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 25: History of Gold Production from the ‘Gold Rush’ to 1914
The World Gold Council estimates that in the years 1840 to 1844, some 146 metric tons of gold were produced worldwide. Between 1855 and 1859, estimated gold production rose to 1,011 metric tons. This is an increase of 590 percent in 15 years. In terms of percentages, this is by far the greatest increase in gold production for which reasonable data on world gold production is available.
The reason for this amazing increase was the discovery of gold in California in 1848 and Australia in 1851. It was this mass of newly mined and refined gold that fueled the expansion of the world market — what Marx called a new 16th century — that, among other things, drowned the hopes of Marx and Engels for a revolution that would bring the working class to power in Europe during the 1850s. Instead, the massive expansion of the market caused by the gold discoveries led to a powerful surge in the development of industry on a capitalist basis.
When gold was discovered in California, much of it was near or even at the surface. The gold was found in stream beds, washed down from the Sierra Nevada mountain range into the streams of its western foothills. The gold found in stream beds is known as “placer gold,” because it changes place when washed down from the mountains to the stream beds.
The individual value of the gold found in the stream beds was very low. It took relatively little labor to “pan” the gold nuggets from stream beds. Indeed, when somebody accidentally discovered a large nugget of gold in a stream, the individual value of the gold was trivial.
Once gold was discovered in California, swarms of people — known in history as 49ers — searched for quick and easy wealth. They began staking their claims to promising stream beds in the Sierra foothills, known in California as “the gold country.”
The result was that this easy-to-obtain gold with a very low individual value was quickly exhausted. If this had not been the case, the value of gold — the amount of labor it took on average to produce a given quantity of the metal measured in terms of weight — would have declined drastically. This would have led very quickly to the demonetization of gold.
As the pannable placer gold was quickly exhausted, the initial surge in simple commodity production gave way to capitalist production of gold proper. Capitalist-organized mining companies employing wage labor arrived and began to drill for gold in granite rock formations. The individual value of the gold produced by these industrial capitalists was already much higher than the placer gold panned from the stream beds, but still considerably lower than the previous value of gold on the world market. The result was a major fall in the value of gold money worldwide.
When gold functions as the money commodity, prices are expressed in the use value of gold measured in weight. Under the gold standard, various gold weights are given names such as pounds and dollars. The resulting decline in the value of gold relative to most commodities then expresses itself as a rise in the general price level.
The quantity theory of money versus the Marxist theory of money
Bourgeois economists and bourgeois economic historians applying the quantity theory of money to metallic money always claim that the great increase in the quantity of gold caused by the California and Australian gold discoveries led to the considerable rise in prices between 1848 and 1873. The latter year marked the peak of the price rise that had begun with the discovery of California gold.
However, as we have already seen, the quantity theory of money does not apply to metallic money. According to Marx’s law of labor value, the fall in the value of gold relative to the value of most other commodities caused prices to rise in the years after 1848. An increase in gold production with gold and other commodity values remaining unchanged will cause an expansion of the market. But, all other things remaining equal, this will not lead to a permanent rise in the general price level.
How much did prices rise after the gold discoveries of 1848 and 1851?
We can use the British wholesale price index to measure the decline in the purchasing power of gold after the gold rush. Britain was on the gold standard throughout this period. The gold value of the British pound did not change during this period. Therefore, price changes in terms of pounds were identical to price changes in terms of gold.
The British wholesale price index rose from 86 in 1849 to 130 in 1873 (1913 = 100). Prices in 1873 were not only well above those in 1849 when the first California gold reached Europe, but they were also well above the level of 1913. Since Britain was continually on the gold standard during these years, this rise in prices did not reflect any depreciation of the British pound against gold but represented a real fall in the purchasing power of gold relative to commodities.
By what mechanism does a fall in the relative value of gold raise prices? Some Marxists have expressed puzzlement at exactly how a fall in the value of gold relative to commodities leads to a rise in the price level. This is a good question. The industrial capitalists certainly do not calculate the value of gold in terms of the labor time socially necessary to produce it, then calculate the value of the commodities they are selling in terms of the labor time needed to produce them, and set prices accordingly.
In reality, it is the industrial cycle or a series of industrial cycles that adjusts the actual market prices to the values of commodities. When a sudden fall in the value of real money — gold — occurs, a series of industrial cycles dominated by the boom phase of the cycle follows that ratchet up the general price level. That is, the rise in the general price level during the upward phase of the industrial cycle, when the demand for the number of commodities on the market is greater than their supply at current prices, is greater than the fall in prices that occurs during the downward phase of the industrial cycle, when the converse is true.
The result will be a rise in prices across the cycle. Here we see that the industrial cycle is the instrument that the law of value utilizes to keep prices more or less in line with actual commodity values on average over the long run. Interestingly, while this value-price adjustment process in response to the fall in the value of gold was underway between 1849 and 1873, though there were crises, there were no prolonged depressions in the world capitalist economy.
Effects of increased gold production, the relative values of gold and commodities remaining unchanged
What would happen if new gold deposits were discovered that made possible a considerable rise in the production of gold, but the new mines were no richer than the existing ones? As we have seen, an economic boom of more than average strength and duration would also lead to a rise in prices.
However, as soon as the general price level begins to rise, the cost price of the gold mining capitalists will rise, lowering their rate of profit to a level below the average rate of profit. As the rate of profit of the gold capitalists falls below the average rate of profit, capital will flow out of gold mining into other, more profitable branches of industry. There will be a fall in gold production, with all the consequences in rising interest rates and tightening money markets ending in a crisis of overproduction.
During the crisis, commodities are largely unsalable at existing prices. Prices are then slashed as the industrial and commercial capitalists scramble for liquidity by selling off their overproduced commodities at reduced prices. By reducing gold production as the general price level rises above the labor value of commodities, the law of value prevents the general price level from rising permanently in a situation where the relative value of gold and commodities remains unchanged.
Effects of increased gold production when the value of gold falls relative to commodities
Suppose, as happened after 1848, the value of gold itself fell due to the discovery of new, richer gold deposits. The mines that make it possible to produce a given quantity of gold will take less labor on average than before. This will mean the average cost price for the industrial capitalists involved in gold mining and refining will drop. The rate of profit in gold production will then rise both absolutely and relative to the average rate of profit. Capital, always in search of super-profits above and beyond the average rate of profit, will flow into the gold mining and refining industries, causing the production of gold to climb.
This will lead to an accelerated rate of growth in the quantity of gold on the world market. Bank reserves will rise, the rate of interest will fall, and the profit of enterprise will increase. In other words, more of the surplus value will go to the industrial capitalists and less to the money capitalists. This will encourage a portion of the money capitalists to convert themselves into industrial (and commercial) capitalists.
The market will expand at an accelerated rate, and the whole process of capitalist expanded reproduction will accelerate. The resulting boom conditions will mean that demand will exceed the supply of commodities at existing prices. Prices will have to rise to close the gap between supply and demand.
At some point, prices will again reach the level where they will more or less directly reflect the values of commodities. As prices continue to rise above this level, the rate of profit in the gold mining and refining industry will fall below the average level, capital will begin to flow out of the gold mining and refining industries, and gold production will decline. The growth in the quantity of real money, gold, will begin to slow down.
As the growth rate of the world’s hoard of monetary gold relative to the rate of growth of real capital begins to slow down, the rate of interest will rise, lowering the profit of enterprise. Sooner or later, a crisis of overproduction — or a series of crises — will break out that will again lower the prices of commodities to — or below — their values.
At that point, gold production — all else remaining equal — will again increase. But this equality, on average, between market prices and underlying labor value will be expressed by higher prices than before. Prices will now fluctuate around an axis determined by the relative values of gold and commodities, just like before the discovery of the rich gold deposits, but the axis of prices — or prices of production — around which market prices fluctuate, will be higher than before. Instead of a temporary price rise caused by a stronger-than-average economic boom, we would have a permanent rise in the average level of prices across the industrial cycle.
This long-term process of adjusting prices to values looks suspiciously like a mechanism for the proposed Kondratiev cycle. Marxists as different as Trotsky and Sweezy rejected the Kondratiev cycle because they didn’t see a cyclical mechanism that could operate over 50 years. However, here we see a possible mechanism for a long cycle involving the production — mining and refining — of money material.
Suppose we have a situation where the relative values of gold and commodities remain unchanged, but, as always, market prices fluctuate on average around the values — or, more strictly, the direct prices — of commodities. If the adjustment process of prices to underlying values unfolds over several industrial cycles rather than a single industrial cycle, we will have a true long cycle, not a mere “wave.”
For example, when a boom phase of an industrial cycle drives prices above values, it will take a while for gold production to begin to decline. Even as gold production declines, it takes a period before the ratio between the total quantity of monetary gold in the world and the total amount of real capital changes significantly. As profit in gold mining declines both relatively and absolutely, exploratory budgets devoted to finding new gold mines will be cut back. But again, it will take a certain period before the reduced exploratory budgets are reflected in declining gold production. Eventually, however, such a situation will lead to a “depression” in gold production, defined as a lower level of gold production than the previous peak.
The longer the depression in gold production lasts, the greater the disproportion between money capital — gold — and real capital will become. Or what comes to the same thing, the more severe the shortage of money will be. Eventually, the increasing shortage of liquidity — money — relative to the continued rise in the production of commodities will lead to a series of crisis/depression-dominated industrial cycles. This would represent the down phase of the proposed “long cycle.”
Once the general price level falls below the value of commodities, it will take a while for gold production to increase in response to a rise in the gold mining and refining industry’s absolute and relative rates of profit. For example, the rise in both the relative and absolute rate of profit in the gold mining industry will lead to an increase in exploratory budgets, but it will take time before new gold-bearing land is found and new mines are developed and put into production. Eventually, however, a “boom” in gold production will develop.
The longer the boom in gold production lasts, the greater will be the quantity of money capital relative to real capital. Huge hoards of idle money will build up in the banks, and the rate of interest will fall to very low levels. A huge mass of idle money will burn a hole in the collective pocket of the capitalist class. Eventually, the capitalists will move to transform the hoards of money into capital; the market will suddenly expand. This process will launch the upward phase of the long cycle.
The mechanism for the long cycle?
The above-described cycle is a true cycle and not just an accidental long wave. One phase of the cycle leads to the next phase of the cycle. And unlike the case with Mandel’s long waves, we have a mechanism for both the downward turning point and the upward turning point of the cycle. There is also a material basis for such a long cycle. If the material basis for the 10-year industrial cycle is the periodic renewal of fixed capital, and the expansion of commodity capital — inventory — forms the material basis of the short Kitchen cycle, the material basis of the long cycle would be long-term cyclical swings in the production of money material — gold.
Changes in the level of gold production are not necessarily cyclical
However, here we have a difficulty. Are changes in the level of gold production dominated by cyclical forces or accidental forces?
To the extent that the value of gold falls relative to commodities due to the discovery of rich new deposits or technological breakthroughs in gold production, such as the use of cyanide to extract gold from ores containing only minute quantities of gold, the resulting periods of accelerated capitalist expanded reproduction that follow would have a non-cyclical or accidental character.
The same would be true in the converse situation if the depletion of existing gold mines without the discovery of new gold deposits or technological advances in gold mining allows the production of a given amount of gold from poorer ores or makes the digging of mines deeper into the earth’s crust possible. In this case, we have a rise in the value of gold relative to commodities. The resulting series of crisis/depression-dominated industrial cycles would also be non-cyclical.
In the case of the progressive exhaustion of new sources of gold, there would be nothing to prevent the crisis-depression series of industrial cycles from lasting until the capitalist mode of production is finally transformed into socialism or the class struggle ends in the mutual ruin of the contending classes.
In the real world, we would expect the cyclical and accidental elements to be intertwined, though one or the other may predominate in different historical periods. I will use this as a working hypothesis during this phase of my investigation of long cycles versus non-cyclical or quasi-cyclical long waves.
From the mid-Victorian boom to the ‘Long Depression’ of 1873-1896
During the mid-Victorian boom of 1849-1873, two forces were working to bring the period of exceptional capitalist prosperity caused by the extraordinary jump in gold production in the wake of the California-Australian gold discoveries to an end. One was cyclical, and the other accidental.
First, although the value of gold fell with the California and Australian discoveries, there was still a limit to how far prices could rise before they would once again exceed the value of commodities. Once prices exceed commodity values—direct prices—falling profits, both relative and absolute, sooner or later bring the boom in gold production to a halt. Here we see a cyclical force at work.
The accidental factor involves the exhaustion of the newly discovered gold mines over time. The gold nearest the surface in both California and Australia was soon exhausted, and the industrial capitalists had to dig deeper, driving up their cost prices. This again raised the value of gold — the quantity of labor on average necessary to produce a given quantity of gold.
Rising market prices collided with what would have been falling prices of commodities if the value of the commodities were expressed directly in gold. Or, what comes to the same thing, if market prices were always equal to direct prices.
Here we see a non-cyclical force at work, the depletion of the existing gold mines. Here, it was an accidental, or at least extra-economic, factor — the absence of additional geographical discoveries of gold-rich land or technological discoveries that could again lower the relative value of gold.
Both these forces worked hand in hand to bring the boom in the production of money material that followed the gold discoveries of 1848 and 1851 to an end. By the 1860s, the exceptional rate of growth of production was a thing of the past. While gold production remained at a high level relative to the levels that prevailed before 1848, the rate of increase in world gold production started to slow dramatically.
Gold production rose 211 percent in the years 1850-54 compared to the years 1845-49. In the years 1855-59, gold production rose by 170 percent over the amount produced in 1850-54. Gold production was still increasing at an astounding rate, but the rate of increase was beginning to slow down a bit. (“Central Bank Gold Reserves, A Historical Perspective Since 1845,” by Timothy Green, World Gold Council Research Study No. 23, November 1999)
And then, the rate of increase in world gold production came to a halt. It remained extremely high by pre-1848 standards, but it was no longer increasing. Between 1860 and 1864, gold production fell by 9.5 percent compared with the previous five-year period. Gold production increased about 7.2 percent in the period 1865-69 compared to the previous five-year period. However, the overall trend in gold production was now one of stagnation.
In the five-year period that includes 1873, the year in which the general price level peaked just before the financial crashes in Austria, Germany, and the United States of that year, world gold production was about 10.5 percent lower than it was in the previous five-year period. It was now no longer simply a question of stagnation in gold production; the trend was definitely downward.
The two ways in which high prices undermine capitalist prosperity
High prices relative to underlying labor values undermine capitalist prosperity in two ways. First, everything else remaining equal, the higher the general price level, the lower will be the quantity of monetary gold in terms of purchasing power — the real quantity of money. That is, if prices in terms of gold double, everything else remaining unchanged, this will have the same effect as reducing the quantity of monetary gold by half.
Second, when prices rise above the values — direct prices — of commodities, gold production declines, and with it, the rate of growth in terms of weight — not purchasing power — of monetary gold. When combined with expanded capitalist reproduction, such a situation sooner or later leads to a severe economic crisis of overproduction — or a series of crises — that again lowers prices. Prices will fall once again to — and for a while below — the price level that would directly express commodity values.
How low prices lead to prosperity
Prices below the values of commodities affect the capitalist economy conversely, though in this case, the effects on capitalist expanded reproduction are highly favorable.
First, lower prices in terms of gold increase the purchasing power of the existing quantity of monetary gold. A drop in prices by 50 percent, for example, will have the same effect in terms of purchasing power as doubling the quantity of gold. Second, lower prices in terms of gold mean higher profits for the gold mining industry, both absolutely and relative to the average rate of profit. This encourages an increase in the production of gold. The purchasing power of the total quantity of gold money rises due to an increase in its purchasing power brought about by lower prices and, over time, a rise in the quantity of gold in terms of weight due to increased production.
The ‘Long Depression’ of 1873 to 1896
The years from 1873 to 1896 were called the “Great Depression” before the disaster of the 1930s usurped that title. To avoid confusion, the 1873-1896 era of falling prices across the industrial cycle has been renamed by some the “Long Depression.” The Long Depression was considerably longer than the Depression of the 1930s but far less severe in terms of lost output and employment. Indeed, there is evidence of considerable economic growth in this period in some countries, especially the United States and Germany.
What we did have was a persistent downward trend of the general price level. There was great distress among indebted farmers in the United States, and periods of mass unemployment among U.S. workers. During the Long Depression, Britain was losing the monopoly of industrial production it had enjoyed during the first decades of the 19th century. Industrial production in Britain, at best, increased slowly during those years, and unemployment showed a strong tendency to rise. While the long depression of prices was unfavorable to highly indebted farmers and small business people, it made it easier for workers of that era to defend and win rises in their real wages.
During the Long Depression, prices did not fall every year. During the boom phase of the industrial cycle, prices still rose. But booms with their rising prices were short-lived, while the periods of crisis-depression — or at least periods of falling prices — absorbed most of the industrial cycle. As a result, each price peak was lower than the preceding one, and each price trough was below its predecessor until 1896, when the process reversed.
Virtually all supporters of the Kondratiev long cycle consider the 1873-1896 Long Depression to represent a down phase of the Kondratiev cycle, or K-cycle for short. After the K-cycle upturn of 1848-1873 came the K-cycle downturn of 1873-1896.
Ernest Mandel, as well as Anwar Shaikh, consider the Long Depression one of his “long waves with an undertone of stagnation.” Though, as we have seen, he attributed the downturn of 1873-1893 — for some reason, Mandel and Shaikh give 1893 as the trough rather than 1896, which represents the actual low point of world commodity prices — to a long-term fall in the rate of profit caused by a rise in the organic composition of capital that occurred during the mid-Victorian boom.
Changes in gold production between 1873 and 1896
Unless the world were running out of gold, which was far from the case in those years, as we now know in light of the big rise in gold production that occurred in the 20th century, we would expect the falling tendencies of prices to have stimulated increased gold production at some point.
At first, however, the falling price level failed to increase gold production. Production continued to decline through the first half of the 1880s. But starting in the decade’s second half, this trend began to reverse. In 1885-1889, gold production rose by 9.2 percent compared to the previous five-year period, a modest increase but still the first rise since the Long Depression began.
Over the next five-year period, 1890-94 — the last full five-year period of the Long Depression — world gold production increased by 32.5 percent. Following the great decline in prices after 1873, by 1896, British wholesale prices had fallen below the 1849 level, standing at index 72 compared to index 86 in 1849 (1913 = 100). (“An International Gold Standard Without Gold,” by Ronald I. McKinnon, Cato Journal, Vol. 8, No. 2, Fall 1988)
This fall in prices considerably increased the purchasing power of monetary gold. And the production of gold was increasing, too, though it remained below the previous peak of 1855-59. In the five years 1895-99, which marked the end of the Long Depression and the beginning of the prosperity during the late 1890s, gold production increased considerably faster — up 67.4 percent compared to the preceding five-year period. For the first time, the five-year world record in gold production of 1,011 metric tons produced in 1855-1859 was broken with 1,851 metric tons produced in 1895-1899.
The most important variable is not the changes in annual gold production as such, but the rate of growth in monetary gold measured in terms of weight and the increase in the quantity of real capital measured in prices that are also measured by weights of gold. According to the laws of arithmetic, if gold production remains unchanged, the rate of increase of monetary gold will progressively decline. Therefore, gold production must increase over time to avoid a falling price level with a given rate of economic growth. If it doesn’t, either economic growth must slow down, implying that the process of expanded capitalist reproduction must also slow, or the general price level in terms of gold must decline.
What caused the increase in gold production after 1880-84? At some point, we would expect that the falling prices of the ongoing Long Depression would stimulate a rise in gold production as prices finally fell below values. But again, there were also new geographical discoveries and one major technological breakthrough that lowered the value of gold in a distinctly non-cyclical way.
First, there was the discovery of gold in South Africa. Indeed, South Africa was destined to become the chief gold-producing country during the 20th century. There were also the famous gold rushes in Alaska and northern Canada in the mid-1890s. None of this compared to the “gold rushes” of 1848 or 1851, but still brought a considerable rise in gold production after years of stagnant or declining production.
During these years, the cyanide process, which enables the extraction of minute amounts of gold from very poor ores, was first applied on a large scale to refine gold-bearing ores. This also helped to lower the value of gold considerably. So non-cyclical forces and cyclical factors were working towards a rise in gold production. In the economic history of the late 19th century, the two are intertwined and hard to separate.
In 1900-1904, gold production rose an additional 21.0 percent. The Boer War in South Africa probably held back the rise in production somewhat in this period. In 1905-1909, the rate of increase in gold production picked up again, rising 40.8 percent over the preceding five-year period. But during the years immediately preceding the outbreak of World War I, the rate of gold production decelerated dramatically, increasing during 1910-14 by only 5.9 percent. The extremely rapid rise in prices in terms of gold — about 3 percent per year — in the absence of any new dramatic geographical discoveries or new technological breakthroughs comparable to the cyanide process, was bringing the late 19th-century, early 20th-century boom in gold production to a halt.
Kautsky foresees the approach of a new revolutionary epoch
Karl Kautsky noted the return of stagnation to gold production in what proved pretty much to be his swan song as a Marxist on the eve of World War I: “So we may confidently enter upon the conflict which the new era of capitalism has for us, in which no rapid addition to gold production can longer interfere with the sharpening of class antagonisms, in which capital extends its domain only at the expense of the growing misery of the mass of the population, and the latter is more and more compelled to cause the overthrow of the capitalist system on pain of its own destruction.” (“The High Cost of Living,” by Karl Kautsky, 1913)
The fact that Kautsky proved personally unequal to the challenges of a new revolutionary era does not detract from his amazing prediction of a revolutionary era based on a developing stagnation in world gold production.
In light of the growing stagnation in gold production, if World War I had not intervened shortly, the rise in prices in terms of gold that had been going on since 1896 would not have been sustainable much longer. Instead, either prices would have fallen in terms of gold and currency, or a major devaluation of the world capitalist currencies would have occurred, ending the international gold standard. But either way, the world commodity prices calculated in terms of the use value of the money economy would have fallen.
The roots of World War I
Great Britain had long been in relative economic decline. Younger capitalist countries such as Germany, but above all the United States, had outstripped her both in the quantity of industrial production and the productivity of their labor. A century earlier, at the end of the world war that had followed the French Revolution, Britain had enjoyed an overwhelming economic superiority based on its pioneering of industrial capitalism. Compared to Britain, all other countries were underdeveloped agricultural countries. In today’s terms, they were all “Global South” countries.
But by 1914, this situation was only a distant memory. Britain’s continued dominant role in finance, politics, and military power no longer reflected economic reality. It had to be overthrown, and it was. In addition to being a war for the re-division of the world between rival imperialist powers, World War I marked the first stage in the collapse of the British Empire and its replacement by the world empire of the United States.
War economy, values, prices, and gold production
Between 1914 and 1918, the whole process of expanded reproduction came to a halt in war-torn Europe, though it continued in the United States and Japan. How does the war economy affect capitalist expanded reproduction?
When all-out war begins, industrial production will, as a rule, rise sharply. This is especially true if, as is often the case, the economy is in a state of recession or depression when the war erupts. Beginning in 1913, a worldwide recession affected both the United States and Europe. This recession was in full swing when war erupted in Europe in August 1914.
As war begins, governments embark on massive deficit spending, and demand soars, causing a sharp rise in industrial production. Unemployment disappears. The “prosperity” of war begins. All-out war means that many enterprises of Department I, and some of Department II, are obliged to shift from the production of capital goods — means of production — and consumer goods to machines of destruction and means of subsistence purchased not by private industrial capitalists or productive of surplus value workers but by the military.
In addition, many producers of raw materials, also located in Department I, now produce for war purposes, and therefore, these raw materials are not available for capitalist reproduction. Many productive workers — workers who produce surplus value — are shifted to the military, where their labor power is employed not to produce surplus value but to slaughter their fellow workers in uniform. The result is that a considerable number of potential producers of surplus value are killed in the war.
Contracted reproduction
Normally, when industrial capitalists attempt to transform their money capital into machines, raw materials, and labor power, they have little difficulty finding those commodities on the market. Generally, it is the sale of the commodities produced, not the purchasing of commodities necessary to carry out production and reproduction, that is the biggest problem for the industrial capitalists.
But in a war economy, the commodities that make up productive capital — the labor power of productive workers plus means of production, including both raw and auxiliary materials — are in short supply relative to demand at current prices. As the war continues, industrial capitalists are increasingly unable to find the commodities that make up productive capital on the market. Instead, they are forced to purchase government bonds. So the longer the war continues, the more the capital of the industrial capitalists consists of government bonds, that is, promises by the government to pay in the future when the war has reached its victorious conclusion. This is the classic definition of fictitious capital. This suspends the process of expanded reproduction and transforms it into what Ernest Mandel called contracted reproduction in his “Marxist Economic Theory.”
Though Keynes-influenced economists often blur the difference between a war economy and the boom phase of the industrial cycle, the two are opposites in many ways. During the industrial cycle’s boom phase, capital investment soars, and the expansion of real capital peaks. The productive forces experience a powerful advance. In a war economy, in contrast, the real economy is contracting. Increasingly, real capital is replaced with government bonds — fictitious capital. Far from increasing the productive forces — including the most important productive force, the workers — the productive forces are progressively destroyed.
War operations can also directly destroy capital with the physical destruction of industrial capital through military operations. The direct destruction of real capital was a much bigger factor in World War II than it was in World War I, since in World War I air power was only in its infancy, and its destructive potential was still quite limited.
The capitalists are willing to hold on to government bonds as long as they retain hope for victory. If their government emerges from the war victorious, it will be able to pay off the debts it owes to the industrial (and other) capitalists at the expense of the defeated powers. The government bonds of the losers generally lose most or all their value. Having exchanged real capital for fictitious capital, the industrial and other capitalists of the losing power end up with a dead loss. Therefore, war, especially an all-out world war, is a major business gamble.
The effect of war on prices
Even though industrial production soars at first and unemployment disappears, the quantity of real capital isn’t expanding; it begins to contract. Commodities are in short supply at current prices. Prices, therefore, must rise substantially to reduce demand to the supply. If prices are forcibly held down by wartime price controls, shortages lead to underground markets where commodities are sold illegally at much higher prices, which will reduce the demand to the supply. If the war and associated contracted reproduction go on too long, industrial production begins to decline, and shortages grow.
It is important to emphasize that the rise in prices in wartime is a rise in terms of gold, real money. Indeed, it has been noted that while “investing” in gold is often considered a good hedge against inflation, gold is actually a poor hedge against inflation caused by war. Of course, currencies are often devalued during wars; if that happens, the rise in nominal currency prices is all the greater. But here, it is the rise in prices in terms of actual money material — gold — that concerns us.
The effect of war on prices in terms of gold can be appreciated if we look at the U.S Producer Price Index. Since the United States remained on the gold standard, the price change reflected price changes measured in gold, not a depreciating currency. In August 1914, when the war erupted in Europe, the U.S. PPI was 12.0 (1982 = 100). In November 1918, the war ended, and the U.S. PPI had nearly doubled to 23.5. (U.S. Department of Labor: Bureau of Labor Statistics)
Looked at in another way, in four years of war in which the United States was not even an official participant until the last year and a half, prices increased dramatically more than British wholesale prices increased during the entire quarter of a century that followed the 1848-51 gold discoveries (95.8 percent versus 51.2 percent)!
And remember, since gold production was already stagnating before the war broke out, prices were apparently too high relative to underlying commodity values before the war even erupted. Remember, before the war economy began, Kautsky had foreseen the approach of a revolutionary epoch based on stagnating gold production — that is, prices that were already too high relative to labor values. The world war vastly increased the contradiction between prices and values.
The effect of wartime price increases on gold production
In theory, a sudden rise in prices should sharply increase the cost price and cause a sharp drop in the rate of profit, both relatively and absolutely, in the gold industry, causing production to drop sharply. This is the market’s way of reacting to a sharp rise in prices above the values of commodities. So much for theory, but what actually happened to gold production during World War I?
In 1915-19, world gold production declined by 5.7 percent compared to 1910-14, the first overall decline in world gold production over five years since the 6.7 percent decline between 1875-79 and 1880-84 during the Long Depression. The pre-war stagnation in gold production had been transformed into an actual decline.
But prices did not stop climbing at the end of the war. They kept rising until May 1920, when the U.S. PPI finally peaked at 28.8, a rise of 140 percent from the start of the war. Therefore, in theory, we wouldn’t expect gold production to hit bottom simply because the war had ended.
And this is exactly what happened. In the following five-year period, from 1920 to 1924, gold production declined by 16.5 percent. This far exceeded the greatest decline for a similarly defined five-year period registered during the Long Depression of the 19th century (6.7 percent).
In 1920-21, a very sharp economic recession occurred, which caused the inflated level of U.S. producer prices to crash. From 28.8 in May 1920, the PPI fell to 15.7 in January 1922, a more than 45 percent fall. But this still left the index more than 30 percent above the pre-war level. And since gold production was already beginning to stagnate on the eve of the war, the implication is that even after the violent deflation of 1920-21, prices were still far too high relative to underlying labor values. Indeed, this proved to be the lowest point that the PPI reached before the onset of the super-crisis of 1929-33.
As economic recovery took hold after 1921, the PPI climbed somewhat and then fluctuated. In August 1929, near the peak of the 1920-29 industrial cycle, the producer price index was at 16.6. This was more than 38 percent above the levels that prevailed in August 1914, when World War I began. Bourgeois economists, especially those of the “monetarist” school of Milton Friedman, emphasize how stable prices were in the period leading up to 1929.
They claim that this indicates that the U.S. economy was in great shape and that the economic prosperity of the 1920s would have continued if only the Federal Reserve System had not carried out an insanely deflationary monetary policy.
What they don’t understand, and cannot understand because of their false marginalist theory of value, is that though prices were not increasing, they were far too high relative to underlying values. And the longer a situation lasts where the market prices exceed their prices of production – and their underlying labor values – the greater the gap will be between the ability of capitalist industry to produce commodities and the ability of the market to absorb commodities without an unsustainable expansion of credit.
Therefore, as dramatic as the price deflation of 1920-21 was, it still had not restored prices to their pre-war levels. This failure reflects the underproduction of the World War I war economy. And unlike the 1850s, or to a lesser extent the 1890s, there were no geographical finds or technological breakthroughs in gold mining that lowered the value of gold relative to that of commodities.
With gold production beginning to stagnate in 1913, we would expect that an epoch of longer crises and depressions would set in that would lower the general price level once again in a way that would stimulate a renewed rise in gold production. Instead, World War I intervened and violently interrupted the whole process of expanded reproduction, causing the general price level to soar at a moment when prices were already too high relative to underlying labor values.
This proved to be a radically destabilizing set of circumstances and prepared the way for the collapse of the entire process of capitalist expanded reproduction in the decades that followed. But this entire process was and is hidden from the eyes of the bourgeois economists and economic historians. It is also hidden from the eyes of academic Marxists, who have only a partial, Ricardo-like understanding of Marx’s theory of value, money, and price.
Here we find another powerful non-cyclical force affecting prices and gold production — war. Though war in the short run creates war prosperity and “full employment,” in the years following the war — all other things remaining equal — there will be a considerably increased chance of prolonged depression and mass unemployment.
All things, however, are never equal. The economic situation after a war will be very much dependent on the level of prices relative to underlying labor values, the consequent level of gold production, and the vigor of the process of expanded reproduction that prevailed in the years before the war broke out. The effects of war then interact with all the other forces that determine whether a particular series of industrial cycles is dominated by the boom phase or by the crisis-depression phase of the cycle.
Marx wrote in the chapter on “Precious Metal and the Rate of Exchange” in Capital Vol. III that a gold drain is relatively ineffective — at producing a crisis — if it does not occur at the critical point of the industrial cycle. Our investigation leads towards the conclusion that a world war is ineffective at producing a super-crisis and Depression with a capital “D” unless it occurs when gold production and the relationship of prices to values is in a “critical phase,” as was the case in the summer of 1914. But as we will see later, it was not the case in 1939.
The deflation of 1920-21, by lowering prices by almost half, would be expected to relieve the pressure on gold production partially. And this is exactly what we see. In the years 1924-29, leading up to the super-crisis, gold production rose by almost 15 percent over the years 1920-24. Normally, this would be a respectable if not spectacular increase in gold production. However, since it is calculated from the extremely low level of the previous five-year period, gold production was still well below the levels that prevailed before the war.
For example, in the years 1924-29, 3,021 metric tons of gold were produced worldwide. This was below the 3,154 metric tons produced in 1905-09, when overall worldwide commodity production and commodity prices were considerably lower. And it was even further below the 3,340 metric tons of gold that were produced in 1910-14.
Indeed, at 3,021 metric tons, world gold production was more than 9.5 percent less than that produced in the five years immediately preceding the war. This would not have been such a problem if prices had been similarly below the pre-war level, but they were substantially higher. The combination of lower gold production plus higher prices that reduced the purchasing power of existing gold indicates an unprecedented conflict between price and value in the final years leading up to the Depression. This sheds a whole new light on the question that bourgeois economists, even a century later, are unable to answer convincingly. What caused the Depression?
Remember, one of the key functions of a crisis of overproduction is to keep the general price level in line with the values of commodities. If crises of overproduction never occurred, there would be no reason why market prices wouldn’t rise forever, losing all relationships with their labor values.
Indeed, if World War I had not occurred, such a massive divergence between prices and values would not have been able to develop. A crisis would have broken out and lowered prices once again before they got so completely out of line with underlying labor values. But war had broken out and interrupted the normal progress of the industrial cycle through which prices were equalized with values.
If the industrial cycle had continued to develop normally without the war economy with its contracted reproduction and price rises, only normal crises would have been necessary to keep prices in line with values.
But the war and its inflation had come. Because of the effects of World War I, the relationship between prices and values had gotten so out of line that it could only be corrected by a much nastier than normal downturn in the “K-cycle.”
A Critique of Crisis Theory 