Paul Volcker’s Banking Reform Proposals and Socialist Revolution

A reader wants to know what I think is behind Paul Volcker’s banking reform proposals.

Paul Volcker (1927- )—yes, the same Paul Volcker who was the chief architect of the “Volcker Shock” a generation ago, and a long-time Democrat—is currently head of President Obama’s Economic Recovery Advisory Board. On January 21, Obama with Volcker at his side proposed a series of reforms that Obama dubbed the “Volcker Rule.”

Volcker’s proposed new regulations would ban commercial banks from owning or investing in hedge funds and private equity firms. Essentially, Volcker’s proposed rule would ban, or at least limit, any firm engaged in commercial banking from owning and trading stocks, corporate bonds, commodities and derivatives for its own account.

Unlike his predecessor, Republican Alan Greenpan (1926- ), Volcker is highly dubious about so-called “financial innovation.” He has remarked that “the only useful banking innovation was the invention of the ATM.”

In August 1979, then U.S. Democratic President Jimmy Carter appointed Volcker to be chairman of the Federal Reserve Board—the government body that controls the U.S. Federal Reserve System. Volcker reversed the Keynesian policy of attempting to keep interest rates low by increasing the rate of growth in the quantity of token money that the Fed creates. Instead, he allowed interest rates to increase to a level never seen before—or since.

For example, at one point under Volcker, the federal funds rates—the rate of interest that commercial banks pay on overnight loans they make to one another—hit 20 percent, a far cry from the Fed’s current federal funds target of between 0 and 0.25 percent! These unprecedentedly high interest rates sent the U.S. economy into a tailspin pushing even the official unemployment figures into the double digits for the first time since the end of the 1930s Depression.

But the high interest rates—known as the “Volcker Shock”—did halt the depreciation against gold of the U.S. dollar and the other paper currencies linked to it under the dollar system, bringing the 1970s “stagflation” to an end.

The Volcker Shock marked the transition from the reformist “Keynesian” era of making concessions to the working class and to the oppressed countries to the period of “neo-liberalism” with its rising imperialist exploitation of the oppressed countries combined with the global offensive by the ruling capitalist class against the world working class aimed at raising the rate of surplus value. The abnormally high interest rates, which lingered for many years after the Volcker Shock, also witnessed the emergence of the phenomena now called “financialization.” I plan to examine financialization in a future reply.

Gibson’s Paradox, the Gold Standard and the Nature and Origin of Surplus Value

Charley in a comment on this post pointed out an article, “Gibson’s Paradox and the Gold Standard,” by U.S. marginalist economists Robert B. Barsky and Lawrence H. Summers, that appeared in the June 1988 edition of the Journal of Political Economy.

To tell the truth I played with the idea of working Gibson’s paradox into the main series of posts but ultimately couldn’t quite find an appropriate way to do it. I therefore am delighted that Charley raised the subject.

Gibson’s paradox—a term coined by Keynes in his 1930 book “A Treatise on Monetary Reform”—is named for British economist Alfred Herbert Gibson, who noted in a 1923 article for Banker’s Magazine that the rate of interest and the general level of prices appeared to be correlated.

The “paradox” involves a major contradiction between marginalist economic theory on one hand and the actual history of prices and interest rates under the gold standard on the other.

The question of “interest” involves the holiest of holies of economics, the nature and origin of surplus value. The marginalists confuse the rate of interest, which is only a fraction of the total profit, with the rate of profit. They falsely claim that if the economy is in equilibrium, there will be only interest and no profit. They therefore make their task of explaining away surplus value much easier by first reducing the total surplus value, or profit—which is divided into interest and profit of enterprise—plus rent, into interest alone.

Why Prices Rise Above Labor Values During a Boom

Nikolas wants a clearer explanation of exactly what causes commodity prices to rise above their labor values during the upswing in the industrial cycle. In order to fully grasp the nature of the capitalist industrial cycle, it is important to understand why this is so.

In my answer to Nikolas, I want to emphasize that I am discussing changes in prices in terms of money material, or gold. I am not interested here in price changes that represent changes in the value of paper money in terms of real money—gold. I am also assuming for purposes of simplification a single ideal industrial cycle and ignore the question of long waves or long cycles in prices, since these do not affect the basic argument I am making.

Responses to Readers — Austrian Economics Versus Marxism

Some readers have expressed interest in the Austrian School of economics. What is the Austrian School, and what is its role?

The Austrian School is a branch of marginalist economics. It differs from the other schools of marginalism by avoiding mathematics. Instead, it specializes in advocating marginalist ideas in ordinary language. In contrast, most of the other schools of modern marginalism specialize in building mathematical models that are only accessible to those who have mastered the necessary higher mathematics.

The reason why the Austrian School avoids math is that unlike most professional economists they aim their arguments at the “non-mathematical” lay public. The Austrian School—as its name implies—began in German-speaking Austria. As a result, it soon found itself in intense ideological combat with the Marxist-led Austrian workers’ movement. While most marginalists simply ignored Marx, the Austrian School attempted to refute him.

The Austrians specialize in demoralizing intellectuals attracted to the workers’ movement, attempting to steer them toward reactionary bourgeois economics and politics instead.

Since they concentrate on refuting Marx, they are frequently somewhat more familiar with Marxist ideas than are most professional bourgeois economists. As intellectuals they love to play with ideas, and have in fact absorbed certain ideas from Marx, which they use for their own purposes. Undoubtedly, Austrian economic theory was influenced by the Austro-Marxist School and the Austro-Marxists were, in turn, influenced by the ideas of the Austrian School. I will examine some of these mutual influences below.

Factors that Limit the Life Span of the Capitalist System

In this final post in the series that began in January 2009, I will summarize the various factors that make impossible the permanent existence of the capitalist system of production.

First, let’s examine the effects of the tendency of the rate of profit to fall. Many Marxists see this tendency as the crucial factor that dooms the capitalist system to perish in the long run.

Capitalism is above all a system of production for profit and only profit. But Marx showed that with the growth of the productivity labor—expressed under capitalism by a rise of the organic composition of capital—the rate of profit tends to fall. A major contradiction of capitalism is that though it is a system of production for profit its very development tends to lower the rate of profit. Doesn’t this make the downfall of capitalism inevitable sooner or later.

Can the World Market Ever Become Exhausted?

A century ago, the belief that the world market was headed for eventual exhaustion was widely accepted among the left wing of the Social Democracy, especially in the German-speaking world. But the refutations of Rosa Luxemburg’s “Accumulation of Capital” and her “Anti-Critique,” based on Marx’s volume II diagrams of capitalist reproduction, pretty much discredited the idea that the world-market could ever face a situation ofpermanent exhaustion.

Cyclical crises were viewed as being caused by disproportions among the various branches of production. Such disproportions were viewed as temporary. In the long run, the limits of the market were seen as the limits of production.

Yet no less a Marxist than Frederich Engels himself apparently shared the idea that the world market could become exhausted. Engels believed this not only in the days of his youth but at the very end of his life. In chapter 31 of volume III of “Capital,” Marx’ used British export data to demonstrate that each successive peak in the industrial cycle exceeded its predecessor. Engels included in brackets this interesting note, which I will quote in full:

“Of course, this holds true of England only in the time of its actual industrial monopoly; but it applies in general to the whole complex of countries with modern large-scale industries, as long as the world-market is still expanding [emphasis added—SW].”

So in 1894—the year before he died—Engels could still imagine a time when the world market would no longer be expanding. It is significant that the above remarks of Engels appear in volume III of “Capital,” nine years after Engels had brought out volume II of “Capital,” the volume that includes Marx’s famous diagrams of simple and expanded reproduction. Therefore, presumably Engels was throughly versed in Marx’s theories and mathematical diagrams of simple and expanded reproduction, but he apparently didn’t draw the conclusion that so many other Marxists drew from them. That conclusion being that as long as the correct proportions were maintained between the various branches of production, the market would only be limited by production.

Economic Crises, the ‘Breakdown Theory’ and the Struggle Against Revisionism in the German Social Democracy

Among the assertions of the revisionist movement, led by Eduard Bernstein within the German Social Democratic Party, was their claim that generalized world economic crises were unlikely to recur. Similar claims were made during the 1960s—taken seriously by certain Marxists of those days—as well as during the recent “Great Moderation.”

Bernstein thought that general crises were already a thing of the past in the late 1890s. A little premature to say the least! This was well before such economists as John Maynard Keynes and Milton Friedman, who according to their followers had discovered the way to abolish capitalist crises without abolishing capitalism itself. It seems that such bourgeois claims—always duly echoed by certain forces in the workers’ and left movements such as Bernstein’s original revisionists—are themselves cyclical.

While Bernstein and other like-minded forces in the old Social Democracy held that capitalist crises were fading away, revolutionists like Rosa Luxemburg put great emphasis on the periodic capitalist economic crises. To the revolutionary wing of the Social Democracy, the recurring capitalist economic crises were a sign of the approaching “breakdown” of capitalism, the very “breakdown” that the revisionists denied. The revisionists pointed to the “fact” that crises were becoming less intense and generalized as a sign that capitalism was adapting itself to the new forces of production that were being created.

Bernstein and his fellow revisionists drew the conclusion that the perspective was not a workers’ revolution that would overthrow the political rule of the capitalist class and then transform the capitalist form of economy into socialism. Instead, the revisionists foresaw a gradual and more or less continuous reform of the existing social order in the interest of the workers.

Or, as Bernstein put it, the movement is everything, the final goal is nothing. From the revisionist perspective, a major future capitalist economic crisis would only get in the way of the struggle for reforms. The different views on capitalist crises and their future among the German Social Democrats of a century ago coincided with the divisions between the revolutionists on the left, the revisionists on the right, and the centrists who wavered between the two.

In the years that followed, and down to our own day, the attitude toward crises and the tendency toward a an economic breakdown of capitalism has continued to divide the left and right wings within the workers’ movement.

The Dollar Empire and the ‘Great Moderation’

During the “Great Moderation,” the United States became increasingly dependent on imports to maintain its standard of living. When we talk about the standard of living of a nation, we should always be careful to distinguish between the standards of living of the different classes and strata of the population.

The decaying U.S. industrial base and the consequent absolute decline in the level of factory employment during the Great Moderation devastated the standard of living of factory workers. Those industrial workers who did maintain their jobs often had to accept wage cuts and worsening working conditions. This was particularly true for the young generation of factory workers. The unions often accepted two-tier contracts that protected the wages and benefits of older workers at the expense of those of new young workers.

The younger workers who found factory jobs during the Great Moderation were lucky. Many young workers, especially workers of color in the inner cities often couldn’t find any jobs—let alone factory jobs. If they could, it was usually in low-wage, non-unionized “service” establishments such as MacDonald’s or Walmart. It is significant that the biggest U.S. corporation in terms of revenues is not an industrial giant such as U.S. Steel, as it was early in the 20th century, or General Motors, at mid-century, but rather a trading company, Walmart.

The growing mass of more or less permanently unemployed, or at most marginally employed, youth has encouraged the growth of inner-city street gangs engaged in the drug trade. This has swollen the U.S. prison population. At any given time, there are now considerably more than 2 million people, disproportionality young people of color, in U.S. prisons and jails. Many more people pass through jails or prisons in the course of a year, or are in other respects “in the system,” fighting criminal charges, on parole or on probation.

It remains important, however, for the U.S. ruling class to maintain a large percentage of the population in a relatively comfortable “middle-class” lifestyle. This is a key difference between the United States as the world’s leading imperialist country and an oppressed “third world” country.

From the Dollar-Gold Exchange System to the Dollar System

The Bretton Woods dollar-gold exchange standard began to unravel with the collapse of the gold pool in March 1968 and collapsed completely in August 1971, when Nixon formally ended the convertibility into gold of the U.S. dollar by foreign governments and central banks. The U.S. dollar, even dollars in the central banks or treasuries of foreign governments, was now a purely token currency and no longer a form of credit money. From now on, the dollar would follow the laws of token money, not credit money.

The question posed by Nixon’s August 1971 move was whether the U.S. dollar could maintain its position as the main world currency now that it was a token currency and not credit money. As long as the dollar had retained its convertibility into gold at a fixed rate by foreign central banks and treasuries—which also meant that the open market dollar price of gold could not move very far from the official $35 an ounce—commodity prices quoted in dollars and international debts denominated in dollars were in effect quoted and denominated in terms of definite quantities of gold.

But with the transformation of the dollar into token money, this was no longer true. The dollar no longer represented a fixed quantity of gold but a variable quantity. Its gold value could change drastically over a short period of time.

Reagan Reaction and the ‘Great Moderation’

After World War II, the Keynesians reformers took unjustified credit for the postwar economic upswing. Similarly, in the 1980s the extreme right-wing governments that came to power in Britain in 1979 and the United States in 1980 also took unjustified credit for the end of the protracted economic crisis of 1968-1982.

These right-wing governments attempted to take back as many concessions as possible that had been granted to the working class after World War II. At first, the policies of the new reactionary governments was called “monetarist,” but later they were called “neoliberal” for reasons that will become apparent below.

As I mentioned last week, the “monetarist,” or “neoliberal,” era in the United States actually began with the appointment of Paul Volcker as chairman of the U.S. Federal Reserve Board by the Democratic administration of Jimmy Carter in August 1979. The post-World War II reformist era had been made possible by the generally expansionary economic conditions that prevailed between 1948 and 1968. The collapse of the London Gold Pool in March 1968 marked the end of the early post-World War II era of capitalist prosperity.

Attempts to relaunch the post-World War II capitalist prosperity through Keynesian methods repeatedly failed during the 1970s. This was the economic basis for the new era of reaction that was symbolized by the election of Ronald Reagan in the November 1980 U.S. presidential election, as well as the rise to power of Margaret Thatcher in Britain with her “there is no alternative” slogan.

What Thatcher really meant was that there was no “Keynesian” alternative to her reactionary “monetarism” as long as the British pound was plunging in value both against gold and even against the dollar on world currency markets.