Last month, we saw that Shaikh’s view of “modern money” as “pure fiat money” is essentially the same as the “MELT” theory of money. MELT stands for the monetary expression of labor time.

The MELT theory of value, money and price recognizes that embodied labor is the essence of value. To that extent, MELT is in agreement with both Ricardian and Marxist theories of value. However, advocates of MELT do not understand that value must have a value form where the value of a commodity is measured by the use value of another commodity.

Supporters of MELT claim that since the end of the gold standard capitalism has operated without a money commodity. Accordingly, prices of individual commodities can be above or below their values relative to the mass of commodities as a whole. However, by definition the prices of commodities taken as a whole can never be above or below their value.

Instead of the autocracy of gold, MELT value theory sees a democratic republic of commodities where, as far as the functions of money are concerned, one commodity is just as good as another. Under MELT’s democracy of commodities, all commodities are money and therefore no individual commodity is money.

MELT and ‘Say’s law’

Once we accept this argument, we inevitably arrive at Says law. If you double the quantity of commodities, and if all commodities are equally money so that none are money, you double the purchasing power available to purchase commodities.

Marx’s law of value holds that the value of a commodity—defined as X-amount of abstract human labor, where X stands for some unit of time—must be measured by commodity Y representing some unit of the use value of Y. Marx called X the relative form and Y the equivalent form. In the beginning, when exchanges of the products of labor were only occasional, all commodities served as both relatives and equivalents. This might be called the primitive democracy of commodities.

However, as the exchange of commodities developed, this primitive democracy gave way to autocracy. A few and eventually a single commodity became the universal equivalent of all other commodities. (1) From this point onward, all other commodities played the role of the relative form. A general overproduction of all commodities relative to the commodity serving as universal equivalent became a theoretical possibility.

It seems that the commodity that plays the universal equivalent has a magical power that is somehow bound up with its physical substance. In reality, this seemingly magical power arises from the social relations of production that we call commodity production. Money is therefore defined as abstract human labor that is directly social embodied in the commodity that serves as money. Some commodities can play this role more conveniently than others. To paraphrase Marx, gold is not by nature money but money is by nature gold.

Gold won the monetary crown, because, first, it represented a great amount of value—abstract human labor measured by time—in a physically small amount—weight—of gold; second, it was durable and did not tarnish, since it did not react with other chemical elements; third, due to it scarcity (2) it has throughout the history of commodity production up until the present held its value; and fourth, it was soft and therefore could be easily coined, fashioned into bars, and melted down.

Other commodities that have served as money, some of which are illustrated in Shaikh’s “Capitalism,” lacked one or more of these attributes, so over time lost the “monetary crown” to gold. Silver, gold’s greatest “rival” for the monetary crown, has since the late 19th century fallen sharply against gold and other commodities in terms of value. Also, unlike gold, silver tarnishes.

All incomes—rents, profits and net profits, interest, and money wages—must also be measured in terms of the use value of the money commodity. Like prices, they too must be “golden.” However, when workers consume their wages, they are more interested in the use values of the items they buy and consume than monetary value.

Capitalists are also interested in the use values of the items of personal consumption their profits enable them to buy. However, when they engage in personal consumption, they are not acting as capitalists. When they act as capitalists—that is, transform profits into capital—it is profits as money—the use value of the money commodity, but not any other use value—that counts. This function of capitalists consists of adding the part of their profit they do not use for personal consumption to their existing capital. Both the profit and the capital must consist of the same social substance—value—and both must be measured in terms of the use value of the commodity that serves as money.

This reality is reflected in everyday language—even if it escapes the learned economists. For example, capitalist families refer to their capital as “the money,” even though only a small part of their capital exists in the form of actual money. Similarly, capitalists refer to the profits they realize as the “money they make.” Making money is the end all and be all of capitalism. Making anything else—whether bread, cars, Gulf Streams, expensive wine, cheap wine, socks, shirts, and so on is, under the capitalist mode of production, always merely a means to an end. And the end is “making money.”

Not money in the literal sense of gold bullion—except in the case of the gold bullion-making capitalists—but money in the sense of commodities that are convertible in the market into actual money—gold bullion—and therefore can be measured in terms of gold bullion through their golden prices. Commodities not purchased for personal consumption are absolutely useless to a capitalist if they are inconvertible into money. One of the beauties of the full Marxist theory of value—and its great superiority over other theories of labor-based value such as the Ricardian and MELT theories—is that it explains why people in capitalist society are, and must always be, obsessed with money.

Since the MELT theory of value includes by its very nature, whether or not its supporters realize it, Say’s law, the MELT theorists have to explain cyclical capitalist crises by something other than a periodic general relative overproduction of commodities. The most popular explanation is to appeal directly to the tendency of the rate of profit to fall, which Marx did call the most important law of political economy. Because the natural tendency of profit rates is downward, capital is obliged by hell or high water to resist it. Therefore, the law of the tendency of the rate of profit to fall retains its full importance as the most important law of political economy, even during historical periods when the rate of profit does not fall or even rises.

Among the consequences of this is that periodically the rate of profit falls and capital is obliged to extend the scale of production, which leads to crises of overproduction. These periodic commodity gluts then become powerful means by which capital resists the fall in the rate of profit. As a result of periodic relative overproduction of commodities and capital, the absolute overproduction of capital is avoided as the reserve industrial army of the unemployed is reinforced.

Rising rates of surplus value that accompany the crises cause capital to slow the rate of increase in the organic composition of capital and therefore slow the fall in the rate of profit. In addition, crises enforce the periodic devaluation of constant capital in the sphere of prices—which is what counts for the capitalists—which further counteracts the fall in the rate of profit.

Shaikh and MELT

On one point, some MELT theorists are actually superior to Shaikh. These theorists point out that in calculating profits one has to start with the level of prices that prevail at the time the industrial capitalists advance their capital—that is, at M—C. If prices fall between M—C and C’—M’, it is the prices that prevail when the capitalists advance their capital that count.

On this point, Shaikh the engineer eclipses Shaikh the economist. He observes that if there is a drop in prices during the process of production, though the drop in prices may cause the capitalist to lose money, the capitalist might still be able in physical terms to carry out expanded reproduction because the cost in terms of money is now lower.

What this overlooks is that the capitalists are not interested in expanding the scale of production in engineering terms. Instead, they are interested in making money. If the capitalists fail to expand M when they carry out a cycle of production, they will have been better advised to hold on to M until conditions once again become favorable for its expansion.

Assume that there are two capitalists, A and B. Both start with 100 of some unit of money. Due to a sharp fall in prices, capitalist A has lost money and now has only 75 units. But this capitalist has expanded his or her means of production in real terms. Capitalist B has held on to his or her money during the cycle of production and still has 100. He or she hasn’t made any money but hasn’t lost money either.

Now assume that prices stop falling and it is possible once again to carry on production profitably in terms of money. Capitalist B has 100 and therefore can now purchase 100 worth of means of production and labor power, while capitalist A can only purchase—or already possesses—75 worth. Now capitalist B, armed with the larger means of production, will be well positioned to drive Capitalist A out of the market and perhaps even buy A’s own means of production at a discount and hire A’s “own” workers. Capitalist enterprises can fail when they are short of M—money—even if they still have plenty of C—means of production.

But Shaikh is more consistent than the MELT theorists. He realizes that under the democratic republic of commodities that he believes replaced the autocracy of gold around the year 1940, commodities cannot really have prices at all. Instead, we merely have rates of exchange between the different commodities, just like we had at the dawn of exchange when every commodity functioned simultaneously as the relative and equivalent forms of value.

However, this situation that prevailed when the exchange of products was the exception cannot possibly prevail in highly advanced post-1940 capitalism. If it did, every commodity would have N minus one prices, where N stands for the total number of commodities.

Shaikh the engineer sees capitalist production as a system of physical production driven by the rate of real net profit. In this engineering view, capitalists are seeking to accumulate wealth in the form of use values, not exchange values. This wealth must be measured in the terms of all the many use values that are produced, each use value with the unit of measure appropriate to it. Here Shaikh’s “capitalists” are seeking to accumulate wealth as use values and not capital. Whatever such persons are—they might be the leaders of a socialist economy—but they are not capitalists.

Capitalist production is mostly not about the accumulation of value in the physical form of money material—I say mostly because a small but definite part of the wealth capitalists accumulate does have to be accumulated in the form of money. Instead, capitalist accumulation is about the accumulation of wealth in the form of commodities that are convertible on the market into the money commodity. It is in this sense that capitalists are interested in “making money” and only money.

Since the Great Depression, many economists—most importantly John Maynard Keynes, but Milton Friedman as well—have realized that general gluts are possible, marginalist theory notwithstanding. The pure quantity theory of money, which assumes that prices and wages adjust instantaneously to any changes in the quantity of money relative to the quantity of commodities, actually agrees with Shaikh’s view that it is current prices and not prices at the time capital is advanced that count.

This is why the pure quantity theory of money holds that money is neutral. Shaikh himself rejects this view in the scientific parts of his “Capitalism” and his work in general—for example where he clearly realizes that an increase in the quantity of money can by expanding the market accelerate economic growth in a capitalist economy.

Milton Friedman, in contrast, in his attempt to save the quantity theory of money from Keynesian criticisms, introduced the concept of lags into his version of the quantity theory of money. In Friedman’s modified quantity theory of money, prices and wages do not adjust immediately but with lags to changes in (the rate of growth of) the quantity of money. Therefore, in practice, the otherwise “amazingly stable” capitalist economy experiences booms and contractions—general gluts.

Friedman continued to defend “the neutrality of money” but only in the long run. In the short run, Friedman was forced to concede, fluctuations in the rate of growth of the quantity of money was anything but neutral—after all, according to Friedman, the Great Depression itself was caused by a fluctuation in the quantity of money. Like Keynes, Friedman wanted to eliminate the role of gold from the monetary system—establish pure fiat money—because he believed that this would enable the monetary authorities to ensure a stable rate of increase of the money supply. (3)

Decline and fall of the gold standard

John Maynard Keynes “hated” gold. He believed the rules of the gold standard artificially limited production and led to otherwise avoidable economic crises. The so-called marginalist revolution, which began around 1870, coincided with the rise of the classic international gold standard. Before that date, many capitalist nations had silver rather than gold standards. However, by the turn of the 20th century all the capitalistically developed nations, and some not so developed such as Russia, had adopted gold standards. Only nations that were extremely underdeveloped capitalistically, like China and Mexico, retained silver standards or had fiat money systems. However, the heyday of the international gold standard was destined to be short lived. It began to break apart in 1914.

During its brief heyday, marginalist economists had a hard time explaining why the gold standard was useful for capitalism—or indeed why gold had any special role at all under capitalism. Marginalist theory claims that objects of utility have economic value because they are scarce. Since commodities are characterized by their scarcity, how can they ever be overproduced? Say’s law is therefore built into the very foundations of marginalism, along with the quantity theory of money and the view that commodities are all equally “money” and so none are money.

Neither the classical economists who understood labor value but never analyzed the form of value, still less the marginalist economists, who rejected any concept of labor value at all, could explain what appeared to be the supernatural power gold holds over the capitalist economy.

To the extent the marginalists supported the gold standard at all, they simply saw it as a legal defense against the age-old tendency of governments to create “too much” money, leading to inflation. The argument goes that inflation gives government the power to confiscate a portion of the wealth of capitalists through an inflation tax that can be imposed by the government through the monetary authority without a vote for or against it in parliament. The despotic ability of government to use currency devaluations to appropriate wealth was viewed by liberal marginalists as undermining the right and security of private property.

Marginalist opposition to the gold standard was based on the fact that the economy was held hostage to the quantity of gold that the for-profit gold mining and refining industry produced. Sometimes these industries produced “too little gold” to support prevailing prices leading to deflationary depressions. Other times, they produced “too much” gold leading to golden inflations.

Some marginalists believed that it would be better to eliminate the role of gold in the monetary system and run the risks involved in having the government or the central bank determine the money supply instead, despite the dangers to liberal principles. The small minority of economists today who support a return to the gold standard—almost all far-right “libertarians”—make this argument.

At the turn of the 20th century, the gold standard was considered one of the pillars of the “liberal world order.” However, as economic crises—which were not supposed to happen at all according to marginalist theory—continued to periodically return, finally culminating with the Great Depression of the 1930s, support for the gold standard declined in policymaking circles. In retreat, economic liberalism blamed instability of gold production for the instability of the otherwise stable capitalist system. This was the essence of Milton Friedman’s teachings.

Keynes caught the trend, though he was moving away from economic liberalism. He now acknowledged that capitalist investment could be quite unstable. From the 1920s on, Keynes strongly believed that whatever the “anti-inflationary” benefits of the gold standard were, the purely artificial legal barriers to pumping up “effective demand” and lowering real wages in order to ensure “near to full employment” had become a danger to the continued existence of the capitalist system. (4) The view that the gold standard was responsible for crises and unemployment quickly became the ruling orthodoxy that prevails today.

Keynes realized that a shortage of money relative to commodities could occur and that general gluts were possible. However, these general gluts—crises—occurred because bad policies arbitrarily tied the quantity of money to the quantity of gold. If the monetary authorities instead tied the quantity of money to the quantity of commodities as a whole—and if governments were willing to step in with extra deficit-financed spending when private investment lagged—the whole problem of “general gluts” would in Keynes’s view disappear and capitalism would be saved.

Accepting the claim, advanced by Keynes, Friedman and their followers among professional economists, that general gluts can be avoided under capitalism has considerable implications when it comes to analyzing not only crises but real competition in general, the subject of Shaikh’s “Capitalism.” Competition will have quite a different character and outcomes where the market can be glutted only for particular commodities—backed by shortages of other commodities—and, alternatively, a situation where general gluts of commodities are not only possible but inevitable at quasi-periodic intervals.

The year 1940

While many supports of MELT would date the birth of pure fiat money to the end of the dollar-gold exchange standard in August 1971, Shaikh believes that it replaced gold as the “medium of price” around the year 1940. Why 1940 and not 1944, with the Bretton Woods agreement, or 1971, when the U.S. Treasury finally defaulted on its promise to redeem every $35 for one ounce of gold at the request of foreign governments and central banks?

Shaikh rests his case for 1940 on the fact that before 1940 world commodity prices, whether quoted in British pounds or U.S. dollars, fell as much as they increased. The history of prices in terms of dollars or pounds before 1940 reveals a wiggly graph but shows little long-term tendency. Shaikh realizes that in the pre-1940 period British pounds and U.S. dollars were only pseudonyms for particular weights of gold bullion.

Gold, therefore, served as the “medium of price” before 1940. But after 1940, prices rise without interruption, whether quoted in U.S. dollars or other currencies linked to the U.S. dollar through the Bretton Woods system, or later through the unofficial dollar system. Shaikh therefore draws the conclusion that pure fiat money had displaced gold from its role as the “medium of price” as the World War II war economy engulfed the world.

But why was this any different than August 1914, when the World War I war economy engulfed the world but gold according to Shaikh retained its role as the medium of pricing? Shaikh would argue that the sharp fall in prices in terms of pounds and dollars that occurred in 1920-21 and 1929-33 indicates that gold retained its role as the “medium of price” in this period. But after 1940, prices in terms of dollars and other currencies linked to it rise virtually without interruption, though the rate of increase varies.

In reality, the behavior of prices quoted in U.S. dollars and its satellite currencies can be fully explained with Marx’s concept of token money, where monetary tokens represent gold bullion in circulation. The U.S. dollar was already devalued against gold by about 40 percent between 1933 and 1934. Though the dollar prices of commodities changed very little during the remainder of the Depression-ridden 1930s, one would expect, assuming that “golden prices” (prices in gold terms) remained within their historic ranges, that dollar prices would rise well above their historic levels during the economic upswing that followed World War II. Roosevelt’s devaluation of the dollar fully explains why the high dollar prices of the World War I era were temporary while the elevated prices in dollar terms after World War II were permanent. Therefore, higher U.S. dollar prices after World War II was exactly what Marx’s theory of credit and token (5) money would predict.

What was new in the 1940s was not the rise of pure fiat money—that is forever impossible under the capitalist mode of production—but the rise of the U.S. world empire. Just like the competition among different capitals where the capitalist ability to produce more commodities exceeds the ability of the market to absorb them at current prices leads to the centralization of capital, intense political and military competition among the imperialist powers—whose highest form is war—leads to the centralization of political and military power. The U.S. world empire did not eliminate the nation-state, nor did it repeal the law of uneven development among capitalist nations. However, it did permit the U.S. dollar, even after it completely lost its role as international credit money in 1971, to become a token currency that could escape the limits of the U.S. nation-state and circulate internationally.

Thanks to the U.S. world empire, the dollar reigns supreme. The prices of globally traded commodities are quoted in dollars and international debt is consequently denominated in U.S. dollars. What would happen if Saudi Arabia and the other oil monarchies started to quote oil not in terms of U.S. dollars but weights of gold? Overwhelming military force, probably through NATO, would be applied to overthrow them. Indeed, the attempt of the Libyan government to establish a “gold dinar” as an alternative to the U.S. dollar in Africa was one of the reasons for the U.S.-NATO attack that overthrew it.

On Jan. 12, 2016, then-President Barack Obama observed that the U.S. spends more on “defense” than the next eight countries combined. President Trump and congressional Republicans and Democrats are moving to further increase U.S. military spending. Therefore, Marx’s observation that a token currency can only circulate within the sphere where the state power that issues it reigns supreme applies very much to the U.S. dollar’s evolution in the post-1945 world, where no country—especially no capitalist country—has come anywhere close to equaling the U.S. militarily.

Between 1945 and 1971, the U.S. dollar was on the international level still a form of credit money insomuch as it was convertible into gold at a fixed rate. Beginning in 1971, its overwhelming military power enabled the U.S. to convert the dollar into a token currency with an internationally forced circulation—the force consisting of the overwhelming military power of the U.S.

Therefore the dollar on an international scale follows the same laws that purely national unconvertible paper currencies followed in Marx’s time. Behind dollar prices—and prices in terms of its local satellites—there continue to lurk golden prices, both market prices and prices of production. The U.S. dollar, like all unconvertible paper currencies before it, is merely a pseudonym for a variable, as opposed to a fixed, weight of gold.

Under a gold standard, and in earlier times a silver standard, currencies performed their role as a standard of price well because they were mere pseudonyms for a fixed weight of precious metal. Under the dollar standard, the U.S. dollar performs its role as a standard of price—though poorly—because it has some stability against gold. It is far more stable than bitcoins, for example. However, the U.S. dollar performed its function as a standard of price much better when it represented a fixed amount of gold.

This is why the dollar price of gold—despite the claims of economists that gold has virtually no importance—is followed so closely by the financial world. If the dollar price of gold moves too rapidly either downward or upward, the U.S. Federal Reserve System will take action to stabilize its price by either moving to lower interest rates if the dollar price of gold falls sharply, or raise interest rates if the dollar price of gold rises sharply.

Indeed, the inability of the Federal Reserve to ignore changes in the price of gold has caused some to speak of the current international monetary system as Bretton Woods II. Like Bretton Woods I and the classical international gold standard before, it continues to be, in the final analysis, based on commodity—gold—money. It cannot be otherwise as long as capitalism continues to exist. Indeed, along with the rate of interest on U.S. government bonds, the dollar price of gold constitutes the financial pulse of the U.S. world empire.

Almost half a century has elapsed since the gold-dollar exchange standard gave way to the dollar standard. It is now possible to establish how the industrial cycle manifests itself under the new system. Remember, the dollar system means that all internationally traded commodities are priced in dollars, and other countries back their domestic currencies with U.S. dollars. (6) The Federal Reserve, which issues dollars, is obliged to maintain some stability of the dollar gold price but makes no attempt to fix the price.

This system effectively makes the U.S. Federal Reserve System the world central bank, because it creates the reserves that back up the currencies of all other nations. A shortage of dollars will therefore undermine the currencies of other nations, and if severe enough, signals a global money crunch and subsequent global slump. On the other hand, an inflationary over-issue and subsequent devaluation of the U.S. dollar means the devaluation of the reserve that other central banks use to back their currencies. Again the value of those currencies is undermined. The result is then a period of global inflation that ends in a global slump.

The world economy—global trade, industrial production and employment—will avoid crisis only so long as the Federal Reserve issues dollars in the quantities that avoid both a global dollar shortage and a sharp depreciation of the dollar as measured by the dollar price of gold. The catch is that the Federal Reserve can only do this during the expansionary phases of the global industrial cycle. As a result, the Federal Reserve—or any other global central bank that in the future might replace it—cannot avoid periodic global economic crises as long as the world economy retains its capitalist character. (7)

Below is a description of an “ideal” industrial cycle under the dollar standard. Real cycles will be a little more complicated. However, the sharper the cycle the more the phases of the cycle are clearly defined. The cycle that ended in 2008 comes very close to the ideal cycle.

An ‘ideal’ industrial cycle under the dollar standard

Global overproduction is defined as the total quantity of commodities other than gold, measured in terms of their prevailing golden prices, increasing faster than the supply of gold bullion, measured in some unit of weight. The symptom of this situation is a rising trend in the rate of interest. In the course of the industrial cycle, the U.S. Federal Reserve System must accommodate this rise in interest rates if it is to avoid a sharp devaluation of the U.S. dollar. The rise in interest rates is followed, sooner or later, by a global economic crisis.

Therefore, under the dollar system, just as was the case under various forms of the gold standard, the Federal Reserve—or any other central bank—is powerless to prevent an economic crisis once the global overproduction of commodities has reached the critical point.

The expansionary phase of each industrial cycle lasts as long as the rise in interest rates—which must remain lower than the rate of profit—is gradual. But as the expansion continues, growing overproduction of commodities reaches a point where the rise in interest rates needed to prevent a sharp drop of the U.S. dollar against gold is no longer compatible with continued economic growth. This is the critical point of the cycle that immediately precedes the crisis.

If the Federal Reserve attempts to keep the expansion going beyond this critical point by issuing additional token dollars in a bid to check the rise in the rate of interest, the result will be a sharp rise in the dollar price of gold followed quickly by an accelerating global inflation that will forcibly raise the rate of interest leading to a global economic slump.

Beyond the critical point of the industrial cycle

Once the crisis/recession breaks out in full force—assuming the dollar system has survived, which it has up to now—the role of the U.S. dollar as the global means of payment comes to the fore. At this point, the dollar price of stocks, primary commodities and gold will register sharp drops. As a result, the Fed gains the power to create dollar currency in much greater amounts than it normally can without the dollar price of gold rising. The reason is that payments for outstanding debts is demanded in dollars so that many capitalists have to dump on the market any other assets they have including gold in order to obtain the needed dollars.

Therefore, once the crisis breaks out, interest rates can fall sharply without provoking a rise in the dollar price of gold. This was clearly illustrated during the last quarter of 2008, which marked the sharpest crisis that has occurred so far under the dollar system. As the Fed increased the growth of the dollar monetary base at annualized rates in the four digits and interest rates plunged, the dollar price of gold actually fell. Had the Fed increased its issue of dollar liquidity at those rates under normal circumstances—or even a few weeks earlier when the industrial cycle was still in its critical phase—the U.S. dollar price of gold would have skyrocketed with all the consequences.

During the crisis proper—which reached it most intense phase during the fourth quarter of 2008—world trade, industrial production and investment fell at a faster rate than during the super-crisis of 1929-33, though the crisis this time was considerably shorter. The sharp drop in global economic activity showed that overproduction had been halted.

While global industrial production declined, the production of gold bullion not only did not decline but was greatly stimulated as the relative profitably of producing gold compared to non-money commodities increased. This reversed the decline in global gold production that had begun in 2001 and soon once again reached record levels. While on the eve of the crash of 2008, the capitalist economy was producing “too little” gold and too many other commodities, now it was producing “too much” gold and not enough other commodities. The crisis (of the general relative overproduction of commodities) was therefore resolving itself and in due course a new—if weak—economic expansion began.

Since global capitalist economic crises are crises of overproduction, their resolution can only occur through a period of underproduction of commodities relative to the production of the money commodity. These events have nothing to do with the Phillips curve nor are they caused by the rate of unemployment falling below some natural rate.

However, one the effects of this crisis—and of capitalist overproduction crises in general—was a sharp rise in unemployment. In this way, the crisis of 2008 prevented what for the capitalists would be a far more serious economic crisis from developing—a crisis of the absolute overproduction of capital. Such a crisis would be more serious because the very conditions enabling surplus value to be produced—not just realized—would have been destroyed.

Now, after nine years of economic expansion, the overproduction of commodities against gold has begun and a new critical point in the world industrial cycle is approaching. The Fed is being forced to allow interest rates to rise, which will in the near future lead to another global slump. Once the critical point is reached, if the Federal Reserve resists a further rise in interest rates to “keep the expansion going,” there will be a new sharp increase in the dollar price of gold with all the economic and political consequences.

In the event of a new dollar/gold crisis, an even sharper spurt in interest rates will occur that will only sharpen the next global slump. The presidency of Donald Trump by bringing into question the political stability of the United States—one of the conditions that enable the U.S. dollar to serve as the world currency—is simply the cream on this cake that Janet Yellen and her colleagues at the Federal Reserve will have to eat one way or another as the current world industrial expansion approaches and then reaches its critical point.

The birth of the dollar system

Since the 1970s, central bankers and policymakers have learned the basic laws and limitations that govern the dollar system the hard way. This explains why during the last critical point in the industrial cycle—the one that occurred between August 2007 and August 2008—the Federal Reserve, contrary to widespread expectations on Wall Street, did not quickly expand the U.S. monetary base. Instead, the Fed created new emergency credit and discount facilities but worked with the existing monetary base. These attempts failed, and in September 2008 as the global capitalist economy entered the crisis proper the Fed was able to launch its unprecedented quantitative easing—printing money—policy without destroying the dollar system, in order to save what could be saved.

It was during the 1970s that the Federal Reserve, admittedly in a pragmatic and empirical way, learned what happens under a fiat token money system when the central bank and government attempts to continue “expansionary monetary and fiscal policies” once the critical point of the industrial cycle is reached. They learned that, contrary to widespread hopes in the 1960s, replacing the gold standard with paper money does not enable capitalist governments and central banks to expand demand up to the physical ability to produce and thus abolish periodic crises of general overproduction.

Policymakers learn that ‘demand management’ cannot prevent periodic crises of overproduction

By the late 1960s, conditions were fast ripening for the first major economic crisis since the Great Depression—as opposed to lesser recessions such as the one that broke out in 1957. As a result of global overproduction, the gold liquidity that resulted from the extreme under-production of the Depression was finally absorbed. At the same time, the steady rise of golden prices since the end of the Depression meant that gold production was becoming increasingly unprofitable, both relatively to other capitalist industries and absolutely.

This showed that once again the golden prices of most commodities had risen above their prices of production. This combined with the political situation that emerged in the post-Depression world made the collapse of the dollar-gold exchange standard, which had grown up since the end of World War I and had been formalized at the Bretton Woods conference of 1944, inevitable.

The Bretton Woods system would have collapsed sooner if it hadn’t been for the apartheid system in South Africa, which from the late 19th to late 20th century was the leading gold producer. Apartheid effectively prevented the unionization of African gold miners. As a result, the value of African miners’ labor power was held down. This enabled golden prices to rise somewhat above their prices of production before the falling absolute and relative profits in the gold mining and refining industries began to reduce the level of gold bullion production.

But the criminal policy of apartheid supported by the United States—though increasingly shamefacedly due to the effects of the Civil Rights and Black liberation movements—could only postpone the inevitable. Beginning in the middle 1960s, the industrial cycle boom combined with extra demand added by the deficit-financed Vietnam War raised golden prices of commodities above their prices of production. As a result, the rate of increase of global gold production slowed to a crawl. After 1970, the profit squeeze in gold mining and refining led to actual recession followed by stagnation in the gold mining and refining industries, which lasted through the decade of the 1970s.

Under the rules of the Bretton Woods system, the U.S. was obliged to maintain the dollar gold price at $35 an ounce. During the 1960s, in order to prolong the life of the Bretton Woods System the U.S. Treasury and foreign central banks created a gold pool, which was eventually obliged to dump huge amounts of gold on the market to prevent the dollar price of gold from rising above $35.

The “straw” that finally broke the back of the Bretton Woods System was the Tet Offensive of the Vietnamese resistance in January 1968 and the Johnson administration decision to further increase the number of U.S. ground troops in Vietnam. The gold pool soon suffered a massive “gold drain.”

The classic gold drains of the 19th century observed by Marx saw gold flow from the banking system of one country to the banking system of another. For example, gold might flow from the vaults of the Bank of England into the vaults of the U.S. commercial banking system, or vice versa. But under the centralized Bretton Woods system, the gold drain of 1968 saw a massive drain out of the U.S. Treasury and foreign central banks into the hands of private gold hoarders/speculators betting on a rise in the dollar price of gold.

Behind this gold drain was the fact that the industrial cycle of the 1960s had reached its critical point. In theory, at this point the Bretton Woods system could still have been saved. But that would have required the Federal Reserve to raise interest rates beyond their already high levels—relative to the rate of profit—that would then have triggered a crisis allowing both dollar as well as golden prices to fall once again below the prices of production.

Such a policy would have created a global dollar shortage. As a result, the other countries that “backed” their currencies by the U.S. dollar would have been obliged to limit the issuance of their currencies. If they didn’t, the currencies would have fallen against the U.S. dollar, which would not only have broken the rules of the Bretton Woods System but would have put their capitalists—who had assets denominated in local currencies but had debts denominated in dollars—in a tight spot.

If the Federal Reserve System had acted to save the Bretton Woods System, interest rates would have briefly spiked and deep recession and mass unemployment would have spread around the capitalist world as world trade and employment fell. But as Thomas Tooke would have predicted, the deep deflationary world recession would have caused interest rates to drop sharply as well.

However, as the role of the U.S. dollar as a means of payment asserted itself, the Federal Reserve would be able to once again increase its issue of dollars within the framework of the rules of the Bretton Woods System. Private gold hoarders would have responded to the brief interest rate spike by selling their gold back to the U.S. Treasury to take advantage of the high interest rates and to meet the demands of their creditors for payment in U.S. dollars. The U.S. Treasury’s gold hoard at Fort Knox and other depositors would have been rebuilt, once again putting the Bretton Woods System on a solid foundation.

With the fall in dollar as well golden prices, the cost price of producing gold in dollar terms would have fallen while the dollar “selling price” could then have been retained at $35 an ounce. The result would have been a sharp rise in the rate of profit in the gold mining and refining industries.

Capital, always on the lookout for the highest possible rate of profit, would have flowed back toward the gold mining and refining industries resulting in a rise in global gold production. The rate of increase in the growth of the world supply of gold bullion would have once again increased while the amount of currency measured in terms of gold necessary to circulate commodities would have been lessened considerably as a result of the fall in the golden—as well as dollar—prices of commodities. After a few years of deep depression and massive cyclical unemployment, a new economic upswing financed by the massive hoard of idle money accumulated during the depression would have ensued.

(We will examine this alternative outcome to the crisis more closely next month.)

However, defending the Bretton Woods gold-dollar exchange system in this way was never seriously considered. Avoiding a major depression was considered the top priority in light of the “struggle against communism,” which included the struggle against socialist countries with full-employment planned economies. In return for allowing capitalism to have another chance after the disasters of the 1914 through 1945, the capitalists had, after all, promised the working class and masses of people “near to full employment” through Keynesian “demand management” policies.

This promise was incompatible with the measures necessary to save the Bretton Woods system. Therefore, policymakers raised on Keynesian “macro-economics” considered the final elimination of the role of gold in the international monetary system not only possible but an urgent necessity. To these macro-economists, the crisis in the international monetary system in the late 1960s was a sign that the time had arrived to complete the task of eliminating gold from the international monetary system.

As the Bretton Woods System entered its death agony, the term “demonetization of gold” often appeared in the financial media. Instead of being “backed by gold,” the U.S. dollar would be backed by the ever-increasing quantity of commodities that U.S. industry and capitalist industry throughout the world was churning out. Gold would be finally ousted officially from the monetary throne—the economists claimed that it had already been ousted in practice.

The “democratic republic of commodities” in which all commodities would be money and therefore none would be the money commodity would end gold’s tyrannical rule over the world of commodities forever. As a result, Say’s law would finally come into its own, banishing general gluts permanently.

The 1960s represented the flood tide of Keynesian economics in both policymaking and academic circles. If there was one time in the history of modern capitalism when the academic and political mainstream believed that they had finally beaten the “business cycle” once and for all, it was then. Even many Marxists seemed willing to accept these claims, especially but not only the Monthly Review school.

Now that his “metallic majesty” had been overthrown, the government and central bank would always see to it that “effective demand” was sufficient to buy the vast and ever-growing quantity of commodities capitalist industry was churning out. The remaining disagreement among economists and policymakers involved the relative importance of fiscal versus monetary policy. Right-wingers like Milton Friedman argued that seeing to it that there was a steady expansion of money supply was enough and that fiscal stimulation was both unnecessary and harmful. Friedman claimed, contrary to Keynes, that capitalism and capitalist investment—monetary shocks aside—was remarkably stable. (8)

The great monetary experiment begins

Many economists guided by the marginalist theory of value believed that the dollar price of gold would drop. They reasoned that as gold became “de-monetized” the demand for gold would drop because gold’s main use value was its role as money. But the opposite occurred. The result was that the U.S. dollar’s function as a standard of price was seriously impaired. As long as the dollar price of gold was stable, golden prices and prices quoted in dollars were simply different ways of expressing the same thing. But as the dollar fluctuated—mostly downward but occasionally upward—in value against gold, golden prices and dollar prices increasingly diverged. As the 1970s progressed, prices in terms of dollars rose sharply, while golden prices plunged.

Far more important than the divergence between dollar and golden prices was the divergence between profits measured in paper dollars and profits, or rather the lack thereof measured in terms of gold—golden profits. The capitalists still calculated profits in terms of U.S. dollars, and to a lesser extent the stronger satellite currencies. The dollar retained its function as the chief means of payment on the world market. But every businessperson knew that nominal profits were, once inflation was taken into account, less than “real” profits—profits calculated in terms of commodities. Expanded reproduction could go on, though at a reduced pace, as long as “real profits”—or real net profits measured in terms of the use values of commodities—remained positive.

This is what Shaikh sees. However, an increasing number of capitalists noticed that merely hoarding gold bullion yielded a higher dollar profit than almost any other investment. The only rivals—leaving aside production in gold mining and refining—to gold hoarding in terms of “profitability” were “collectibles,” which are by definition unreproducible.

This showed that, calculated in terms of gold bullion as opposed to dollar terms or “real terms,” the rate of profit was sharply negative. As this continued—with some fluctuations—the demand for gold became ever more frantic as capitalists piled into this now extremely “profitable” investment—simply purchasing gold bullion and watching its dollar price rise ever higher.

As a consequence, the dollar fell in terms of its gold value at a faster rate than the Federal Reserve System was creating new dollars and the commercial banks were creating new dollar-denominated credit money on the basis of their dollar-denominated reserves, whose purchasing power was being undermined by the accelerating inflation.

The dollar prices of primary commodities spiraled upward and dollar price increases spread from the wholesale to the retail level. As old Thomas Tooke would have expected, the U.S. dollar rate of interest began to rise above the already high level of the late 1960s, and repeated credit crunches sent sales of homes and autos and other consumer durables slumping.

As long as “inflation expectations” remained high, capitalists also tended to flee to “brick and mortar.” Industrial capitalists transformed their dollar-denominated money capital into real capital before it lost even more purchasing power. The tendency was for the consumer goods industries—especially credit-dependent consumer durables like automobiles and housing—to slump while “Department I” industries kept booming.

This condition acquired the name “stagflation.” However, precisely because of the divergence in demand between the production of the means of production and personal consumption, any attempt by the Federal Reserve to halt the depreciation of the U.S. dollar against gold quickly turned “stagflation” into deep recession. This is what occurred in 1974-75 as soon as the Federal Reserve raised interest rates to slow the pace of inflation in 1973-74 but then quickly retreated in the face of the sudden recession.

Faced with the unexpected inflation and the resulting credit squeezes that triggered the 1974-75 recession, Keynesian economists hoped that the problems of inflation and the rise in dollar-denominated interest rates would simply go away. They tried to explain away the high rate of inflation through a series of one-offs in particular markets. For example, Keynesians claimed that soaring oil prices were caused by political factors such as the Israeli-Egyptian war of 1973 and the brief Arab oil embargo that followed. At the same time, a die-off of anchovies off the coast of South America caused the price of that commodity to rise sharply.

Above all, Keynesians argued that the “strength of the unions”—which were a lot stronger in those days—was driving up commodity prices in a so-called wage-price spiral. Keynesian economists therefore called for “wage-price controls” that would stop the rise in money wages that were supposedly causing the inflation.

Nixon did impose wage-price controls, which were mostly wage controls, between 1971 and 1973 as the Bretton Woods System collapsed. Keynesian economists praised the Republican president for his “bold move,” but Milton Friedman denounced his fellow Republican’s “socialist policies.”

Though the wage-price controls did accelerate the developing decline in real wages—and slowed the rate of growth in labor productivity—inflation continued on its merry way. In reality, the inflation was actually a price-wage spiral not the other way around. The economic situation was a mess, but Keynesian economists argued that it was better than the alternative deep recession/depression necessary to stop inflation the old-fashioned way.

The monetary crisis of 1979-80

During most of the 1970s, the official U.S. dollar rate of inflation was in the high single digits. In Britain, where the British pound was falling against the U.S. dollar, the inflation rate rose into the double digits. As far as President Carter was concerned, the economic situation was bad but perhaps not intolerable. As the AFL-CIO unions went along with demands for wage moderation, the rate of inflation according to Keynesian theory would eventually decline. In the meantime, Carter’s policy amounted to “muddling through.”

But things came to a head in 1979. During the year, signs multiplied that a new recession was developing only four years after the deep recession of 1974-75 had bottomed out. The reigning Keynesian orthodoxy, which dominated among Carter’s economic advisors, held that when recession threatened, as it was in 1979, the central bank should issue a sufficient quantity of new currency to prevent interest rates from rising and if possible even lower them. In the past, this had often been impossible due the role of gold in the international monetary system. But since 1971, gold was no longer supposed to be an obstacle to Keynesian anti-recessionary polices. Avoiding a 1980 recession was particularly important to President Carter, who was up for re-election in November of that year.

In 1979, a high rate of inflation relative to the rate of growth of the monetary base was pushing up interest rates. The high interest rates were once again biting into demand for automobiles and housing and if unchecked would soon lead to a worldwide recession. The capital goods industries were still booming only because the industrial capitalists, lacking confidence in the dollar and fearing that inflation would accelerate, wanted to buy equipment and open new factories before the prices in terms of dollars rose even more.

In retrospect, we can see that in 1979 the U.S. and global capitalist economy had once again entered the “critical stage”–only four years after the last recession had bottomed out. At this point, Carter’s economic team was divided on what to do. One possibility was to ignore the fact that the industrial cycle was in the “critical stage” and continue with Keynesian expansionary policies.

Investors–fearing that Carter’s Keynesian advisors would indeed triumph–as Keynesian policymakers had been triumphing since the 1960s–panicked. Between August 1979 and January 1980, the dollar price of gold rose from under $300 to $875 at one point. The U.S. dollar had lost more than half its gold value in just five months! Supposedly this had no particular importance because gold was now “just another commodity.”

In reality, as the dollar price of gold doubled, dollar inflation accelerated. But the dollar monetary base had come nowhere close to doubling. It only increased about 4 percent—fast by historic standards but hardly enough to support a more than doubling of dollar commodity prices in a few months. But despite the fact that gold was, according to the Keynesian economists and Milton Friedman, “just another commodity and had no particular importance,” businesses attempted to raise dollar prices as much as the market would allow to compensate for the dramatic fall of the dollar’s gold value over the five-month period between August 1979 and January 1980.

Business people were becoming ever more conscious of the relationship between the dollar price of gold, the dollar prices of primary commodities, their dollar cost prices, and prices in general. When gold rose sharply, businesses learned that their cost prices would soon increase and that they had do everything they could–such as holding commodities off the market–to drive up their dollar prices in order to preserve their dollar profits. With prices now rising much faster than the monetary base–in terms of purchasing power–the reserves of the commercial banks were shrinking. Old Thomas Tooke would not have been surprised as soaring dollar prices led to a sharply higher dollar interest rates. The hope that “stagflation” might be a stable condition that could be lived with was turning out to be wishful thinking.

At this point, the Fed and Carter’s policymakers had essentially two choices. One, they could have followed the advice of the more “radical” Keynesians and more than doubled the monetary base. This is what they were to do in 2008. But conditions were very different in the fourth quarter of 1979 compared to those prevailing in the fourth quarter of 2008. In 1979, there was a flight from the U.S. dollar–and paper currencies in general–into gold. The industrial cycle was still in the critical phase that immediately precedes the actual crisis. This is the phase where under the dollar system the demand for gold is strongest while the demand for the U.S. dollar is weakest.

In contrast, in the fourth quarter of 2008 the Fed waited until the industrial cycle had passed the “critical phase” and had entered the crisis proper when under the dollar system the demand for U.S. dollars as a means of payment rises while the demand for gold falls. In the fourth quarter of 2008, as sales of commodities abruptly fell and commodities piled up unsold on shelves and in warehouses, panic-stricken money lenders demanded payment of debts that were overwhelmingly payable in U.S. dollars. As a result of the scramble for dollars as a means of payment, the dollar price of gold fell. The U.S. dollar was king as never before.

In the fourth quarter of 1979 and the beginning of 1980, on the other hand, it was the demand for gold and not U.S. dollars that was soaring. At that time, far from demanding U.S. dollars the capitalists were attempting to get rid of them as fast they could and increasingly flee into gold.

If the Fed had actually doubled the U.S. monetary base in order to stave off a 1980 recession, the already extreme demand for gold–not U.S. dollars–would have increased even faster as more and more capitalists would have joined the gold bandwagon. The dollar price of gold would have soared while the rate of increase in dollar commodity prices would have accelerated. Double- and triple-digit inflation and beyond would have resulted as the dollar prices of commodities raced upward against the soaring dollar price of gold. The world capitalist economy would have faced its first global–as opposed to national–runaway inflation.

If the Federal Reserve had actually allowed this to occur, the paper dollar system, then only eight years old, would have failed, bringing down the U.S. world empire, at least financially, and forcing the international monetary system “back on gold” in some form. The Soviet Union and eastern European socialist allies with their full-employment planned economies still existed. World history would have taken a different turn, though we can only speculate exactly what would have happened. We should keep in mind that the transfer of political power to the working class without which the transformation of capitalism into socialism cannot occur is never automatic no matter how deep the crisis of capitalism.

Not surprisingly, the Fed, by then under the leadership of Democrat Paul Volcker, rejected this course and allowed interest rates to soar. The U.S. and global capitalist economies passed the critical phase and entered the crisis/recession phase in which the problem of overproduction began to be resolved.

There were a few more twists in the story. The “premature” recovery that the Fed had forced in 1975 collapsed causing the official U.S. rate of unemployment to rise back to double digits for the first time since the Great Depression. But this was the price that had to be paid in order to save the dollar system and with it the U.S. world empire.

Volcker shock a mistake?

To this day, many well-meaning “post-Keynesian” economists, and indeed many Marxists, claim that the Volcker shock was a mistake. Because of Volcker’s mistake, the world experienced a completely unnecessary recession and resulting mass unemployment. If you mean by this that the refusal of the U.S. world empire to commit financial suicide was a mistake, it was a mistake. If the U.S. world empire had disappeared in the 1980s, the world would be a very different and perhaps much happier place–though that would have depended on the course of the class struggle, so here we enter into the speculative field of alternative history.

But within the framework of saving the U.S. empire, which was Volcker’s job description–not the happiness of the world–there really was no alternative. The only positive alternative, a world socialist revolution, was hardly a policy option for Volcker. It is no accident that Volcker is today one of the most respected elder statesman in U.S. ruling-class circles. This would hardly have been the case if as a result of a “mistake” he put the U.S. and global capitalist economies through years of unnecessary grueling recession.

The rate of profit and the monetary crisis of 1979-80

But the real secret of the monetary crisis of 1979-80, and the Volcker shock that resolved it, involves the measurement of the rate of profit. The high inflation of the 1970s kept profits strongly positive in U.S. dollar terms. It was recognized that due to the rapid fall in the purchasing power of the U.S. dollar in real terms–the use values of commodities, including the machinery and means of subsistence that are necessary to expand production–profits were considerably less in those day than the nominal profits implied. This is what Shaikh sees.

But we have seen that the whole logic of capitalism demands that profits including net profits must be measured in terms of the use value of the money commodity and not the use value of commodities in general. Profits that are positive in “real terms” but not in gold terms just don’t cut it. During the period between 1970 and 1979–with a few fluctuations–the most “profitable” investment was simply holding gold bullion.

Once we grasp the fact that profit must be measured in terms of the use value of the money commodity, the rate of profit of hoarding gold bullion–leaving aside storage costs–is by definition zero. If hoarding gold bullion was the most “profitable” investment available–leaving aside the production of gold itself–this means that there were no truly profitable fields of investment available. Capitalist production cannot continue for very long on such a basis.

Whenever production becomes unprofitable in gold terms, an invisible hand guides the capitalists back to the port of golden profitability. It is true that in dollar terms and even in “real terms,” production remained profitable between 1970 and 1979–unlike the early 1930s. But in terms of what really matters to capitalists–profits measured in terms of the use value of the money commodity–production was unprofitable between 1970 and 1979. Something had to give. And it did in the form of the monetary crisis of 1979-80 and the Volcker shock, which restored the profitability of capitalist production in the only terms that matter–in terms of gold bullion. The only question left to answer is how this impressed itself on the minds of the capitalists.

As we know, capital is ever flowing from less profitable to more profitable fields of investment. During 1970-79, the most “profitable” field of investment as it appeared to everyday businesspersons and the money capitalists was simply hoarding gold and watching its dollar price soar. As they did this, the capitalists were in effect ceasing to be capitalists and instead converting themselves into misers. They didn’t know that they should be calculating their profits in terms of gold rather than in dollars or in “real terms,” but their drive to maximize profit was causing them to “invest” in gold in order to maximize what they thought were profits. Their drive for individual profit—notwithstanding their lack of theoretical understanding of what was really happening—was as though guided by “an invisible hand” to “do the right thing.”

During this period of unprofitable production, they were increasingly holding on to M until the possibility of carrying out M—C—M’ returned, which it inevitably did. Indeed, by holding on to M—purchasing gold and throwing the whole global monetary system into crisis by doing so—they were forcing a return to conditions that would again allow M—C..P..C’—M’, where M and M’ represent quantities of gold measured in some unit of weight.

What really happened during the monetary crisis of 1979-80 was that the economic law that, under the capitalist mode of production, production has to be profitable not just in “dollar terms” or in “real terms” but in terms of gold bullion was violently asserting itself.

Within the marble walls of the Fed, Paul Volcker got the message. And his successors have not forgotten it, though they dare not probe too far into the inner secrets of capitalist production to explain it. Their class position prevents them from doing this. That is the job of those who represent the working class—Marxists.

How did Volcker resolve the monetary crisis? He did it by simply declining to accelerate the rate of growth of the dollar monetary base. Interest rates responded as Thomas Tooke would have expected by dramatically increasing. In the 19th century, there was a saying on the English money market that 6 percent would draw gold from the moon. It took a lot more than 6 percent—rates well into double digits—but the money capitalists finally began to dump gold and instead bought securities to take advantage of these sky-high interest rates. The monetary crisis was broken, though the U.S. and world economy had to go through several years of grueling recession as the industrial cycle left the “critical phase” behind and entered into the crisis/recession phase proper.

Aftermath of the monetary crisis and the determination of the quantity of money loan capital

In the early 1980s, Volcker couldn’t simply flood the commercial banks with dollar reserves—essentially print fresh dollar bills (or the electronic equivalent)—as Bernanke was able to do beginning in 2008. As a result of the failed great experiment in “demand management” of the 1970s, confidence in the U.S. dollar had been severely shaken and it could not be fully rebuilt overnight. A period of exceptional high though now falling interest rates still lay ahead. Indeed, it would take many years before interest rates were to return to normal levels. And unlike the situation during the monetary crisis itself, these high interest rates were positive in both “real terms” and more so in what really counted—in gold terms.

While Shaikh does not understand that profits have to be positive in terms of gold bullion—his acceptance of pure fiat money bars the way for him here—he does understand that the rate of profit has to exceed the rate of interest. If the rate of interest equals or exceeds the rate of profit, capitalists will find it more “profitable” to act as money capitalists M—M’ rather than as industrial capitalists M—C..P..C’—M’. The problem is that if all the capitalists were to shift to M—M’—which they eventually all would if interest rates remained permanently equal to or higher than the rate of profit—no surplus value would be produced. But since interest is simply a fraction of realized surplus value, this would be impossible.

Marx realized that in a situation where the rate of interest equaled or exceeded the rate of profit, thereby leaving net profits zero or negative, a portion of the industrial capitalists would convert themselves into money capitalists, which would inevitably bring the rate of interest down to a point below the rate of profit once again. In Marx’s time this happened at best only momentarily. But thanks to the failed attempt to establish pure fiat money, this process actually unfolded in the late 20th century.

During and after the Volcker shock, as interest rates rose above the rate of profit, money capital was diverted from the circuit M—C..P..C’—M’—the circuit of industrial capital—and M—C—M’—the circuit of merchant capital—into M—M’—the circuit of money loan capital. The result was that once the U.S. dollar was stabilized by the Volcker shock, the quantity of money loan capital exploded, eventually leading to the very low interest rates that prevail today. This process even acquired a name—financialization. Next month, we will examine the consequences.

To be continued.

_______

1 In ancient republics and monarchies, executive power was divided between two consuls, as was the case in the Roman Republic, or two kings, as was the case in Sparta. This is reminiscent of the situation that prevailed through most of the history of commodity production, where both gold and silver functioned as money commodities. However, just as all modern republics and monarchies are centered on a single chief executive—whether king, president or prime minister—so the modern monetary system is centered on a single money commodity—gold bullion. (back)

2 Gold does not have a high value because it is scarce in the Earth’s crust like bourgeois economists believe. Instead, because of its scarcity a large amount of labor on average produces only small amounts of refined gold bullion. Therefore, throughout the history of production up to the present, a small amount of gold bullion has represented a large amount of abstract human labor compared to most other commodities. (back)

3 The Austrian school criticizes Friedman because he advocated strict centralized planning when it came to the “quantity of money” while fanatically opposing centralized planning in the sphere of production. This is indeed a contradiction in Friedman’s work. (back)

4 The Russian Revolution, the “threat of communism,” and the 1926 British General Strike played no small role in the evolution of Keynes away from the economic liberalism he had supported in his youth. (back)

5 The U.S. dollar remained credit money as far as foreign governments and central banks were concerned, because it remained convertible at a rate of a troy ounce of gold bullion for every $35 presented to the U.S. Treasury by foreign governments and central banks. However, for U.S. citizens the dollar was an inconvertible token money after Roosevelt assumed office on March 4, 1933. (back)

6 This is the essence of the present-day international monetary system, though a bit of an oversimplification. Countries keep their reserves mostly in short-term dollar-denominated U.S. Treasury notes. However, the Treasury notes of European governments denominated in euros, and to a considerably lesser extent the treasury notes of other countries denominated in their local currencies, are convertible into their local currencies. The IMF SDRs (Special Drawing Rights) are also used as reserves. SDRs are a market basket of major currencies held by central banks and treasuries are convertible into actual currency at the IMF. And virtually all central banks and treasuries continue to hold a certain amount of gold. But these facts only modify but don’t change the essence of the dollar system. (back)

7 Even if there were a single capitalist state with a central bank that issued a token currency declared legal tender for all debts public and private anywhere in the world—or the solar system—the currency issued by such a central bank would still represent the money commodity in circulation and the central bank would still be unable to eliminate periodic crises of overproduction. (back)

8 Keynes considered capitalist investment—the process by which capitalists transform profits into new capital—to be inherently unstable and subject to sharp fluctuations. He therefore believed that government spending at times would have to be used to offset declines in capitalist investment in order to maintain effective demand and “full employment.”

Friedman, in contrast, claimed that as long as the rate of growth in the “money supply” is stable, private investment will increase at a steady and predictable rate. Progressives, therefore, find Keynesian economics to their liking because the government spending that Keynes believed would be necessary to stabilize overall spending in the economy can in principle be used to help the middle and working classes and the poor.

However, government spending can also be used for military purposes—called military Keynesianism—as the Monthly Review school emphasizes. Friedman, since he saw only the rate of growth of the money supply as a source of instability in capitalism, did not believe that government spending was necessary to stabilize overall spending and demand in the economy. Therefore, according to him, it was only the rate of growth of the “money supply” that had to be centrally planned by a “monetary authority.” This fitted in with his overall opposition to government social programs that help the middle and above all working classes. (back)