The Federal Reserve System, Its History and Function, Part 1

This is a special post in two parts on the U.S. Federal Reserve System. It is in response to the rise of the Occupy Wall Street movement. Part 2 will be published on November 6, and the next regularly scheduled reply on the crisis of the dollar system will be published on November 20.

The last weeks in the United States have seen a sudden surge of anti-Wall Street demonstrations that have targeted the policy of the U.S. government of “bailing out banks and not people.” The occupation movement has since spread first across the United States and now the world.

The followers of Ron Paul, a right-wing Republican congressman and presidential primary candidate from Texas, have appeared at some of the occupations and raised the slogan “End the Fed.” Paul believes that not only “the Fed” but democracy in any form should be abolished. Paul’s followers blame the Federal Reserve System for virtually all the problems faced by the lower 99 percent—high unemployment, the high cost of living, mass indebtedness, “underwater” homes, and foreclosures.

But what actually is the Fed, or to use its formal name, the Federal Reserve System? Is it some kind of privately owned bank, or is it a government agency? What is the difference between the Federal Reserve Board and a Federal Reserve bank? Is the Fed really to blame for the problems of the lower 99 percent of the population? And if the answer is yes, why would such an evil institution have been established in the first place?

World Trade and the False Theory of Comparative Advantage

Some introductory remarks

This reply and the one that will follow should be seen as a continuation of my reply criticizing the view of economist Dean Baker that the U.S. dollar is “overvalued” and his claim that the U.S. trade deficit could easily be corrected and the U.S. unemployment crisis eased by simply lowering the exchange rate of the U.S. dollar against other currencies.

I had originally planned to continue the discussion of world trade and currency exchange rates the following month but the contrived U.S. government debt crisis in August forced a change of plans.

Reader Mike has made some interesting remarks about world trade and the dollar system—the foundation of the American empire, which has dominated the world politically, militarily as well as economically since World War II. To understand the growing threat of a renewed crisis barely two years after the official end of the “Great Recession” of 2007-09, it is important to understand both world trade and the dollar system.

Discussing Baker’s arguments for a lower dollar, Mike wants to know if there is an objective basis for determining if currencies are “high” or “low” in relation to one another. Baker summarizes his argument as follows:

“The U.S. pattern of spending more than it takes in is due to the fact that the dollar is too high. In a system of floating exchange rates, like the one we have, the price of currencies is supposed to fluctuate to bring trade into balance. This means that the trade deficit is caused by the over-valued dollar and a decline in the dollar is the predictable result.”

The obvious problem with the view that the U.S. dollar is “overvalued” is that ever since the end of the Bretton Woods system 40 years ago, the exchange rate of the U.S. dollar has shown a secular tendency to decline against other currencies. If the dollar was “too high” in the sense that there is a correct level of exchange rates that would end the U.S. trade deficit, why hasn’t the secular fall in the dollar brought the U.S. trade account into balance?

A Keynesian Takes on Karl Marx

In this reply, unless otherwise noted, text in italics and in brackets in Marx quotes is carried over from the version taken from the Marxist Internet Archive.

A friend N has asked if there is any difference between “the over-accumulation of capital” and “the overproduction of commodities.” Another friend M sent me a critical article by leading American Keynesian economist Brad DeLong on Chapter 17 of Marx’s “Theories of Surplus Value.” DeLong’s article is titled “Marx’s Half Baked Crisis Theory and His Theories of Surplus Value, Chapter 17.”

It so happens that in Chapter 17 Marx deals with the relationship between the “overproduction of capital”—also called the “over-accumulation of capital”—and “the overproduction of commodities.” The economists of Marx’s time—the middle years of the 19th century—admitted the “overproduction of capital”—equivalent to the over-accumulation of capital—while denying the “overproduction of commodities.”

Therefore, DeLong’s critique of Marx and N’s question about the relationship between the overproduction of commodities and the over-accumulation of capital are connected by Chapter 17 of “Theories of Surplus Value,” the target of Brad DeLong. It is therefore possible to deal with DeLong’s critique and N’s question in a single reply.

Is the Economic Crisis Over?

According to the media, the world capitalist economy has been in a recovery for almost two years. Yet there remains a widespread impression that the economic crisis that began in 2007 is far from over. True, the rate of profit has risen sharply since 2009, and the mass of profits is at record levels. Yet the crisis of mass unemployment persists.

At the current rates of job creation in the U.S. and other imperialist countries, it will be years before the number of jobs returns to the levels that prevailed in 2007 on the eve of the crisis. And even the pre-crisis 2007 levels were far from full employment. Therefore, is the economic crisis that began in 2007 really over?

The passage of a cyclical crisis described

Rosa Luxemburg in “What Is Economics?”—which was written shortly after the economic crisis of 1907-08—gave this vivid description of how a cyclical crisis of overproduction is reflected in the capitalist media:

“…once the crisis is in full swing, then the argument starts about who is to blame for it. The businessmen blame the abrupt credit refusals by the banks, the speculative mania of the stockbrokers; the stockbrokers blame the industrialists; the industrialists blame the shortage of money, etc.”

Though these words were written a century ago shortly after the 1907-08 crisis, they could just as well have been written to describe the crisis that began exactly a century later in 2007.

The recovery

“And when business finally picks up again,” Luxemburg continued, “then the stock exchange and the newspapers note the first signs of improvement with relief, until, at last, hope, peace, and security stop over for a short stay once more.”

“Modern society,” Luxemburg further explained, “notes its [the cyclical crisis—SW] approach with horror; it bows its head trembling under the blows coming down as thick as hail; it waits for the end of the ordeal, then lifts its head once more—at first timidly and skeptically; only much later is society almost reassured again.”

Crisis of 1907-08 in historical perspective

As it turned out, after the crisis of 1907-08 capitalist society had little time to get “reassured again.” If the industrial cycle that began with the crisis of 1907 had followed the typical 10-year course, the next crisis of overproduction would have been due around 1917.

Instead, a new worldwide recession began in 1913, about four years early. In Europe, this new recession did not end with a new upswing that left society “almost reassured again.” Instead, it ended with the “Guns of August”—the outbreak of World War I.

Capitalism ‘celebrates’ the anniversary of 1907 crisis

The capitalist economy “celebrated” the 100-year anniversary of the crisis of 1907 in the most “appropriate” way possible—with yet another crisis. And like its predecessor a century earlier, the crisis that began in 2007 proved to be unusually severe. There is a feeling now that the crisis of 2007-09 is perhaps, like the crisis of 1907-08, no ordinary crisis. Could this crisis, too, be the herald of a far more fundamental crisis of capitalist society?

Are Marx and Keynes Compatible Pt 8

Sweezy attempts to develop a theory of crises in ‘Theory of Capitalist Development’

In “Monopoly Capital,” Sweezy (and Baran) treated crises and the industrial cycle only in passing. In contrast, in “The Theory of Capitalist Development” Sweezy examined Marxist crisis theory in considerable detail. Even today, “The Theory of Capitalist Development” can be recommended for anybody interested in the development of Marxist crisis theory in the first part of the 20th century.

In his survey, Sweezey examined the writings of such Marxists as Kautsky, Hilferding, Rosa Luxemburg and Henryk Grossman. Sweezy found essentially three crisis theories among these early 20th-century Marxists.

One was put forward by Karl Kautksy around the turn of the 20th century. It involved the question of whether capitalism was evolving toward a state of chronic depression.

What is sometimes called the “Great Depression” of 1873-1896 had come to an end, and the world capitalist economy was entering a phase of rapid economic expansion. According to Kautsky, it was the existence of agrarian markets still dominated by pre-capitalist simple commodity production that explained capitalism’s continued ability to grow.

However, as capitalism continued to develop, these markets would be expected to decline in importance and the world capitalist economy would, if socialist revolution did not intervene, sink into a state of more or less permanent depression. This would mark the end of capitalism’s ability to develop the productive forces of humanity.

Therefore, according to Kautsky, the cyclical crises and their associated depressions were heralds of the approaching state of permanent depression. As such, they were reminders that capitalist production was historically limited and would inevitably give way to a higher mode of production.

Later, in 1912, Rosa Luxemburg attempted to prove Kautsky’s turn-of-the-century views in a rigorous way in her “Accumulation of Capital.” Luxemburg believed that she had indeed proven that assuming that all production is capitalist—that is, there are no more simple commodity producers—expanded capitalist reproduction would be a mathematical impossibility. And remember that according to Marx capitalism can only exist as expanded reproduction.

Are Marx and Keynes Compatible? Pt 5

Keynesian economists blame their failure on the trade unions

Keynesian economists in general—and some Marxists influenced by them—blame the failure of the Keynesian policies of the 1970s on the trade unions. Basing themselves on Keynes, they falsely blame the inflation of the 1970s not on the inflationary monetary policies of the central banks that were so strongly supported by Keynesian economists at the time but on the trade unions.

These economists claim that by achieving raises in money wages during the inflation, “over-strong” unions were responsible for the inflation of the 1970s. Supposedly, a “wage-price spiral” pushed money wages relentlessly higher forcing the central banks to periodically raise interest rates to prevent even worse inflation, which in turn led to the recessions and unemployment of the 1970s and early 1980s.

However, in reality it was the trade unions that found themselves increasingly on the defensive as both inflation and unemployment rose during the 1970s and into the early 1980s. What the Keynesian economists call the “wage-price spiral” of the 1970s was really a “price-wage spiral.” The unions were only reacting to the ongoing inflation in their attempts to maintain—not entirely successfully—the living standards of their members.

Are Marx and Keynes Compatible? Pt 4

The Keynesian revolution in economic policy

Before Keynes, neo-classical marginalist economists believed that capitalism was stable if left to its own devices. These economists held that a capitalist economy tended strongly toward an equilibrium at full employment of both workers and machines. Therefore, if a recession were to occur the response of the authorities should be pretty much confined to having the central bank lower the discount rate. Otherwise, the government should stay out of the way. As long as it did, the marginalists claimed, the capitalist economy would quickly move back to its only possible equilibrium position, “full employment.”

The events that followed World War I, especially the U.S.-centered Great Depression of 1929-1941, discredited this view. Under the influence of Keynes—and more importantly the Depression itself—most of the new generation of (bourgeois) economists believed that it was now the duty of the capitalist government to actively intervene whenever recession threatened.

Bourgeois economics split in two. One branch, purely theoretical, is called “microeconomics.” Microeconomics is simply the old marginalism. The branch that emerged from the Keynesian revolution is called “macroeconomics.”

Macroeconomics tries to explain the movements of the industrial cycle. More importantly, it seeks to arm the capitalist governments and “monetary authorities” with “tools” that will keep the capitalist economy from sinking again into deep depression with the resulting mass unemployment. The new stance of the bourgeois economists was that if the capitalist governments and their monetary authorities use the “tool chest” provided them by macroeconomics correctly, they should be able to maintain “near to full employment with low inflation.”

Full employment was defined by this new generation of (bourgeois) economists not the way workers would define it—everybody who desires a job can quickly find one—but rather as a level of unemployment sufficiently high to keep the wage demands of the workers and their unions in check but low enough to prevent wide-scale unrest that could lead to working-class radicalization and eventually socialist revolution.

Are Marx and Keynes Compatible? Pt 3

In the October 2010 edition of Monthly Review, John Bellamy Foster wrote that John Maynard Keynes demonstrated that ”the economy did not automatically [emphasis added—SW] equilibrate at full employment.” (“Notes from the Editors”)

Here Foster does not in any way distinguish his own views from those of Keynes. He seems to assume that Marx as well held the view that while capitalism does not automatically equilibrate at full employment it can be made to do so if the government and the monetary authorities follow policies designed to achieve full employment. This was indeed Keynes’s opinion. But did Marx agree? Is it really possible to achieve full employment under the capitalist system?

A New Gold Standard?

A reader asks, what is the significance of the reported moves by the central banks of China, India, Russia and perhaps other countries to increase their gold reserves? Why are China, India and Russia moving to increase the percentage of their reserves held in gold as opposed to foreign currencies such the dollar and euro? Could the moves of these countries to increase their gold reserves point to a possible revival of the international gold standard in some form?

The answer to the first question is that these countries are nervous about the future of all paper currencies. During the first phase of the crisis of 2007-09, the dollar fell not only against gold but also against the euro. Naturally, countries increased the percentage of euros in their reserves, since it seemed like a good bet against the falling dollar.

Then came the sovereign debt crisis in Europe that assumed acute form just a month or so ago. The euro plunged against the dollar. But the dollar is not looking too good itself. While the dollar was soaring against the euro, it was slipping against gold, the money commodity. For the first time, the dollar price of gold inched above $1,200. Unlike paper currencies, gold is a commodity. And like all commodities, its value is determined by the amount of labor socially necessary to produce it under the prevailing conditions of production.

With the world’s gold mines facing growing depletion, the value of gold for the foreseeable future seems a little more certain than the future value of any paper currency, whether the dollar, euro or yen. No matter how bad things get, gold cannot be “run off the printing presses.” New gold can be produced and the existing supply increased only by the slow process of the labor of workers in the gold mines and in the gold refining industry.

Does this mean that the international gold standard is about to be restored? The answer for the immediate future is a definite no. The three countries that are reportedly moving to increase their gold reserves are not imperialist countries. Indeed, these countries have few gold reserves. The great bulk of the gold that is held by governments or central banks is held by the governments of the United States and the European satellite imperialist countries such as Germany, France and Italy.

The Greek Workers Show the Way

A reader wants to know how the crisis that has developed in European and world financial markets will affect the current economic and political situation.

In the first week of May, renewed panic hit world financial markets. This time the crisis was centered in Europe and the European government debt market. The immediate cause of the crisis was the fear that the government of Greece would not be able to meet payments on its bonds that were coming due later in the month.

The resulting panic drove the interest rate on Greek government bonds well into the double digits, while stock markets plunged around the world. The crisis began to spread from the bonds of Greece to the bonds of other weaker European powers such as Portugal, Spain and Ireland.

Both Washington and the European governments fear that a major new contraction in credit could set in that would end the weak economic recovery that has been visible since the middle of last year, and renew the worldwide economic downturn—perhaps transforming the “Great Recession” into Great Depression II.

After a round of frantic emergency meetings over the weekend of May 8-9, the European Union, the International Monetary Fund and the U.S. Federal Reserve announced a round of emergency measures to raise almost a trillion dollars aimed at propping up the global credit system and bailing out the holders of Greek government debt—not the Greek people—while preventing the collapse of the euro.

The situation was so grave that French President Nicolas Sarkozy canceled a scheduled visit to Moscow to celebrate the surrender 65 years ago of Nazi Germany. During the frantic meetings, German Finance Minister Wolfgang Schauble collapsed and had to be hospitalized.