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 8
Money as a Means of Payment
Credit relations separate the act of buying from the act of paying. Therefore, the development of credit gives rise to a new function of money: money as a means of payment.
Credit allows me to purchase a commodity with credit rather than with money. But in doing so, I incur a debt payable in money. The capitalists actually purchase the commodity labor power with credit rather than money. When I sell my labor power to an industrial (or other) capitalist, I have to work for a week or more before I collect my wage in money form. It’s not unheard of for industrial (and other) capitalists to go bankrupt and fail to pay the debts they owe the workers for the labor power they bought with credit.
Not all debts payable in money are created by the purchase of commodities with credit. For example, tax liabilities payable to the state under conditions of capitalist production have to be paid for in money. In pre-capitalist times, taxes were sometimes payable in kind, but under capitalism, they are almost always payable in money. Ground rent liabilities are also payable in money under capitalist conditions.
Under the feudal system of production that dominated Europe in the centuries before the rise of capitalism, feudal ground rents were either payable in labor — the enserfed peasants having to work on the lord’s lands for part of the workweek — or they were payable in kind. During the transition from feudalism to capitalism, rents payable in labor or kind were replaced by rents payable in money.
The history of credit, Marx pointed out in Volume III of Capital, Chapter 36, can be divided into two stages. Before the transition to the capitalist mode of production, money lenders lent money to members of the property-owning classes to finance personal consumption or small commodity producers. These money lenders were known as usurers, and their capital was called usurers’ capital. The interest rates they charged were far above the interest rates that prevailed later under capitalist production. The exploitation by usurers’ capital of small peasants and other small commodity producers was extremely brutal. That is why pre-capitalist money lenders were so widely hated.
Marx writes in Chapter 36, Volume III of Capital: “The characteristic forms, however, in which usurer’s capital exists in periods antedating capitalist production are of two kinds. I purposely say characteristic forms. The same forms repeat themselves on the basis of capitalist production, but as mere subordinate forms. They are then no longer the forms that determine the character of interest-bearing capital. These two forms are: first, usury by lending money to extravagant members of the upper classes, particularly landowners; secondly, usury by lending money to small producers who possess their own conditions of labor-this includes the artisan, but mainly the peasant, since particularly under pre-capitalist conditions, in so far as they permit of small independent individual producers, the peasant class necessarily constitutes the overwhelming majority of them.” (1)
Peasants, for example, often fell into debt to the landowners and had to borrow money either from the landowners themselves, who therefore doubled as usurers, or from a separate class of usurers who charged high interest rates that kept their victims continuously in debt. During the transition to capitalism, peasants were frequently reduced to debt slaves. In this way, usury capital helped to dissolve the pre-capitalist community and create the modern proletariat as a class with nothing to sell but its labor power.
Marx wrote: “Usury has a revolutionary effect in all pre-capitalist modes of production only in so far as it destroys and dissolves those forms of property on whose solid foundation and continual reproduction in the same form the political organization is based. Under Asian forms, usury can continue for a long time without producing anything more than economic decay and political corruption. Only where and when the other prerequisites of capitalist production are present does usury become one of the means assisting in the establishment of the new mode of production by ruining the feudal lord and small-scale producer, on the one hand, and centralizing the conditions of labor into capital, on the other.”
But with the transition to capitalism, credit is subordinated to the needs of capital. Marx wrote: “The credit system develops as a reaction against usury. But this should not be misunderstood, nor by any means interpreted in the manner of the ancient writers, the church fathers, Luther, or the early socialists. It signifies no more and no less than the subordination of interest-bearing capital to the conditions and requirements of the capitalist mode of production.”
This transition was marked by the rise of the modern banking system accompanied by a considerable fall in the rate of interest. The banks became the pivot of the new capitalist credit system, which from then on served the needs of capitalist production. With the development of the capitalist credit system, the metallic hoard — and later the hoards of token money — were increasingly centralized in the hands of the banks.
Credit money
The development of the modern credit system gave rise to a new form of money: credit money. Credit money is an IOU that can be transferred from one person to another to either purchase commodities or make payments. These IOUs were generally issued by the banks, and increasingly replaced in circulation coins made of money metals such as gold, and later, legal-tender token — paper — money issued by the state monetary authority.
Credit money combines credit relations with monetary relations. Credit money can replace gold and legal-tender token money as a means of purchase or payment. However, the basic function of money, the universal equivalent that measures the exchange values of all commodities in terms of their use value, can only be played by a special money commodity such as gold. In this basic monetary function, gold cannot be replaced by either token money or credit money. Credit money is always payable in another form of money, either in full-weight gold coins, bullion, or nowadays in legal-tender “fiat money” — token money — issued by the state’s monetary authority.
In Marx’s day, credit money was sometimes called “circulating credit.” Though any form of IOU that can be used to purchase commodities and make payments can be considered a form of credit money, credit money has generally taken two forms. Banknotes were widely used as credit money during the 18th and early 19th centuries. Even before the 18th century, bankers sometimes issued a note to a depositor confirming that a certain sum of money in either coin or bullion, had been deposited at the bank. If you wish, you could use such notes to make purchases or pay off your debts in place of actual gold or silver.
The next, and far more important, step was when banks began to make loans or discount commercial paper not in gold or silver coins but in their banknotes instead. This enabled the banks to create a supply of credit money in the form of banknotes above and beyond the actual amount of (metallic) money that they had on hand in their vaults. This practice is called fractional reserve banking.
Bankers learned from experience that not all owners of banknotes would normally demand redemption of their banknotes at the same time. However, when a bank’s credit was shaken for one reason or another, a “run” would develop on the bank. The owners of the bank’s notes would attempt to convert the bank’s notes into “specie” — gold or silver coin. The bank would fail, and the banknotes would then become worthless.
Originally, such banknotes were issued by private commercial banks. Gradually, the central banks—in their early days called national banks — achieved a monopoly on the issue of banknotes. Since the government kept its bank account at the national bank, these banks became increasingly intertwined with state power. They were thus gradually transformed from corporate, for-profit banks into their modern incarnation as governmental monetary authorities.
During this transition, the national-cum-central banks gradually shifted from making the maximum profit for their shareholders to stabilizing the currency and, insomuch as it is possible under capitalism, the economy. Instead of representing the interests of their shareholders, they came to represent the interests of capitalist society as a whole. When the central banks acquired a monopoly on the issuance of banknotes, they became the sole “bank of issue.”
This made it very easy for the government to convert the credit money of the central banks into token money by simply ending the obligation of the central bank to convert their notes into gold or silver on demand. This happened in England for the first time as early as the Bank Restriction Act of 1797, which converted the banknotes of the Bank of England into legal-tender token money.
After the world war that followed the French Revolution, the convertibility of the notes was restored. This renewed convertibility into gold of the Bank of England’s banknotes lasted for almost a century but was suspended again when the next world war broke out in 1914.
Banknotes issued by a central bank are credit money as long as they are convertible into either gold coin or bullion. But since they are issued by a central monetary authority closely intertwined with the state power, they can be easily converted into token money by declaring them legal tender for all debts, private and public, and suspending their convertibility into gold. Therefore, this kind of credit money, whether issued directly by the state or a central bank closely linked to the state power, is always one step away from being converted into token money.
State-issued credit money is, in a sense, a hybrid form of money somewhere between credit money issued by for-profit capitalists and pure token money issued by the state power. In contrast to state-issued credit money, the convertibility of the credit money issued by for-profit commercial banks — whether into gold or token money — can only be briefly suspended if it is not to lose its character of money altogether. Nobody will accept a check drawn on a bankrupt bank that has no prospect of ever redeeming the check in hard cash.
Token money has existed for thousands of years
The evolution of banknotes convertible into gold (or silver) into modern inconvertible paper token money has led to the illusion that token money evolved from credit money and represents an ultra-modern form of money that gives its issuer almost supernatural powers to suspend basic economic laws. But the opposite is the case.
As Marx demonstrated in the first three chapters of Volume I of Capital, token money first arose out of coins that, though they were made of metals that functioned as money commodities, became worn down below their legal weight in circulation. As long as the price of bullion in terms of these light coins did not rise above its mint price, the coins were not depreciated. Token money is, therefore, almost as old as coined money itself and has existed for several thousands of years.
Credit money, in contrast, presupposes the rise of the modern capitalist credit system. As long as they remain inconvertible into gold, the banknotes issued by today’s central banks are simply a form of token money. They will again become credit money only if and when their convertibility into gold is restored.
The other main form of credit money is deposit money that can be transferred from person to person either by check or today by electronic means. As with banknotes, the banks create deposit money by making loans or discounting commercial paper. Economists sometimes call the deposit — credit — money that is created by the banks through loans and discounts, without actually issuing banknotes, “bank money.”
Commercial paper takes two forms. One is a short-term IOU called promissory notes. The other form is the draft or bill of exchange. A draft is a legal document where one person instructs a second person to pay a third person. The most well-known example is the bank check. When you write a check — you are instructing your bank — person two — to pay the third person the check is made out to.
In 19th century Britain a manufacturer would often sell a commodity to a merchant and then draw up a bill of exchange against the merchant due perhaps in three months. The merchant could then sell the bill at a certain discount, the amount of which was determined by the rate of short-term interest to a commercial bank in exchange for banknotes or a credit to their checking account. The commercial bank could either hold the bill until it came due or sell it to the Bank of England at a discount in exchange for Bank of England banknotes, or the commercial bank’s checking account at the Bank of England would be credited.
Nowadays, such transactions generally occur through bookkeeping entries — accounts receivable and accounts payable — at least in domestic trade through formal drafts might still be drawn up in international trade where the risk is greater. Today the main form of commercial paper is unsecured short-term promissory notes that corporations and banks issue to raise quick cash.
These operations swell the mass of deposits or bank money far beyond the cash they have, either in the form of vault cash or deposits (“reserves”) with the central bank. As was the case with banknotes, a relatively small hoard of “hard cash” can be pyramided up into a much larger quantity of credit money.
Therefore, a considerable “multiple” of credit money can be created on top of the actual amount of metallic money or legal tender token money issued by the state monetary authority — the quantity of token money in real or purchasing-power terms remaining limited by the quantity of gold that exists either in the country or world market as a whole. The development of credit money makes possible a development of the market far beyond that which would be possible with metallic and token money alone.
This enables modern capitalist production with its tendency to expand production without limit to overcome the “metal barrier” — as Marx called it in Volume III of Capital, — at one level, which is built into the commodity foundations of capitalist production. Credit money makes possible overproduction on a gigantic scale and therefore plays a crucial role in the formation of crises. For this reason, modern crises of overproduction appeared only after the modern capitalist credit system and its system of credit money had achieved a considerable degree of development.
Unlike token money, which is generally issued only by the state or its monetary authority, credit money, in contrast, is, as a rule, issued by private capitalists, whose aim, like all other capitalists, is profit. If such profit-motivated private capitalists attempted to issue their own token money, the token money would quickly become worthless because the desire for profit by private capitalists can never be quenched. If they could issue token money, private for-profit capitalists would issue it in unlimited amounts, leading to its complete collapse.
Limitations on the amount of credit money that can be created
If credit money were limited only by the number of commodities in circulation, it would be able to banish generalized crises of overproduction. Like Say claimed, demand would only be limited by production. But credit money cannot achieve this because it is payable in money, not commodities. Ultimately, the amount of credit money that can be created is limited by the amount of metallic money, either directly when the credit money is payable either in gold coins or bullion or indirectly when it is payable in legal tender token money. Therefore, while the quantity of credit money can greatly exceed the quantity of metallic money, that quantity is also limited in the final analysis by the amount of metallic money in existence.
The total quantity of credit money cannot exceed a certain multiple of the amount of metallic money. What determines that multiple? Like all forms of credit, credit money runs into the limit that a piece of money — whether metallic or token — cannot discharge two debts at the same time. If the mass of credit money keeps on growing relative to the mass of either the metallic or token money it is payable in, it will implode sooner or later. At some point, the issuers of credit money will find themselves unable to raise enough metallic or token money to redeem all the credit money they have created. The result is then a credit and banking crisis.
The moment that owners of credit money begin to sense that the issuers can no longer meet all the demands to redeem the credit money, a panic develops. Such panics are sometimes called “monetary crises.” The owners of credit money attempt all at once to convert their credit money into hard cash — whether gold or legal-tender paper money. The result is that a portion of the credit money is destroyed. Or, as the bourgeois economists say, the money supply contracts.
Clearing agreements make possible economizing of metallic and token money and the expansion of the market
The ability to economize on either gold coin or token money by increasing its velocity of circulation runs into the limit that a single coin or currency note can only make one purchase at a time. “The fact that a number of sales take place simultaneously, and side by side,” Marx writes in Chapter 3, Volume I of Capital, “limits the extent to which coin can be replaced by the rapidity of currency.”
However, Marx explains that this becomes “a new lever in economizing the means of payment.” He continues: “In proportion as payments are concentrated at one spot, special institutions and methods are developed for their liquidation. Such in the middle ages were the virements at Lyons. The debts due to A from B, to B from C, to C from A, and so on, have only to be confronted with each other in order to annul each other to a certain extent, like positive and negative quantities. There thus remains only a single balance to pay. The greater the amount of the payments concentrated, the less is this balance relatively to that amount, and the less is the mass of the means of payment in circulation.”
These clearing agreements, as they are known, enable the market to be extended beyond what could otherwise be supported by a given quantity of money. As capitalism developed, clearing agreements became centralized in the hands of the banking system. Since the late 19th century, most business payments have been settled by check, not by metallic or banknote money.
Capitalist A has to discharge a debt to capitalist B. A writes a check that instructs his banker to pay B. B, for his part, rather than cash the check, will deposit A’s check with his or her own banker. If A and B share the same banker, no money will actually change hands. The bank will simply debit A’s account and credit B’s, a purely bookkeeping transaction.
But banks take this one step further. They form clearing houses, which are nowadays managed by the central bank. On any given day, many checks are written against a given bank, but on the same day, many other checks are deposited in the same bank. A bank does not need to make a cash payment every time a check is written against it.
Instead, what the banks have to do is get together in the clearing house and calculate the overall net balances. The vast majority of checks that are drawn on the banks simply cancel each other out. If the reserves of the bank(s) that need to come up with cash were to drop below the required level as a result of making the payments, they borrow the money overnight from banks with a surplus of reserves at the “federal funds rate” as it is called in the U.S., greatly economizing on the need for actual cash on hand.
In this way, the modern banking system supports a vast mass of transactions with a relatively small amount of cash. This makes possible a vast expansion of the market based on a given quantity of metallic or token money. But the market still cannot overcome the ultimate limit set by the fact that a single piece of money, whether metallic or token, can only discharge one debt at a time. The whole system of payments becomes more and more artificial, shaky and unstable as the number of credit money grows relative to metallic and token money. This vast growth in the amount of transactions supported on the base of a relatively tiny amount of metal and legal tender token money becomes a powerful force for instability and the formation of crises.
“The function of money as the means of payment,” Marx wrote in Chapter 3 of Volume I of Capital, “implies a contradiction without a terminus medius.”
He continues: “In so far as the payments balance one another, money functions only ideally as money of account, as a measure of value. In so far as actual payments have to be made, money does not serve as a circulating medium, as a mere transient agent in the interchange of products, but as the individual incarnation of social labor, as the independent form of existence of exchange-value, as the universal commodity. This contradiction comes to a head in those phases of industrial and commercial crises, which are known as monetary crises. Such a crisis occurs only where the ever-lengthening chain of payments and an artificial system of settling them, has been fully developed.
“Whenever there is a general and extensive disturbance of this mechanism, no matter what its cause, money becomes suddenly and immediately transformed, from its merely ideal shape of money of account, into hard cash. Profane commodities can no longer replace it. The use-value of commodities becomes valueless, and their value vanishes in the presence of its own independent form. On the eve of the crisis, the bourgeois, with the self-sufficiency that springs from intoxicating prosperity, declares money to be a vain imagination. Commodities alone are money. But now the cry is everywhere: money alone is a commodity! As the heart pants after fresh water, so pants his soul after money, the only wealth. In a crisis, the antithesis between commodities and their value-form, money, becomes heightened into an absolute contradiction. Hence, in such events, the form under which money appears is of no importance. The money famine continues, whether payments have to be made in gold or credit money such as bank notes.”
The dollar system and the empire
We should make a few observations about the above quote. In Marx’s time, only gold or banknotes convertible into gold, such as the banknotes of the Bank of England, were widely accepted as a means of payment on the world market. However, in today’s world, the U.S. paper dollar, though it is not convertible into gold, and is therefore token money, not credit money, is widely accepted as a means of payment. The world economy has become “dollarized.”
Some of the more brazen champions of U.S. imperialism argued that the huge debt that the United States acquired starting in the early 1980s through its trade and balance of payments deficits is not a danger because “we [U.S. imperialism -S.W.] can pay our debts in our own currency.” This is like using your computer’s printer to print money to pay off your debts. Since the U.S. government happens to own a printing press that prints dollars that “we can pay our debts with” — a privilege denied to everybody else — “we don’t have to worry about our foreign debt.”
This argument, though it contains an element of truth, goes much too far. Take the example of a government that issues its own paper currency. This does not mean that such a government doesn’t have to collect taxes because it can always pay for the commodities, including labor power, it must purchase through its newly printed paper money. If it attempted to do this, it would not get away with it for very long. Such paper money would quickly fall into disrepute and become worthless as the quantity of such paper would explode.
Currency issue whether convertible into gold currency or paper currency must be balanced-off by a mechanism that withdraws currency from circulation. In the case of state-issued paper money, taxes provide such a mechanism because taxes are always payable in paper money. This prevents the quantity of paper money from exploding. There are many examples in history where governments have attempted to finance their expenditures by issuing paper money while unwilling or unable to collect sufficient taxes to finance these expenditures. Invariably the result is runaway inflation.
The fact that so many debts are denominated in dollars, though the dollar represents a variable, not a constant amount of real money — gold — on the world market, does however give U.S. imperialism extraordinary power.
This power was illustrated during the crisis of 2007-2009. The first phase of the crisis began in August 2007 when U.S. credit markets first froze up. The immediate reason for the freeze-up was the dawning realization by market traders that many of the “sub-prime” mortgages had been issued to home buyers who couldn’t possibly afford to pay them. This meant that the huge mass of securities that had been issued on the basis that these mortgages were collectible was, in fact, “toxic assets.” In reality, subprime mortgages were simply the weakest link in a huge chain of credit.
Like all chains, it broke first at its weakest link. In earlier times, a huge scramble for “hard cash” such as occurred in August 2007 would have caused world commodity prices to plummet! But “the markets” — that is, the capitalists who speculate on changes in the prices of stocks, bonds, commodities, and so on — assumed that the U.S. Federal Reserve Board would simply run the “printing presses” to prevent the international chain of credit from collapsing at that point. If the credit chain was allowed to snap, the speculators reasoned, a serious global recession would result, and the Fed certainly wouldn’t allow that to happen, would they?
Instead, the speculators dumped dollars and bought gold and commodities, or rather contracts to receive them — such speculators have no intention of actually receiving the physical commodities. For example, they have no facilities to store the oil.
After only briefly plunging in August 2007, commodity prices as measured in U.S. dollars quickly reversed direction and started to soar instead. As the dollar declined against gold, prices in terms of dollars for commodities such as oil soared. Oil rose from about $75 per barrel just before the initial panic of August 2007 to $147 at one point the following July.
However, figures issued by the Federal Reserve Bank of St. Louis show that the Fed did not create the huge mass of new dollar-denominated token money that the speculators were counting on. Instead, the Fed played a trick on the market. It attempted to redirect credit to places where the chain of payments was breaking, much like the captain of a leaky ship tries to keep the ship afloat by patching the individual leaks. The actual growth rate of the quantity of dollar token money barely rose.
However, since the market expected the Fed to create a huge new mass of token money, the dollar did indeed depreciate against gold. The dollar price of gold bullion rose from about $672 when the crisis first broke out in August 2007 to over $1,000 at one point in March 2008 and generally remained around $900, sometimes higher, through August 2008. Commodity prices responded naturally. Since the U.S. paper dollar now represented less real money — gold — primary commodity prices in terms of paper dollars rose.
This, however, only made the credit strain worse. As prices rose, more dollars were needed to circulate the mass of commodities in the world market, and the debts payable in U.S. dollars rose. But the amount of actual dollar token money necessary to support the increased dollar prices of commodities and pay the rising dollar-denominated debt rose hardly at all. When the market participants realized what was happening, a panic far worse than the one of August 2007 hit the global credit markets in September 2008, starting with the failure of (in)famous Lehman Brothers investment bank.
The chain of credit broke at a thousand and one points; world trade, industrial production, and employment all sharply contracted. Cash — in the form of U.S. dollars, which under the dollar system is the medium in which most debts are denominated — was king. Many speculators who had bought huge amounts of gold expecting its dollar price to rise were forced to sell off their gold to meet demands that their debts denominated in U.S. dollars be paid off immediately. Even if they hadn’t bought their gold on credit, they were often forced to liquidate their gold to meet other debts they had incurred that were being called in that were payable in U.S. dollars. In this way, the panic prevented the grave crisis of the dollar system (reflected in the dollar’s collapse in value against gold) that seemed to be developing between August 2007 and September 2008.
When the panic broke out in full force in September 2008, the dollar, which had been sinking against other currencies such as the euro, pound, and yen as well as against gold, suddenly reversed direction and started to soar. The dollar price of gold, which measures the amount of gold that the dollar represents at any given moment, fell from over $964 on July 12, 2008, to less than $724 on October 31 at the height of the panic.
The dollar hadn’t completely recovered the gold value it had lost after the initial crisis of August 2007, but it had staged a considerable recovery all the same. The dollar’s role as the world’s main means of payment was reaffirmed. The hope expressed by some Marxists and other anti-imperialists that the dollar system was finally on the way out proved once again premature.
At this point, the Fed panicked and began to create token money at a rate that, in the absence of this extraordinary demand for dollars as a means of payment, would imply a five- or six-digit annual level of inflation! The Fed resorted to this desperate measure because it, for good reason, feared a bank run far worse than anything ever seen before in the storied history of capitalist panics, including ones that occurred during the infamous crisis of the early 1930s.
If such a bank run had developed, the hugely inflated mass of credit money, and credit on top of that, would have imploded. The “money supply” would have collapsed much as it did during the 1929-33 crisis. This would have led to a disaster far worse than anything that occurred in the early 1930s. Not only would there have been almost unimaginable levels of unemployment, but there could have been widespread starvation beyond anything that occurred in the early 1930s if wholesale and retail grocers had begun to refuse payment in anything other than green legal tender dollars.
Why is this the case? Society today is far more dependent on credit and credit money — especially credit money issued by the for-profit commercial banks as opposed to the convertible-into-gold currency that was issued by either the U.S. Treasury or the Federal Reserve System until 1933, which could always in a crunch be converted into token money by “simply going off gold.”
During the crisis of 1929-33, there were neither credit cards nor debit cards. In those days, people mostly used cash in the form of either coin made of base metals — a form of token money — or at most, dollars issued by the U.S. Treasury and Federal Reserve that could easily have been converted into token money to purchase food and other essential daily commodities.
The temporary strength of the dollar based on the panic-driven demand for dollars as a means of payment enabled the incoming Obama administration to launch its so-called $800 billion “stimulus plan” — while at the same time continuing to spend hundreds of billions of dollars more on the occupations and wars against the people of Afghanistan, Iraq, and other countries. The Obama administration as well as the leadership of the Federal Reserve System hoped the “monetarily effective demand” that these measures were expected to create would kick-start a new upturn in the worldwide industrial cycle. However, because the demand for dollars was so strong as a means of payment and as a means of hoarding against a renewed crisis, the subsequent rise in the industrial cycle was much weaker than expected.
The European Central Bank, because of the far more limited role of the euro as a means of payment and the lack of a centralized European-wide central government, was obliged to be far more cautious. Indeed, the crisis of 2007-09 was followed by a long-drawn-out “sovereign debt crisis,” as it was called, in Europe. This crisis renewed the recession in the weakest European countries, such as Greece, as they were forced to adopt drastic cuts in government spending.
This sovereign debt crisis greatly hindered the recovery from the global recession but also helped keep the demand for the U.S. dollar high as a means of payment — though not as high as at the height of the crisis in 2008 and early 2009 — thereby staving off for the time being a full-scale dollar crisis despite the continued rapid growth of the quantity of dollar-denominated token money.
As a general rule, it is correct for the monetary authority to meet the demand for extra means of payment during a crisis. Marx strongly criticized the English banking legislation of 1844 precisely because it prohibited the Bank of England from issuing extra banknotes in excess of its gold reserves during crises, even when there was no threat to the continued convertibility of the Bank of England’s banknotes into gold. Since the public knew that due to the Bank Act of 1844, the Bank of England could not issue banknotes to meet the extra demand for them as a means of payment during crises, capitalists would attempt to immediately convert their deposits and other assets into Bank of England notes at the first sign of the crisis. This greatly intensified the crises.
As a result, during the three successive crises of 1847, 1857, and 1866, the banking legislation that limited the issuance of banknotes by the Bank of England had to be suspended. In two of the three cases, the crises of 1847 and 1866, no additional banknotes had to be issued to halt the panic. All it took was for the public to know the Bank of England could issue extra notes if additional means of payment were demanded.
Only during the crisis of 1857 were extra banknotes actually issued, and then only briefly. On that occasion, the issuing of banknotes in excess of the Bank of England’s gold reserve in no way threatened the convertibility of the Bank of England banknotes into gold.
But when the monetary authority goes beyond the meeting of a demand for extra means of payment in a crisis and expands the supply of means of payment in the form of token — not credit — money to prevent the prices measured in terms of paper money from falling, there are indeed serious economic consequences. First, such policies, sometimes called “inflation targeting,” are incompatible with any form of the gold standard, including the post-World II Bretton Woods system.
A situation where prices of most commodities rise continuously — as opposed to periodically — in terms of the money commodity is highly unlikely. The reason is that if the commodity that serves as the universal equivalent — money — falls continuously in its relative value against most other commodities, it will lose its role as money.
For example, silver in the final decades of the 19th century started to fall sharply in value against other commodities. As a result, silver became progressively demonetized. If in the future, the value of gold were for a prolonged period to fall relative to the value of most other commodities, it too would be replaced in its role as money by another commodity, probably another still more precious metal.
Keeping the above in mind, we know that market prices fluctuate around prices of production, sometimes exceeding them and sometimes falling below them. And we also know that with certain modifications [see appendix on the transformation problem] prices of production are themselves governed by relative labor values of commodities, on one side, and the commodity that in its use value measures the value of all other commodities on the other. This means that under the gold standard, periods of rising prices must be offset by periods of falling prices.
However, since the economic crisis of 1929-1933 — the causes of the extraordinary severity of this crisis will be examined in future chapters — the monetary authorities have striven to prevent any fall in the general price level measured in terms of currency. The only way to prevent periodic falls in prices is to periodically devalue the paper currencies against gold — that is, the currency price of gold must periodically be allowed to rise.
Over time, the monetary tokens of a given denomination — such as one dollar — have come to represent ever more minute weights of gold. For example, the U.S. dollar, which represented 0.04838 troy ounces of gold before 1933 when the policy of preventing any fall in the general price level as measured in currency began, had fallen to around 0.00067 troy ounces by 2011. In May 2011, the dollar represented only about 1.38 percent of the gold — money material — that it represented in February 1933 just before the periodic dollar devaluations began!
These policies of the U.S. government and its monetary authority — the Federal Reserve System — made the collapse of the post-World War II Bretton Woods System inevitable. The Bretton Woods system was a modified form of the international gold standard. Its centerpiece was the fact that the dollar was defined as 1/35th, or 0.2857, troy ounce of gold. However, there was no way to keep the dollar price of gold at $35 an ounce while the price of almost all other commodities kept right on rising.
The cost price of a troy ounce of gold kept rising while the “selling price” remained $35. This progressively undermined the profitability of mining gold, both relative to other commodities and absolutely. A commodity that is not profitable to produce — even if it functions as the money commodity — is not produced under the capitalist mode of production. Eventually, the growing shortage of gold meant that the dollar price of gold could not be maintained at $35 — despite the continuing promises of the U.S. Treasury to the contrary — and the dollar price of gold exploded upward, depreciating the dollar.
This is an example of the law of the labor value of commodities in action. The real prices — that is, the prices of commodities measured in the use value of gold — could not keep rising indefinitely no matter how much the economists influenced by Lord Keynes believed that was desirable. The only way to keep the dollar price of commodities rising once the price of commodities in terms of gold had risen significantly above their prices of production was to devalue and depreciate the dollar — reduce the quantity of gold that a dollar represented. When this happened, the actual commodity prices in terms of the use value of gold — real prices — fell sharply, and only the dollar price of commodities continued to rise.
Lack of liquidity versus lack of solvency
Accountants define a company as insolvent when its liabilities exceed its assets. If prices rise, assuming its liabilities remain unchanged, a company that may be insolvent at one price level becomes solvent at a higher price level. We know as Marxists — though not modern bourgeois economists — that commodity prices are, in the final analysis, governed by the relative labor values of commodities and the money commodity. Therefore, if a company’s assets exceed its liabilities when commodity prices are at their average levels — that is, more or less at levels that directly reflect their labor values — the company can be considered solvent.
During periods of abnormal demand for means of payment, such as during crises of overproduction, a perfectly solvent enterprise might be unable to come up with the cash to meet panicky demands for immediate repayment of debts that would not be made under normal conditions. Under these conditions, industrial and commercial capitalists are forced to sell their commodities at prices that are well below their prices of production to raise cash to meet immediate demands for payment under pain of losing all their capital. Therefore, capitalists that are perfectly solvent, assuming market prices that are near the prices of production, can be forced into bankruptcy.
The classic case involves commercial banks under the fractional reserve system. The bankers know that under normal circumstances, their customers will never attempt to withdraw all their money at the same time. They, therefore, keep far less cash on hand — in the form of vault cash and their deposits in the central bank — than they would need to pay all their depositors if the depositors suddenly cashed in their accounts. All other things remaining equal, the bankers make higher profits the less cash they keep idle in their vaults or at the central bank.
However, during a crisis, an abnormal demand for money as a means of payment develops. This creates a danger that a substantial fraction of the deposit-owning public will attempt to withdraw money from the commercial banking system. Such bank runs can force perfectly solvent banks into bankruptcy.
It is, therefore, a legitimate operation from the viewpoint of the economic laws that govern the capitalist system for the central bank to loan extra means of payments to such banks until the panic subsides and the demand for money as a means of payment returns to a more normal level.
Proper and improper financial operations
To avoid misunderstandings regarding proper and improper operations, I am referring to what is proper and improper from the viewpoint of the economic laws that govern the capitalist system and not what the workers should demand. These are two completely different things. The workers’ movement is not — or at least should not — be bound by the economic laws of capitalism. Unlike the capitalist class, the working class has the power to go beyond them by building a socialist economy.
However, if a bank has loans to enterprises and people who cannot repay them, even when there is no abnormal demand for money as a means of payment, such a bank, like the enterprises it has loaned money to, is insolvent. The bank’s liabilities in the form of deposits will exceed its assets — its loans. Such a bank will collapse sooner or later. In this case, the job of the central bank and bank regulators is to liquidate such an institution in a way that does not disrupt the payments system as a whole — that is, disrupt the convertibility of deposit money into hard cash. In such cases, the stockholders of such a bank are supposed to lose their entire investment in the bank. This was the reigning doctrine among bank regulators in England by the late 19th century.
However, today’s bourgeois economists and central bankers, who have no understanding of the law of labor value of commodities, believe that they can “manage the currency” in such a way that there is a continuous if gradual rise in the general price level — between 1 to 3 percent per year. Therefore, they believe that many industrial and commercial enterprises and the banks that loan money to them that would be insolvent under a gold standard, where prices must periodically fall, can thus be kept solvent. In this way, they imagine they defeat the basic economic laws of capitalism without abolishing capitalism.
Stabilization recessions
This playing with the basic laws that govern the capitalist system, however, has all kinds of effects that we will examine closely in future chapters. One example that we can look at here is what is sometimes called a “stabilization recession.” Such a recession occurs when the monetary authorities stabilize the gold value of the currency after a period of progressive currency devaluation.
During periods of currency devaluation — defined as a rising currency price of gold — both industrial and commercial capitalists expect primary commodity prices measured in terms of the depreciating currency to rise. The capitalists buy commodities and stockpile them before commodity prices — in terms of the depreciating currency — rise while putting off the sale of the commodities they sell to allow for as much time as possible for the prices of these commodities to rise.
Speculators appear who buy commodities for the sole purpose of withholding them from the market as prices rise. Such speculation further accelerates inflation but is not the real cause of it.
As long as primary commodity prices remain high in terms of depreciating currency, it is only a matter of time before the higher primary commodity prices work their way through “the pipeline” of wholesale prices to retail prices.
Therefore, the measures that all capitalists must take under pain of losing all or part of their capital lead to higher prices — first primary commodity prices, then wholesale or producer prices, and finally retail prices. The workers, too, must demand higher wages in terms of the depreciating currency, or sooner or later, real wages will fall below the levels that enable the workers to reproduce their labor power.
Economists of the Keynesian school then blame the rise in the nominal wages of the workers for inflation, which is really caused by the inflationary policies of the monetary authorities. They falsely claim that if only the workers were to practice “wage moderation,” inflation would not occur no matter how much the currency is devalued (against gold). Such demands for “wage moderation” are never matched with demands for profit moderation. On the contrary! A rise in the rate and mass of profit for the capitalists is seen as the key to recovery! We will examine this more closely in future chapters that will deal with the work of Keynes.
As the currency depreciates, a race develops between the rising general price level and the growth of the quantity of both token money and the much greater quantity of credit money that is built on top of the base of token money. At some point, the monetary authority, under pain of the collapse of the currency altogether, is forced to “stabilize the currency” — that is, halt its further depreciation. One such example is the “Volcker shock” of 1979-1982.
The Volcker shock is named after Paul Volcker, who was chairman of the board of governors of the Federal Reserve System between August 1979 to August 1987. During the five months between August 1979 and January 1980, the dollar price of gold more than doubled, rising from around $300 in August 1970 an ounce to $875 an ounce at the peak in January 1980. In less than six months, the U.S. dollar, which wasn’t just any currency but the pivot of the entire world’s monetary and credit system, lost more than half its gold value! The market feared that in a last-ditch attempt to stave off the then-looming recession, the Federal Reserve System would double the dollar monetary base in a bid to prevent the rate of interest from exploding.
In the fall of 2008, this is exactly what the Federal Reserve Board did. It was able to do so because the panic was already in full swing creatin,g an extraordinary demand for the dollar as a means of payment and hoarding. But this was not the case when Paul Volcker was appointed chairman of the Federal Reserve Board. Volcker though he did not slow down the rate of growth of the dollar monetary base, refused to accelerate it either to accommodate the soaring rate of dollar price inflation. The result was an explosion of the rate of interest, a contraction of credit, and a prolonged period of recession that led to the collapse of much of U.S. and British basic industry. That was the price that had to be paid to save the dollar system.
The general pattern of crises under the dollar system is that a crisis of the dollar immediately precedes the outbreak of a general crisis of overproduction. When the crisis does break out, it creates a sudden increase in the demand for U.S. dollars as a means of payment and hoarding, thus ending the immediate threat to the dollar system.
When the monetary authority, after a period of currency depreciation, moves to stabilize the currency, a stabilization recession results. The stabilization recession develops as it becomes clear to the capitalists that the monetary authority is serious about “halting inflation.” Expectations of rising primary commodity prices change into expectations of falling primary commodity prices.
Instead of buying more commodities to “beat the price increases,” the capitalists suddenly put off purchases as long as possible to take advantage of the now-falling primary commodity prices. On the other hand, commodities that were previously withheld from the market in order to wait for still higher prices are suddenly dumped on the market in the hope they can be sold off before prices fall even more.
Apparent commodity shortages turn into commodity gluts overnight. One-day production can’t keep up with demand. The next day, mountains of unsold commodities pile up in the warehouses. The result is canceled orders, falling industrial production, and contracting employment, just like what happens during crises of overproduction. Such stabilization crises, therefore, mimic the symptoms of crises of overproduction and can indeed become intertwined with actual crises of overproduction, as we will see in future chapters.
However, in principle, we should distinguish between stabilization recessions that can be abolished by restoring the gold standard — that is, passing legislation that takes away the ability of the central bankers to lower the value of the currency by forcing them once again to redeem the currency they issue for gold bullion or coin at a fixed rate to the bearer on demand — and crises of overproduction that can only be abolished by transforming capitalist production into socialist production. Crises of overproduction and stabilization recessions are two quite different things.
Therefore, a theory of crisis must first be constructed assuming a gold standard where only metallic and credit money exist. Only in this way will it be possible to separate the cyclical movements that arise from the basic contradictions of capitalism from the additional layer of instability that arises from attempts to manipulate the value of the currency in an attempt to offset the fluctuations of the industrial cycle.
(1) Capital, Volume III Part V: Division of Profit into Interest and Profit of Enterprise. Interest-Bearing Capital. Chapter 36. Pre-Capitalist Relationships https://www.marxists.org/archive/marx/works/1894-c3/ch36.htm (back)
A Critique of Crisis Theory 