustrialization, wave after wave of corporate downsizing, and a vast weakening of the position of the trade unions as the balance of forces on the labor market swung in favor of the buyers of the commodity labor power.
Indeed, the level of employment in U.S. manufacturing, at least according to official government figures, has never again returned to the levels that prevailed when the crisis erupted in the fall of 1979. All this made a mockery of Keynesian economics. The monetary authorities proved completely powerless to prevent the explosion of the rate of interest and all the disastrous consequences that followed.
The attempt of the central banks to follow Keynes’s advice and hold down interest rates by expanding the supply of their token money backfired big time. In reality, Keynesian economics works only when the evolution of the industrial cycle already favors an upturn. It works best of all after a period of brutal deflation. At best, therefore, Keynesian policies can accelerate an upturn that is already on the way. A combination of the increased purchasing power of money combined with strong gold production enables the central banks to issue much more token money without it depreciating even as interest rates fall to very low levels.
Keynesian economists take credit for the cyclical boom
Keynesian economists are glad to take the credit for such happy results as they did after World War II. But when conditions favor a major downturn in the industrial cycle, the attempts by the monetary authorities to hold down interest rates by expanding the rate of growth of their token money lead to rising inflation and soon to skyrocketing interest rates, which inevitably ends in a violent recession. When interest rates are already rising rapidly, increasing deficit spending by the central government will only drive interest rates higher, paralyzing the “stimulative” effects of deficit spending, as Keynes himself understood. He believed that under those circumstances, the solution was for the monetary authority to increase the growth rate of the quantity of money, but that would whip up the demand for “real money” — gold bullion — to a frenzy, driving interest rates even higher.
The Keynesian “tool chest,” then, turns out to be completely powerless to prevent the crisis. All it can do is change the form of the crisis somewhat, from a classic deflationary depression to a 1970s-style “stagflationary crisis” that combines high inflation, extremely high interest rates, falling real wages for the workers, and mass unemployment.
All this would be bad enough. But even worse, Keynesian “stimulus” policies disrupt the cyclical mechanism that brings about a “healthy recovery” and a new “great boom.” This was shown by the abnormal evolution of the world capitalist economy during the “Great Moderation” of 1993 to 2007.
Normally, at the beginning of the recovery, we have a low interest rate combined with a high rate of profit. This encourages capitalists to act as industrial capitalists rather than money capitalists. The “spirit of enterprise” is thus stimulated, and a “great economic boom” develops. Instead of inflation of credit, the market expands through the mobilization of the great hoard of idle money created during the preceding liquidity trap. Only when overproduction again begins to develop do we again see a new inflation of credit. This is exactly what we saw after World War II.
In contrast, at the beginning of the “Great Moderation,” interest rates were very high. Many U.S. corporations that had been predominantly industrial corporations — collective industrial capitalists — transformed themselves into collective financial capitalists to take advantage of this situation. The result was the “financialization” that fascinated Paul Sweezy during his final years. The huge credit expansion finally lowered interest rates, but at the expense of creating an unprecedented credit bubble.
From the viewpoints of the inner needs of capitalist production — as opposed to the needs of the working class and the overwhelming majority of the people — the “mistake” of the Volcker Fed was to “ease” prematurely. Volcker “should” have held firm until long-term interest rates had fallen to low levels. Then the Latin American debt crisis of the 1980s would have brought down many U.S. banks and other financial institutions, but the necessary liquidity trap would have been created that would have brought on a new “great boom” by the late 1980s or early 1990s that would in time have also ended in a new crisis.
To eliminate crises, an entirely different “tool chest” is required, a working-class revolution that ends once and for all the contradiction between socialized production and private appropriation that is the ultimate cause of crises.
A Critique of Crisis Theory 