Paul Krugman on interest rates and gold: The Price of Everything, The Value of Nothing
“The mode of production is in rebellion against the mode of exchange.” — Frederick Engels, Socialism: Utopian and Scientific, 1880
Krugman confuses the superficial relations of exchange for a deeper analysis of the capitalist mode of production. This failing might help him when he wishes to ignore the likely results of this sort of examination, but when he actually tries to understand how capitalism works — for instance, why rising gold prices might be a warning sign of a deflationary event — his inability to get beyond the superficial appearances lead him straight into a dead end.
Had Krugman looked at data from the 1980s and 1990s, he would have immediately noticed the slide in the price of gold over that period, and the incongruity of this decline for his argument. His hypothesis turned things exactly upside down — associating a negative so-called real interest rate with a period of general expansion. This is at odds with historical evidence to the contrary: prior to 1934 rising prices and generally rising interest rates and profit have always been associated with economic growth.
Speaking of the impact of Fed’s current counter-cyclical strategy on the price of gold, Krugman writes:
…there has been a dramatic plunge in real interest rates…What effect should a lower real interest rate have on the Hotelling path? The answer is that it should get flatter: investors need less price appreciation to have an incentive to hold gold…if the price path is going to be flatter…it’s going to have to start from a higher initial level…And this says that the price of gold should jump in the short run…with lower interest rates, it makes more sense to hoard gold now…which means higher prices in the short run and the near future.
Krugman is arguing Federal Reserve policy over the last three years is responsible for more than a decade of persistently rising gold price. He wants to explain gold price movements by interest rates, when it is clear he should be explaining interest rates by the movement in gold prices. The data suggests he has the situation exactly reversed. Moreover, if the connection I have made between generally falling gold price and economic expansion is correct, logic suggests the Federal Reserve is not trying to reduce real interest rates, but working feverishly to raise them. The real interest rates is only the change in the price of dollars over a period of time measured in gold (or some other commodity serving as money). If, at the beginning of the year, the price of dollars is such that one ounce of gold can buy 1400 dollars, but at the end of the year this price has changed so that one ounce of gold can now only purchase 1260 dollars, the real price of dollars has increased by 10 percent — restated in conventional terms, the “price” of gold has fallen from $1400 an ounce to $1260 an ounce.
Since, as Krugman argues, the rising price of gold is a sign of a depressed economy, it follows that a falling annual average price of gold must be evidence, at least, that this depression may be lifting. When the price of gold is falling, as during the 1980s and 1990s, it is a sign that real interest rates are positive, not negative. Moreover, it is a sign that the purchasing power of gold, as measured in dollars, is falling. Which is just what I would expect based on Marx’s theory of value.
All of this forces me to conclude the question of whether there is a persistent inflation or deflation hinges not on the general price level as measured in dollars or some other ex nihilo currency, but on the real price level — the purchasing power of gold (the purest commodity money) as measured in the sum of dollars or other ex nihilo currency a definite unit of this commodity money can purchase. When the quantity of dollars a troy ounce of gold can purchase is increasing, deflation is positive; when the quantity of dollars a troy ounce of gold is falling, deflation is negative. But, from the standpoint of the ex nihilo currency the situation is reversed: as the price of a troy ounce of gold decreases, the so-called real interest rate is positive; when the price of a troy ounce of gold increases, the so-called real interest rate is negative.
Rather than removing the change in the general price level from the equation of nominal interest rates, so-called real interest rates are only a measure of the change in the price of ex nihilo currency.
As we stated in the previous part of this series, gold is money, dollars are not — this is also true for all ex nihilo currencies in the world market, they are not money. The object serving as money is the material expression of the value contained in commodities solely because it is itself a product of a definite quantity of human labor. However, the value contained in a single dollar bill is the same as that contained in a one hundred dollar bill — or that contained in $700 billion created with a few keystrokes in a computer terminal at the Federal Reserve Bank in Washington; namely, zero. Once this is understood, it is possible to see that holders of ex nihilo currencies do not buy gold — that dollars are not here serving in the exchange as the money pole in the transaction, but as something else. Rather the situation precisely is the reverse: the holders of ex nihilo currencies are sellers who auction off their currencies to the highest bidder, while the holders of gold buy these worthless currencies from their holders.
Although it appears otherwise on the surface — that we must explain why, and under what circumstances, the holders of currency will choose to place their savings in gold — the case is exactly opposite of appearances: the fact that gold is exchanged for a valueless currency requires us to explain not why the holder of an ex nihilo currency would want to get out of her holdings of dollars or euros, but why the holders of gold would want to exchange their gold for these worthless currencies.
To be sure, since the ex nihilo currencies have no value, they are not purchased for their value. If dollars are not purchased for their value, the motivation for the exchange on the part of the holder of gold cannot be the value contained in the ex nihilo currency but the use value of the currency to the holders of gold. While gold serves especially well as a store of value, as a form of riskless savings, these saving can only become capital if this gold can be turned into land, machinery, factories, and other elements of fixed and circulating capital, and, above all, into a mass of labor power that is the source of surplus value and what makes real capital out of capital. For the owner of a hoard of gold to actually become the owner of a mass of capital, this gold must be converted into one or another currency, allowing it to assume the form of money-capital. This conversion is nothing more than the conversion of money into capital once removed.
The conditions determining this conversion are established by laws in each nation, which determine what is and is not to be used as money within the borders of that particular nation. If the laws of a nation establish that its currency shall exchange with an ounce of gold for, say, $20.67 per ounce, then the owner of gold can use his hoard to purchase 20.67 dollars for each ounce of gold he is willing to give in exchange. If the laws of the nation should suddenly change, so that now an ounce of gold will exchange for $35, then the owner of gold use his hoard to purchase 35 dollars for each ounce of gold he is willing to give in exchange. Finally, if the laws of a nation establish that its currency will have no fixed exchange rate with an ounce of gold, then the owner of gold must search in the market for the best exchange rate for the currency concerned. All other things equal, in the first two cases, the capacity of the state to issue currency is more or less severely constrained by the need to maintain the proper balance between the quantity of currency in circulation and the quantity of gold it must represent. In the final case, this constraint is relaxed.
If the point of the exchange of an ounce of gold for any quantity of dollars was a mere commodity transaction, the owner of the gold would be giving her gold away for free, no matter the quantity of dollars she received in return. Since the dollars contain no value, were the exchange regulated by the law of value, it would require an infinite quantity of dollars to equal the value in one ounce of gold. It should be obvious that equal exchange plays no role in this transaction, but only the laws of the state concerned. The state has determined that its ex nihilo currency is money; should the capitalist wish to turn his hoard of gold into capital, and become a real not imaginary capitalist, he must purchase this ex nihilo currency. He, therefore, purchases not the value contained in the dollars, but the use value of the dollars: its capacity to become capital.
It is the use value of the currency — its capacity to become capital — that serves as the basis for determining the exchange ratio of an ounce of gold with the currency, i.e., that determines the price of dollars expressed in units of gold, or, in the eyes of simpleton economists like Paul Krugman — whose point of view is determined by the needs of Fascist State monetary and fiscal policies, as “essentially a capitalist machine” — determines the price of gold. The use value of currency consists entirely of its use as capital, as self-expanding value, as value set in motion for the purpose of creating more value. From the point of view of the owner of gold, the ex nihilo currency is but the form his gold must take on, before it can take the form of capital — of fixed and circulating capital, and of labor power. Far from being something mysterious, it is actually no more mysterious than the need to exchange dollars for euros in order to purchase fixed and circulating capital and labor power in the Eurozone. What motivates this latter exchange is not the exchange rate of dollars for euros, but the specific use to which these euros can be put as capital.
There is, however, a problem with this that might throw a monkey wrench into the gears of capitalist production: to assume the form of capital, our would be capitalist must exchange his gold, containing real value, for a currency containing no value of its own. To expand the value of his gold holding, the capitalist must first strip off the value of the gold. What does he get in exchange for this quantity of gold? He receives in return some quantity of use value in the form of so many dollars, which, despite their usefulness as capital, contain not a single jot of value. The capitalist places this quantity of dollars in motion as a capital, and, after some period of time, withdraws it plus an additional quantity of dollars which make up the profit on his activity. But, it is not until he has reconverted this quantity of dollars back into gold, and assured himself that, indeed, the new quantity of gold is greater than the original quantity, will he know that, in fact, his gold became capital.
When there is a fixed exchange rate between a definite unit of gold and a definite unit of dollars, it is not at all complicated to assess whether the capitalist currency profit is also a definite quantity of surplus value. However, when the exchange rate between a definite unit of gold and a definite quantity of dollars is subject to fluctuations within the world market, assessing whether some profit in currency form is actually surplus value is complicated by the fluctuations in the rate of exchange itself.
The capitalist exchanges 100 ounces of gold for dollars at a given rate of 1000 dollars per ounce of gold. He then places this total capital of $100,000 in motion as capital; later drawing out of it a new sum of $150,000 — $100,000 is his initial capital plus a profit of $50,000. However, upon reconverting his $150,000 back into gold, he is surprised to find that his 100 ounces of gold is now only 50 ounces of gold, or, alternately, has grown to 200 ounces of gold. In the first case, this is because the new exchange rate of gold has changed from 1000 dollars to an ounce of gold to 3000 dollars to an ounce of gold. In the second instance, the exchange rate has changed from 1000 dollars to an ounce of gold to 750 dollars to an ounce of gold. In the first instance, he has lost fifty percent of his capital; while, in the second instance, he has doubled his capital.