CLUELESS: “Deflation is bad. M’kay?”

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.

CLUELESS: How Ben Bernanke is managing the demise of capitalism

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.

Gold and Exchange Rates (Random thoughts)

This is very geeky, sorry. I posting it because I intend to revisit it sometime in the near future in the context of a review of the Euro-zone crisis.

My post on Moseley’s MELT paper (pdf) argues the so-called “price of gold” is actually the standard of price for a currency. I argued in the paper that dollars do not buy gold, gold buys dollars. Dollars are “sort of” a commodity necessary to convert gold into capital. I said “sort of”, because I really cannot describe it, except along the line of Marx’s argument on loaned capital:

M ==> M ==> C.

Where the first M is the bank’s money to be loaned, and the second M is the actual conversion of this loaned money into industrial capital. We could think of the movement of gold similarly as:

Mg ===> Mc ===> C.

Where Mg is a quantity of gold, Mc is a quantity of a particular currency, and C is the commodity.

The owners of gold, however, have a choice of currencies whose bodily form their gold can assume: euros, dollars, yen, yuan, reals, pesos, etc. And, each of these currencies have their own standard of price, i.e., their own specific exchange rate with gold. Each of these standards of price is an expression of the quantity of a given currency in domestic circulation to the quantity of domestic socially necessary labor time. Since, in each country, the relation between the total currency in circulation and total socially necessary labor time is different, the standard of price for each country currency must necessarily be different.It would seem to follow from this that the relation between currencies, their relative exchange rates, should be determined by the above. For instance, if country A has a standard of price with gold of 10 currency A units per ounce of gold, while country B has a standard of price of 20 currency B units per ounce of gold, the relation between the two should be:

one unit of currency A = 2 units of currency B

However, just as different industries have different composition of capital, so different nations have different compositions. The composition of capital in the US is far higher than that of the People’s Republic of China, or Zimbabwe. The movement of gold between currencies, I think, is determined much like the movement of capital between industries. On the one hand, the standard of prices in various countries arise from the domestic quantitative relation between the currencies and socially necessary labor time. On the other hand, for the owners of gold, these currencies are no more than forms gold must take if it is to become capital — and capital is self-expanding value, the production of surplus value through the consumption of labor power.

This suggests that although the standard of price of a currency is determined solely by the relation between the mass of currency and the mass of socially necessary labor time; it is also being determined by the rate of surplus value within each country as determined by their varying compositions of capital.

I think we are again face to face with Marx’s transformation problem, where the law of value confronts the law of average rate of profit. One law suggests the standard of price of a currency is determined solely by the relation between the total quantity of currency in circulation domestically and the total quantity of socially necessary labor time; the other law suggest the relative exchange rates among all currencies is determined by the law of the average rate of profit. The latter law suggests currencies are exchanging in the world market above or below their actual domestically determined standard of prices.

What use might this argument have?

1. This might just offer an idea how, without violating Marx’s labor theory of value, imperialist super-profits are obtained.
2. It could offer a way of modeling the emergence of world market prices, and the dollar as world reserve currency.
3. It could also explain the empirical data, which shows neoliberal free trade policies produced a US expansion in the 1980s and 1990s.
4. Finally, it explains why China’s currency appears undervalued on the world market and the US dollar overvalued against what we would expect.

Unemployment: Job Creation or Liberation?

“All paid jobs absorb and degrade the mind.” – Aristotle

I find it amazing that people will demand Washington create work, but will not demand freedom from unnecessary work created by Washington. The fixation on work is the principal lever of the fascist state. But, the fixation on work is only a reflex of the role fascist state issued currency plays as the mediator of the means of life. The very same means the fascist state employs to satisfy the demand for jobs, currency issue, increases the demand for jobs.

Paul Krugman on interest rates and gold: When a dollar was real money

From Wikipedia: A picture of a pre-1933 gold certificate currency

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.

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.

Paul Krugman on interest rates and gold: Why gold is money and dollars are kindling

I have a simple hypothesis for how Krugman managed to reach the correct conclusion regarding the relationship between the price of gold and the general level of economic activity: he probably started with his conclusion and tried to work backward. He needed an argument for why the rising price of gold might signal deflation rather than inflation. So, he took his conclusion and looked for some argument on which he might hang this conclusion.

Hey, it happens sometimes — that is how intuition works. The problem in this case is that Krugman’s argument requires us to ignore so many facts it is clear he did not think the problem through completely.

The upward sloping demand curve for gold (2001-2011)

The most vital empirical fact Krugman overlooks is the rather jarring upward slope of the demand curve for gold. This means increasing demand for gold is driven by its increasing price (if not completely insensitive to price altogether). If this seems bizarre, that’s because the actual relationship between gold and currency is reversed in the demand schedule. The demand schedule for gold can be restated thus: the quantity of dollars demanded in the market is the inverse function of its price in ounces of gold. In other words, if the observation of our gold-bug in China can be believed, ex nihilo dollars is the “commodity”, and gold is its price. I am not the first person to note this. The writer, FOFOA, often quotes another anonymous writer from 1998, who observed:

It is gold that denominates currency.

FOFOA, commenting on this argument, states:

Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero.

The upward slope of the demand curve for gold can be seen in the above chart for the years 2001 to 2010, using data, supplied by the World Gold Council, of demand for gold in the form of bars and coin plus gold purchased by exchange traded funds. The pronounced upward slope is unmistakable. This curve suggests that the story of gold as just another commodity is wildly off-base.

To put this in terms that might be less opaque, when CNBC states an ounce of gold is going for $1400, they are not telling you the value of an ounce of gold, but the value represented by 1,400 dollars, using an ounce of gold as the unit of measure. Gold is money by reason of its natural (physical) properties; while dollars are money only through the fiction of a state law that says they must be accepted as payment for transactions. Having no value of their own, the value represented by a quantity of dollars is solely dependent on the ratio between this quantity of dollars and a definite quantity of gold (or, some other commodity that can serve as money in the relationship). So, when Krugman proposes to explain the “real price of gold” in this situation, he is employing a meaningless term. Unbeknownst to him, he is merely asking what quantity of gold can be used to purchase that quantity of gold. If, instead, he had asked what determines the “real price” of a dollar in gold terms, it would immediately have been obvious that the price of a dollar is the physical quantity of gold that can purchase it. Moreover, it would have been obvious that the change in the price of the dollar is identical to the change in the quantity of gold with which it can be purchased — in other words, that the so-called “real interest rate” of dollars is equal to the change in the quantity of dollars that gold can buy over some period of time.

*****

Average annual price of gold (1980-2011)

Now that we solved the riddle of the unusual demand curve for gold, we can resolve, as well, the paradox of ex nihilo currency real interest rates in the United States over the long period from 1980 until now. As I stated in the last post, Krugman’s argument implied interest rates were negative for most of the 1980s and 1990s, and that interest rates have been positive since 2001.  Now, it is obvious that the case must have been the exact opposite of Krugman’s implicit argument: For most of the 1980s and 1990s, as the average annual price of gold fell, the real interest rate averaged +5% per year. This is because the quantity of gold necessary to purchase a given quantity of dollars — i.e., the real price of dollars — was increasing over that 20 year period by 5% per year. In 1980, an ounce of gold could purchase $595, but by 2001, it could only purchase $271. By the same token, as the average annual gold price has risen at an average rate of 15% per year for the entire period from 2001 to 2011, this implies the real interest rate has been -15% per year over the period.

Since, gold is money (a specific money commodity at least), we can explain its use as a store of value. When gold serves as a store of value, it is merely serving as a form of savings for its holders. In this case it becomes clear why gold is a preferred form of saving. First, it has an unlimited shelf-life; but, second, and more important, Washington cannot devalue gold as it can dollars, by printing dollars indiscriminately.

We can also explain the relation between gold and dollars: gold is money, and ex nihilo currency is not. Gold has value but no purchasing power — you can’t use it to buy groceries — since it is not legally recognized as money and it does not serve as the standard of prices. On the other hand, while ex nihilo currency has no value, it does have purchasing power, since it is officially recognized as money and serves as the standard of prices. However, despite the legal definition of the dollar as official money in the United States, money is not just whatever the state says it is. It is a real relation between members of society that exists independent of the thing government legally defines as money (or, even the commodity serving as money).

What else dollars might be is not our concern right now.

When a worthless ex nihilo currency has a floating exchange rate against gold, it doesn’t represent any real value itself but only that expressed in its actual exchange rate with gold over a period of time. Based on this, it is now clear that the “real price” of a good is not its ex nihilo currency price — as measured in so many dollars — but the definite quantity of gold that can purchase this quantity of dollars. Even if it is not obvious to us in our daily shopping activities, the “real price” of a commodity is derived from the quantity of gold that can be used to purchase the quantity of money listed as the price of the commodity.

*****

We have examined the relation between gold and ex nihilo dollars, showing that gold is money while dollars are not. We also showed why the value represented by any quantity of dollars is only an expression of the value contained in a definite quantity of gold that can purchase this definite quantity of dollars.

So, for example, the value of the price of a 42 inch, wide-screen, high definition, plasma television at Best Buy, with a price of $1400, has the value of one ounce of gold when that ounce of gold can purchase 1,400 dollars. If that ounce of gold can purchase 2,800 dollars, then the television has the value equal to one half ounce of gold. And, if,  If that ounce of gold can purchase only 700 dollars, then the television has the value equal to two ounces of gold. In any case, the price of the television only reflects the value of the quantity of gold that can purchase a quantity of dollars equal to that price.

It might appear, at first, that the value of the television could be doubled simply by doubling its price, but this would be an error. As we stated above, the dollars used in such a transaction have no value of their own, and, therefore, cannot express the value of either the television or gold. So, if the prices of all goods were suddenly doubled, this would not result in the doubling of the value of the total output; it would simply double the dollar price of the existing output — leaving the value of the output unchanged. The relationship between the value contained in the commodity and the corresponding value contained in a unit of gold is determined not by the price paid for the commodity, but their respective socially necessary labor times of production. As long as these respective socially necessary labor times do not change relative to each other, the change in dollar price of either is of no consequence.

This statement has implications for both calculating inflation and nominal interest rates, as we will see in the next post.

Paul Krugman on interest rates and gold: “Mr. Magoo, you’ve done it again”

"ROAD HOG!!"

Once again, Paul Krugman manages to stumble Mr. Magoo-like to his analytical destination through a series of comical errors.

Krugman’s argument on gold and deflation is actually an argument on gold and depressions. Krugman begins by explaining that rising gold price has been popularly linked to the prospect of inflation created by the monetary policies of the Federal Reserve Bank. He has ignored this argument, because he thinks Fed policy is far too restrictive to create inflation — deflation is his worry. He has, in fact, brushed rising gold prices aside as something caused by gold-bugs and the like — until now.

Now, he thinks, he can explain why rising gold price may actually be an expected outcome of a deflation, not inflation. I know Krugman’s argument here is flawed, but coincidentally on the right side of the relation: rising gold price implies the economy is experiencing a depression but this real contraction of economic activity does not necessarily lead to a general fall of prices — the deflation Krugman thinks he can explain. So, I want to examine his argument to locate the fallacy in it.

In the model Krugman is using, gold is an ordinary commodity like oil or coal; i.e., without any significant monetary properties. Gold is used primarily for its industrial applications:

Imagine that there’s a fixed stock of gold available right now, and that over time this stock gradually disappears into real-world uses like dentistry. (Yes, gold gets mined, and there’s a more or less perpetual demand for gold that just sits there; never mind for now).

At this point, we need to make explicit what Krugman wants to dismiss in the set up of his argument: First, he is dismissing what is undeniably the most important use of gold: its use as money, as measure of value and as standard of prices. The use of gold as a way to store value — as gold “that just sits there” — does not consume the gold; it simply sits in a bank vault or some other storage facility and is rarely if ever moved, except to be transferred to the ownership of another person. What makes gold ideal for this is that it has a shelf-life that is unlimited — because it does not corrode or otherwise decompose. Even as standard of price gold does not necessarily get consumed. If it is used as currency it may be eroded during the course of circulation. But if it is not directly used as currency, this is not true — again, it simply sits in a bank vault until it is exchanged for paper tokens of itself.

Second, Krugman wants us to ignore the fact that the existing stock of gold is constantly being added to by production of new gold from sources deep in the earth. Most of this new gold also does not enter into production, but is used for its principal purpose as money — as a store of value (savings). Production of gold has to be important in any explanation because of a unique characteristic this gold production has: the production of gold does not appear to be significantly affected by the laws of supply and demand. While the price of gold may rise or fall, the amount of gold produced manages to remain in a very narrow band; rarely, if ever falling out of this narrow limit — e.g. between 2001 and 2010 production ranged between 2400 to 2650 tons per year, while prices quadrupled. As a commodity, gold behaves very curiously in a non-commodity fashion

These two objections are enough to raise serious questions about Paul’s entire model, but, for the moment, we will set them aside and continue to examine Paul’s argument:

The rate at which gold disappears into teeth — the flow demand for gold, in tons per year — depends on its real price

We have a fixed stock of gold that is gradually being consumed by various uses in production. Krugman argues that the rate this stock of gold is consumed will depend on its “real” price. What is the “real” price of gold, and how does this differ from the nominal currency price of gold? Krugman does not tell me. He simply throws the term out there and expects me to figure it out for myself. Since, I can only price gold in an existing currency, I assume by “real” price, Krugman means its currency, e.g. dollar, price. We will see why my assumption is not be correct — gold, it turns out, does not have a price, “real” or otherwise. For now, let’s continue:

Crucially, at least for tractability, there is a “choke price” — a price at which flow demand goes to zero. As we’ll see next, this price helps tie down the price path.

Krugman is arguing there is a price at which the “flow demand” (the money demand for a good over time) for gold in the market goes to zero. He slips this assumption into his argument without discussing it, but I am forced to wonder how he arrives at this statement. Certainly, for use as an ordinary commodity, as a commodity used in industrial processes, we can assume there is a point at which the price of gold might become prohibitive. But, as money — as store of value, or as the standard of prices — is there any evidence that gold has a price point at which demand for its goes to zero? Well, no and yes. One of the paradoxes of gold is that demand tends to increase along with the price. Here is just one example taken from a gold-bug (he even calls himself “Mr. Gold”) doing research on China’s demand for gold:

When at the beginning of this century I studied the elasticity of gold demand to incomes, I was stunned by how steep the demand curve was in China.  PRC gold demand was unlike in any other country because, precisely, it was upward sloping – the more expensive the gold, the more the Chinese bought of it.  The trend has not changed since then…

Note, how this gold-bug asserts the demand curve for gold is “unlike in any other country because, precisely, it was upward sloping.” This is hardly true, as we can see at least in the anecdotal evidence with demand for gold in the United States — the hysteria for gold increases as the price of the metal increases here as well. This pattern of behavior is not unusual if we assume gold is exhibiting the kind of money-like qualities associated with appreciating currencies. As a currency appreciates, demand for it increases. This suggests that price is driving demand, not vice-versa, that the demand curve for gold is upward sloping — which is to say, the higher the price rises, the greater the demand for gold. Moreover, there is no evidence of a price point, no matter how high, where the demand for gold goes to zero.

To argue this another way: In the real world, economists argue that deflation reduces the willingness of individuals to part with their money for commodities. They hold onto it as they anticipate even lower prices in the future. It is clear that gold is behaving in this fashion — as its price increases — which is to say, as its purchasing power increases — people want to hold onto it, and hold more of it. A hypothesis which does not account for this money-like behavior is not a hypothesis at all.

However, even if there is no price point where the demand for gold goes to zero, this does not mean there is no price point where “flow” goes to zero. If gold does indeed exhibit money-like qualities with an upward sloping ‘demand curve’, this would imply gold can fall to some price below which it no longer circulates as money. We can return to this point later as well.

Krugman now turns to the core question of his post:

So what determines the price of gold at any given point in time? Hotelling models say that people are willing to hold onto an exhaustible resources because they are rewarded with a rising price.

At this point we should say something about this “Hotelling model”. Harold Hotelling developed an economic model to describe how cartels act to restrain the supply of a commodity in the market in order to maximize profit, that is, the return on their investment in the production of the commodity. The Wikipedia has this to say about Hotelling’s Rule regarding scarcity rent — excess profit derived by creating scarcity in the supply of a product:

Hotelling’s rule defines the net price path as a function of time while maximising economic rent in the time of fully extracting a non-renewable natural resource. The maximum rent is also known as Hotelling rent or scarcity rent and is the maximum rent that could be obtained while emptying the stock resource. In an efficient exploitation of a non-renewable and non-augmentable resource, the percentage change in net-price per unit of time should equal the discount rate in order to maximise the present value of the resource capital over the extraction period.

Simply stated, if I have a commodity that will eventually be exhausted, I will manage its production so that, over the lifetime of its production, the amount of money I can charge for it will be maximized. Think about, for instance, OPEC, who wants to be sure they produce no more oil each year than is demanded by the market when the price of oil is the highest and the amount demand is the greatest.

The problem with applying this rule to a stock of gold is that, as we saw above, gold exhibits the characteristic features of a money, not of an ordinary commodity. This will seem to be a non sequitur to Krugman’s core argument — until you realize the aim of maximizing rent on the production of a commodity is to maximize the quantity of money one receives in return for that commodity. Essentially, Krugman is arguing that owners of a lifeless hoard of gold sitting in a vault seek to maximize rent on that lifeless hoard of gold sitting in a vault.

Since the gold never moves from the vault, never enters into circulation, never exchanges with other commodities, and, thereby, become the form of the profits sought by producers of commodities, its role in its own price appreciation or depreciation must be completely passive — it is a mere victim of circumstance, a bystander to events. Whatever the change in the price of gold that occurs must be the result of other processes in the economy that impose themselves on the price of gold, causing this price to vary over time.

So, whatever is happening with the price of gold is not the result of any change in the behavior of the owners of the commodity, nor of any rent maximizing effort on their part. In fact, from what we have seen above, there is no reason to assume the owners of gold do anything with this gold except hold onto it. The entire point of having the gold is to hold it irrespective of any change in its price. While there may be some fluctuations of willingness to hold gold at the margins — of interest in supplies of newly produced gold — the great bulk of gold is likely no more traded than do people trade their savings in any other form. The question raised by this is obvious:

What determines the preference of individuals to hold their savings in the form of gold as opposed to some other form? But, we will leave this to the side as well for now.

Krugman next states:

Abstracting from storage costs, this says that the real price [of gold] must rise at a rate equal to the real rate of interest.

As with the “real price” of gold, I am at a loss at to what the “real rate of interest” refers. So, I went looking for a definition of the term on Wikipedia and found this:

“The nominal interest rate is the amount, in money terms, of interest payable.

For example, suppose a household deposits $100 with a bank for 1 year and they receive interest of $10. At the end of the year their balance is $110. In this case, the nominal interest rate is 10% per annum.

The real interest rate, which measures the purchasing power of interest receipts, is calculated by adjusting the nominal rate charged to take inflation into account. (See real vs. nominal in economics.)

If inflation in the economy has been 10% in the year, then the $110 in the account at the end of the year buys the same amount as the $100 did a year ago. The real interest rate, in this case, is zero.”

Krugman is arguing that the price of gold will rise or fall to reflect interest rates once inflation has been stripped out of the equation. If the real interest rate is positive, gold will tend to appreciate relative to currency. If the real interest rate is negative, gold will tend to depreciate relative to currency. If, at the end of a year $100 in your savings account has increased to $110, and inflation that year is zero, an ounce of gold will appreciate by a proportional amount — say, from $1400 to $1540.  If, at the end of a year $100 in your savings account has decreased to $90, and inflation that year is zero, an ounce of gold will depreciate by a proportional amount — say, from $1400 to $1260.

This latter example would likely cause some difficulties: you would go storming into your local bank branch to inquire why you were being charged an astonishing ten percent a year to keep your money in the bank. Once informed that the current interest rate charge by your bank was now -10% per year, you would promptly withdraw your funds — triggering what, in time, will grow into a run on the bank, as everyone withdraws their saving in the face of stiff new negative interest rates.

Why might this cause some difficulties? Between 1980 and 2001, the average annual price of gold fell on average by 5 percent per year; while, since 2001, the average annual price of gold has risen on average by 15 percent per year. The surprising result of Krugman’s argument is that, after accounting for inflation, real interest rates were negative for most of the 80s and 90s, but have been decidedly positive since then.

We will leave this for later examination as well.

Krugman concludes the recent jump in the price of gold is the result of the Federal Reserve Bank’s zero interest rate policy:

Now ask the question, what has changed recently that should affect this equilibrium path? And the answer is obvious: there has been a dramatic plunge in real interest rates, as investors have come to perceive that the Lesser Depression will depress returns on investment for a long time to come:

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.

There are two things I question about this reasoning. First, the price of a troy ounce of gold has been increasing since 2001, when it hit bottom at an annual average price of $271. That means, for whatever reason having nothing to do with the Fed’s zero interest rate policy, investors have had an incentive to hold gold as its purchasing power, measured in dollars, has been rising for a decade now. Second, since in my argument, gold is playing only a passive role, the historical evidence suggests the Fed’s zero interest rate policy is being driven by the same forces that are also causing gold to appreciate in price and investors to hoard it.

Rather than driving events, the Fed’s zero interest rate policy is completely reactive. Simply stated, based on Krugman’s argument, the Fed’s zero interest rate policy is not sending capitals scurrying into gold and driving gold price higher, rather it is responding to whatever economic forces are doing this, and, driving real interest rates to an average 15% a year for the last decade — it is trying to drive real interest rates negative to reverse those forces, and to reverse the depressed return on investment.

We will show why this argument falls flat on its face as well

Says Krugman:

The logic, if you think about it, is pretty intuitive: with lower interest rates, it makes more sense to hoard gold now and push its actual use further into the future, which means higher prices in the short run and the near future.

The evidence is, in fact, the exact opposite: the behavior of gold indicates the Federal Reserve’s zero interest rate policy is a failure so far (along with all the fiscal stimulus and backdoor bailouts) since, despite the effort and unprecedented scale of the various policy actions, the price of gold indicates interest rates remain stubbornly high at levels not seen since the 1970s depression. And, moreover, still increasing.

Nevertheless his string of errors in reasoning, Krugman manages to end up, Mr. Magoo-like, at what is somewhat close to the right conclusion:

…this is essentially a “real” story about gold, in which the price has risen because expected returns on other investments have fallen; it is not, repeat not, a story about inflation expectations. Not only are surging gold prices not a sign of severe inflation just around the corner, they’re actually the result of a persistently depressed economy stuck in a liquidity trap — an economy that basically faces the threat of Japanese-style deflation, not Weimar-style inflation. So people who bought gold because they believed that inflation was around the corner were right for the wrong reasons.

Krugman is correct to state rising gold price is a sign of an economy in a depression, where returns on investment have fallen flat. He is also correct to state gold is not signalling future inflation. But, Krugman arrives the correct conclusion only by making a series of Mr. Magoo-like blunders that just manage to offset each other — blunders, which, when stripped out of his argument, allow a simpler explanation for the relation between gold and real interest rates.

In the next part of this series, I will show why Krugman’s model, although arriving at something close to the truth of the matter, is nevertheless wholly wrong.

A Critique of Pure Bullshit, Part Three: Eichengreen on Ron Paul (A Tale of Two Monies)

I have been critiquing Barry Eichengreen’s unprincipled attack on Ron Paul and his demand for a return to the gold standard, but, so far, I have danced around the real question posed by this vicious hit piece. Eichengreen’s argument is not about whether or not Ron Paul’s ideas can be compared to the insanity of Glenn Beck, nor is it even about the criticism of the Fascist State proposed by the argument of Frederick Hayek, who plays in this venal attack only the role of betrayer — Ron Paul having based his argument on many of the insights of Hayek, is ultimately betrayed by him when the latter dismisses
the possibility of a return to the gold standard.

Hayek concedes, in other words, to the necessity of totalitarianism.

Ron Paul, having been deserted by Hayek, even before he begins his career as a politician, is left alone in the company of Glenn Beck, who (Beck) is trying to foist gold coin on you at an astounding markup. The implication of this being that if Ron Paul is not himself in cahoots with Glenn Beck, he is just another hopeless sucker to be played. Just another miser looking for a place to safely store up his accumulated wealth from the predations of the investment banksters.

All of this is nothing more than an attempt at misdirection, a ploy to distract you from asking the important question:

What is money?

Ask this question to Ron Paul, and he will tell you gold is money — honest money, not a fiction of money as is ex nihilo currency. When Ron Paul asked Fed Chairman Ben Bernanke if gold was money, the Chairman tried his damnedest to avoid giving a straight answer. The chairman knows that money can perform two useful functions: universal means of payment in an exchange, and store of value. Even if gold is not recognized as the official standard of prices in a country, it can still perform exceptional service as store of value. And, in this function, it entirely fulfills the definition of a money – moreover, it fulfills this function better than any other commodity. And, it certainly fulfills this function better than currency created out of thin air.

Yes. Gold is money. But, of course, that is not the question I am asking:

“What is money?”

Not what thing can serve as money, but what is money itself. No matter what serves as money, or the functions of money it fulfills; what is money itself, i.e., the functions to be filled by the things?

Simply stated: Gold is money, but money is not gold.

People always make this silly argument: “Why can’t dogs, or sea shells or emeralds be money?” Yes. Within limits, anything can serve as money; and, this fact makes the thing serving as money appear entirely accidental and arbitrarily established. So, for instance, whether gold or dancing electrons on a Federal Reserve terminal is money seems simply a matter of convenience and fit.

But, the real questions raised by this is why anything serves as money? That is, why money? This question appears to us entirely irrational. We take the existence of money for granted, and therefore, argue not about money itself, but the things to be used as money. Eichengreen wants us to believe the question, “What thing should serve as money?”, has no deeper significance but for a handful of scam artists and marks like Glenn Beck and Ron Paul. A fifty dollar gold coin (worth some $1900) is inconvenient for daily purchases; we should use dancing electrons on a Federal Reserve terminal.

But, why do we have to use anything at all when it comes time to fill up the SUV for a trip to the corner store? Why isn’t the gas free? In other words, what is money doing coming between us and the things we need?

“Because”, the economist Barry Eichengreen will tell us, “there is not enough of stuff to go around.” Well, how does Barry know this? Does he have some insight into how much of one or another thing is produced in relation to demand for that thing? No. He doesn’t. The function of money is to tell us which things are in shortfall relative to demand because those things have a price in the market place. Prices presuppose the existence of scarcity; of a relation to nature marked by insufficiency of means to satisfy human want. Money is not an attribute of a fully human society, but the attribute of a society still living under the oppressive demands of nature.

So, the question,

“What is money?”

really comes down to

“What is scarcity?”

And, this can now be answered: it is insufficient means to satisfy human needs. But, this answer is still insufficient, because we really have no way to know directly if scarcity exists, right? What we know is the things generally have a price, and we infer from this that things must be scarce. But, this too is a fallacy like “gold is money = money is gold”. I stated that prices presuppose scarcity — but I must now correct myself. Scarcity of means to satisfy human needs is necessarily expressed by prices, but prices do not of themselves necessarily express scarcity of means.

Catelization, monopoly pricing, false scarcity and the Fascist State

We know, for instance, near the turn of the 20th Century, certain big industries learned they could maintain artificially high prices on their products by creating entirely artificial scarcities. We know also how this expertise was put to use and the reaction of society to it. Or, at least, we think we do. Folks like Joseph Stromberg, Murray Rothbard, Paul Baran and Paul Sweezy tell a much different story than the official record. That alternative narrative is summed up brilliantly by Kevin Carson in his work here.

Carson argues:

But merely private attempts at cartelization before the Progressive Era–namely the so-called “trusts”–were miserable failures, according to Kolko. The dominant trend at the turn of the century–despite the effects of tariffs, patents, railroad subsidies, and other existing forms of statism–was competition. The trust movement was an attempt to cartelize the economy through such voluntary and private means as mergers, acquisitions, and price collusion. But the over-leveraged and over-capitalized trusts were even less efficient than before, and steadily lost market share at the hands of their smaller, more efficient competitors. Standard Oil and U.S. Steel, immediately after their formation, began a process of eroding market share. In the face of this resounding failure, big business acted through the state to cartelize itself–hence, the Progressive regulatory agenda. “Ironically, contrary to the consensus of historians, it was not the existence of monopoly that caused the federal government to intervene in the economy, but the lack of it.”

In fact, these folks argue, cartelization and monopoly pricing wasn’t very successful until the state stepped in at the behest of industry to organize them. Carson again:

The Federal Trade Commission created a hospitable atmosphere for trade associations and their efforts to prevent price cutting. (18) The two pieces of legislation accomplished what the trusts had been unable to: it enabled a handful of firms in each industry to stabilize their market share and to maintain an oligopoly structure between them. This oligopoly pattern has remained stable ever since.

It was during the war [i.e. WWI] that effective, working oligopoly and price and market agreements became operational in the dominant sectors of the American economy. The rapid diffusion of power in the economy and relatively easy entry [i.e., the conditions the trust movement failed to suppress] virtually ceased. Despite the cessation of important new legislative enactments, the unity of business and the federal government continued throughout the 1920s and thereafter, using the foundations laid in the Progressive Era to stabilize and consolidate conditions within various industries. And, on the same progressive foundations and exploiting the experience with the war agencies, Herbert Hoover and Franklin Roosevelt later formulated programs for saving American capitalism. The principle of utilizing the federal government to stabilize the economy, established in the context of modern industrialism during the Progressive Era, became the basis of political capitalism in its many later ramifications. (19)

But, there’s a problem with this cartel argument by Austrians, like Hayek and Mises, and Marxist-Keynesians, like Baran and Sweezy: Following Rudolf Hilferding, they describe prices realized by cartelization as “tribute exacted from the entire body of domestic consumers.”

The “monopoly capital” theorists introduced a major innovation over classical Marxism by treating monopoly profit as a surplus extracted from the consumer in the exchange process, rather than from the laborer in the production process. This innovation was anticipated by the Austro-Marxist Hilferding in his description of the super profits resulting from the tariff:

The productive tariff thus provides the cartel with an extra profit over and above that which results from the cartelization itself, and gives it the power to levy an indirect tax on the domestic population. This extra profit no longer originates in the surplus value produced by the workers employed in cartels; nor is it a deduction from the profit of the other non-cartelized industries. It is a tribute exacted from the entire body of domestic consumers. (64)

The problem with this theory is this: if we assume a closed system where the wages of the working class are the overwhelming source of purchasing power for the goods produced by industry, with prices of commodities more or less dependent on the consumption power of the mass of workers who produce them, these workers are unable to buy what they produce. The problem cited by Marx that the consumption power of society is an obstacle to the realization of surplus value is only intensified by cartelization.

Cartelization, even if it could be achieved in one or two industries, could not be the principle feature of any closed economy. Moreover, Marx’s theory predicts as productivity increased, and the body of workers needed to produce a given output shrank, this imbalance worsens. Even with the full weight of the state behind it, monopoly pricing would result in the severe limitation of the consumption power of society. This wholly artificial limitation on the consumption power of society would be expressed as a reduced demand for the output of industry and generally falling prices. So, in any case, the attempt to impose a general scarcity on society through cartelization alone must, in the end, fail miserably.

At this point it is entirely necessary to again ask the question:

“What is money?”

But, this time, not in the fashion we previously addressed it,

“Why is money coming between us and the things we need?”

We now can ask it in the form Barry Eichengreen wants us to consider it:

“What thing should serve as the money?”

As we just saw, cartelization must fail, even if it is sponsored by the state, owing to the artificial limits on the consumption of society. The limited means of consumption in the hands of the mass of workers must place definite limits on the demand for the output of industry.

But, what if — and this is only a silly hypothetical — another source of “demand” could be found within society? What if, out of nowhere, government should suddenly find itself in possession of a previously untapped endless supply of gold? What if, no matter how much of this supply of gold was actually spent, the gold coffers of the state remained full to the bursting point. Indeed, what if, for every bar of gold the state spent, 2 or 3 … or one thousand bars took the place of the spent gold?

In this case, the consumption power of society lost by cartelization and monopoly pricing could be made up for by judicious Fascist State spending, for instance on the military or building out an entire highway system or leveling the industiral competitors of entire continents in a global holocaust or pursuing a decades long Cold War/War on Terror/War on Democracy, to offset the limited demand of society. Since all gold bars look pretty much the same, no one need know that the state had a secret vault that produced gold as needed. No one need know that gold had lost its “price” as a commodity, because it was so incredibly abundant as to exceed all demand for it.

Which is to say, no one need know that in gold-money terms, all other commodities, including labor power, were essentially being given away for free.

The only people who would know this would be the men and women who managed the vault. And, since they were getting a cut of every bar spent into circulation, they could be relied on to keep this a tightly held secret.

So, again:

“What is money?”

Is it gold, a commodity in limited supply, and requiring a great deal of time and effort to produce? Or, is it the dancing electrons on a computer terminal in the basement of the Federal Reserve Bank in Washington, DC? Is it real gold, available in definite limited quantities? Or, is it “electronic gold”, available in infinite quantities? The first choice makes it impossible for state enforced monopoly pricing and cartelization; the second makes it entirely possible.

So far as I know, I am the only one making this argument — Marxist or non-Marxist. But, it is the entire point of Ron Paul’s campaign. It is what makes his campaign a potentially revolutionary moment in American society. Of far greater importance than he imagines, because, like any petty capitalist, he is only looking for a safe place to store his wealth. The radical potential of a demand for the return to the gold standard, even from the mouth of this petty capitalist, this classical liberal is a dagger aimed directly at the heart of the Fascist State, and of its globe-straddling empire.

A Critique of Pure Bullshit: Part Two: Eichengreen on Ron Paul (Money and Crisis)

Austrian School economists Ludwig von Mises and his student Friedrich A. Hayek

Barry Eichengreen makes much of the role the theories of Friedrich Hayek play in Ron Paul’s world view for a reason that becomes immediately clear:

In his 2009 book, End the Fed, Paul describes how he discovered the work of Hayek back in the 1960s by reading The Road to Serfdom. First published in 1944, the book enjoyed a recrudescence last year after it was touted by Glenn Beck, briefly skyrocketing to number one on Amazon.com’s and Barnes and Noble’s best-seller lists. But as Beck, that notorious stickler for facts, would presumably admit, Paul found it first.

The Road to Serfdom warned, in the words of the libertarian economist Richard Ebeling, of “the danger of tyranny that inevitably results from government control of economic decision-making through central planning.” Hayek argued that governments were progressively abandoning the economic freedom without which personal and political liberty could not exist. As he saw it, state intervention in the economy more generally, by restricting individual freedom of action, is necessarily coercive. Hayek therefore called for limiting government to its essential functions and relying wherever possible on market competition, not just because this was more efficient, but because doing so maximized individual choice and human agency.

Yes, folks: Ron Paul is a follower of the very same theories recently endorsed by that cheap huckster of gold coin: right wing conspiracy theorist nut job, Glenn Beck.

Indeed, Ron Paul hails from that portion of the libertarian movement that is a reactive response to the growing role of the state in the economic activity of society. While Marxists predict this increasing state role — demanding only that state power must rest in the hands of the workers whose activity it is — libertarians of Paul’s type reject this role entirely and warn it can only have catastrophic implications for human freedom. Thus, these two streams of communist thought diverge less significantly in their respective diagnoses what was taking place in 20th Century than in their respective solution to it.

As Eichengreen points out, Ron Paul sees in the ever increasing interference by the state in economic activity a danger to individual freedom and a growing threat of totalitarian statist power, in which the state attempts to determine the individual and society rather than being determined by them. This has echoes among Marxists, who themselves had nothing but disdain for nationalization of industry, and by Marxist writers, like Raya Dunayevskaya, who, during the same period Hayek was developing his own ideas, observed an inherent tendency of the state to organize society as if it were a factory floor.

“At the same time the constant crises in production and the revolts engendered befuddle the minds of men who are OUTSIDE of the labor process… where surplus labor appears as surplus product and hence PLANLESSNESS. They thereupon contrast the ANARCHY of the market to the order in the factory. And they present themselves as the CONSCIOUS planners who can bring order also into ‘society,’ that is, the market.”

Paraphrasing Marx, Dunayevskaya points to the inherent logic of this process:

If the order of the factory were also in the market, you’d have complete totalitarianism.”

What Eichengreen wants to treat as an observation specific to the “loony right” turns out to be a view held in common by both the followers of Marx and the followers of the Austrian School. Moreover, it is not just the fringes of political thought who warned of growing convergence between the state and capital, the mainstream of political thought also recognized this inherent tendency, Eichengreen acknowledges, by citing President Richard Nixon’s famous quote, “we are all Keynesians now.” What emerges from this is a very different impression than the one Eichengreen wishes us to take away from his tawdry attempt to discredit Paul by noting his affinity with Glenn Beck for the writings of Nobel Laureate Friedrich Hayek and the Austrian School within bourgeois economics: As Engels predicted, the state was being driven by Capital’s own development to assume the role of social capitalist, managing the process of production and acting as the direct exploiter of labor power.

While mainstream bourgeois political-economy was treating the convergence of Capital and State power as a mere economic fact, the followers of Hayek and the best of the followers of Marx warn not merely of the effect this process would have on economic activity, but the effect it must have on the state itself — as social manager of the process of extraction of surplus value from the mass of society, the state must become increasingly indifferent to its will, must increasingly treat it as a collective commodity, as a mass of labor power, and, therefore, as nothing more than a collective source of surplus value.

Although lacking the tools of historical materialist analysis, that comes from familiarity with Marx’s own methods, libertarians, like Ron Paul, have actually been able to better understand the implications of increasing state control over economic life than Marxists, who, having abandoned Marx’s methods to adopt spurious theories propagated from whatever academic scribbler, still to this day have failed to completely understand the Fascist State.

*****

Eichengreen, worthless charlatan that he is, deftly sidesteps this critique shared by both Austrians and Marxists of the political impact of growing Fascist State control over the production of surplus value, and instead directs our attention to the entirely phony debate of whether gold as money serves society better than ex nihilo currency to abolish the crises inherent in the capitalist mode of production itself. He begins this foray by admitting the failure of of monetary policy to prevent the present crisis, but poses it as a non sequitur:

Why are Ron Paul’s ideas becoming more popular among voters?

The answer, as is Eichengreen’s standard practice in this bullshit hit piece, is to blame Ron Paul’s popularity on Glenn Beck:

BUT IF Representative Paul has been agitating for a return to gold for the better part of four decades, why have his arguments now begun to resonate more widely? One might point to new media—to the proliferation of cable-television channels, satellite-radio stations and websites that allow out-of-the-mainstream arguments to more easily find their audiences. It is tempting to blame the black-helicopter brigades who see conspiracies everywhere, but most especially in government. There are the forces of globalization, which lead older, less-skilled workers to feel left behind economically, fanning their anger with everyone in power, but with the educated elites in particular (not least onetime professors with seats on the Federal Reserve Board).

Only after we get this conspicuously offensive run of personal attacks on Ron Paul’s reputation, does Eichengreen actually admit: Ron Paul’s ideas are gaining in popularity, because the Fascist State is suffering a crisis produced by a decade of depression and financial calamity:

There may be something to all this, but there is also the financial crisis, the most serious to hit the United States in more than eight decades. Its very occurrence seemingly validated the arguments of those like Paul who had long insisted that the economic superstructure was, as a result of government interference and fiat money, inherently unstable. Chicken Little becomes an oracle on those rare occasions when the sky actually does fall.

Ah! But, even now, Eichengreen, forced to admit, finally, the present unpleasantness, cannot help but label Ron Paul a broken clock for having rightly predicted it in the first place. Okay, fine.

So, it turns out that the banksters really do extend credit beyond all possibility of it being repaid; and, it turns out that this over-extension of credit plays some role in overinvestment and the accumulation of debt, and, it turns out prices spiral to previously unimaginable heights during periods of boom — and, finally, it turns out all this comes crashing down around the ears of the capitalist, when, as at present, a contraction erupts suddenly, and without warning.

This schema bears more than a passing resemblance to the events of the last decade. Our recent financial crisis had multiple causes, to be sure—all financial crises do. But a principal cause was surely the strongly procyclical behavior of credit and the rapid growth of bank lending. The credit boom that spanned the first eight years of the twenty-first century was unprecedented in modern U.S. history. It was fueled by a Federal Reserve System that lowered interest rates virtually to zero in response to the collapse of the tech bubble and 9/11 and then found it difficult to normalize them quickly. The boom was further encouraged by the belief that there existed a “Greenspan-Bernanke put”—that the Fed would cut interest rates again if the financial markets encountered difficulties, as it had done not just in 2001 but also in 1998 and even before that, in 1987. (The Chinese as well may have played a role in underwriting the credit boom, but that’s another story.) That many of the projects thereby financed, notably in residential and commercial real estate, were less than sound became painfully evident with the crash.

All this is just as the Austrian School would have predicted. In this sense, New York Times columnist Paul Krugman went too far when he concluded, some years ago, that Austrian theories of the business cycle have as much relevance to the present day “as the phlogiston theory of fire.”

(I think it is rather cute to see Eichengreen present himself as the disinterested referee between the warring factions of bourgeois political-economy, by gently chiding Paul Krugman for going too far in his criticism of the Austrians — after all, the Fascist State will have to borrow heavily from the Austrian School to extricate itself from its present predicament)

Where people like Ron Paul go wrong, Eichengreen warns, is their belief that there is no solution to this crisis but to allow it to unfold to its likely unpalatable conclusion — unpalatable, of course, for the Fascist State, since such an event is its death-spiral as social capitalist. Apparently, without even realizing it, this pompous ass Eichengreen demonstrates the truth of Hayek’s argument:  Fascist State management of the economy, once undertaken, must, over time, require ever increasing efforts to control economic events, and, therefore, ever increasing totalitarian control over society itself.

Eichengreen pleads us to understand the Fascist State does not intervene into the economy on behalf of Capital (and itself as manager of the total social capital) but to protect widows and orphans from starvation and poverty:

Society, in its wisdom, has concluded that inflicting intense pain upon innocent bystanders through a long period of high unemployment is not the best way of discouraging irrational exuberance in financial markets. Nor is precipitating a depression the most expeditious way of cleansing bank and corporate balance sheets. Better is to stabilize the level of economic activity and encourage the strong expansion of the economy. This enables banks and firms to grow out from under their bad debts. In this way, the mistaken investments of the past eventually become inconsequential. While there may indeed be a problem of moral hazard, it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.

Thus, in order to protect widows and orphans from starvation, the Fascist State is compelled to prop up the profits and asset prices of failed banksters and encourage the export of productive capital to the less developed regions of the world market — not to mention, leave millions without jobs and millions more under threat of losing their jobs. Eichengreen even has the astonishing gall to state the problem of moral hazard identified by Austrians, “is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.” Eichengreen takes us all for fools — did not Washington deregulate the banksters prior to this depression, precisely when the economy was still expanding? If banks are deregulated during periods of expansion, and they cannot be regulated during periods of depression, when might the time be optimal to address moral hazard?

The question, of course, is rhetorical — and not simply because Eichengreen is only blowing smoke in our face. Eichengreen actually argues that Fascist State intervention prevented a depression!:

…we have learned how to prevent a financial crisis from precipitating a depression through the use of monetary and fiscal stimuli. All the evidence, whether from the 1930s or recent years, suggests that when private demand temporarily evaporates, the government can replace it with public spending. When financial markets temporarily become illiquid, central-bank purchases of distressed assets can help to reliquefy them, allowing borrowing and lending to resume.

And, here we can see the role of the thing serving as money and its relation to the crises inherent in the capitalist mode of production. Ex nihilo currency does not abolish crises, it merely masks them from view: while ex nihilo dollar based measures of economic activity indicate the economy suffered a massive catastrophic financial crisis in 2008, gold indicates this financial crisis is only the latest expression of an even more catastrophic depression that has, so far, lasted more than a decade.

NEXT: The tale of two monies