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 30: The Industrial Cycle and the Collapse of the Gold Pool in March 1968
Industrial cycles normally last about ten years — give or take a year or two. The second industrial cycle after World War II began with the 1957-58 global recession. Given that the industrial cycle lasts about ten years, we normally expect the next global downturn to occur around 1967. Indeed, 1966-67 saw a credit crunch and a “mini-recession” in the United States, as well as a recession in West Germany from 1966 to 1967.
However, in 1967, the U.S. government and the Federal Reserve System were determined to avoid a recession on a scale similar to the one a decade earlier. As we saw in the last chapter, the Keynesian economists believed that they understood the workings of the capitalist economy well enough to develop the “tools” that would allow the capitalist governments and central banks to avoid full-scale recessions. Indeed, in 1967, the U.S. economy escaped with only a “mini-recession.”
But just as the Keynesians were celebrating their ostensible victory over the industrial cycle and its crises, there came the March 1968 run on gold, which led to the collapse of the London Gold Pool. The U.S. government and Federal Reserve System, seeking to stave off the complete collapse of the dollar-gold exchange standard, felt obliged to take deflationary measures. The Fed Funds Rate, which had fallen to as low as 2 percent on October 25, 1967, rose to 5.13 percent on March 15, 1968, the day the Gold Pool collapsed.
As the Federal Reserve System’s deflationary measures took effect, the Fed Funds Rate rose to as high as 10.50 percent during the summer of 1969. Long-term interest rates rose, too, if to a lesser extent. On September 6, 1967, the rate on U.S. government 10-year bonds had risen to 5.20, well above the level of around 4 percent that prevailed during the first half of the 1960s — not to speak of the less than 2.5 percent rate at which Truman had expected to finance the Korean War. On December 29, 1969, the yield on the long-term government bond hit 8.05 percent.
With both long-term and short-term interest rates at such high levels, the demand for gold bullion was finally broken, and the dollar price of gold fell to around $35 an ounce by 1970. The dollar-gold exchange standard had been saved for the moment.
Restrictive fiscal policy
As we saw in the previous chapter, the March 1968 Gold Pool crisis forced the Johnson administration to rescind its decision made weeks before to grant Westmoreland’s request for hundreds of thousands more troops to serve in the war against Vietnam. The hope was that the decision not to send more troops would mean a smaller U.S. balance of payments deficit, and some of the pressure would be taken off the U.S. dollar — and U.S. interest rates. In 1969, the investment tax credit was repealed, a measure designed to encourage capital investment — expanded capitalist reproduction. The aim was to reduce the demand for credit used to finance capitalist investment. Looking at this more profoundly, the tax increases were aimed at slowing the pace of the ongoing overproduction.
Government deficit spending ended momentarily as the U.S. government moved to balance its budget. The hope was that by ending government long-term borrowing, if only briefly, the rise in interest rates, especially long-term interest rates, would be minimized. This would, it was hoped, avoid a credit crunch like that of 1966-67, or at least reduce it. In this way, the extent of the economic downturn following the move to the higher interest rates necessary to save the Bretton Woods dollar-gold exchange system would be lessened.
The recession of 1969-70
The combination of these deflationary measures pushed the U.S. economy into the first “official” National Bureau of Economic Research downturn since the recession of 1960-61. However, the recession of 1969-70 was a rather mild one as capitalist recessions go. Unemployment rose considerably but not as much as in 1957-58.
After the supply of credit on the U.S. domestic credit markets began to dry up, the Federal Reserve rapidly reversed direction, and “expansionary policies” were resumed. If this shift had not happened quickly, the U.S. economy would have experienced the sharpest downturn since the 1930s, with collapsing prices, profits, industrial production, and employment.
This was shown by the near-panic conditions on U.S. money markets in the spring of 1970, similar to the seizing up of credit that preceded the global collapse of industrial production, employment, and world trade at the end of 2008. If events had been allowed to take this course in 1970, unemployment would have increased much faster than in 1957-58, when there had been no such “panic,” at least among the large industrial and commercial corporations.
The quick move to expansionary policies meant that the 1970 recession turned out to be a “shallow” saucer-type recession. A slow recovery began in 1971 — such recessions tend to be followed by slow recoveries. So it appeared that Keynesian economics had scored another victory, though not as impressive as the apparent victory in 1966-67, when an “official” recession, as defined by the NBER, had been avoided altogether.
The July-August 1971 international monetary crisis
But again, the victory was to prove illusory. In July and August, a new and this time fatal crisis of the dollar-gold exchange system erupted. On August 15, 1971, U.S. President Richard M. Nixon ended the convertibility of the dollar into gold. Though the suspension was described as temporary by Nixon until a new schedule of currency exchange rate could be agreed upon, it soon became clear that the suspension of dollar gold convertibility was not temporary at all, but permanent.
Officially, a new series of fixed exchange rates was soon announced, and a new, slightly higher official dollar price of gold was established at $38 an ounce. But the official price of gold now meant nothing. The U.S. dollar was inconvertible into gold not only for ordinary people — that had long been the case — but for governments and central banks as well. The only dollar price of gold that mattered now was the one on the open market.
There was to be one more agreement to establish yet another schedule of fixed exchange rates and another meaningless rise in the “official” dollar price – this time to $42.22 a troy ounce – of gold. However, these new international monetary agreements quickly collapsed. Soon, the Bretton Woods system based on fixed exchange rates was declared dead. Instead, currencies were free to float against one another. However, governments continued to intervene in the currency markets by buying and selling currencies to manipulate these ever-changing exchange rates.
Keynesians delighted by end of the dollar-gold exchange standard
Keynesians were delighted, convinced that gold had finally been “demonetized” for all practical purposes. With gold “officially” dethroned, the Federal Reserve System’s and the government’s fiscal policies could finally concentrate on achieving “full employment” — as defined by the bourgeois economists. Freed of the need to worry about defending either their gold reserves or a fixed dollar price of gold, the central banks would be free to lower interest rates to whatever level was necessary to ensure “full employment” with “stable prices” — meaning the desired level of inflation.
Nixon’s other moves on August 15, 1971
Nixon announced two other moves to deal with the plunging value of the U.S. dollar. One, he announced a “temporary” 10 percent surcharge on imports. This was a threat to close access to the U.S. market that had been granted to the European and Japanese capitalists after 1945 in exchange for giving up any attempt to compete with the United States politically and militarily.
But Nixon could not go very far down this road. Doing so would have incentivized the European and Japanese imperialists to rebel against the U.S. empire. In addition, the closing of the U.S. market, leading to mass unemployment in either Western Europe and/or Japan, could have resulted in the radicalization of the European and/or Japanese working class at a time when the Soviet Union and its Eastern European allies with their planned economies still existed.
In addition, the shooting war against Vietnam was still raging. Nixon’s moves were, at most, designed to give the U.S. government some bargaining power in negotiating cartel agreements with Western European and Japanese capitalists — for example, limiting imports of Japanese cars.
Wage and price controls
Much more important were the wage-price controls that Nixon announced. Here, too, Nixon, though very much a right-wing Republican, followed Keynesian theory and not the ideas of Milton Friedman — later to be called “neoliberalism” — to be embraced by his successors.
In an earlier chapter, we saw that according to Keynes, the general price level is governed by the level of money wages. As prices began to rise from 1965 onward, Keynesian economists advocated so-called “incomes policies” to limit wage increases.
The labor unions would agree to hold back wage increases to the level of the increase in labor productivity as reported by the capitalist governments. In effect, the unions would agree not to use their full market power to raise wages as high as market conditions permitted. If wage increases were limited to productivity increases, then — according to the bourgeois economists of the Keynesian school — price increases would slow down. These economists claimed that since real wages, as opposed to money wages, are determined by “productivity,” real wages would not be affected.
And, they explained, the workers would benefit from “wage restraint” in another way. The Keynesian economists explained that with inflation controlled through “incomes policies,” the Federal Reserve System and the other central banks would be free to follow “expansionary policies,” and recession and mass unemployment would be avoided.
As inflation kept accelerating, however, the Keynesians blamed the unions for failing to practice “wage restraint.” The Keynesian economists and the capitalist media described the accelerating inflation as a “wage-price spiral,” though in reality, it was a price-wage spiral. More and more Keynesian economists advocated compulsory wage and price controls to halt inflation. This would mean that the capitalist government would set the levels of both prices and wages. Wages are, after all, simply the price of a particular commodity — labor power.
Since the controls would be compulsory, the unions would have to go along with the wage freeze. The only other alternative would be to openly fight the government, which was something that unions, especially those in the United States, were ill-prepared to do. Especially since the New Deal, the U.S. union leadership had increasingly tended to rely on the government as opposed to the union consciousness, solidarity, and militancy of their members.
Wage and price controls fail to prevent accelerating inflation
The only alternative to wage and price controls, the Keynesians argued, would be a rise in interest rates sufficient to cause a recession with its associated unemployment. According to Keynesian theory, a recession of sufficient severity would end inflation. As unemployment rose, the balance of forces on the labor market would swing sharply in favor of the bosses, and the rise in money wages would taper off. The Keynesians claimed this would finally cause inflation to slow down or cease.
But this would be achieved only through mass unemployment, with all the suffering that goes with it. However, if the unions agreed to moderate wages “voluntarily,” or if the moderation of wage increases was part of a government-enforced mandatory wage and price control system, inflation could be capped without a recession and mass unemployment. Or so the Keynesians promised.
In the United States, this seemed reasonable to many workers who were uneducated in Marxist theory. Indeed, in a socialist society, setting wages and prices would be part of the economic plan. But the economic laws of socialism are not those of capitalism. Under capitalism, any wage and price controls are a trap for the unwary sellers of the commodity labor power.
The Keynesian economists pointed to World War II as an example of successful mandatory wage and price controls. But how did the wage and price controls actually work during World War II? In a situation where prices are lower than the level necessary to equalize supply with demand, such as during World War II, a price freeze paralyzes the mechanism that, under capitalism, reduces demand to supply — a rise in prices. The result will be shortages and government rationing.
While rationing can ensure a fairer distribution of scarce commodities than high prices that only the rich can afford, it goes against the grain of capitalism. In such a “shortage economy,” capitalists tend to hold commodities off the “legal markets.” Instead, they offer commodities in the more or less illegal, so-called “black markets” at much higher prices. The high prices on the “illegal” markets reduce demand to the supply.
The longer price controls are in effect, the more they will tend to break down as commodities become increasingly unavailable at legal prices and can only be obtained illegally at much higher prices. Eventually, price controls are abandoned, and official prices rise rapidly to levels that again balance supply and demand. The “black markets” disappear. If the trade unions cannot win wage increases, the result will be a sharp decline in real wages.
Wage and price controls combined with currency depreciation
As the 1970s progressed, inflation increasingly reflected not so much excess demand at existing prices — as had been the case in the mid-1960s — but rather the depreciation of the U.S. dollar and other paper currencies against gold. Many modern Marxists, to the contrary, believe that paper currency cannot represent value — abstract human labor — directly.
The gold market establishes exactly how much gold a dollar or other paper currency represents in terms of a standard of weight, such as a troy ounce — a unit in which the quantity of the use value of the commodity gold is measured. In turn, depending on the ever-changing conditions of production in the gold mining and refining industries, a given quantity — weight — of gold will represent a definite amount of abstract human labor.
Unlike the abstract human labor embodied in non-money commodities, the abstract human labor embodied in a given quantity of gold is directly social. That is, the abstract human labor necessary to produce a given quantity of gold does not have to be exchanged for another commodity to demonstrate that it forms a part of the social labor of society. (See the first three chapters of volume I of “Capital” for a full examination of this extremely subtle, little understood, but vital point.)
Suppose a commodity — let’s say a radio of a given make and quality — is selling at its value. Assume the radio is selling for $35. And assume the dollar price of gold on the open market is $35 an ounce, which was the case in 1970. In this case, it will take the same amount of abstract human labor to produce this radio as it takes to mine and refine an ounce of gold.
Now, assuming everything else is unchanged, let’s say the dollar price of gold rises to $70 an ounce. If the radio continues to sell for $35, the economic real price of the radio — the price of the radio in terms of gold — will not be one ounce of gold for the radio but rather one-half ounce.
Under these conditions, the radio will be realizing only half of its value in terms of the use value of the money commodity that measures the value of all other commodities. But sooner or later, the market corrects this imbalance. If the dollar price of gold remains at $70 an ounce — all things remaining equal — the price of the radio will rise sooner or later to $70.
So, the more the price of a paper currency, such as the U.S. dollar, rises against gold, and the longer the higher dollar price of gold persists, the higher will be the rate of inflation in terms of that currency. These inflationary pressures will last until, once again, commodity prices are more or less in line with underlying labor values, and prices of production are, with some modification, ruled by value as measured in terms of weights of gold.
Now, what happens if the paper currency price of gold is allowed to soar on the open market while the capitalist government tries to freeze prices and wages? The capitalists respond to the government’s attempt to force them to sell their commodities at economically real prices below the actual value and prices of production of the commodities involved by withdrawing them from the legal market. This situation leads to shortages at official prices and so-called black markets where commodities can be obtained only at much higher prices.
As sellers of the commodity labor power, the workers should do all they can to raise wages in terms of a depreciating currency, just as the capitalists do with the prices of their commodities under the same circumstances. When the government allows the currency to depreciate — as measured by the price of gold in terms of that currency — while telling the workers not to demand higher wages in the name of fighting inflation, it is the job of the unions to do everything they can to defeat the wage controls and raise the price of their members’ labor power.
If the workers don’t do this, prices — the Keynesians notwithstanding — will still rise in terms of the depreciating currency. If this happens, wages in terms of gold — real money — and purchasing power — real wages — will fall. The result will be a rise in the ratio of unpaid to paid labor. The rate of exploitation of the workers by the capitalists will rise.
When Nixon announced his controls, the dollar price of gold — that is, the amount of gold measured in terms of weight that a dollar represented in the sphere of circulation — was already between $42 and $43 an ounce. That dollar already represented markedly less gold than it had when Roosevelt established the $35 an ounce dollar price of gold in 1934. In August 1973, the dollar price of gold rose to over $67. That is, the dollar had already lost almost half of its gold value since the days of Roosevelt.
Sure enough, shortages began to appear throughout the economy, and commodities were increasingly sold illegally at much higher prices on the black market. Unlike during World War II, no rationing system had been established. Working-class people and others with low incomes were especially hard hit by this concealed inflation. Things weren’t helped by the failure of the U.S. trade unions to launch a broad struggle against wage controls. The collapse of the price controls was rapidly approaching.
Did the 1973 oil embargo and price increases cause the inflation?
Keynesian economists blamed the failure of their prediction that the wage and price controls program would halt inflation, not on their false economic theory — if they did that, they would have ceased to be Keynesian economists — but instead on the dramatic rise in oil prices that followed the so-called Yom Kippur war between Zionist-apartheid Israel and Arab countries.
At that time, the Arab countries announced a boycott of the United States and its satellite imperialist powers, which were supporting Israel. This short-lived boycott led to gasoline shortages in the imperialist countries and was soon followed by sharply higher oil prices in dollars and other depreciated paper currencies.
The Keynesian economists, forgetting their theory that changes in the general price level are caused by changes in money wages, blamed the rise in prices on the sharp increase in the price of oil and the OPEC “oil cartel.” However, today, it is clear that the real reason for the rise in oil prices was the accelerating decline of the U.S. dollar — the currency in which oil prices are quoted — against gold. If the U.S. government had not wanted the dollar price of oil to rise, it should have preserved the gold value of the dollar.
Wikipedia writes: “This [the depreciation of the dollar against gold -SW] led to the ‘Oil Shock’ of the mid-seventies. In the years after 1971, OPEC was slow to readjust prices to reflect this depreciation [of the dollar -SW]. From 1947-1967 the price of oil in U.S. dollars had risen by less than two percent per year. Until the Oil Shock, the price remained fairly stable versus other currencies and commodities, but suddenly became extremely volatile thereafter. OPEC ministers had not developed the institutional mechanisms to update prices rapidly enough to keep up with changing market conditions, so their real incomes lagged for several years. [The depreciation of the dollar hit the OPEC countries very hard when they failed to quickly increase the dollar price of oil as the dollar depreciated against gold, just like the real wages of the workers in the U.S. fell when the unions failed to fight for higher wages in dollar terms when the dollar began its plunge against gold -SW]. The substantial price increases of 1973-74 largely caught up their incomes to Bretton Woods levels in terms of other commodities such as gold.”
In other words, OPEC’s readjustment upward in the dollar price of oil, far from causing inflation as the Keynesian economists and the capitalist media falsely claimed at the time, was a purely defensive move in reaction to the devaluation of the U.S. dollar against gold and the inflation it had unleashed.
Since oil, as the basic source of energy, is so important to the modern world capitalist economy, it is especially sensitive to changes in the gold value of the U.S. dollar.
We can confirm this by looking at changes in both the dollar price of gold and the price of oil from September 2004 to the summer of 2008, when there was no oil embargo. At the beginning of September 2004, the dollar price of gold was $400, while the price of oil was being quoted at a little more than $40 a barrel. On August 6, 2007 — just before the initial panic of August 2007 — the dollar price of gold rose to $651.50, while the price of a barrel of oil had risen to $69.14. Therefore, the dollar price of oil more or less tracked the dollar’s declining value against gold.
Then, when the initial panic hit later that month, speculators assumed that the U.S. Federal Reserve System would flood the banking system with reserves — that is, its dollar-denominated token money — in an attempt to stave off a severe recession.
In anticipation of the radical explosion in the quantity of dollar token money — paper dollars — speculators drove the dollar price of gold to over $900 — and briefly over $1,000 — at times during 2008. Not surprisingly, the price of oil soared too, despite signs that the U.S. and world economies were approaching a recessionary downturn. Indeed, even our friends at the NBER now say that the U.S. economy entered a “contraction” in December 2007, just a few months after the initial August 2007 credit market panic.
Despite the slowing economy — which, all things remaining equal, would be expected to lead to lower oil prices — the dollar price of oil reached $147 in July 2008. This, even though the Federal Reserve Board had not yet, in fact, greatly expanded the quantity of token money.
The effect on wages and politics
The failure of the unions to demand wage increases in line with the soaring cost of living did not stop inflation, as the Keynesian economists claimed it would, nor, as we will see, did this prevent the recession and soaring unemployment that was to follow quickly. While the official price levels were held back for a while by the wage and price controls, shortages and black markets multiplied as the dollar plunged against gold. What the wage-price controls did achieve was to lower the real wages of U.S. workers.
Even 40 years later, the real hourly wages of U.S. workers have yet to rise again to the levels that prevailed in 1973, despite a huge increase in labor productivity of U.S. workers over that period. Contrary to the theories of the bourgeois economists, real wages did not increase with labor productivity. Instead, in the United States, they fell as labor productivity rose.
As I have already explained, the unions were greatly undermined, which helped turn U.S. and world politics sharply to the right. The way was prepared for the election of Ronald Reagan to the U.S. presidency a few years later.
Inflation breaks out into the open
The wage-price controls imposed in August 1971, combined with easy money policies by the Federal Reserve System, created soaring demand, a wave of shortages, and, at first, a sharp rise in industrial production. Officially, the producer price index rose “only” a little more than 7 percent in 1972.
The sharp rise in industrial production and associated growth in employment, along with suppressed inflation — momentarily artificially suppressed by the wage and price controls — combined with the approaching withdrawal of U.S. forces from the war against Vietnam, enabled Nixon to win a landslide reelection victory against his opponent, the liberal Democrat George McGovern. But as the dollar’s fall against gold accelerated, the price controls crumbled. Inflation broke out into the open.
In 1973, the rate of inflation in the U.S. economy, as measured by the producer price index, rose above 17 percent! The index rose similarly in 1974 — a far cry from the mere 3.5 percent rise in the producer price index that was considered so alarming back in 1965!
Nixon’s Keynesian wage and price control program had failed miserably as an anti-inflation program, though it was all too successful in lowering the living standard of U.S. workers.
Inflation turns into stagflation
What was happening was a new form of financial crisis. Traditionally, in the days before Keynesian economic policies, the sellers of commodities would often panic when a crisis hit and dump their commodities on the market at significantly depreciated prices. In the days of the classical international gold standard, the devaluation of the currency against gold was considered unthinkable, so there was no panic as far as currency values in terms of gold were concerned.
In 1973-74, however, the financial crisis took a different form. The sellers of commodities weren’t all that concerned that their creditors would demand repayment, forcing them to raise cash at almost any price. Keynesian government and Federal Reserve policies would keep up demand and maintain the flow of credit, or so it was believed.
Rather, in the “Keynesian world, ” the owners of currency and currency-denominated financial assets — money capitalists — panicked. Fearing that the dollar and the other paper currencies were about to lose the bulk of their value, the money capitalists stampeded into the gold market — and, for a while, into oil and other commodity markets.
Back in the 19th century, Marx noted that a panicky move into banknotes — currency convertible into gold — had largely replaced moves to hoard gold itself that had occurred in former times. In 1973-74, the “former times” returned — thanks to Keynesian economics — and gold itself rather than currency was once again the object of hoarding.
The result, not surprisingly, was a sharp rise in commodity prices — not just oil — in terms of dollars, if not gold. The market was attempting to raise all commodity prices to match the suddenly sharply reduced gold value of the dollar and other paper currencies.
But the market couldn’t succeed in this endeavor because, though the Federal Reserve System was increasing the quantity of dollar token money — the monetary base — it was not doing so at anywhere near the rate that the dollar was now depreciating. In terms of the gold that the monetary base and the broader money supply represented, and in terms of real purchasing power, the monetary base and with it the broader money supply were contracting.
Keynesian economics bankrupt
The Keynesian economists relied on the belief that inflation and recession are opposite states of the economy that could not occur at the same time. But what if economic stagnation and inflation coincided? That is exactly what confronted the U.S. — and world — capitalist economies in 1973-74.
Since prices in terms of depreciating currency were rising faster than the central banks were printing/creating it, interest rates soared, and credit froze. Credit-sensitive industries such as construction and automobiles fell into a sharp recession. But there were also big movements into oil and many other primary commodities as the capitalists sought to rid themselves of dollar — and other currency — denominated assets.
This maintained the demand for these commodities at the expense of other commodities, such as autos and houses. The overall result was that monetarily effective demand stagnated, real wages rapidly declined, and interest rates rose sharply. Stagflation had arrived.
If the Federal Reserve Board had moved to increase the rate of growth of the monetary base — token, or paper, money — to the actual level of price increases in a bid to stave off recession, the panicky move out of paper currencies and into “hard gold money” and critical primary commodities such as oil would only have accelerated. The printing presses of the governments and central banks would have found themselves in a race with the skyrocketing general price level — in terms of paper money.
In this type of panic, if they doubled the monetary base, for example — as they did during the more traditional type of panic of 2008 — prices might have jumped not two-fold but four-fold in a very short period of time. The rate of inflation would have increased geometrically.
If the central banks had attempted to keep up with the rising general price level in terms of their plunging currencies, they would have had to keep the printing presses turning ever faster. This is exactly how runaway inflation and even hyperinflation leading to the complete collapse of the currency, such as in Germany in 1923, develops.
Inflationary crises and the Austrian school
The Austrian school upholds Say’s Law and thus denies even the possibility of a general overproduction of commodities. Instead, to use Marxist terminology, the Austrian school claims that crises occur because of overproduction in Department I — means of production — relative to Department II — means of consumption.
Inflationary crises, such as those in 1973-74 and again in 1979, indeed do cause an overproduction in Department I relative to Department II, though not for the reasons the Austrians give. According to the Austrian school, the central banks’ inflationary policies cause the market’s long-term interest rate to fall below the “natural” interest rate. According to the Austrians, industrial capitalists are, in effect, tricked into thinking that society wants to save — as opposed to consume — more than it does.
If central banks were abolished, the Austrians argue, the market interest rate wouldn’t deviate significantly from the “natural” rate of interest. According to the Austrian theory, the natural rate of interest reflects society’s desire to “save” — put off consumption instead of immediately consuming. As long as the market rate of interest equals the natural rate of interest, the Austrian school holds, the market maintains a correct proportion between Department I and Department II. Therefore, the Austrians conclude that as long as the market rate of interest is not allowed to deviate from the natural rate of interest, there will be no economic crises.
As we have seen in earlier chapters, there is, in reality, no such thing as a natural rate of interest. The idea of a natural rate of interest is a false analogy with the role of commodity prices in the classic school of political economy and the Marxist critique of classical political economy.
What determines the rate of interest?
In addition to their market price, commodities indeed have a natural price — the price of production determined by labor values — that forms an axis around which market prices fluctuate according to supply and demand. In contrast, the rate of interest is determined by the quantity of loan money capital versus the demand for loan money capital. But what determines the quantity of loan capital?
The quantity of loan money is determined in the long run by the quantity of gold bullion produced relative to other commodities. Therefore, everything else remaining equal, the more gold bullion that is produced, the lower will be the rate of interest.
However, the quantity of gold bullion produced is determined by the rate of profit in gold mining and refining, both absolutely and relative to the other branches of production, and not the rate of interest. A high rate of interest in no way stimulates the production of gold bullion unless or until the high rate of interest leads to a crisis that lowers the general price level.
Therefore, in contrast to commodity prices, there is no “natural” rate of interest. What is true is that the long-term rate of interest cannot, for very long, rise above or equal the rate of profit. If the long-term rate of interest equals the rate of profit, the profit of enterprise falls to zero, and the incentive to produce surplus value disappears. In such a situation, a portion of the industrial and commercial capitalists will convert themselves into money capitalists.
For example, largely industrial corporations will close down factories and instead enter the “financial services” business — that is, turn themselves into money lenders. The increase in the number of money lenders will once again lower the long-term interest rates to a level below the rate of profit and thus restore a positive profit of enterprise. We will be able to examine this phenomenon more closely in the chapters that examine the post-stagflation economy — the era of “financialization.”
In contrast to the Austrians, capitalist crises are indeed caused by an overproduction of commodities in both Department I and Department II relative to effective monetary demand, which is ultimately determined by the quantity of gold bullion produced relative to the production of other commodities.
To claim that crises are caused by an overproduction in Department I relative to Department II — or an overproduction of Department II relative to Department I — is thus another way of denying that the general overproduction of commodities is the cause of crises and staying within the limits of Say’s Law. Say’s Law concedes that a partial overproduction of commodities backed by an underproduction of other commodities is possible. It only denies the possibility of a general overproduction of commodities.
That said, an overproduction of commodities by Department I relative to Department II is perfectly possible, either within the framework of a general overproduction of commodities or in its absence. One of the consequences of rapid currency depreciation is that it causes overproduction of commodities in Department 1 relative to Department II.
During a period of rapid currency devaluation, industrial capitalists are eager to get rid of their rapidly depreciating currency and convert it into commodities as quickly as possible. Or, as they see it, they want to buy the elements of constant capital, including both the elements of circulating capital, such as oil and fixed capital — for example, steel, machine tools, etc. — before their prices in terms of depreciating currency rise even more.
However, such inflationary devaluations of currency have the effect of undermining the credit system. Prices are rising faster than the rate of growth of the quantity of money tokens, which ends up limiting the growth in the quantity of loan money in terms of purchasing power.
Under these conditions, the velocity of circulation accelerates towards the maximum possible that the development of the banking system, computerization, and so on allows. As the limits of the velocity of circulation are reached, the money supply grows tight, and any attempt by the central bank to ease the money market by accelerating the rate of growth of the (token) money supply leads to even faster depreciation of the currency against gold and a consequent rise in the rate of inflation.
Therefore, during periods of rapid currency depreciation, it becomes difficult for consumers to obtain mortgages and loans for durable consumer goods such as automobiles. In addition, the purchasing power of the general population, even for commodities bought with cash and not credit, is undermined by the falling real incomes caused by inflation.
Therefore, as the industrial capitalists scramble to convert their depreciating money capital into new means of production at an accelerated rate, the demand for consumer commodities, especially but not only those consumer commodities purchased with credit, declines. This leads to a growing disproportion between a “booming” Department I and a contracting Department II.
Therefore, the Austrian theory of crises does not reflect so much the workings of the industrial cycle as the runaway and hyperinflations that hit Austria, Germany, and other central and eastern European countries in the wake of World War I and the Russian Revolution.
The reasons for the inflation of 1918-23 in central Europe and the worldwide 1970s inflation were quite different. In 1918-23, the inflation reflected the wave of revolutions that swept the eastern half of Europe — especially the Russian socialist revolution of October 1917 and the fear on the part of the ruling classes of eastern and central Europe that this revolution would spread to their countries, as well as the effects of a lost war, reparations payments and so on.
In the 1970s, in contrast, inflation was caused by the doomed attempt to prevent the outbreak of a cyclical overproduction crisis by expanding the quantity of paper — token — money.
But despite their different causes, in both cases, the inflation did generate a relative overproduction in Department I relative to Department II. In both cases, the inflation was followed by years of stagnation in heavy industry — especially the steel industry — that had boomed during the inflation but then suffered a dramatic collapse in demand for their products as soon as the currencies stabilized.
How hyperinflations develop
If the central banks keep attempting to accelerate the rate at which they create token money in an attempt to keep up with the accelerating rate of inflation — the accelerated rate of currency depreciation — a vicious circle sets in. The more the central banks accelerate the rate of growth of the quantity of token money, the more the market prices further accelerate the growth rate. The result is that prices rise faster relative to the quantity of money. This is how genuine hyperinflations developed, such as in Germany in 1923.
Therefore, the only way in the 1970s for the central banks, led by the U.S. Federal Reserve System, to avoid this ultimate economic catastrophe of global runaway inflation within the framework of the capitalist system was to halt a further acceleration of the rate of growth of token money.
Usually, central bankers target short-term interest rates, like the U.S. Federal Funds Rate — the rate at which the commercial banks lend out their surplus reserves to other commercial banks experiencing a shortage of reserves.
During the 1970s, however, currency devaluation against gold had already gone so far that ever-higher interest rates were needed to prevent a descent into runaway, if not full-scale, hyperinflation. Under the conditions of the 1980s, if the Federal Reserve had attempted to halt the further rise in interest rates by accelerating the rate of growth of the quantity of token money it was creating, the result would have been runaway inflation and even full-scale hyperinflation where the currency essentially becomes worthless — is demonetized.
In the 1970s, the Fed could not avoid severe recessions since an extreme economic collapse would have followed runaway or worse inflation. A merely “severe recession” was the best that could be achieved under the prevailing conditions. The Keynesian nostrums were melting away, along with the gold value of the U.S. dollar and its satellite paper currencies.
Where the Keynesians went wrong
Remember, Keynes conceded that crises of generalized overproduction were possible in a capitalist economy. But he denied they were inevitable.
In reality, due to the basic contradiction of the capitalist mode of production — the contradiction between socialized production and the continued private appropriation of the product — periodic crises of generalized overproduction are not only possible, but inevitable once capitalist production has developed to a certain point.
Capitalist production can only exist as the expanded reproduction of capital. And the expanded reproduction of capital, if it is to continue, means periodic crises of generalized overproduction.
The inflationary panic of 1973-74 showed the limits of Keynesian “expansionary policies” that attempted to suppress the symptoms of contradictions of capitalist production — periodic crises of generalized overproduction — while retaining the capitalist mode of production itself, with all its contradictions that make, among other things, periodic crises of the generalized overproduction of commodities inevitable.
Statistics kindly made available by the U.S. Federal Reserve System tell the story. On July 24, 1974, the Fed Funds Rate hit the then-unheard-of level of 14.19 percent! That level proved necessary to finally break the back of the demand for gold and halt an acceleration of the inflation rate.
Long-term interest rates tell a similar story. On August 15, 1971, the rate of interest that the U.S. government had to pay on 10-year bonds was 6.41 percent. In August 1971, when Nixon finally killed what was left of the international dollar-gold exchange standard, the fed funds rate stood at 5.63 percent.
But with the end of the last remnants of the international gold standard, the Fed was now free — or so the Keynesians imagined — to drive down interest rates to a level that would ensure “full employment” — meaning the level of unemployment that, in the judgment of the Fed leadership, represented the best interests of the capitalist system.
But the Keynesians were fooling themselves. Gold got in the way under the “fiat” monetary system far more brutally than ever before under any form of the gold standard. In February 1972, the Fed Funds Rate fell to as low as 3.13 percent, fueling a strong surge in industrial production.
The consequent “prosperity” helped re-elect President Nixon by a landslide in the November 1972 presidential elections. There was no repeat of 1960 when a recessionary dip in the economy helped ruin “Tricky Dick’s” first try for the White House. So far, so good. But by July 1973, the Fed Funds Rate rose above 13 percent for several days, and it was often above 10 percent for the rest of the year.
The long-term interest rate rose, too, though, as is always the case during crises, not quite as much as short-term interest rates. The long-term rate was soon above 6 percent again, and during 1973 rose for a while above 7 percent, hitting 7.20 percent on September 14, 1973. The Fed, determined to compensate for the oil boycott and the sharp rise in the price of oil, then drove the long-term interest rate back below 7 percent.
But the growing panicky demand for gold soon undid the Fed’s “Keynesian” moves to lower interest rates. By February 1974, the long-term interest rate was back above 7 percent. On August 26, 1974, long-term interest rates ratcheted to 8.16 percent. As is typical, long-term interest rates are more stable than short-term interest rates, but their movements, too, pointed relentlessly upward.
As interest rates soared, the demand for gold was finally broken. Remember, if interest rates rise high enough, the demand for gold will always be broken. But it now took considerably more than the 19th century’s 6 percent to “draw gold from the moon.” On December 30, 1974, the dollar price of gold hit $195.25. After that, the dollar price of gold began to decline; that is, the depreciation of the dollar for the time being was halted.
Though shaky, the dollar had stabilized, even if only briefly, as it turned out. As soon as the shaky stabilization of the dollar occurred, a recession hit with full force, beginning in the fourth quarter of 1974 and continuing through the first quarter of 1975. Industrial production and employment plunged, and unemployment soared. The rate of decline was even sharper than had been the case in 1957-58.
Back in August 1971, the Keynesians claimed that Nixon’s wage and price controls would end the problem of accelerating inflation without a recession. But Keynesian policies had not only brought soaring inflation and lower real wages; they had completely failed to stave off recession. Their only “achievement” was to lower the living standards of wage earners. In every other respect, Keynesian policies had failed.
No full industrial cycle in the mid-1970s
Industrial production peaked in the fall of 1973, only four years after it had peaked in 1969. The four-year period between the third quarter of 1969 and the third quarter of 1973 did not constitute a full industrial cycle. The crisis of overproduction that was already heralded by the credit crunch and mini-recession of 1966-67, then by the collapse of the gold pool in March 1968, and finally the recessionary dip in the economy in 1969-70, now broke out into the open as a sudden glut of unsold inventories appeared in warehouses in the fourth quarter of 1974. This led to the usual results: the collapse of industrial production and employment not only in industry but throughout the economy. As is the case with all general crises of overproduction, the crisis unfolded on the entire world market.
Resemblances to 1957 and 1960-61
In some ways, the 1974-75 collapse resembled the second dip of the double-dip recession of 1957-61. The recession of 1957-58 was followed by the secondary recession of 1960-61 when the Fed eased “too rapidly” and gold began to flow out of Fort Knox. Or perhaps it was a triple dip if we take the 1966-67 “mini-recession” as the first dip. But unlike the case in 1957-61, when the secondary recession of 1960-61 was milder than the primary recession of 1957-58, the recession of 1974-75 was much worse than the recession of 1969-70, not to mention the “mini-recession” of 1966-67.
Though economic indicators began to rise again in the spring of 1975, the economic crisis was far from over. More dips were coming before the U.S. and world capitalist economy finally emerged from the crisis in the early 1980s.
A Critique of Crisis Theory 