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 31: The ‘Volcker Shock’ and Start of the Neoliberal Era
As we saw in the previous chapter, the devaluation of the U.S. dollar in terms of gold had temporarily halted by the end of 1974. After peaking at $195.25 an ounce on December 30, 1974, the dollar price of gold fell to $104.00 on August 31, 1976.
As a result, during 1975, the rate of U.S. inflation, as measured by the government producer price index, was “only” about 4.4 percent. Still, the index rose more in the recession-depression year of 1975 than in the inflationary boom year of 1965. This was despite a slump that was considerably worse than that of 1957-58.
Workers in the U.S. — and other capitalist countries — were hit in two ways. First, workers’ living standards were lowered by the rising cost of living in terms of the devalued currency their wages were paid in. The cost of living would have declined in a more traditional type of recession-depression.
Second, as was the case in a traditional recession-depression, wages were under downward pressure from the high unemployment rate. In the case of U.S. workers, this was on top of the disastrous wage and price controls imposed by the Nixon administration and applauded by “pro-labor” Keynesian economists.
Keynesians plead ‘special circumstances’
Neither the U.S. government nor the Federal Reserve System was quite ready yet to ditch the Keynesian economics that had dominated “macroeconomics” up to that time. As we have seen, Keynesian economists pleaded special circumstances to explain away the inflationary economic crisis of 1974-75.
These economists claimed that the Arab oil boycott of late 1973 and early 1974, followed by the sharp rise in the price of oil carried out by the OPEC cartel, had caused prices in general to soar. This inflation, in turn, reduced real purchasing power, which led to the severe recession of 1974-75. Indeed, the capitalist media and most economists of the time described the recession of 1974-75 as “oil-induced.”
The Keynesian economists overlooked the fact that the global oil industry had long been dominated by the “seven sisters” international oil cartel, which OPEC was now challenging. Why was the oil cartel of the oil-producing oppressed nations inflationary while the oil cartel of the big oil corporations owned by U.S. and European capitalists was not?
Due to the continued high unemployment from the 1974-75 recession, continuing if reduced inflation, as well as the aftermath of the Watergate scandal that had swept the Nixon administration away, the Democratic candidate for president, Jimmy Carter, managed to defeat the unelected Republican president Gerald Ford in the 1976 U.S. presidential election. The new Democratic administration wanted to continue the traditional Keynesian policies. After all, Keynesian policies had worked reasonably well before 1968. Why wouldn’t they work again in the future?
By late August 1976, the dollar price of gold had fallen back to $104 an ounce. This was partly achieved by renewed U.S. gold sales on the open market, designed to discourage speculation in gold. The fact that these sales were deemed necessary shows that the broader economic crisis that had begun with the collapse of the London Gold Pool in March 1968 had not been overcome. This was the case notwithstanding the rise in industrial production and the reduction in the rate of inflation that became apparent from the spring of 1975 onwards.
However, even before the U.S. presidential election of November 1976, the dollar had resumed its decline against gold. This was a bad omen for the new Democratic administration of Jimmy Carter. At first, however, the renewed decline of the dollar was modest. It wasn’t until July 1978 that the dollar price of gold rose above the $195.15 level first reached on December 30, 1974. Soon after this happened, the whole “recovery” that had begun in the spring of 1975 began to unravel. The chronic crisis the U.S. and world economies had faced since March 1968 was about to become acute again.
In 1976, as a result of what proved to be a short-lived partial recovery in the dollar’s value against gold, the producer price index rose just 4.84 percent, only slightly higher than the rise that occurred during the crisis-depression year of 1975. The Federal Funds Rate, which had risen to as high as 14.33 percent during the crisis in 1974, fell back to 4.72 percent on January 23, 1976.
The ability of the Federal Reserve System to lower the Federal Funds Rate to the relatively low level of 4.72 percent without the dollar price of gold soaring was a sign that the acute monetary crisis of 1973-74 had been eased, though only at the price of the deep industrial slump of 1974-75.
Long-term interest rates remain stubbornly high
However, long-term interest rates fell far less than the Federal Funds Rate. The rate the federal government had to pay on 10-year bonds hit 8.13 percent in September 1974. On September 16, 1975, the rate for these bonds reached 8.59 percent, a bad sign for the economic “recovery” that had begun the previous spring. On December 28, 1976, reflecting the rise in the gold value of the dollar, the interest rate on “10-year governments” dropped to a still historically high level of 6.84 percent.
This showed that the money capitalists still lacked long-term confidence in the dollar. They feared — and correctly, as it turned out — that the massive devaluation of the dollar would soon resume. The stubbornly high rate of interest was particularly alarming for Keynesian economists.
Remember, in his “General Theory,” Keynes had counted heavily on the alleged ability of the “monetary authority” under a paper money system to lower long-term interest rates by increasing the supply of token money. Just as an increase in the quantity of gold money, all else remaining equal, will lower long-term interest rates, Keynes hoped that an increase in token money — not metallic money — created by the monetary authorities would also lower interest rates.
Keynes made the mistake — fatal to his conclusions — that token money would follow the same laws as metallic money. However, as we saw earlier, token money follows laws quite different from gold money. What happened next provided a classic illustration of this.
Soon after the dollar resumed declining against gold, long-term interest rates began to rise again. By the summer of 1979, with the dollar price of gold hovering around $300 — well above the high point reached in the crisis year of 1974 — long-term interest rates were around 9 percent, higher than they had been at any stage during the crisis of 1974-75.
Inevitably, by 1978, the rate of inflation, as measured by the U.S. producer price index, accelerated once again, rising by more than 10 percent that year. It was becoming clear to both Wall Street and Washington that something was very wrong with Keynesian economics.
In 1979, President Jimmy Carter nominated fellow Democrat Paul Volcker as chair of the Board of Governors of the Federal Reserve System. Volcker was confirmed by the U.S. Senate and assumed office in August 1979. Volcker, who had been head of the Federal Reserve Bank of New York, the Federal Reserve Bank closest to Wall Street, was highly respected in top Wall Street and Federal Reserve System circles. It wasn’t long before the new Fed chief faced a major crisis.
The crisis of 1979-80
At the time of Volcker’s appointment in August, the dollar price of gold — the measure of the dollar’s growing depreciation against gold — was fluctuating around $300 more or less. On January 21, 1980, gold was quoted at $850 a troy ounce at the afternoon London gold market fixing. In intra-day trading, the dollar price of gold hit $875 before falling back. That is, the U.S. dollar had lost considerably more than half its gold value within only five months!
In August 1979, one dollar had represented 1/300th of an ounce of gold, or a little more on some days, while on January 21, 1980, the dollar represented only 1/850th of an ounce of gold. It was becoming clear to the leaders of the Federal Reserve Board that a drastic change in policies was necessary if U.S. and world capitalism were to avoid a disaster far worse than even the super-crisis of 1929-33.
Paul Volcker, Milton Friedman, and the crisis
The immediate problem that Volcker faced was similar to the problem that the U.S. and world capitalist economies had faced in 1973-1974. But now the situation was far more serious. By giving Keynesian economics “one more chance” and following “expansionary policies,” the Federal Reserve System had dealt a mighty blow to what remained of the confidence the world’s money capitalists held in the U.S. dollar, the main reserve currency of the capitalist world.
Confidence in the U.S. dollar was collapsing as money capitalists dumped dollar-denominated assets and shifted to gold or primary commodities such as oil. It seemed that the world capitalist economy was on the brink of its first global runaway inflation in its history.
While many capitalist countries have experienced runaway inflation or even hyperinflation, runaway inflation has never hit the central or reserve currency. If the dollar succumbed to runaway inflation, it would drag down every other capitalist currency with it. If this ever happens, the result will certainly be the worst crisis — not excepting the super-crisis of 1929-33 — by far in the history of capitalism.
After the German papiermark collapsed in 1923, massive loans from the United States stabilized the German currency and credit system. But if the dollar had gone the way of the German papiermark, who would make the loans to the United States to reestablish a functioning currency and credit system? It was the threat of just such a nightmare crisis that Paul Volcker faced shortly after he assumed office.
The coming of the Volcker shock
The immediate task before the Volcker Fed was to break the panicky demand for gold, whatever the cost of employment and output. And under capitalism, there is only one way to do this. Interest rates had to rise and rise drastically, and then stay at extremely high levels for an extended period. Any further delay, even a delay of a few weeks — or even days — would mean that interest rates would have to rise considerably more and stay up all the longer to break the abnormal demand for gold. Without this, the necessary degree of confidence in the dollar as a national and world currency, without which the modern capitalist economy could not function, would not be restored.
The political problem
The problem facing Volcker and his Federal Reserve Board colleagues was not technical. Under a paper money system, it is not that hard for a capitalist central bank like the Federal Reserve System to raise interest rates when confidence in the currency plunges. All the central bank has to do is slow the growth rate of its token money creation, or, as was the case with the “Volcker shock,” simply refrain from increasing it. The real problem facing Volcker and his colleagues at the Fed was political.
High interest rates are extremely unpopular among people of virtually all classes except for the money capitalists. If the Fed had announced that much higher interest rates were necessary — for the capitalist economy, they certainly were — and then proceeded to take the actions necessary to raise them, there would have been a huge public outcry. The demand would have been raised for Congress and President Carter to oust Volcker and take direct command of the Fed.
The neoliberal era begins
Instead, the ruling group in the United States — this was before Reagan’s election — decided to dump Keynes and instead embrace the theories of Milton Friedman. By dumping Keynes, the Reagan era of “neoliberalism” in a very real sense was already beginning, even though Reagan’s election was more than a year in the future.
In contrast to Keynes and to the central bankers themselves, who, after all, are practical people, Friedman advocated a slow, steady rate of growth of the money supply, which he defined as cash not deposited in the banks plus the credit money — checking account deposits — created through bank loans.
Friedman, as a neoclassical economist, dogmatically insisted that the capitalist economy was extremely stable, abstracting the rate of change in the quantity of money. He insisted that all the real instability — the inflations, booms, and busts — that mark the actual history of capitalism was caused by changes in a single independent variable — the rate of change in the quantity of money. The University of Chicago neoclassical economics professor then went on to treat the rate of change in the quantity of money as though it were external to the capitalist system.
Under the gold standard, Friedman reasoned, changes in the quantity of money were determined by changes in the balance of payments and globally by the level of gold production. That is why Friedman supported Nixon’s decision to finally end the dollar’s limited convertibility into gold in August 1971 while denouncing the rest of Nixon’s“anti-inflation program” as “socialist.” The reason that Friedman supported Nixon’s decision to finally end the dollar’s limited convertibility into gold was that, as long as the U.S. Treasury’s gold window remained open, a steady rate of growth of the U.S. money supply would be impossible.
But Friedman complained that the Federal Reserve Board, as a government agency, was doing a lousy job of keeping the rate of growth of the money supply stable. In the early 1930s, the Fed had allowed the money supply to contract by one-third, allegedly bringing on the Great Depression. In the 1970s, it was making the opposite mistake and was allowing the money supply to soar. Friedman held that the cycles of booms and busts would virtually disappear if only the central banks followed his advice and stabilized the rate of growth of the money supply.
Since capitalist central banks under a paper money system only really control the quantity of token money it issues — the monetary base — Friedman’s theory comes down to the claim that the ratio between the broader money supply (cash plus credit money) and token money is stable, or at most changes only very gradually over long periods. It also depends on the turnover of money — the velocity of circulation — being stable.
However, the concrete history of capitalism shows that neither the ratio of the broader money supply to the monetary base nor the velocity of circulation of the currency is stable. Even if these variables are somewhat stable over periods of decades, they are certainly not stable during the different phases of the industrial cycle.
During crises, as we have already seen, the quantity of credit money contracts sharply relative to the monetary base, and the velocity of circulation slows dramatically. The classic demonstration of this occurred during the super-crisis of 1929-33. The growth rate of the monetary base accelerated just as the Friedman-defined money supply began to contract rapidly in 1931. This is all illustrated in the concrete statistical data found in the back of Friedman and Schwartz’s “Monetary History.” Friedman, the statistician, refuted Friedman, the economist.
The crisis of 2008-09 provided yet another illustration of this economic law. Though the Fed doubled the monetary base, the broader money supply grew much more slowly while the velocity of circulation declined sharply. If the relationship between the monetary base and the broader money supply had remained unchanged, the doubling of the U.S. monetary base would have caused the U.S. economy to experience triple-digit inflation in 2008 and 2009. But in reality, the general price was stable, almost unchanged.
During booms, in contrast, the supply of credit money expands rapidly relative to the monetary base as demand for bank loans soars and the velocity of circulation of the currency accelerates. Far from being the cause of the industrial — or business — cycle, fluctuations in the money supply, as defined by Friedman, are the consequences of the cycle. Friedman built his entire theory of inherent capitalist stability on this fallacy—inverting cause and effect. If there were no industrial cycles and instead only “full employment,” the rate of growth of the money supply would be stable. A capitalist economy without industrial cycles crowned by periodic crises of overproduction is indeed a basic assumption of neoclassical economics and the quantity theory of money. Friedman was guilty of attempting to prove capitalist stability by assuming capitalist stability.
As a practical macro-economist and banker — not an ideologue like Friedman — the Democrat Volcker knew full well that Friedman’s theories were nonsense. Volcker had only contempt for Friedman as an economic theorist who had spent his entire adult life as an ivory tower professor and, unlike Volcker, had never actually worked in a commercial or a central bank. Volcker had done both. However, as it turned out, Friedman was very useful politically.
Friedman had his uses
During the 1970s, Friedman wrote a popular economic column that appeared in Newsweek magazine, where he was paired off against the conservative pro-business “neo-Keynesian”, neoclassical economistPaul Samuelson. As the decade of the 1970s wore on, and inflation kept on accelerating, Friedman’s “common sense” claim that inflation would not go away until the rate of growth of the money supply was reduced — as he explained in popular language in his Newsweek column — made him appear to be some sort of economic genius compared to the blundering Keynesians.
In contrast to the Keynesians, Friedman kept predicting — correctly — that inflation would accelerate and existing Keynesian policies would not solve the growing unemployment crisis. The University of Chicago professor kept being vindicated on these points by the course of events as the decade wore on.
Therefore, the Federal Reserve System, shortly after Volcker’s appointment, decided that instead of announcing that they were going to allow interest rates to rise sharply — which was their real policy — announced that from now on, the “quantity of money” would be targeted, as opposed to short-term interest rates such as the Federal Funds Rate, as is normally the practice of central banks. The Federal Reserve leadership would then explain that since they no longer targeted interest rates, they could do nothing about the skyrocketing interest rates.
Birth of the ‘Rust Belt’
As the “Volcker shock” unfolded over the next three years, unemployment soared, credit-sensitive industries such as residential construction and auto plunged into deep depression, and much of basic industry collapsed, especially in the older capitalist countries such as the United States and Britain. The “rust belt” was born, as much of the steel industry — which had been the backbone of the huge U.S. industrial machine — was shut down and the plants demolished.
Unlike the case during the Depression, when factories idled by the super-crisis were reopened as that crisis passed, this time, the plants were closed for good. The same process unfolded in Britain, the birthplace of modern industry, under the government of “Iron Lady” Margaret Thatcher.
In the United States, whole cities that had been built around heavy industry, such as Buffalo, New York, were devastated. As the old U.S. steel industry centered in Pittsburgh, Pennsylvania, all but died, the United Steel Workers union, which had represented the workers who had worked in these plants for generations, was largely wiped out.
African Americans especially hard hit by the Volcker shock
Especially from World War I onward, African Americans were able to get jobs — though they were the worst and most dangerous jobs — in heavy industry. Escaping from the dying sharecropping economy of the old Jim Crow South, they were able, with the rise of the Congress of Industrial Organizations, to gain experience in union organization — though, unfortunately, the new CIO unions were far from free of racism. At least the CIO, for all its defects, gave African American workers an arena in which to fight.
The experience gained by the African American working class in the unions prepared the way for the Civil Rights movement of the 1950s and 1960s. But the Volcker shock slammed the door that the CIO had opened for African Americans — and poor people of other races and nationalities as well. The result was ruined cities, generations of working-class youth — especially working-class youth of color — who never could get jobs, the growth of urban street gangs that lived off the drug trade, and a soaring prison population that rose over the next few decades to well above 2 million.
Paul Volcker quickly became one of the most hated men in America. “Volcker’s Fed,” Wikipedia writes, “also elicited the strongest political attacks and most widespread protests in the history of the Federal Reserve (unlike any protests experienced since 1922), due to the effects of the high interest rates on the construction and farming sectors, culminating in indebted farmers driving their tractors onto C Street NW and blockading the Eccles Building.”
But Volcker was respected on Wall Street. Much to the chagrin of the liberal-progressive wing of the U.S. Democratic Party, he served as a senior economic advisor to President Barack Obama, who took over as president from the hated George W. Bush during the 2008-09 economic crisis.
Naturally, many well-meaning progressives wondered: What was this Wall Street favorite, the hated chief organizer of the Volcker shock, which destroyed the chances of several generations of working-class youth — especially African American youth — doing in the administration of the supposedly progressive Barack Obama?
Was there an alternative to Volcker’s policies?
In volume III of “Capital,” Marx wrote: “For the sake of a few millions of money many millions of commodities must therefore be sacrificed. This is inevitable under capitalist production and constitutes one of its beauties.”
In other words, the Bank of England, to save a few millions in gold in its vaults, had to sacrifice much of the wealth of the nation — and the jobs of British and indeed workers throughout the world. Marx described this ironically as one of the “beauties” of the capitalist system.
The founder of scientific socialism, however, did not denounce the Bank of England for doing this in the way U.S. progressives denounced Paul Volcker for doing the same thing. Instead, Marx used his characteristic irony to explain how the Bank of England had no real choice under the capitalist mode of production. And that as long as the capitalist system lasts, so will this “beauty” — along with the other “beauties” of the capitalist system.
Unlike Marx, Keynesian economists, starting with Keynes himself — and many no doubt well-meaning reformers — believed that there must be a way of removing this “beauty” from the capitalist system. But the crises of the 1970s — even more than the super-crisis of 1929-33 and more than the crisis of 2007-09 — demonstrated the need to sacrifice the wealth of the world periodically — and the lives of the world’s workers — to save the gold bars in the vaults of the central banks or the gold value of the currency under a paper money system.
It is a built-in feature of the capitalist system. You cannot get rid of this necessary “beauty” without the transformation of capitalist production into socialist production. This was the conclusion of the greatest economic scientist of all time, Karl Marx. Marx’s finding was confirmed in practice by the crisis of the 1970s and its climax — the Volcker shock.
Therefore, the “real barbarous relic” isn’t the role of gold within the capitalist monetary system, as Keynes claimed. Nor is gold the cross that weighs down on the backs of labor as the silver-tongued William Jennings Bryan proclaimed. The real “barbarous relic,” the “cross” that weighs down on the backs of all those who must work, is the capitalist system of wage labor itself.
The real alternative
Under the conditions prevailing in 1979 — that is, a crisis of overproduction that had long been prevented from coming to a climax as a result of repeated “Keynesian” interventions in the economy — the only alternative to the Volcker shock was to end the contradiction between the socialization of the process of production and the private appropriation of the product, which is the real cause of the periodic crises of overproduction.
In other words, the only alternative to the Volcker shock — and the “monetarist” policies as they were called in the 1970s in Britain, presided over by Margaret Thatcher and similar policies in other capitalist countries — would have been a socialist revolution.
However, no economic crisis, no matter how severe, can bring about a socialist revolution automatically. That was true during the super-crisis of 1929-33, and it was true during the 1970s. The socialist transformation of society must be carried out as a conscious act of liberation by the working class. Unfortunately, in 1979, neither the U.S. working class nor the global working class was anywhere near the level of organization, especially political and class consciousness that would have been necessary to carry out such a revolution.
Given this political reality — and, of course, our job as Marxists is to change this political reality — there was no alternative to the Volcker shock. Closing their eyes to reality, many well-meaning liberals and progressives who want to avoid the dangers of revolutions and the excesses that often accompany them — and unfortunately, many Marxists as well — treat Volcker’s policies as some kind of horrible mistake.
According to them, Volcker and the Federal Reserve System should have expanded the quantity of token money to the extent necessary to prevent the already extremely high interest rates of August 1979 from rising further. This, they claim, would have avoided the contraction of industrial production, employment, and indeed entire industries with all the consequences that necessarily followed.
Exactly how the collapse of the dollar and the satellite capitalist currencies would then have been avoided is something that our progressive critiques fail to explain. If the progressives are correct, then Paul Volcker is one of the greatest criminals of all time. Yet far from being treated as a criminal by his “liberal” and “pro-labor” Democratic Party, Volcker was to serve as a respected elder statesman in the Democratic administration of Barack Obama.
If we claim in the face of reality that Paul Volcker made a “mistake” when he allowed interest rates to rise as high as they did, we are covering up the realities of the capitalist system. This is, of course, exactly what the professional bourgeois economists are paid to do, whether they are Austrians marginalists, traditional neoclassical marginalists, Keynesians, or Friedmanites.
However, when Marxists prettify the capitalist system — through the failure to fully appreciate and understand Marx’s economic discoveries — we are betraying our mission. Our mission is to tell the truth about the capitalist system, no matter how ugly this truth is. And the truth about capitalism is very ugly indeed!
Volcker shock no mistake
The Volcker shock was therefore no mistake. It was necessary at the time to maintain the capitalist system of exploitation of wage labor in the long run. The “masters of the universe” on Wall Street know this full well, which is why, a generation later, they so respected the by then elder statesman Paul Volcker.
As Marxists, we, of course, despise the Paul Volckers of this world for devoting their considerable intellects and talents to extending the life of the capitalist system. We must, however, despise them for their real crime. Their real crime is the defense of the capitalist system despite all its “beauties.”
Remember, the Volckers did not design the capitalist system or craft its beauties. If they had been able to design a system of exploitation from the ground up, we could assume, as intelligent and sane human beings, that they would have designed a more rational system. But as practical people functioning in the real world, they and their successors have had no other choice but to defend the capitalist system as it is and not a more rational system of exploitation that can exist only in the fantasies of reactionary ideologues like Milton Friedman, or in the heads of well-meaning Keynesian reformers.
The numbers tell the story
When Paul Volcker was appointed, the Federal Funds Rate was already closing in on 11 percent. But by the end of October, the federal funds rate had soared to over 16 percent as the Volcker Fed moved to keep the growth of bank reserves to a rate below the soaring rate of inflation and the consequent growth in the demand for credit defined in dollar terms.
Despite this, the dollar price of gold — the measure of the dollar’s depreciation against gold — continued to soar. This shows how much Keynesian policies had “succeeded” in undermining the confidence of money capitalists in the currency. Not until January 21, 1980, did the dollar hit rock bottom at $875 an ounce.
How high would the dollar price of gold have risen — or more properly, how far would the gold value have fallen — if the onset of the Volcker shock had been postponed for a few months or even a few weeks?
On March 14, 1980, Carter imposed credit controls — that is, restricted the ability of commercial banks to sell securities for cash. This drove the Fed Funds Rate even higher. On March 28 and 29, the Fed Funds Rate soared to 19.71 percent! As the commercial banks halted bank loans, the supply of credit money — checking account deposits — and the “real economy” began to fall off the cliff. Since the Volcker Fed was committed to a reduced rate of growth in the money supply — not a dramatic contraction — it quickly reversed policy. President Carter, for his part, quickly canceled the credit controls.
The demand for gold broken
The super-high interest rates finally broke the demand for gold. On January 21, 1980, gold closed in London at $850 an ounce. Remember, it had been under $300 an ounce five months before. But right after Carter announced his credit controls, the dollar price of gold fell briefly below $500. The collapse of the dollar against gold was brought to a screeching halt.
As the credit controls were lifted, interest rates plummeted. By May 1980, the Fed Funds Rate had fallen below 9 percent. Soon, the level of economic activity, which had been falling rapidly as credit contracted, began to revive. The National Bureau for Economic Research announced that the “contraction” of 1980 was over, and a new economic expansion was beginning. Though the recession had been sharp, it was also the shortest on record, according to the NBER and the capitalist media.
However, the sharp fall in interest rates caused the demand for gold to begin to soar once again. By October 9, 1980, gold closed in London at $690 an ounce. The run into gold, briefly halted by the sky-high interest rates and recession in the spring, was gaining momentum once again as interest rates fell. The only solution available to the Volcker Fed was to restrict again the growth of its token money, which would enable the rate of interest to rise sufficiently to break the renewed rush into gold before it gained even more momentum, even if this meant that interest rates would rise above their heights of March 1980.
The Fed also had to avoid repeating the mistake — and it was a mistake — that it and President Carter had made in the spring and summer of 1980 of easing too quickly in the face of weakening economic data. Interest rates would not only have to rise sharply again, but they would have to stay up for a prolonged period. This time, however, the Carter White House stepped aside, allowing Volcker to let interest rates rise in a more orderly way than had been the case in 1980.
By mid-December 1980, the Federal Funds Rate was above 20 percent. By the end of December, it reached 22 percent, higher than it had been in March during Carter’s short-lived credit controls.
Long-term interest rates tell a similar story. On March 24, the rate of interest on 10-year U.S. government bonds hit 13.17 percent. But on September 8, 1981, long-term interest rates rose to 15.59 percent. This was the price for the “premature” easing during the summer of 1980.
The NBER ‘expansion’ that was ‘dead on arrival’
With interest rate levels like these, the “recovery” the economy had begun in the summer of 1980 had no chance of surviving. The “expansion” of 1980 was truly dead on arrival. By the fall of 1981, the NBER was forced to acknowledge that the “expansion” of 1980-81 had turned out to be the shortest in history. Of course, a one-year “expansion” does not represent a real upturn in the industrial cycle!
The rate of profit during the 1970s
It is widely understood that inflation inflates profits. If commodity prices rise between the time the production process is completed and the time the commodities are sold, profits will rise accordingly. However, if prices keep rising, more money will be necessary to carry out production on the same scale, let alone on the expanded scale that the capitalist economy requires.
Therefore, most economists assume that profits during periods of inflation, calculated in terms of currency, are partially illusory. Various attempts to adjust profits for the inflation of the 1970s have been made by economists, both bourgeois and Marxist. Among Marxists, these calculations have played a role in the attempts to document Marx’s law of the tendency of the rate of profit to fall, which he developed in Volume III of “Capital.”
The problem with these estimates is that their authors don’t understand that what matters in capitalist production is not “real profits” in terms of commodities — “real purchasing power” — but profits in terms of money — that is, real — gold — money. Economically, real profits must always be measured in terms of the use value of the commodity that serves as money.
A capitalist deciding whether to expand their real capital now or wait for a more favorable moment does not have a choice of holding or investing “unchanging real purchasing power.” The only choice is between holding money in some form or investing.
True, the purchasing power of money — even gold money — is a variable and not a constant. Despite this, the exchange values of commodities and capital are always measured in terms of money. Pure real purchasing power as some sort of mathematical constant does not and cannot exist outside of the imagination of economists and statisticians.
Indeed, during periods of crisis, the fact that the purchasing power of money is not a constant but a variable is an advantage to its holders since the purchasing power of money rises. Even — and especially — during the inflationary 1970s, while the purchasing power of paper money was declining, the purchasing power of gold money increased dramatically.
When the official currency rapidly loses purchasing power, the capitalists can hold real money — gold — instead of the depreciating currency, but not unembodied, unchanging “purchasing power.” During the 1970s — leaving aside the production of gold itself — holding gold was more “profitable” in terms of depreciating paper currencies than almost every other “investment,” with the possible exception of holding non-reproducible works of art and other such collectibles.
During the decade of the 1970s, misers who simply hoarded gold emerged richer than those individuals and corporations who attempted to act as capitalists — that is, to expand their capital as measured in the use value of gold. As it became evident that simply holding gold — hoarding it — was the best “investment,” more and more capital flowed into gold.
This explains why it took ever higher interest rates to prevent the dollar and other paper currencies linked to it from collapsing altogether. Such a trend cannot last for long under capitalist production. Capitalism could not have continued if it had not returned to profitability on a gold basis. A capitalism where, in the long run, simply hoarding gold is more “profitable” than actually carrying out capitalist production in order to produce additional surplus value is not a sick capitalism; it is a dead capitalism.
During the 1970s, the capitalist economy was operating at a loss in real money — gold. This does not mean that workers were not producing surplus value any more than the massive losses in U.S. dollars in the early 1930s meant that workers weren’t producing surplus value back then. In both cases, it meant that though surplus value was being produced, it wasn’t being realized in terms of real money. This is why the Volcker shock was absolutely necessary if the capitalist system of production was to continue.
What really happened during the 1970s?
As both interest and inflation rates soared during the 1970s, Keynesian economists tried to comfort themselves with the thought that while nominal interest rates were climbing, the “real” rate of interest was below zero. Therefore, even if the monetary authorities couldn’t control the nominal interest rates, they could, the Keynesians argued, still control the “real” rate of interest. And, they argued, isn’t it the real rate of interest — the rate of interest in terms of commodities as opposed to money — that matters?
However, when inflation fell dramatically during the Volcker shock, nominal interest rates remained stubbornly high. The long-term rate of interest on government bonds, for example, didn’t fall below double-digit levels until 1985! Suddenly, it wasn’t only nominal interest rates that were very high; it was “real” interest rates. Interest rates in terms of commodities were extremely high, as well as the interest rate in terms of real money – gold.
This was all the more ironic because Keynes had predicted that interest rates would fall toward zero as “scarcity” vanished and the rentiers would be “euthanized.” But that was not how things were working out. The era of “financialization,” when the money capitalists — Keynes’s rentiers — were to thrive like never before, was dawning.
Price, profit and gold production in the 1970s
Earlier, we saw that the growth in world gold production, which was slowing sharply in the late 1960s, started to drop in 1970 when commodity prices in terms of gold — not just paper dollars — experienced a final spike. The very brief success that the government and the Federal Reserve System had in driving the dollar price of gold back to $35 an ounce without any deflation in the nominal price level meant that prices in terms of gold had now reached the highest levels since the immediate post-World War I period.
Even the slave-like conditions of apartheid that prevailed in South Africa, then the leading gold bullion-producing country, which had kept profits in the industry artificially high, could no longer keep profits high enough to prevent gold production from entering its first sustained decline since the end of World War II.
When the Fed and the other central banks tried to continue stimulating the economy by holding down the interest rate by increasing the rate of growth of their token money, the price of gold in terms of the various paper currencies soared. Between 1970 and January 1980, the dollar price of gold rose from $35 an ounce to $875.
As long as there were huge reserves of idle money capital left over from the Depression, long-term interest rates remained very low. Under these conditions, Keynesian economics seemed to work well. But, under the economic conditions that prevailed after the Depression and World War II, the global capitalist economy would have been expected to expand rapidly even without Keynesian policies. If Keynesian policies had not been followed, crises like the one that began in 1957 would have been sharper and cyclical swings greater, but interest rates would in the long run have been lower, and the long-term growth of the capitalist economy would have been higher.
As the industrial cycle resumed from 1948 onward, real capital began to expand more rapidly than the world’s supply of monetary gold. The result was a gradual tendency for interest rates to rise. Interest rates still rose in booms and fell during recessions, but they rose more in booms than they fell in recessions.
Since interest rates were initially extremely low due to the Depression and the prolonged halt in expanded reproduction that lasted through World War II, interest rates were well below the rate of profit in the early postwar period, which was also the early post-Depression period. They could rise for some time before they threatened to wipe out the profit of enterprise — which forms the real incentive to produce surplus value. As long as these conditions prevailed, the Keynesian policies of weakening recessions or even postponing them by cutting interest rates and increasing demand through government deficit spending could work.
But even during the heyday of Keynesian economics, the secular rise in long-term interest rates indicated that it was only a matter of time before the efficacy of Keynesian policies would end. By the end of the 1960s, as the boom, intensified by the expansionary Kennedy-Johnson tax cut and the Vietnam War, accelerated the rise in prices in terms of gold, gold production first stagnated and then, after 1970, declined.
If the rules of the gold standard in any form — including the rules of the Bretton Woods dollar-gold exchange standard — had been followed, the result would have been a classic deflationary depression. Such a depression on the backs of the workers and other toilers would have sharply lowered long-term interest rates and thus set the stage for a new series of “expansionary” industrial cycles.
The combination of falling prices, which would have increased the quantity of gold money in purchasing power terms, combined with the rise in both the relative and absolute profitability of gold mining and refining industries, would have increased gold production and thus, over time, increased the quantity of gold in terms of weight as well. This would have created the conditions for a new expansion of the world market and a new upsurge in capitalist production, always assuming that the political rule of the capitalist class would have survived.
In a classic depression — one without Keynesian intervention — the stagnation in the accumulation of real capital, combined with rising gold production, reduces the ratio of real capital to gold. That, in turn, leads to lower interest rates. More of the surplus value goes to the industrial and commercial capitalists in the form of the profit of enterprise and less to the money capitalists in the form of interest. All of this encourages a rise in investment when the economy recovers, just as it did after World War II.
The high unemployment of depression also leads not only to lower money wages. It leads to a rise in the rate of surplus value. Not only does a greater mass of the surplus value go to the industrial and commercial capitalists in the form of the profit of enterprise, but the total mass of surplus value also increases. This acts as a powerful counter-tendency to the tendency of the rate of profit to fall. One, it counteracts the tendency of the rate of fall by increasing the rate of surplus value. Two, it encourages the industrial capitalists to employ cheap variable capital as opposed to constant capital, thereby slowing the rise in the organic composition of capital. In this way, the law of the rate of profit to fall is transformed into the law of the tendency of the rate of profit to fall.
The policies of the Keynesians did change the form of the economic crises somewhat. Instead of deflation of prices in terms of currency, there came the “deflation” of the value of a currency in terms of gold and the resulting inflation of prices in terms of depreciated currency, combined with unprecedented interest rates, as the money capitalists progressively lost confidence in paper currencies.
On two occasions, first in 1973-74 and then in 1979-1980, panicky flights to safety in gold led not only to extreme inflation but violent recessions that finally drove even the official unemployment rate in the United States above 10 percent by late 1982. In Western Europe, too, unemployment reached levels characteristic of the post-World War I period rather than the “full employment” of the early post-World War II years.
While some of the “third world” countries — and also the Soviet Union, which was a major oil producer — had benefited from the high prices of primary commodities during the 1970s, they were hard hit by the Volcker shock. They were squeezed between the rising interest rates on the high debts they had contracted during the inflationary period and the falling prices of the primary commodities they sold.
From the 1970s to the ‘Great Moderation’
Many Marxists during the 1970s assumed that the inflationary conditions with frequent and increasingly severe recessions would simply continue, just as many economists, both bourgeois and Marxist of an earlier generation, had assumed the Depression conditions of the 1930s would continue or resume after World War II.
Similarly, many bourgeois and Marxist economists had assumed that the prosperity of the 1950s and 1960s, thanks to new Keynesian economic policies, would continue indefinitely. But the “stagflationary” conditions of the 1970s did not prove any more permanent than the Depression conditions of the 1930s or the postwar prosperity of the 1950s and 1960s had been.
Indeed, the fact that during the 1970s, the capitalists could not make profits in terms of gold meant that the stagflationary conditions of that decade could not possibly have continued for much longer. These conditions were brought to an abrupt end by the Volcker shock of 1979-80, giving way to a new and very different period, commonly referred to as the “Great Moderation,” which will be the next chapter’s subject.
The level of gold production during the 1970s
As anybody who has studied the history of the 1970s knows, prices in terms of dollars—and other paper currencies—rose sharply. But though prices in terms of paper currency rose sharply, they had not risen nearly as fast as the gold value of the dollar, and the other paper currencies more or less linked to it had fallen.
Therefore, already in the wake of the crisis of 1974-75, prices in terms of gold were considerably lower than they had been in 1970. If you look at the trend line in world gold production, you will notice that after declining for about five years in the first half of the 1970s, gold production bottomed out, though it remained depressed compared to the peak of 1970.
Ironically, the effect of the highly inflationary recession of 1974-75 on gold production was similar to the effect of the highly deflationary recession of 1920-21. The deflation of 1920-21 halted a sharp decline in gold production, though gold production remained depressed relative to the previous peak around 1915 until the super-crisis of 1929-33 stimulated it anew. While the recession of 1974-75 was highly inflationary in paper money terms, it was highly deflationary in gold prices.
However, the decline in gold prices brought about by the 1974-75 crisis was not enough to turn gold production decisively upward. This took a new crisis within the crisis, which erupted beginning in 1979. This, too, brought an even greater surge in paper money prices and an even sharper deflation in terms of gold prices.
The result was that the profitability of the world gold mining and refining industry, both relative to other industries and absolutely, soared. The gold industry was the great exception to the lack of profitability of capitalist production during the 1970s. Not surprisingly, beginning with the 1979-82 crisis, global gold production began a prolonged upward movement that was to continue until the turn of the 21st century.
At the beginning of the prolonged crisis in March 1968, I showed how the prices of commodities in terms of gold had risen above the underlying labor values of commodities. By the early 1980s, the prices of commodities in terms of the money commodity, gold — the commodity that measures the value of all other commodities in terms of its use value — were now well below the values of those commodities.
Behind the scenes, the law of value of commodities had once again asserted itself.. With respect to the fall in market prices measured in terms of gold bullion, the situation resembled the bottom of earlier periods of deep crisis. But in one respect, the level of interest rates, the situation was the exact opposite of earlier crisis bottoms.
By dramatically lowering the prices of commodities in terms of gold — though, of course, not paper currency — the prolonged economic crisis that raged with varying degrees of intensity from March 1968 to the end of 1982 had acted as a classic depression. The paper money inflation in prices had simply hidden the deflation in terms of gold.
But in terms of the rate of interest, the division of the profit between the money capitalists on one side and the industrial and commercial capitalists on the other, the results were virtually the opposite of a classical depression.
For example, in March 1968, at the beginning of the protracted crisis that extended through the decade of the 1970s into the 1980s, the yield on 10-year government bonds was about 5.57 percent. In January 1983, at the end of the prolonged crisis, the rate of interest on 10-year bonds was hovering around 10.5 percent! It wasn’t until August 1993 that the yield on the U.S. 10-year government bond finally fell below the levels that had prevailed in March 1968, more than a quarter of a century before.
A Critique of Crisis Theory 