Based on what I have described of Bernanke’s policy failure so far, is it possible to predict anything about the future results of an open ended purchase of financial assets under QE3? I think so, and I share why in this last part of this series.
I stopped my examination of Bernanke’s approach to this crisis and the problem of deflation after looking at his 1991 paper and his speech in 2002. I now want to return to that series, examining two of his speeches this to discuss the problems confronting bourgeois monetary policy in the crisis that began in 2007-8.
The world market had been shaken by a series of financial crises, and the economy of Japan had fallen into a persistent deflationary state, When Ben Bernanke gave his 2002 speech before the National Economists Club, “Deflation: Making Sure “It” Doesn’t Happen Here”. Bernanke was going to explain to his audience filled with some of the most important economists in the nation why, despite the empirical data to the contrary, the US was not going to end up like Japan.
So I am spending a week or so trying to understand Ben Bernanke’s approach to this crisis based on three sources from his works.
In this part, the source is an essay published in 1991: “The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison”. In this 1991 paper, Bernanke tries to explain the causes of the Great Depression employing the “quantity theory of money” fallacy. So we get a chance to see this argument in an historical perspective and compare it with a real time application of Marx’s argument on the causes of capitalist crisis as understood by Henryk Grossman in his work, The Law of Accumulation and Breakdown.
In the second part, the source is Bernanke’s 2002 speech before the National Economists Club: “Deflation: Making Sure “It” Doesn’t Happen Here”. In this 2002 speech, Bernanke is directly addressing the real time threat of deflation produced by the 2001 onset of the present depression. So we get to compare it with the argument made by Robert Kurz in his 1995 essay, “The Apotheosis of Money”.
In part three, the source will be Bernanke’s recent speech before the International Monetary Fund meeting in Tokyo, Japan earlier this month, “U.S. Monetary Policy and International Implications”, in which Bernanke looks back on several years of managing global capitalism through the period beginning with the financial crisis, and tries to explain his results.
To provide historical context for my examination, I am assuming Bernanke’s discussion generally coincides with the period beginning with capitalist breakdown in the 1930s until its final collapse (hopefully) in the not too distant future. We are, therefore, looking at the period of capitalism decline and collapse through the ideas of an academic. Which is to say we get the chance to see how deflation appears in the eyes of someone who sees capitalist relations of production, “in a purely economic way — i.e., from the bourgeois point of view, within the limitations of capitalist understanding, from the standpoint of capitalist production itself…”
This perspective is necessary, because the analysis Bernanke brings to this discussion exhibits all the signs of fundamental misapprehension of the way capitalism works — a quite astonishing conclusion given that he is tasked presently with managing the monetary policy of a global empire.
FOFOA’s argument against modern money theory can be summarized as follows:
A staggeringly massive hyperinflationary event is already latent in the global economy. The dollars currently in circulation only retain their purchasing power because of the function of money as medium for the circulation of commodities. Modern money theory, which proposes the fascist state faces no monetary constraint on spending in excess of its ability to tax or issue debt, is making an argument for monetary policies that will only exacerbate the latent hyperinflation already present in the economy. The problem posed by hyperinflation, “too little money”, is not mitigated when the state creates new currency out of nothing. Rather, the case is the reverse: emitting new dollars does not create additional purchasing power; it simply dilutes the purchasing power of the dollars already in circulation, adding to the implosive potential of the inevitable hyperinflationary event.
According to FOFOA, the hyperinflationary event has been held back so far by the self-interested action of Europe, Japan, and China; who have recycled their dollars back to the US to buy its debt over the past thirty years. This recycling of dollars into US debt has supported the purchasing power of the dollar, but it has reached its limit. The dollar is now suffering a credibility crisis among US creditors, that must lead to an effort by these creditors to exchange their dollars for real, not fictional, assets. With the US’s creditors losing faith in the stability of dollar purchasing power, and boycotting the purchase of US debt, the US is actually engaged in wholesale creation of dollars out of nothing to fund its operations, driving the dollar into actual hyperinflation.
This latter scenario, the impending and irreversible loss of dollar credibility, is where FOFOA badly stumbles in his argument against the advocates of modern money theory.
I apologize for this part of the series, because it is hopelessly geeky. Unfortunately, I see no way to move forward without getting into the weeds of Marx’s unique contribution to the theory of money at this point. Please bear with me on this. As I really need to explain the difference, before 1933, between a token currency and the commodity money that underpinned its value. Without understanding this relationship, it is impossible to truly understand what happened when the dollar was removed from the gold standard in 1933. Nor is it possible to understand why ex nihilo dollars can’t tell us anything about anything.
As I explained in the previous post, to become capital, a quantity of gold must be exchanged for ex nihilo currency, but this exchange also strips the capital of the value it contained when it was in the form of gold. This requires a bit of digression: In Marx’s labor theory of value, when a currency of a state no longer has a fixed exchange rate with gold, the value contained in a unit of gold no longer has any definite relationship with the use value of the currency as medium of circulation. This has a radical implication for political-economy that has been long overlooked by both Marxist and bourgeois economists. I will try to explain the implications of going off the gold standard using as little jargon as possible.
Background: Prior to debasement dollars served in the United States both as a measure of value contained in an individual commodity, and the medium of circulation for commodities. By the term “value”, I mean the labor time required by producers on average to produce any object. If an automobile takes as much time on average as a ounce of gold to be produced, we can say that the value of the car is equal to one ounce of gold. Gold acts as a socially valid measure of the value of other commodities when it is used as money. Before money was debased, the value of any good was loosely bound to some definite quantity of money because both the money and the commodity were the product of some definite expenditure of socially necessary labor time. The movement of market prices over a period of time worked to align the socially necessary labor time of a good with the quantity of money containing the same amount of socially necessary labor time. The two functions of money are closely connected: the price of any commodity, when this price was denominated in a currency that observed the gold standard, followed the general rule that, on average and over a period of time, this price was also a measure of the value contained in the commodity.
A token (e.g., paper) currency only could serve as measure of value contained in the commodity if it was fixed to a definite quantity of gold — for instance, prior to the Great Depression law stated one ounce of gold could be exchanged for 20.67 dollars. Since an ounce of gold always had a definite quantity of value (socially necessary labor time required to produce it) fixing the token currency to this definite amount of gold served to fix the currency itself to a definite amount of socially necessary labor time. Token currency, therefore, could only serve as the material expression of socially necessary labor time, because it was itself tied to gold.
We could say the term “dollar” was not only the name of the official currency, it was also the “name” established by law of some definite quantity of gold.
On the other hand, when used directly in circulation, a gold coin served as medium of circulation of commodities in such a way that its actual use in any particular exchange for commodties was very brief; the coin constantly moved from one person to another in the course of commerce — rarely, if ever, staying in one hand for long, since it would almost immediately be used in the next transaction. Marx argued gold in this function was, for several reasons, merely a token of itself used to facilitate the circulation of commodities.
One particular example of this token role was the use of a coin that had been eroded by use over a period of time and was now no longer of legal weight. Although the coin carried a legal definition of one dollar, its weight now no longer adhered to the standard of legal definition of a dollar. Since the coin was legally a dollar, but did not actually contain a dollar’s weight, if it continued in circulation it had been reduced to a token of itself. As a practical matter, this meant, within certain limits, the gold coin could be replaced in circulation by a token currency provided this token was redeemable for a definite quantity of gold. Thus, a token currency like the dollar could serve as money only because it had a fixed and definite relation with some commodity money.
So, when the dollar was debased from gold, there was more at stake than a simple legal redefinition of money. The Roosevelt and Nixon administrations were severing the currency from the only thing that gave it the ability to express in price form the value contained in a commodity. This legal redefinition of what was officially called money, concealed within itself an unprecedented break in the role of prices in a modern economy. It would not be an exaggeration to say Roosevelt and Nixon, through their executive orders, chopped off Adam Smith’s invisible hand, and replaced it with the iron fist of Fascist State economic policy.
With the debasement of the currency, the two functions of money — measure of value contained in an individual commodity, and the medium of circulation for commodities — devolved on different objects whose relationship was no longer fixed and given. As the material to express the value contained in each commodity, gold no longer played a role as a medium of circulation of these commodities; while token currency, as medium for circulation of commodities, could no longer serve as the material to express their values in the prices we paid for goods.
But, the crises which produced this change offer an even more profound argument about why this debasement occurred. Every commodity is both a useful object and an object containing a definite amount of value (socially necessary labor time to produce it.) Debasement suggests that the routine exchange of commodities is now fundamentally at loggerheads with the routine production of these commodities. As an object containing value — i.e., a definite amount of socially necessary labor time — the commodity cannot circulate; as a particular useful object in circulation its value cannot be expressed. The solution adopted by the two administrations essentially severed rules governing exchange from the rules governing production.
On the one hand, this means commodities no longer circulate as objects containing value, but only as particular useful objects differentiated only by their particular useful qualities. This conclusion will be both startling and controversial, because it also implies Marx’s law of value no longer determines exchange. The fact that currency has been debased from gold must force the conclusion that prices no longer express the values of the commodities to which they are attached.
By exchange, we can only mean the exchange of qualitatively different objects having equal values — so many pairs of shoes for so many pairs of pants — but the ex nihilo currency now serving as the medium of circulation has no value of its own, and, therefore, the price denominated in units of the currency cannot express the value of either the shoes or the pants.
After the debasement of the dollar, in any transaction between the seller of a commodity and the buyer with an ex nihilo currency, the seller of the commodity gives it to the holder of ex nihilo currency and receives in return nothing but a piece of paper. She gives away not only the particular use value she has, but also the value contained in this particular use value as well. While receiving ex nihilo currency in return for her commodity, she receives nothing in return for the value contained in her commodity. Although it appears otherwise, the exchange is not determined by the quantitative equivalence of the values contained in the two objects, but by qualitative differences in their respective use values alone.
On the other hand, things having no value at all — for instance, Predator drones — can now circulate alongside shoes and pants, the latter of which have both use value and value. This is already given in the successive transactions involving an ex nihilo currency and commodities, or in the exchange between any two ex nihilo currencies. The state can, for instance, produce a quantity of ex nihilo currency simply by crediting it to the account of a defense contractor and receive in return Predator drones to kill kids in Afghanistan. While the purchase of the drone by Washington using newly created ex nihilo currency looks like just another simple market transaction, and even shows up in measures of gross domestic product side by side with purchases like groceries or a new car — this appearance is really quite deceiving.
The most significant implication of the debasement of the currency that is completely overlooked by Marxist and bourgeois economists is this: once gold was removed as the standard of price by the Fascist State, not only did the currency lose its capacity to express the value of an individual commodity, the market as a whole lost the capacity to distinguish between productive labor and wasted unproductive labor. Rather than limiting society to the productive and efficient employment of labor power, the stage was set for something truly unprecedented: the relentless expansion of superfluous labor time and the attendant secular inflation of prices.
“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.