The followers of Keynes believe that when there is a considerable amount of unemployment of workers and machines, the government and the “monetary authority” can create whatever additional purchasing power is necessary to achieve “full employment” by providing a replacement market for otherwise overproduced commodities.

If this is true, the general overproduction of commodities can only arise because of either policy mistakes by governments and central banks or because the governments and central banks deliberately wish to create unemployment. Therefore, according to this view, it is perfectly possible to avoid the periodic mass unemployment created by crises of generalized overproduction without abolishing capitalist production.

If, on the other hand, crises of generalized overproduction occur because the industrial capitalists periodically produce more commodities than can be purchased by the combined purchasing power of the working class, the capitalist class, the middle class, and the state and its dependents, long-term “full employment” (1) is impossible under capitalism.

In order to examine the question of to what extent if at all the capitalist state can create a replacement market for commodities that otherwise cannot find buyers requires an examination of government finance in light of Marx’s fundamental discoveries involving the nature of value, price and money.

It is pretty obvious how the production of commodities can exceed the purchasing power of provincial governments—including the national governments of the euro zone countries—state governments, and local governments—none of which has the power to issue its own currency. During downturns in the industrial cycle, tax revenues of the governments decline. If they spend more than they take in, they must borrow. If the recession is persistent, their debts will grow so that sooner or later they will be forced into bankruptcy, just as happens with private individuals and individual corporations.

But what about the case of governments that can issue their own currency—most famously the U.S. government, whose currency, the U.S. dollar, is widely accepted as a means of payment, not only in the United States, where it is “legal tender for all debts private and public,” but throughout the world? Why can’t the government make up for any gap between the ability or willingness of the “private sector” to purchase commodities and the ability of the industrial capitalists to produce them?

Different forms of money and government finance

To understand government finance—the purchasing power of the state—you have to understand the three different forms money takes—gold bullion, or metallic money; legal-tender token money; and credit money. I have dealt with the three forms of money elsewhere in this blog, but I will review them briefly again with a view to how they affect the purchasing power of the government. Here I will ignore earlier monetary systems such as the international gold standard and deal only with the current system. (The international gold standard is examined elsewhere in this blog and its operation does not concern us here.)

Different forms of money governed by different economic laws

The three forms of money follow different laws. What Marx called real money must first be a commodity before it can become money. The material substance of the commodity that serves as money is called by Marx money material. Pure money material is uncoined bullion—bars of gold. Under capitalism, money material must be produced by industrial capitalists—gold mining and refining companies—that are in competition with other capitalists and therefore motivated like all industrial capitalists by the search for the highest possible rate of profit. Therefore, the commodity nature of gold precludes any centralized control of the quantity of gold money.

All other things remaining equal, the more gold bullion that is produced the lower the rate of interest and the higher the profit of enterprise. Remember, the profit of enterprise is the difference between the total profit and interest.

Unlike most commodities, gold bullion does not perish or even tarnish (2) and is therefore an “immortal” commodity. This is what makes gold bullion an excellent money commodity. Therefore, as the production of gold bullion as a commodity proceeds, the total quantity of gold bullion in the world grows without interruption in terms of weight, though the rate of increase in the size of the world bullion hoard can and does vary. The increase in the total quantity of gold in the world forms the material basis for the growth of the world market. And capitalism, as Marx stressed, cannot exist without a growing market.

The laws that govern token money

The second form of money is token money, which represents gold bullion in circulation. Token money is what most laypeople think of when they hear the word money. As a rule, the state or an organ of the state such as the central bank issues the token money. Token money consists of monetary tokens—paper money and coins made out of cheap metals, plus as we will see below what economists call central bank money.

Nowadays, the government declares monetary tokens—paper notes and fractional coins—to be “legal tender for all debts private and public.” This is legal language that declares the tokens cannot be legally refused as a means of purchase or a means of payment by a seller or creditor. Unlike metallic money, token money must be issued by a single centralized authority that is not motivated by its individual need for profit. Instead, the issuer of the tokens acts in the interest of capitalist society—and its ruling capitalist ruling class—as a whole. In practice, this centralized authority can be none other than the state power, or a specific designated organ—called by economists the “monetary authority”—that is bound up with the state power.

As a rule, token money can act as a means of purchase and a means of payment only within the area that is ruled by the particular state power that issues a given token money currency. (3) What token money cannot do is act as the universal measure of the value of the commodity—or universal equivalent—that in terms of its own use value measures the values of other commodities. Instead, the tokens—whether paper notes or coins made of cheap metals—represent in circulation the actual money commodity—gold bullion.

The price of gold in a given currency reflects the amount of gold that a given token currency represents at a given moment in time. For example, if the dollar price of gold is $1,500 an ounce, a dollar represents 1/1500th of an ounce of gold. Therefore, prices expressed in terms of U.S. dollars or any paper currency are ultimately simply a disguised form of the prices expressed in terms of weights of gold bullion.

Unlike metallic—gold—money, token money is by its very nature bound up with the state power, and this gives rise to the illusion (4) that money itself is a creation of the state power rather than a social relationship of production mediated by a money commodity such as gold that arises out of the simple exchange of commodities. (For Marx’s explanation of the relationship between money and other commodities, see the first three chapters of “Capital” Volume I.)

Why is token money of necessity bound up with the state power?

The reason that the issuer of token money must be able to control its quantity in a centralized way is that the amount of gold bullion an individual unit of the token money represents—with some fluctuations that we will examine next month—is determined by the quantity of the token money in terms of currency units, such as dollars, pounds, euros, yen and so on, relative to the quantity of gold bullion measured in terms of weight.

The general law governing the value of token money is this: Doubling the quantity of the currency tokens—the total quantity of gold bullion in the area in which the token money circulates remaining unchanged—each individual token will represent half as much gold bullion as before.

The gold bullion that backs the token money need not necessarily be held in the vaults of the state that issues the token money. However, the greater the percentage of the total quantity of gold bullion existing in the area in which the given token currency circulates that is held by the state, the more the total gold hoard can be wielded in a centralized way if a more than the ordinary demand for bullion develops. The centralized hoard held in the vaults of the state that issues the token money is therefore the ultimate weapon the government of the given state can wield against crises.

In a crisis, the state can always reduce the quantity of token money by selling off its gold reserve to private hoarders—as long as it hasn’t exhausted its gold reserve. By doing so, however, it decentralizes the gold hoard, reducing its ability to act as a weapon against crises in the future. We will examine this question more closely next month.

Gold hoards in the hands of private capitalists, in contrast, cannot be wielded in a centralized way against crises, because under the whip of competition individual capitalists are obliged to act in their private interest, even if by so doing the individual capitalist undermines capitalist society as a whole—for example, by making a crisis more intense.

The issuer of the token money—ultimately the state power—in order to control its total quantity must therefore be able to reduce as well as expand the quantity of the currency tokens. Leaving aside operations involving gold, the main way the state power reduces the quantity of monetary tokens in circulation is through its power to tax. It is therefore generally enough for the state to declare that taxes are payable using monetary tokens that it issues to establish the tokens as a representative of the gold—or whatever commodity serves as money—in circulation within the geographic area that the given state rules.

In addition, as we saw above the state can and does take the further step of declaring the currency tokens as legal tender payable for all debts, public—paying of taxes—and private. The overall strength of the state power determines to what extent this can be enforced.

The war against counterfeiting

In order to maintain control over the quantity of token money it issues, the state must defend its monopoly right to issue token money, if necessary by force. Naturally, other players besides the state power are tempted to create counterfeits of the monetary tokens, since if they can make convincing counterfeits and get away with it, they can make … a lot of money. If the state is unable to enforce this monopoly, the quantity of monetary tokens can increase without limit and the tokens will lose their function as representatives of gold bullion—real money—in circulation.

This is one of the reasons why as a rule token money can only circulate within the area ruled by the state power that issues it. Beyond that area, the state cannot suppress counterfeiting of its currency nor can it reduce its quantity through taxation. Counterfeiting can be carried out either by criminals—capitalists or would-be capitalists who operate in defiance of the laws of the state—or by rival states. During periods of war, a government of one warring state will sometimes counterfeit the currency of a rival in order to devalue its currency and sabotage its war economy.

Under the U.S. world empire, the U.S. government has taken upon itself the function of undermining and overthrowing the governments of “rogue states” that defy the Empire’s overlordship, even if the U.S. is not legally at war with the targeted state.

Though I know of no actual evidence, I would not be surprised if it were revealed someday that the U.S. government is now engaged in counterfeiting the monetary tokens of Iran, (5) Syria, and Venezuela. In the case of Iran and Venezuela, these suspicions are heightened by the fact that the U.S. press has recently been gloating about the fall of the value of these two currencies against the dollar.

If the U.S. government is engaged in counterfeiting the currencies of Venezuela, Iran or Syria, it will certainly not officially admit this. The reason is that if states began to counterfeit the currencies of other states, token money in general would be threatened with collapse, since the quantity of token money would start to increase without limit.

In the event that another country (6) attempted to counterfeit U.S. currency, the U.S. government might well go to war to stop it. The ability to prevent other governments from counterfeiting the U.S. dollar ultimately rests on force and therefore is the most important reason why U.S. dollar-denominated monetary tokens can circulate far beyond the borders of the U.S. If the U.S. government were to lose its overwhelming military power relative to that of all other states, and consequently the ability to stop the counterfeiting of U.S. dollars by foreign countries, the dollar-denominated monetary tokens would once again be confined within the borders of the U.S.

Public debt and token money.

Once the state develops the ability to collect taxes in terms of its own token money, it acquires another way to reduce the quantity of token money in circulation—by borrowing money in the medium of the monetary tokens that it issues. If the state borrows money in this way and immediately spends the borrowed token money, no reduction in the quantity of token money is achieved. But if the state borrows token money and does not immediately spend it, the quantity of token money in circulation will fall.

Modern central banks

While the reduction of the quantity of token money in circulation can be achieved by having the ministry of finance or the treasury borrow money by issuing interest-bearing treasury bonds, bills and notes and not immediately spend the money, this runs into the problem that in practice government treasuries are under great pressure to quickly spend any token money that comes their way.

While the ministry of finance or treasury can function as the “monetary authority” and issue monetary tokens—as long as it collects taxes payable in monetary tokens in order to prevent their quantity from exploding—in exchange for the commodities the state purchases, in practice the role of monetary authority is played by a special organ separate from the treasury called a “central bank.”

Historically, central banks developed out of certain commercial banks that loaned money in the form of credit money to the government and held the government deposits. Here, however, we are not interested in the history of central banking but only in the role that the central banks are playing today. Since the U.S. currency and financial system forms the center of the entire world financial system, it is worth examining the institutions of the U.S. monetary system and government financial system in some detail.

Most central banks—the most important central bank by far being the U.S. Federal Reserve System (7)—have the right to deal in government securities and even private securities but not in commodities, with the exception of the money commodity—gold. Since the New Deal, the U.S. Federal Reserve is not even permitted to buy and sell gold. Instead, the hoarding, buying and selling of gold bullion was shifted to the U.S. Treasury.

Therefore, unlike the U.S. Treasury, the Federal Reserve System has authority only to buy and sell securities, traditionally short-term Treasury bills and notes (8) but also long-term bonds and even some private bonds such as mortgage-backed securities. But it has no authority to purchase commodities beyond office supplies and the labor power required to keep its offices functioning—security guards and other personnel. When the Federal Reserve System sells a security, the token money that flows in cannot be spent but is destroyed. Therefore, when the central bank buys securities it increases the quantity of token money, and when it sells securities it reduces the quantity of token money. The buying and selling of securities by a central bank with the aim of either increasing or reducing the quantity of token money are called “open market operations.”

In the past—as recently as 1971—the U.S. Treasury had some authority to issue its own currency independently of the Federal Reserve System, in the form of United States Notes—the original “greenbacks.” However, today the U.S. Treasury has no authority to issue monetary tokens. Instead, this authority is reserved for the 12 U.S. Federal Reserve Banks whose operations are centrally controlled by the Fed’s Open Market Committee.

Difference between printing and issuing paper money

The 12 regional Federal Reserve Banks that have the exclusive power to issue “paper currency” in the U.S. do not actually print the Federal Reserve Notes, as they are formally called. These notes are printed by the U.S. Treasury and then made available to the 12 Federal Reserve Banks. As far as the U.S. Treasury is concerned, the newly printed Federal Reserve Notes that are run off the Treasury’s printing press, are no more money to it than the blank checks you receive from a bank when you open a checking account are money to you.

Only when the dollar bills are issued through the Federal Reserve System do they become (legal-tender) token money. In many other countries, the legal-tender currency notes are actually printed—but not issued—by private capitalists.

The industrial capitalists who print currency notes—not to be confused with the industrial capitalists who mine and refine gold bullion—purchase ink and paper on the market, along with labor power. The paper and ink in the productive process of printing the currency notes absorb necessary and surplus labor—surplus value—and the newly printed notes are sold to the government at a price that more or less conforms to their price of production.

These newly printed notes represent commodity capital—not money capital—to these industrial capitalists until they are sold to the central banks that will issue these notes as (legal-tender token) money that will circulate in the geographic areas that the governments of these countries govern. While the notes are in the hands of the industrial capitalists that produce them, the notes are no more money than the checks that are printed by check-printing companies are money to these check printing companies. The specific use value of the newly printed currency notes is that they can function as representatives of gold in circulation once they are issued by a central bank—for example, because they are difficult to convincingly counterfeit and will not quickly wear out in circulation.

Central bank money

The development of central banking led to another form of token money, alongside the paper notes and coins made out of base metals that constitute the monetary tokens that economists call central bank money. This form of token money consists of the accounts kept by the commercial banks in the central bank.

These accounts are promises by the central bank to pay a commercial bank on demand in legal-tender monetary tokens—either paper money or coin made out of base metals—on the demand of the owner of the account, the commercial bank. In the U.S., for example, when the inventory of the Federal Reserve Notes of one of the 12 regional Federal Reserve Banks is run down, the Federal Reserve Bank simply goes to the printing department of the U.S. Treasury and asks for additional notes. When the inventory of monetary tokens in the form of coin of one of the Federal Reserve Banks is run down, it obtains coin from the U.S. Treasury as well, since the U.S. Mint is part of the U.S. Treasury.

Since the Federal Reserve Banks can obtain either Federal Reserve Notes or coin to the full extent of their legal obligations to pay off their deposit liabilities to the commercial banks, the mere obligation of a Federal Reserve Bank to pay a commercial bank in U.S. monetary tokens is already effectively token money.

When the commercial banks need additional Federal Reserve Notes—paper money—or coin to meet their customers’ demands, they simply withdraw the money from the Federal Reserve Banks, which in turn replenish their own supplies of Federal Reserve Notes or coin from the U.S. Treasury, thus transforming the central bank money into physical dollar-denominated legal-tender monetary tokens.

In practice, when the U.S. Federal Reserve System and other modern central banks expand or contract the quantity of token money through their buying and selling of government or other securities, they actually expand or contract the quantity of central bank money.

The monetary base and the total money supply

The total quantity of token money denominated in a given currency is called by economists the monetary base. The monetary base consists of paper notes, coin and central bank money. It is therefore identical with the quantity of token money. Milton Friedman claimed that there was a stable relationship between the monetary base created by the central bank and credit money—also called bank money—that is created by the commercial banking system (more on credit money below). The monetary authority that issues the token currency is, according to Friedman, therefore able to control not only the quantity of token currency in existence in terms of currency units such as U.S. dollars, pounds, euros and so on but also of commercial bank-created credit money.

However Friedman’s claim is false. Instead, the ratio of credit money to token money varies with the phases of industrial production, expanding during the rising phase and contracting during the downward phase of the cycle. Friedman “explained” the industrial cycle in the most superficial way possible, just as Marx noted the economists of his day also did, by the expansion and contraction of (mostly) credit money, which merely reflects the different phases of the industrial cycle but does not cause the industrial cycle. For this, Friedman won the Nobel Prize in economics!

Token money not the same as credit money

The final form of money and the last to evolve historically is credit money. (9) The legal-tender token paper money created by the state is often incorrectly described as credit money. Though the value represented by legal-tender monetary tokens broadly depends on the credit of the state that issues them, they are not promissory notes payable in some other form of money. True credit money, in contrast, is a legal contract that is payable in another more basic form of money—either gold or state-issued token money.

Unlike token money, credit money can be created in a decentralized way by private corporations whose motive is profit. There is no danger that credit money will be issued in unlimited amounts, because when credit money is “over-issued,” sooner or later the owners of the credit money will rush to redeem it in “hard cash”—either gold or state-issued monetary tokens, which destroys the credit money. This is the crucial difference between token money issued by the state and credit money that is usually created by for-profit commercial banks.

How the commercial banking system creates credit money

The banks make loans in the form of promises to pay in legal-tender token money—that is, they issue the loans in the media of imaginary deposits they create when they make the loans. These promises by the bank to pay in legal-tender token money on demand can then be transferred to another person, traditionally by check but today by electronic means as well. In the 19th century, credit money was sometimes called circulating credit, because it consisted of negotiable promises to pay the bearer on demand in some other more basic form of money such as gold coin or legal-tender token money that could be transferred from person to person in order to make purchases or payments.

The system of commercial bank-issued credit money is called fractional reserve banking, because the bank maintains considerably less than a dollar in legal-tender token money behind each dollar its owes in checkable deposit liabilities. The system of credit money functions smoothly under normal conditions, because only a very small portion of owners of checkable deposits will actually exercise their right to redeem the deposits in legal-tender tokens—cash. This form of credit money is called bank money by economists. If the issuer of the credit money—or their insurer—should be unable to redeem in legal-tender token money the credit money on the demand of its owner, the credit money becomes worthless.

Plastic money—debit and credit cards

Checks are the traditional way of transferring bank money from one party to another. Today, debit cards, credit cards and most recently smart phones can be used to carry out these transfers electronically. The move to electronic systems of transferring these circulating bank IOUs—credit money—from one person to another has made it possible for commercial bank-created credit money to invade even petty retail trade.

Debit versus credit cards

Debit cards enable the user to replace legal-tender token money—paper money and coin—with, under normal conditions, much safer bank money. For example, if my wallet is stolen, I will lose all the bills that I had in my wallet. As a result, people in countries with well-developed banking systems are increasingly using debit cards—sometimes called check cards—rather than carry around old-fashioned paper money. When the banks issue debit cards, they don’t, however, actually create additional money. They are merely replacing one type of money—central bank-issued legal-tender monetary tokens—with another type of money—commercial bank money. If this is all that happened, debit cards would have little economic significance, since the bank money that replaces the legal-tender token money would have a 100 percent reserve backing in token money.

However, the issuing of debit cards means that, everything else remaining equal, a greater part of the paper money plus coin will fall out of circulation and remain in the banks as bank reserves than would be the case without debit cards. Indeed, the more debit cards replace cash, the less cash—and even coin—will have to be printed or minted. This means that token money will consist less and less of actual tokens—paper notes and coin—and more and more of electronic entries in the computers of the banking system.

The economic significance of this evolution is that, all things remaining equal, the ability of the banks with a given reserve—their deposits with the central banks plus their vault cash—to create credit money is increased. What appears at first to be merely a technical matter of bookkeeping therefore has revolutionary implications, because it enables the banking system to create a larger mass of credit money, potentially enlarging the demand for commodities—without an increase in the quantity of gold bullion—which enables the industrial capitalists to develop the forces of production further beyond the capitalistically determined limits of production than would be the case in the absence debit cards. The resulting overproduction can then only be corrected by more intense crises.

Credit cards

Even more revolutionary in the above sense are credit cards. In contrast to debit cards, they not only greatly reduce the need for monetary tokens in circulation, they actually represent the creation of additional money by the commercial banks. When a bank issues me a credit card with a limit of say $1,000, the bank creates an imaginary deposit of $1,000. This $1,000 of credit money enters circulation as I use the credit card to make purchases or pay my bills. There is also a reflux mechanism when I pay my monthly credit bills, which effectively retires some of the credit money created when the credit card was used.

Most recently, smart phones are being used to transfer bank balances—whether real or created by actual deposits of legal-tender token money or by imaginary deposits created by the banks. By making the use of bank-created credit money even more convenient, this will further expand the circulation of credit money at the expense of state-issued monetary tokens, which will make it possible for the industrial capitalists to even further expand the forces of production beyond the capitalistic limits of production, which will lead to even more intense future crises.

A cash-less society?

It is sometimes claimed that we are heading toward a cash-less society where actual “cash”—by which is meant legal-tender monetary tokens—will disappear altogether.

People who make this claim, however, do not understand the nature of credit money. Credit money is the promise by one party to pay another party in another more basic form of money that is transferable to another party. Credit money can function as money as long as it is redeemable in a more basic form of money—either state-issued monetary tokens or gold. The moment that promise to pay cannot be made, the credit money—and with it the purchasing power it represents—vanishes into thin air.

To sum up, if the supply of real money—the total quantity of gold bullion—is increased, the result is a fall in the rate of interest and, under capitalism, sooner or later the growth of the market. If the quantity of token money is increased without a corresponding increase in the quantity of real money, each unit of token money will sooner or later lose value relative to real money, causing inflation. Therefore, the ability of the U.S. Federal Reserve System to expand the monetary base in terms of purchasing power—not in terms of such arbitrarily defined units as the monetary tokens that it issues—U.S. dollars—is limited not by the total quantity of commodities that can be produced by the industrial capitalists but by the quantity of gold bullion in existence.

In contrast, if credit money is over-issued, the result will be a credit and banking crisis that will destroy a portion of the credit money. Ultimately, the amount of credit money in terms of purchasing power that can be created, whether directly on a gold monetary base or as is the case today on an intermediate base of token money, which in turn rests on a gold monetary base, is limited by the fact a given piece of money like a dollar bill cannot settle more than one payment in a given instant of time.

As we saw last month, the Federal Reserve System’s main task is to prevent a collapse of the quantity of loan money capital. This task is not nearly as easy as laypeople as well as economists imagine. Indeed, it is ultimately impossible.

The crisis phase of the industrial cycle is above all else characterized by a drying up of the quantity of loan money capital. At a certain point, the highly artificial system of payments, as Marx calls it, unravels. Debtors attempt to convert the loans and securities they hold into hard cash, partially because they fear that their creditors will call in the loans they have taken out. Debtor drags down creditor. The whole system of credit money and credit suddenly contracts in relation to the monetary base, which in the final analysis must rest on gold.

The central bank attempts to prevent the periodic contraction of the quantity of loan capital, or at least limit it, by expanding the quantity of legal-tender “paper” currency—the monetary base of token money—whenever a crisis threatens. The problem the central bank faces is that it has to fight a war on two fronts. First, if it is to be successful in staving off a crisis, it must expand the monetary base sufficiently to prevent a contraction in the quantity of credit money and credit in general that was built on top of the base of token money.

But the central bank must also worry about the possibility that money capitalists will move to convert the monetary tokens—paper money—into the ultimate “monetary base”—gold bullion, actual money material. This is the reason Keynes—and the non-Marxist political progressives who base themselves on Keynesian economics—”hate gold” so much or deny its role as the “metallic barrier,” as Marx called it, in capitalist crises. If it were possible to somehow eliminate the “lowest” level of the monetary system, gold bullion, the monetary authority that issues the token money could issue enough legal-tender token money to prevent the much larger mass of credit built on top of it, and credit in general, from contracting. In other words, the central bank would be able to prevent the contraction of loan money capital that characterizes the crisis from occurring and thus prevent the crisis itself.

Crisis of 2007-09 a textbook example

It so happens that the last crisis, the crisis of 2007-09, represents the text book case of the two-front war that the central banks—in this case the U.S. Federal Reserve System, which under the dollar system effectively acts as the central bank of the whole world—must wage during a crisis.

Starting in 2001, the dollar price of gold after falling from around $875 an ounce in January 1980 finally bottomed out around $250 an ounce and began to rise. That is, after years of gradually rising against gold, the U.S. dollar once again began to lose gold value. This change in the direction of the dollar price of gold—gold value of the dollar—was accelerated by the decline in global gold production that set in around that time. As sensitive primary commodity prices began to react to the renewed depreciation of its dollar-denominated monetary tokens, the Federal Reserve Board began to restrict the rate of growth of the monetary base.

At first, this seemed to have no effect, as “financial engineering” by the banks and the “shadow banking system” prevented even the modest rise of long-term interest rates the Fed was apparently aiming for. Loan money capital remained abundant.

In August 2007, the first phase of the crisis began with a sudden freezing up in the market for mortgage-backed securities. The quantity of loan capital at last began drying up. If the Federal Reserve System had been fighting a war on only one front, the response would have been simple. It would have greatly increased the quantity of token money—the monetary base. This would mean that more “paper dollars” would be backing each dollar in credit money that had been created by the banking system. But the Federal Reserve System was tripped up, because it had to worry about the declining amount of gold bullion that each dollar of token money it created represented.

Instead of moving to increase the monetary base, like it had at the time of the 1987 stock market crash or the 1998 collapse of the Long-Term Capital Management hedge fund, it merely moved the existing monetary base around. (For a detailed recounting of this operation, see last part of this post.) In this way, it was forced to acknowledge that, contrary to the hopes of Keynes, it simply didn’t have the power to create dollars at will—under pain of the collapse of the dollar system—right up to “full employment,” notwithstanding the lack of a gold standard. The capitalist tiger that the Fed was attempting to ride was obeying the economic laws described in Marx’s “Capital” and not those of Keynes’ “General Theory.”

However, the money capitalists on Wall Street and elsewhere assumed that the Federal Reserve System would expand the monetary base in terms of dollars much like they had in the 1970s. As a result, not only the dollar price of gold but the prices of commodities soared. (See post previously referenced.) Suddenly, it looked as though the “stagflation” of the 1970s had returned.

At the same time, the sudden rise in wholesale prices combined with the more or less stable consumer prices meant that the monetary base in terms of purchasing power began to contract. The stage was set for the greatest contraction in the quantity of loan money capital since the super-crisis of 1929-33, and there wasn’t much the Federal Reserve System could do about it.

While the media kept reporting that the Fed was taking “bold actions,” with the implication that everything would be all right, in reality during the year that followed the opening of the first phase of the crisis in August 2007, the Fed—and other central banks—were effectively paralyzed.

But since the U.S. dollar-denominated monetary base was growing very little in dollar terms and was actually sharply contracting in terms of purchasing power, the chain of payments began to fray in a thousand and one places, and soon debtor began to drag down creditor. Credit vanished as the quantity of loan money capital dried up. The collapse of Lehman Brothers investment bank was simply the most dramatic manifestation of this process.

The Fed was now back on familiar ground. Everybody was demanding dollar liquidity. The demand for dollars suddenly soared. The dollar, which had been falling against both gold and other currencies, reversed direction. The demand for dollars seemed to have no limit. Freed of its paralysis of the preceding 12 months, the Fed now sprang back into action.

To be continued.

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1 Capitalist governments have achieved “full employment” only during periods of all-out war mobilizations. Keynes and his supporters used this fact to argue that what can be achieved during wartime can also be achieved in peacetime. Keynes pointed to the “full employment” achieved during the war economy of 1914-1918 to prove his point.

However, as we have seen in this blog, war economies involve contracted reproduction and cannot therefore be the basis of a long-term economic policy. Capitalist economies can only exist in the long run as expanded and not contracted reproduction. Keynesian economists and the progressives they influence obscure the important difference between production and reproduction when they point to the war economies of World War I and World War II as examples of successful “full employment” policies.

Second, in examining the origins of the extraordinary crisis of 1929-33 we saw that the war economy of 1914-1918 by causing an unprecedented rise of the market prices of commodities above their values—or prices of production—played a decisive role in transforming the “ordinary” cyclical crisis that began in 1929 into the super-crisis of 1929-33 leading to the Great Depression. Therefore, war economy creates full employment in the short run only at the price of increasing unemployment in the long run.

2 In Volume II of “Capital,” in examining the question of simple capitalist reproduction, Marx assumes a system of circulating full-weight gold coins. Gold coins grow light in circulation as a certain amount of money material is lost in the wear and tear of circulation. Therefore, the money material that is lost in circulation (referred to by Marx in “Capital” Volume II as the “depreciation element“) must be replaced by newly mined and refined gold bullion that is then used to mint replacement coins.

However, gold coins have long since vanished from circulation. While governments, including the U.S. government, still mint gold into coins, these coins are used as a convenient way to hoard bullion and not as a means of circulation. They are even called “bullion coins.” Today, the circulation of gold is largely confined to the shadowy world of illegal commerce such as the illegal global drug trade. And even here, gold is largely replaced in circulation by U.S. $100 bills.

Gold bars and bullion coins, whether in the vaults of Fort Knox or in the strong boxes of private gold hoarders, do not experience wear and tear and can as physical objects survive for far longer than the system of capitalist production can. Therefore, as far as the capitalist economy is concerned, economically gold bullion and bullion coins last forever.

3 The euro at first glance appears to be an exception to this rule. It is issued not by a single state but by a collection of states. Looking more closely, we see that the euro is indeed issued by a single centralized monetary authority, the European Central Bank, which is owned jointly by the separate states that make up the euro zone. In addition, all the euro zone states are subordinated to the overwhelming military power of the United States, operating through NATO and other international institutions, backed up ultimately by the military forces of the United States. Even with all this, there is considerable doubt that the euro can survive in the long run.

4 A reader asked whether I had ever heard of chartalism, sometimes called modern monetary theory (MMT), which holds that the origins of money are found in the ability of the state to raise taxes and make tax obligations payable in the monetary tokens it issues. I can assure the reader that I certainly have. Chartalism, or MMT if you prefer, indeed forms the foundation of Keynesian economics. Marx’s theory of value, money, and price is the most detailed refutation of chartalism that can be found in economic literature. In reality chartalism, or MMT, explains only the role of state taxation in the origins of token money.

5 In the case of Iran, the vicious sanctions—actually trade blockade—that is making it difficult for Iran to export oil and other commodities that it produces is undoubtedly playing a big role in the devaluation of the Iranian currency. Whether the U.S. government is also counterfeiting Iran’s currency in a move to drive its currency ever lower against the dollar—and ultimately against gold—is for now known only to the top policy makers of the U.S. government.

6 It occasionally has been alleged that the government of the Democratic People’s Republic of Korea—North Korea—has been counterfeiting U.S. dollars. The U.S. government has done everything in its power to make it impossible for North Korea to engage in normal international trade. The aim is to create so much hardship in North Korea that the people will turn against the North Korean government thereby leading to the annexation of Korea by the U.S.-occupied Republic of Korea, or South Korea, much like West Germany annexed East Germany at the end of the Cold War.

In this case, not only would the results of North Korea’s socialist construction be liquidated but all of Korea would fall under the control of the U.S. empire, which among other things would mean a greatly increased danger of war between the U.S. and the People’s Republic of China.

The claim that North Korea is counterfeiting U.S. currency amounts to asserting that in desperation the government of North Korea, prevented from earning dollars through normal international trade, is resorting to counterfeiting U.S. dollars.

These unproven claims are an attempt to whip up war fever against North Korea and prepare the way for a second Korean war—a war that if it were actually to occur could lead to all-out war between the U.S. and its satellites (such as Japan) and China—in other words a third world war. The answer to the claims that North Korea is counterfeiting U.S. currency is to demand that the U.S. government end its trade blockade against North Korea.

7 As I explained in an earlier post, the U.S. Federal Reserve System consists of the the Federal Reserve Board of Governors plus the 12 Federal Reserve Banks, which have since the New Deal shared central banking functions with the U.S. Treasury.

8 Treasury bills are short-term government IOUs sold at a discount (representing the interest) that mature in less than a year, usually three months. Treasury notes are interest-bearing government IOUs that mature in one, two, five or 10 years. Treasury bonds are long-term IOUs that run more than 10 and as long as 30 years. Traditionally, the U.S. Federal Reserve System has controlled the quantity of token money through the buying and selling of Treasury bills, but since the crisis of 2007-09 the Fed has been dealing in long-term Treasury bonds and even mortgage-backed securities. We will examine this next month.

9 Token money is one of the oldest forms of currency and existed in the form of coins that represented more precious metal in circulation than they physically contained for nearly 2,500 years. Modern paper money issued by the state power is more recent. It can be traced back to the 17th century when some of Britain’s North American colonies began to issue “bills of credit.” Some of these bills of credit were redeemable in gold or silver money, much like the banknotes issued by the Bank of England, which began operations in 1694, were. But some of the bills of credit were not redeemable and simply rested on the general credit of the colonial government. These bills of credit are the first examples of modern paper money. In general, today’s legal-tender paper money notes are called “banknotes” because they are issued by the central bank and descend from banknotes that were redeemable in gold or silver money.

For example, the Federal Reserve Notes are notes on one of the 12 U.S. Federal Reserve Banks. But since they are not redeemable in any form of gold money, and the Federal Reserve Banks that issue the Federal Reserve Notes are centrally controlled by the Federal Reserve Board of Governors, which is an organ of the U.S. federal government, Federal Reserve Notes are in fact “bills of credit” just like those of the colonial governments were, and though they depend on the general credit of the U.S. government, they are not redeemable in gold.

In popular language, the paper currency units of the U.S. are referred to as dollar bills and derive from the original “bills of credit” of colonial times. The popular slang term “dollar bill” is therefore actually more accurate than the official name—Federal Reserve Note.