The Oil Reserve Sales and Stagflation
(Critique of Crisis Theory website)
Reader Jon B asks, what in my opinion are the reasons behind the decision of the U.S. to sell some 30 million barrels of oil from the U.S. strategic petroleum reserve? Could it reflect the cutoff of Libyan oi production and plans for increased warfare by the U.S. government in the Middle East and Africa over the coming months?
The unexpected failure of the Libyan government to quickly collapse before the combined U.S.-NATO-rebel assault means that disruption of Libya’s oil production and exports is likely to last longer than the U.S. government planners expected back in March when the U.S.-NATO war against Libya began. U.S. military activity against Yemen also appears to be increasing. There is also a growing danger of a U.S.-NATO war against Syria. This danger will increase if Libya’s resistance finally crumbles before the overwhelming firepower of the U.S-NATO assault.
It seems likely now, however, that the motive for the sale of oil reserves is largely economic. By driving down the price of crude oil and gasoline, the U.S. and other capitalist governments are attempting to boost purchasing power and thus pump some life into the faltering economic recovery from the “Great Recession.”
Unemployment crisis continues
“A dismal report,” AP Economics reporter Paul Wiseman writes,” shows that employers are adding nowhere near as many jobs as they normally do this long after a recession has ended.” According to official U.S. government figures, only 18,000 additional workers were employed in June compared to the preceding month. Such a low rate of job growth means that real unemployment is increasing as the population grows.
“Workers’ hourly pay fell in June,” Wiseman reports. “They worked fewer hours. And 16.2 percent of those who wanted to work were either unemployed, forced to settle for part-time jobs or had given up looking for work. That figure was up from 15.8 percent in May.”
How bad is the jobs situation compared to recoveries from previous recessions? MRzine has just published an article by Josh Bivens and Issac Shapiro entitled “Historically Deep Job Loss, But not an Unusual Recovery,” which appeared originally in the publication of the Economic Policy Institute. In their piece, Bivens and Shapiro challenge the widely held view that this has been an unusually weak recovery as far as the recovery of employment in the private sector is concerned.
Bivens and Shapiro claim that the current slow growth in private-sector employment is not any worse than the performance of the U.S. economy following the last two recessions. Indeed, according to the authors, the growth in jobs is much better than the continued decline in jobs that marked the first stage of the “recovery” from the last recession.
The unusual thing about the current recovery, according to Bivens and Shapiro, is the sharp decline in government employment. In past recoveries, we have seen a rise in government jobs. This in part reflects the traditional Keynesian policies that since the Great Depression of the 1930s have been used to combat the effects of recessions.
But not this time. Instead, state and local governments have been slashing both jobs and services across the board. There has also been no great surge in federal employment. The stimulative program of the Obama administration has included tax cuts for business and direct purchases by the federal government from private enterprises. But it has included very little direct hiring by the federal government. There has been no New Deal WPA-like program where the federal government hires unemployed workers directly to undertake public works programs.
Now, with the contrived August 2 deadline for raising the federal debt ceiling looming, it appears likely we will see, if anything, cuts in federal employment as well.
However, there are some serious issues with the claim of Bivens and Shapiro that the recovery from the crisis has been a “normal” one if we look at the private sector alone. One problem comes with the dating of the “2001″ recession. In these posts and replies, I have generally referred to the recession of 2000-2003 and not the recession of 2001. There is a reason for this.
The National Bureau of Economic Research, the private organization that dates recessions and expansions, claims that there were only eight months of recession in 2001. Bivens and Shapiro accept this claim. However, there is much reason to believe that the U.S. economy actually entered recession in late 2000 and that the real cyclical recovery did not set in until mid 2003. Due partially to the effects of the events of 9/11, it is unusually difficult to date the true low point of the early 2000s recession.
When the 9/11 attacks occurred, the U.S. industrial and commercial capitalists feared that terrified U.S. consumers would stay home and that as a result sales to consumers would plummet. Not long after the attacks, the capitalists launched the slogan “America is open for business” to get people to return to the shopping malls.
The capitalists reacted to the feared drop in sales by liquidating some of their inventories in the fall of 2001 fearing that sales would decline as consumers stayed home. This seems to have caused a kind of pseudo-bottom in the recession in late 2001, which the National Bureau accepted as the true bottom of the recession. But the fact that employment continued to contract into the 2002 “recovery” implies that the recession was continuing and that the NBER incorrectly dated the recession.
‘V’ versus saucer-shaped recessions
Recessions in general tend to be either severe V-shaped recessions or milder saucer-shaped recessions. In a deep, or V-shaped, recession, the industrial and commercial capitalists are forced to sharply reduce inventories. Or, using Marxist terminology, commodity capital contracts sharply. This depletes inventories so that when recovery begins, businesses have to rapidly rebuild inventories, causing at least the initial recovery in employment to be far more rapid than is the case after a saucer-shaped recession. This initial jump in production and employment forms the right side of the ‘V’.
In a saucer-shaped recession, inventories are run down only modestly. As a consequence, business has no need to rapidly increase inventories when recovery begins. Therefore, the decline in employment is relatively small in such a recession, but so is the recovery in employment when the recession ends.
Great Recession V-shaped on downside, saucer-shaped on the upside
The Great Recession was definitely a V-shaped recession on the left, or downside, of the ‘V’. However, the turn-of-the-century recession—notwithstanding, the brief inventory rundown immediately after 9/11—as well as the early 1990s recession were milder, saucer-shaped recessions. Therefore, in determining the strength of the current recovery in private employment—even leaving aside the dramatic declines in employment in the government sector—we have to keep in mind that we are dealing with a recovery from a V-shaped, not a saucer-shaped, recession.
“Whether regarding private-sector or government employment,” Bivens and Shapiro conclude in their article, “job trends during the last three recoveries failed to approach these levels of growth [of earlier post-World War II recessions—SW].” In other words, leaving aside the problems of dating the “2001″ recession, the Great Recession was the nastiest V-shaped recession since the 1930s on the downside. But on the upside, as far as the recovery in employment is concerned, it has behaved more or less like the last two saucer-shaped recessions.
Historical unemployment crisis
Even the 1929-33 crisis itself, the ultimate of all V-shaped recessions, witnessed a typical V-shaped recovery in employment between 1933 and 1937 before it was interrupted by the government-engineered Roosevelt recession of 1937-38. What we are seeing now is a historical crisis of unemployment—as opposed to simply a cyclical crisis—which is facing capitalism in the old but now declining centers of industrial production in the United States, Western Europe and Japan.
Just as they did in the heyday of their capitalist industry, the imperialist countries experience employment declines in recessions. But now no matter how severe the preceding recession, they experience only painfully slow rises in employment after the recession proper passes.
It is important to stress that the unemployment crisis is not simply affecting the workers engaged in traditional large-scale industrial production. These workers are a shrinking component of the the employed workers in the decaying imperialist countries. But the growing crisis of employment is affecting workers in general.
Before the Great Recession, it was often claimed by bourgeois economists and sociologists that the United States, Britain and Western Europe were entering a “post-industrial” (1) society that was leaving material production behind. Instead of jobs that actually produce material use values, jobs were being created in “financial services,” computer software and other information technology, wholesale and retail trade, health care, and education. The Great Recession and the continuing crisis of mass unemployment has shown up the hollowness of these claims.
The long-term shift of industrial production towards the mainland of Asia and away from the United States, Europe and Japan, though highly profitable for the corporations based in the West and in Japan, has dangerous implications for the stability of the U.S. world empire. The growing numbers of chronically unemployed—or only occasionally employed—in the United States and Europe has dangerous implications for the continued political stability of capitalist rule in the United States and its imperialist satellites. For these reasons, the U.S. and European governments are desperately trying to find a a way to once again boost capitalist economic growth in the “core” imperialist countries.
Oil sale aimed at kick-starting stronger recovery
By selling some of the oil from their reserves, the governments are hoping that the fall in oil and gasoline prices in recent weeks will continue but without the kind of general primary commodity price crash that ushered in the panic of 2008. If gasoline and fuel prices continue a gradual decline, people will not have to spend so much money on gasoline. Therefore they will have more money to spend on other commodities.
The government policymakers are hoping that the resulting acceleration of economic growth will become “self-sustaining” through the operation of the multiplier and accelerator effects—with the next crisis not due before 2017, assuming a typical 10-year industrial cycle. (2)
In the meantime, the governments of the United States and Europe would be able to proceed with their planned deep cuts in spending on education, transportation, social services, conservation, support to the arts, and scientific research without throwing the global economy back into recession. That is the hope. The problem is that, as Jon B mentions, such interventions by governments into the primary commodity markets tend to be relatively ineffective. Why is this so?
The reason is that if a government sells only a small portion of its commodity reserves, the sales are too small to have more than a transitory effect on prices. If the sales are substantial, the market starts focusing on the falling level of remaining reserves. Indeed, the decline in crude oil prices that began in April has, if anything, been losing momentum since the oil sale was announced. The price of oil, which was falling toward $90 after spiking to over $113 in April, has remained above $90, at least as of July 15. More on this below.
In order to keep oil and gasoline prices on a gradual downward trajectory, the factor that caused the prices to spike in the first place must be removed. And this takes us to QE1 and QE2 and now the increasing possibility of QE3. QE stands for quantitative easing by the monetary authority, in this case the U.S. Federal Reserve System. But what is meant by quantitative easing, and how does it compare with ordinary run-of-the-mill “monetary easing” that the central banks engage in during “normal” recessions?
Monetary policy in ‘normal’ times
In “normal” times, the U.S. Federal Reserve—under the dollar system, the world’s leading monetary authority—targets the interest rate on overnight loans—called the federal funds rate—that the commercial banks make to one another.
For example, if the rate of interest on these overnight interbank loans is higher than the Federal Reserve’s “target,” the Federal Reserve Bank of New York is instructed to purchase short-term governments notes. What does it buy them with? It buys them with newly created token money.
If on the other hand, the rate of interest drops below the Federal Reserve’s target, the New York Federal Reserve Bank is instructed to sell some of the short-term government debt it holds in its own account. This lowers the price of the short-term government notes, or what comes to the same thing, raises the interest rates on them. This also has the effect of destroying a portion of the dollar token money that banks hold as reserves with the Federal Reserve System, which tends to raise the rate of interest on the federal funds. Normally, the Federal Reserve deals only in short-term U.S. government debt, not in long-term government bonds. (3)
From normal easing to quantitative easing
However, as a result of the panic of 2008 the federal funds rate fell well below 1 percent. It became virtually impossible for the Federal Reserve System to lower these rates any more. With quantitative easing, the Federal Reserve System is not attempting to drive down the federal funds rate, like it would do with normal easing, but rather aims to increase the quantity of dollar-denominated token money. Leaving the technicalities of quantitative easing aside, the Federal Reserve System is, in effect, “running the printing press.”
Unlike what it does during normal easing, during quantitative easing the Federal Reserve System hasn’t confined itself to purchasing short-term government debt but has purchased long-term government bonds as well. (4)
The rate of interest on long-term government securities defines the long-term rate of interest. (5) By purchasing government bonds, the Federal Reserve System is attempting to lower long-term interest rates directly. The hope is that a lower long-term rate of interest will raise the profit of enterprise and therefore encourage the capitalists to act more as industrial capitalists—actually produce surplus value—and less as money capitalists simply loaning money out on interest.
In these posts and replies, we have seen how the high rate of long-term interest rates in the wake of the 1970s stagflation crisis led to “financialization” and long-term economic decay. By trying to keep long-term interest rates low, the Federal Reserve System hopes to reverse this process and kick off a process of “re-industrialization.”
The Federal Reserve’s initial plan—its “exit strategy”—was that as soon as economic recovery took hold, it would halt the “quantitative easing,” and then as the upswing in the industrial cycle gained momentum it would move to destroy some of the extra token money it created during the crisis. As the Great Recession was left behind and conditions returned to the capitalist “normal,” the Federal System would then be able to return to its policy of conducting monetary policy through manipulating the federal funds rate.
The coming of QE2
When the first signs of economic recovery appeared in the summer—or winter down under—of 2009, the Fed did indeed end its quantitative easing program, though it made no move to destroy any of the huge amount of token money that it had created during the crisis. The problem was that the recovery failed to gain much momentum.
Then in early 2010, the European sovereign debt crisis erupted and signs began to appear that the global recovery was grinding to a halt. There was talk of a “double-dip” recession—that is, a full-scale resumption of the crisis.
In order to prevent this, the Federal Reserve announced a second round of quantitative easing, dubbed QE2, that was to continue until the end of June 2011. Under QE2, the Federal Reserve System transformed $600 billion worth of U.S. government bonds into crisp green dollars—dollar token money—or the electronic equivalent.
The prospect of QE2 sharply raised inflationary expectations, and economic growth accelerated as purchasing managers stepped up their purchases in expectation of higher prices even before QE2 began. But within a few months, economic growth slowed to a crawl once again in anticipation of the end of QE2. To make things worse, as the scheduled end of QE2 approached, the European sovereign debt crisis took a new and more ominous turn. Rumors appeared that not only Greece, Portugal and Spain but perhaps even Italy could default on their debts. (6)
Strangely enough, despite the failure of employment to recover much in the imperialist countries, the profits of U.S.-based corporations have been impressive. Why then hasn’t the rapid recovery of profit led to a comparable rapid recovery in the economy?
In order to answer this question, we have to remember that 65 or even 50 years ago the bulk of the surplus value appropriated by U.S. corporations was produced within the United States or Western Europe, with additional super-profits squeezed out of the super-exploited workers in the colonial, semi-colonial and neocolonial countries. Today, the vast mass of the surplus value appropriated by U.S., European and Japanese corporations is being produced outside of those countries. Instead, the lion’s share of the surplus value is being produced in countries like China and India, where the value of labor power and thus wages have historically been a tiny fraction of the value of labor power in the imperialist countries. And in China and India, capitalist industry is indeed still growing rapidly.
The nature of the current ‘slowdown’
As I mentioned above, the acceleration of the rate of economic growth associated with QE2 soon lost momentum and the world capitalist economy again is in a “slowdown” or pause in the recovery. Could this pause turn out to be the beginning of a renewed global recession?
The capitalist economists and media see two factors behind the current slowdown: One, which I discussed in an earlier reply, can be traced to the disastrous earthquake and Tsunami that hit Japan last March. The other involves the high price of oil and gasoline.
A third factor now has to be added. This is the sharp change for the worse in the European sovereign debt crisis. We can also add the ongoing massive cuts in the spending of state and local governments in the U.S. There is also the prospect of sharp declines in civilian spending of the U.S. federal government that emerge out of the contrived debt ceiling crisis following the August 2 deadline. (7)
Mark Zandi makes the case for optimism
Aron Task reports in the July 5 edition of the Daily Ticker that one of the top corporate economists in the U.S., Moody’s chief economist Mark Zandi, is optimistic that the current pause is about to give way to a renewed acceleration of the global economic recover: “Zandi’s optimism is based on a view that the first half slowdown was due mainly to rising energy prices and the dramatic downturn in Japan’s economy following the devastating earthquake and Tsunami last March. ‘Those weights,’ Zandi says, ‘are lifting.’”
First, let’s take another brief look at the crisis in Japan caused by last March’s earthquake. “The Japanese economy,” Zandi writes, “seems to be gaining traction, [that] augurs well for our manufacturing sector.”
On this point, Zandi is undoubtedly correct, with a qualification. As I explained in my earlier reply on the Japanese earthquake-induced crisis, the pressure of competition is forcing the Japanese industrial capitalists to restore production as quickly as possible. Insomuch as Japanese industry produces components that are necessary to carry out “our” manufacturing—Zandi is referring to U.S. manufacturing, but the same goes for manufacturing in virtually every other country in the world—the restoration of Japanese industrial production is a positive development.
There is, however, a downside insomuch as the Japanese industrial capitalists are not only suppliers but also competitors to “our”—again fill in the country—industry. Remember, the earthquake-induced economic crisis is not a crisis of overproduction but a crisis of underproduction. However, it is a peculiarity of the capitalist mode of production that overproduction is a much bigger threat to capitalist industry and society than is underproduction.
Also on the optimistic side that I discussed several months ago, we can expect a certain reconstruction boom in Japan, which though it will be primarily felt in Japan will provide opportunities for industrial capitalists in other countries as well.
However, while the “weight” of the earthquake-induced Japanese economic crisis is lifting, the same is not necessarily true of the rise in energy prices, as we will see below.
Zandi’s optimism leaves out the third factor in the slowdown, the sovereign debt crisis in Europe, which to be fair to him has worsened considerably since he issued his optimistic analysis only a few weeks ago. Therefore, only the effects of the earthquake-induced crisis in Japan are clearly “lifting” the global economy?
If, contrary to Zandi’s expectations, recessionary forces continue to gather steam over the next few months, it seems virtually certain that the U.S. Federal Reserve System will launch QE3, perhaps by early next year. Fed chairman Ben Bernanke hinted as much on July 13.
With this in mind, let’s look at the effects of QE1 and QE2 on the price of oil. This will give us some idea what will be the effect of a QE3 on oil and gasoline—as well as food—prices if and when it comes.
Two stages of the ‘Great Recession’
The crisis of 2007-09, now called the “Great Recession,” can be divided into two quite clearly defined phases. The first phase began with the initial August 2007 crisis in U.S. and world credit markets and continued until July 2008. This phase was not marked so much by classical recession—economic contraction—but rather by stagflation. This was the first real episode of stagflation since the “Volcker shock” of 1979-82 ended the 1970s stagflation.
The second phase, from August 2008 to the bottom of the recession in July 2009, was marked by financial panic and deep recession but not stagflation.
After the initial panic of August 2007, primary commodity prices and wholesale prices soared and the world economy began to stagnate. But there was little overall decline in world production and world trade. The recession was very uneven, affecting only the producers of consumer goods—Department II in Marxist terminology. The raw material and metal industries—essentially Department I in Marxist terminology—far from falling into recession experienced boom conditions during the first phase of the crisis. This is typical of stagflation. Let’s examine how stagflation affected the price of oil.
Defining a dollar of account
Marx explained that one role of money is to serve as a money of account. We are free to create our own money of account and it is perfectly legal. We can do this without violating any of the counterfeit laws. All we have to do is define a definite weight of gold as our accounting dollar. We can then measure commodity prices in terms of this fixed weight of gold.
Let’s define our dollar of account as 1/1,000 of a troy ounce of gold. Or what comes to exactly the same thing, we assume a dollar price of gold of $1,000 an ounce. By doing this, we can separate the movements of the price of oil in terms of U.S. dollars from the same movements in terms of real money—gold.
Let’s see how the price of oil behaved during the stagflation phase of the crisis that began in August 2007 and ended in July 2008. We will examine the evolution of oil prices in both legal-tender U.S. dollars and in terms of our gold dollar of account.
When the crisis first broke out in August 2007, industrial and commercial capitalists as well as commodity traders—speculators—assumed that the Federal Reserve Board would react much as they had done during the stock market crash in 1987 and the crisis in the credit markets caused by the collapse of the Long Term Capital Management hedge fund in 1998. On both occasions, the Federal Reserve had moved to quickly increase bank reserves—the quantity of dollar token money—and these financial crises quickly subsided.
Why then would the Federal Reserve System react any differently to the credit market crisis that was initially perceived to be a localized crisis involving sub-prime mortgages (though it was pretty obvious to informed observers even at this stage that it was a far more serious crisis than those of 1987 or 1998)?
Most capitalists and commodity traders, therefore, confidently expected the Federal Reserve would not “allow” the credit crisis of August 2007 to turn into a full-scale panic that would inevitably mean a deep recession. Panics like that “used to happen” in the bad old days before World War II. But such a panic, the thinking went, would certainly not be allowed in our enlightened times after the work of Keynes and Friedman.
This belief among the capitalists was all the stronger, since the new chairman, Ben Bernanke, before he was appointed Fed chairman had made clear that he believed that it was the duty of the Fed never to allow the general price level—defined in terms of U.S. dollars—to decline, come what may. Therefore, the big corporate decision-makers and commodity speculators assumed that the Bernanke Fed would flood the banking system with newly created token money in whatever quantity was necessary to contain the credit market crisis—just like his predecessor, Alan Greenspan, had done in 1987 and 1998.
Since the crisis that began in August 2007 was clearly much larger than the ones of 1987 or 1998, the assumption was that the Federal Reserve would have to create a much larger quantity of token money than was the case on the earlier occasions.
Indeed, after only a brief selloff, stock market prices rallied and didn’t peak until October 2007 three months after the initial credit crisis of August 2007. For example, the Dow Jones Industrial Average fell from 13,265 on August 27, 2007, to 13,079 on September 17, 2008. But by October 5, the Dow had hit 14,066, as it rose above 14,000 for the first time in the history of the index.
But while the corporate decision makers and speculators were discounting the danger of a full-scale panic, they did expect the rapid expansion of token dollars that they assumed the Federal Reserve System would create would also mean a major devaluation of the dollar against gold and a consequent wave of inflation such as had last occurred in the 1970s.
Let’s see what happened to the price of crude oil both in terms of U.S. dollars and our gold dollar of account during the stagflation of August 2007 to July 2008. On August 3, on the eve of the crisis, the price of a barrel of crude oil was quoted in terms of U.S dollars at $75 [this and following figures rounded to the nearest dollar—SW]. Remember, under the dollar system oil like all other primary commodities is quoted in terms of U.S. dollars. But in terms of our dollar of account, the price of oil was $112.
The reason that the price of oil was higher in our dollar of account is that our dollar of account represented less gold, 1/1,000 of an ounce, than the actual U.S. dollar represented on August 3, 2007. On that date, the dollar price of gold was quoted as $673, which meant that a U.S. dollar represented 1/673 of a troy ounce of gold.
Oil prices peak
On July 3, 2008, which represented the end of the stagflation phase of the crisis, the U.S. dollar price of a barrel of oil was quoted at $145. In terms of our dollar of account, however, the price of oil was $156. We see that the price of oil in terms of our dollar of account is still higher than the price in terms of actual U.S. dollars, but the gap has narrowed considerably. On July 3, the amount of gold that a U.S. dollar represented was only 1/934 of an ounce as the gold market anticipated the coming explosion in the quantity of dollar token money. By then, the U.S. dollar represented only slightly more gold than our dollar of account.
Whether we use U.S. dollars or the use value of a fixed quantity of gold—here 1/1,000 of a troy ounce of gold that we call our gold dollar of account—we see a substantial rise in the price of oil, though the rise is markedly less in terms of gold compared to U.S. dollars. Why did oil actually rise in price not only in terms of dollars but gold as well during the stagflation phase of the Great Recession?
The reason for this is to be found in oil’s role as a material use value. Oil’s main use value is to function as a source of energy. Without energy, all economic activity—and much else besides—comes to a grinding halt. Since during the stagflationary phase of the crisis the overall recession was mild, the underlying demand for oil as a source of energy remained high. Since the general belief was that the Fed would flood the money market with newly created token dollars, capitalist purchasing managers expected the price of oil to rise sharply. They reacted by buying as much oil as they could before the expected price increases actually occurred.
Traders in primary commodities—the section of the capitalist class that specializes in minute-to-minute changes in primary commodity prices—therefore figured oil—or rather contracts to buy oil—were even a better bet than gold under these conditions. Therefore, speculators figured the best way to make huge profits—like all capitalist traders on the commodity markets are aiming at making—would be to put their money into oil.
Stagflation of 2007-08 collapses
But in order to sustain this kind of inflation, the Federal Reserve System would have had to create a vast new mass of dollar token money. Announcements of “bold moves” by the Fed created the impression that huge amounts of U.S. dollar token money were being or soon would be created. But what the Fed was really doing was simply redirecting credit to the points where the chain of payments was beginning to break in a thousand and one places.
Essentially, the Bernanke Fed at this initial stage of the crisis resembled a captain trying to save a sinking ship by plugging up the leaks one by one.
But any move to actually increase the quantity of token money substantially by the Fed would have had the effect of throwing gasoline on the inflation wildfire and might well have brought the entire dollar system down. The Fed under Ben Bernanke certainly didn’t want a repeat of the crisis of 1929-33, but they also were trying to avoid an even worse version of a 1970s-type stagflation. (8)
The figures on the U.S. monetary base released bi-weekly by the St. Louis Federal Reserve Bank, which measures the quantity of dollar-denominated token money that exists around the world, tells the story. On August 1, 2007, on the eve of the crisis, the dollar monetary base seasonably adjusted was $856 billion worth of U.S. dollar token money in existence. One year later, on July 30, 2008, there was $876 billion in U.S. token dollars in existence.
The growth of token money during the first year of the crisis was a modest 2.3 percent increase from the year before. Indeed, this was one of the lowest annual rates of growth of the dollar monetary base since before the stagflation crisis of the 1970s. No wonder the August 2007 to July 2008 stagflationary explosion of primary commodity prices collapsed!
Therefore, at a certain point the “market”—the collective capitalist—realized that the Fed was not in fact ballooning the quantity of dollar token money as expected. As soon as this realization dawned, primary commodity prices began to collapse and soon full-scale panic broke out on Wall Street and other stock and commodity futures exchanges and credit markets around the world. This was the kind of panic that was not supposed to occur anymore. How did the panic affect the price of oil, both in terms of U.S. dollars and our gold dollar of account?
On December 19, 2008, after months of panic, the price of a barrel of oil in terms of U.S. dollars had fallen to below $34 a barrel! In terms of our dollar of account, the price of oil was now down to a little over $40. Despite the fact that the role of the U.S. dollar as the main means of payment led to some recovery of the dollar’s gold value, the collapse of the price of oil in terms of gold was almost as great as that collapse in terms of U.S. dollars. Gold, which was depreciated in terms of oil in July, was now radically appreciated in terms of oil in December of the same crisis year of 2008. This marked the end of the phase of stagflation.
Why did the price of oil collapse when stagflation ended?
The boom in primary commodities, metals and other Department I commodities collapsed and was replaced almost overnight by deep recession. The recession was no longer spotty—largely confined to the consumer goods sectors and overall mild—it was now universal and deep, both in terms of branches of industry and countries. The oil traders—speculators—were caught with their pants down. Oil would have protected them against continuing and worsening stagflation, but it was no protection at all in the face of panic and deep recession.
Not only was the underlying demand for oil contracting dramatically, but the extra demand for oil created by the inflationary expectations of the industrial and commercial capitalists turned into its opposite. Now the capitalists were dumping oil on the market in order to repay the dollar debts that they had incurred when they bought it in the first place in order to protect themselves against the expected inflation. (9)
The commodity traders reacted the same way and sold contracts to buy oil as fast as they could, accelerating the collapse of the price of oil whether measured in terms of U.S. dollars or gold. But now faced by what was threatening to turn into the worst financial crash in the entire history of capitalism, the Fed quickly reversed direction. Again, the figures for the monetary base tell the story.
Over the year that followed, the dollar monetary base—the total number of token dollars in existence—rose from $858 billion on August 3, 2008, to $1,702 billion by July 29, 2009. That comes to an annual increase of more than 98 percent! Since then, the Fed has increased the monetary base by an additional 60 percent. It hit $2,725 billion on July 7, 2011, an all-time high.
The Fed was clearly hoping that this huge increase in the quantity of dollar token money would not only halt the panic but would also kick-start a strong upswing in the industrial cycle. Under anything like normal conditions, such a doubling of the monetary base in a period of a year followed by a further 60 percent over the next two years would be expected to cause the rate of dollar inflation to soar far into the double digits. This would be a far higher rate of inflation than that of the 1970s.
But these were not ordinary circumstances. The soaring demand for dollars as a means of payment meant that the Fed was in a position to increase the quantity of token dollars without an immediate wave of inflation.
The Fed also announced on October 6, 2008, that it would begin for the first time to pay interest (0.25 percent to start with) on required and excess reserve balances of commercial banks. This encouraged the banks to keep their excess reserves lying idle with the Fed rather than lending the reserves out and ballooning the supply of credit money as a result.
Regardless, the extraordinary increase in the quantity of dollar token money has already led to a devaluation of the U.S. dollar against gold by about 60 percent between the beginning of the crisis and July 15, 2011. And this devaluation contains the seeds of the inflation that is to come. We can see the looming inflation by examining the changes in the price of oil
By June 2009, at the bottom of the recession, the price of oil had already recovered to about $70 in terms of U.S. dollars, about where it was at the beginning of the crisis in August 2007. In other words, at the very lowest point of the worst recession since the 1930s Depression, the price of oil was around the same level in terms of U.S. dollars that it had been at the top of the industrial cycle in 2007. This is highly unusual, since normally at the bottom of a deep recession, we would expect the price of oil to be considerably lower than it was at the top of the industrial cycle.
And indeed this was the case if we measure the price of oil in terms of our gold dollar of account rather than in depreciated U.S. dollars.
For example, the price of a barrel of oil in terms of our gold dollar of account on July 6, 2007 was $110. On June 12, 2009, the price in terms of our gold dollar of account was $77, a fall of 30 percent. So in terms of real prices measured in real money, the price of oil, though fluctuating violently, had after all declined substantially across the recession. QE1 had not been able to repeal the basic laws that govern the capitalist economy.
Unfortunately, workers are paid not in our gold dollars of account but in depreciated U.S. dollars or its various satellite currencies that were also depreciated along with the dollar against gold thanks to QE1. (10)
Recent fluctuations in the price of oil
By April 30, 2010, just before the eruption of the European debt crisis, the price of oil had risen back to $86 in terms of U.S. dollars, or $73 in terms of our gold dollar of account. But when the European debt crisis rose to the surface the following week, oil sold off sharply as market speculators revised sharply downward their expectations for economic growth. By May 2, the dollar price of oil had fallen to $70, or in terms of our gold dollar of account to $60.
But then as the prospect of QE2 began to loom, the price of oil in terms of paper dollars reversed direction. By December 11, 2010, with QE2 about to begin, the price of a barrel of oil hit $87 in terms of U.S. dollars. In terms of our gold dollar of account, the price rose only sightly, however, to a little over $62.
The effects of QE2 combined with the war in Libya drove the U.S. dollar price of oil to its most recent peak on April 29, 2011, of nearly $114 per barrel in terms of U.S. dollars. In terms of our gold dollar of account, the fears about a cut off of supply combined with the acceleration of economic growth brought on by QE2 raised the price of oil to a little over $73.
After that, the easing fears of a major disruption of supply of Middle East oil, slowing economic growth and the scheduled end to QE2 at the end of June caused the U.S. dollar price of oil to fall, but it still remained above the pre-QE2 levels. On June 17, 2011, the price of oil in terms of U.S. dollars was $92 a barrel, and in terms of our gold dollar of account the fall was considerably sharper, all the way back to $47 a barrel.
Slight effects of reserve sales on the price of oil
The following week, the plan to sell oil reserves was announced. The results, however, were slight. The following Friday the price of oil dropped only slightly to a little over $91 in terms of U.S. dollars, while the price in terms of our gold dollar of account actually rose to nearly $61.
As fears of QE3 swept the markets and the U.S. dollar fell to an all-time low against gold, the dollar price of oil rose to over $97 a barrel, while the price in terms of our gold dollar rose to nearly $64.
If the market expectations of a QE3 continue to grow, the price of oil and thus the price of gasoline will soar, reducing purchasing power. The result will, therefore, not be a real economic recovery but rather another round of stagflation, which will devastate the real wages of the working class. And experience both in the 1970s and again in 2007-08 shows that stagflation is soon followed by severe recession and soaring unemployment, which will further drive down real wages.
Most progressives along with Marxists of the Monthly Review school play down the dangers of inflation and stagflation and are supporting suggestions for currency devaluations and continued “quantitative easing” in the belief that these policies will revive the stagnant capitalist economy, create strong economic growth and finally begin to resolve the unemployment crisis created by the Great Recession. However, the facts show that inflation offers no meaningful solution to the unemployment crisis gripping capitalism and contains additional dangers to the living standards of the working class.
We are now at the end of QE2. Let’s summarize what the combined effects of QE1 and QE2 and very slow recovery from the Great Recession have had on the price of oil. On the eve of the beginning of the Great Recession, on August 3, 2007, the U.S. dollar price of oil was $75 while the price of oil in our gold dollar of account was $112. On July 15, 2011, the dollar price of oil was $97 and in terms of our gold dollar of account was $61. How has the price of oil changed in percentage terms over the nearly four years since the eruption of the crisis in August 2007?
In terms of official legal-tender paper dollars, the price of oil has increased by about 29 percent. However, in terms of our gold dollar of account, the price of oil has fallen by about 46 percent. In terms of real money, oil prices have dropped as we would expect them to do after almost four years of severe economic recession and stagnation.
But this drop in oil prices in terms of real money does you little good at the pump because the 59 percent devaluation of the medium you use to purchase gasoline has caused the price of oil—the raw material in the production of gasoline—to rise in terms of devalued currency by 29 percent.
The real solution to the unemployment crisis
Instead of demanding inflationary policies like more quantitative easing and further currency devaluations that accept the continued existence of capitalism, we need to develop a series of “transitional” demands that point the way out of the unemployment crisis. That is, the demands must point the way towards a planned economy run by the “associated producers.” Public works projects where the government directly creates employment are a crucial part of any such a program. But we have to make clear that the workers should not be required to pay for the public works, whether through increased taxation on the workers or through inflationary currency devaluations that lower the real wages of the workers.
Instead, the rich and super-rich, who caused the crisis in the first place by insisting on treating the socialized means of production created by the working class as their private property, should pay the bill. If the burden of the resulting taxation leads to “expropriation of the expropriators,” so be it.
A note on Ron Paul’s suggestion to cancel the public debt held by the Federal Reserve Board
Normally, I wouldn’t comment on proposals made by Ron Paul, the far-right Texas Republican congressman and supporter of the Austrian school of economics. But amazingly the progressive Keynesian economist Dean Baker has publicly endorsed one of Paul’s proposals. Unfortunately, Baker’s piece endorsing the Paul proposal was published in MRzine, the online magazine published by the Monthly Review Foundation.
MRzine now publishes Baker on a regular basis. That was bad enough. But now MRzine has linked to a piece by Martin Hart-Landsberg, one of the Monthly Review school’s Marxist economists, endorsing Paul’s proposal. Paul’s proposal has also drawn support from other progressives and even Marxists on the Internet. Let’s take a look at exactly what Paul proposed.
Ron Paul’s proposal
Paul’s proposal involves the August 2 deadline to increase the debt the U.S. government is legally allowed to carry. The extreme right-wing Texas Republican suggested that the $1.6 trillion dollars in government bonds that the Fed purchased under QE1 and QE2 be canceled. This would reduce the official debt of the federal government by $1.6 trillion dollars. If the debt limit is not raised by that date, the Obama administration claims that it will run out of money and be forced to default on its debt service payments. But under Paul’s proposal, the federal government would be able to borrow an additional $1.6 trillion before the debt limit would have to raised. However, the whole debt limit crisis is completely contrived.
“The basic story,” Hart-Landsberg quotes Dean Baker, “is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling.”
As Baker correctly explains, the Fed is an agency of the government. The government pays no interest on the $1.6 trillion the Federal Reserve Systems holds for its own account. Instead, the Fed returns the interest it collects on the government securities it holds to the Treasury itself net of its operating expenses. In other worlds, the official figure of $14.3 trillion in Federal debt is really only $12.7 trillion in debt.
Why Marxists should not be supporting Paul’s proposals
Therefore, if the federal debt was calculated at the more realistic figure of $12.7 trillion instead of $14.3 trillion, the official debt ceiling could be avoided for awhile. One problem with taking up this proposal of Paul’s is that we fall into the logic of the contrived “debt-ceiling crisis.” It would only be a matter of time before the U.S. federal debt rises by $1.6 trillion and we will then face another contrived debt ceiling crisis.
Under the capitalist system, nothing—not even God himself—is as sacred as the public debt. The sacredness of the public debt is central to the right of private property. And when it comes to sacredness of private property, no man is more committed than the “libertarian” Ron Paul. Therefore, there is no real chance that the U.S. government will actually default on its debt after August 2.
The fact that knowledgeable capitalists do not take the contrived debt ceiling crisis seriously is shown by the quotation on U.S. government bonds. If the possibility of a U.S. default were real, the rate of interest on these bonds would be soaring like indeed has been the case with Greek government bonds. Instead, on July 15, 2011, a 10-year U.S. government bond yielded only 2.91 percent, the lowest quote in the last four weeks.
The real crisis on August 2
This doesn’t mean that there isn’t a real crisis for the workers and their allies
associated with the August 2 deadline. The real crisis consists of the fact that both the Democrats and the Republicans are using this purely theatrical crisis as an occasion to drive through new cuts in social spending as part of their assault on the living standards of the working class and its allies.
It has to be remembered that Paul’s proposals have nothing in common with the proposals raised by various socialist organizations to cancel the public debt owed to the rich and super-rich. Paul’s proposals involve only the part of the debt that the government in effect owes itself.
This doesn’t mean that Paul’s proposals do not have any meaning at all. If the $1.6 trillion worth of bonds that the Federal Reserve System has accumulated under QE1 and QE2 were canceled, the Federal Reserve would lose the ability to destroy all or part of the huge quantity of dollar token money that it has created in the course of both QE1 and QE2 by gradually selling off the huge portfolio in government bonds that it has accumulated since quantitative easing began in late 2008.
If Paul’s proposal were carried out, the Fed would lose credibility, the dollar and its satellite currencies would plunge against gold, and a wave of inflation would sweep the world with all that entails for the real wages of the workers. An extreme recession—perhaps exceeding the “recession” of 1929-33—would be certain to follow on the heels of the resulting wave of stagflation.
The wave of inflation, not to speak of the recession that would result from Paul’s proposals, would not only affect the relatively “well-off” workers of the imperialist world either. Since under the dollar system other currencies are more or less linked to the dollar, the massive dollar devaluation that would occur if Paul’s proposal were actually put into effect would drive down the real wages of the workers in the oppressed countries to or below biological subsistence levels.
In his article published in MRzine, Baker claimed that after the “economy has recovered” and the unemployment crisis has ended, the Federal Reserve Board could neutralize the token money it has created by increasing the amount of reserves that commercial banks in the U.S. have to hold on deposit with the Federal Reserve System. The idea is that while the token money created by QE1 and QE2 would still exist, the commercial banks would not be allowed to use it as a basis for loans and thus create additional credit money.
However, today’s large commercial banks, which themselves are merely arms of the huge universal banks that now dominate the U.S. economy, operate internationally and can easily evade purely national reserve requirements by offshoring their operations. Baker knows this. He and other progressives who have endorsed Paul’s suggestion are “inflationists” who honestly believe—wrongly—that monetary inflation is the key to ending the unemployment crisis.
Unprincipled alliance between inflationary ‘progressives’ and ‘hard money’ gold bug right-wing reactionary Ron Paul
Paul as a “hard money” gold bug is the very opposite of the progressive inflationist economist Dean Baker. Paul believes that the Federal Reserve System should be abolished altogether. He made his proposal to cancel the government’s bonds held by the Fed in order to cripple the Federal Reserve System and prepare the way for its complete liquidation at the next stage.
The Texas Republican believes that the only “monetary authority” that the government should have is a mint to coin precious metals—or perhaps Paul believes that even the government mint should be privatized. According to the theories of the Austrian school that Paul supports, this would abolish the modern credit system, abolish the industrial cycle and finally allow capitalism to achieve the “full employment” that the Austrian school, like other marginalist schools, believes is the natural condition of the capitalist system.
It is ironic that Monthly Review’s decision to emphasize Keynes rather than Marx since the crisis began has led them into an “alliance” with the likes of the arch gold bug and currency crank, the racist and all-around reactionary Ron Paul. If Monthly Review does not soon “rediscover” Marx, there is a real danger that America’s leading socialist magazine will join the long list of currency cranks that have marked U.S. history since the 19th century.
These currency cranks have ranged from well-meaning populist reformers of the late 19th century to demagogues such as the pro-fascist Depression-era “radio priest” Father Charles Coughlin. This would be a sad end indeed for the socialist magazine founded by Paul Sweezy in 1948.
1. In his famous 1916 pamphlet “Imperialism,” Lenin produced a table showing that the number of workers employed in large-scale industry was growing very slowly in England and Wales. He considered this a sign of the decline of English capitalism. Since then, this phenomenon of little growth in the number of workers employed in large-scale industry and now the absolute decline of workers employed in large-scale industry has spread to other imperialist countries, above all to the United States.
While Lenin considered the slow growth of workers employed in large-scale industry to be a sign of economic decay, many books have been written claiming that slow growth and then the absolute decline of workers employed in large-scale industry in the U.S. and Western Europe is a sign that these societies are progressing “beyond” industrial society into a more advanced “post-industrial society.”
Well, lets see. If they really entered into a “post-industrial society,” these writers would find that their computers would disappear. Even if the software that runs on these computers can be considered “post-industrial,” the software can’t run without a computer—produced in factories!
Then, how about the clothes that these esteemed writers wear? Garment and textile factories may be considered old-fashioned and increasingly confined to “developing” countries, but textiles are produced in factories by industrial workers all the same. So it looks as though our writers will have to write in the nude. And since fuel is produced by industrial workers, they will find themselves shivering in winter.
How about housing? Isn’t housing produced by old-fashioned “blue collar” construction workers using components produced by old-fashioned factory workers? What about food? Isn’t that increasingly produced by farms using industrial methods? So it looks as though our writers will have to learn to live without eating.
The point is that the production of material use values still forms the foundation of human civilization without which our species would have to revert to a purely animal existence, or more likely perish altogether. This is the basic idea of historical materialism.
2. The multiplier effect refers to the fact that an initial rise in sales, perhaps initiated by purchases by the government or its dependents, causes the industrial capitalists to hire additional workers to replenish inventories, leading to more sales and more inventory rebuilding and thus more hiring, and so on. If the multiplier is 4, for example, for every $1 the government spends, an additional $3 in sales are generated, leading to increased production and employment.
The accelerator effect refers to the effects of rising investment by the industrial capitalists—in Marxist terms rising productive consumption—that also generates additional sales leading to increased production and employment. The newly hired workers in the industries that produce means of production in turn purchase more consumer goods. Together, the multiplier and accelerator effects push the economy toward full employment—or what Marx called “expanded reproduction”—until it all ends in a new general crisis of overproduction. The process then begins all over again.
3. Things are slightly more complex than this. The Federal Reserve can also use what are called repurchase agreements, where it buys or sells short-term government securities and holds them for brief specified periods. In addition, the central bank buys and sells short-term commercial paper and even makes direct loans to commercial banks.
Before the Depression of the 1930s, the central banks used purchases of short-term commercial paper—called (re)discounting—and short-term loans to commercial banks as their main policy tool, though open market operations were not unknown. Since the Depression, however, open market operations have eclipsed discounting as the main policy tool of the central banks.
4. Under normal conditions, the Federal Reserve System confines itself to purchasing short-term Treasury notes rather than long-term bonds because the purchase of long-term bonds can easy degenerate into financing the government’s operations through printing money rather than raising money through taxes or borrowing. If the government does this, the currency rapidly depreciates and can collapse altogether.
5. Since the risk of government defaulting on debt that is payable in its own currency is nil—the only risk being the risk of the devaluation of the currency—the government is able to borrow money at the lowest interest rate available. Every other borrower has to pay a premium above and beyond what the government pays according to the perceived risk of a default by the borrower in question. Or what comes to more or less the same thing, the more you need credit, the more you have to pay for it.
6. Remember, under the euro system, unlike the government of the U.S. these governments owe their debts in euros, a currency that they do not issue themselves. Their position is more like a state or local government in the United States rather than the central or federal government of the United States.
7. Under U.S. law, the Congress sets a debt ceiling that has to be periodically raised as the federal debt approaches the congressionally mandated ceiling. While the raising of debt ceilings is usually routine, this time congressional Republicans are demanding huge cuts in civilian spending, while resisting demands for any increase in taxes whatsoever. President Obama is supporting somewhat more modest cuts in civilian spending along with some modest tax increases.
In the absence of mass resistance, the danger is growing that the Democrats will agree to a compromise that is very close to the Republican proposals in the name of avoiding a federal default crisis. Indeed, President Obama has now indicated that the Social Security and Medicare government insurance programs for people over 65 are on the chopping block. In reality, since there is no danger that the U.S. government will actually default on its dollar-denominated debt, the “crisis” is a show being put on by the twin parties of capital to drive through cuts in social spending, especially for Social Security and Medicare, that the U.S. capitalists have always desired.
8. During the 1970s stagflation, the U.S. was still the world’s biggest creditor, a position it had occupied since World War I. But already before the end of the 20th century, the U.S. had become the world’s largest debtor nation, a position it still holds. Therefore, the U.S. government and the Federal Reserve System have far less room to maneuver in a crisis than they had when the U.S. was the world’s largest creditor.
10. Before the Depression, even in recessions far milder than the Great Recession of 2007-09, wage cuts were partially offset by falls in the cost of living. During the Great Recession of 2007-09, in contrast, there was overall little change in the cost of living but wage cuts have spread as unemployment first soared and then remained at elevated levels.