So I am spending a week or so trying to understand Ben Bernanke’s approach to this crisis based on three sources from his works.
In this part, the source is an essay published in 1991: “The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison”. In this 1991 paper, Bernanke tries to explain the causes of the Great Depression employing the “quantity theory of money” fallacy. So we get a chance to see this argument in an historical perspective and compare it with a real time application of Marx’s argument on the causes of capitalist crisis as understood by Henryk Grossman in his work, The Law of Accumulation and Breakdown.
In the second part, the source is Bernanke’s 2002 speech before the National Economists Club: “Deflation: Making Sure “It” Doesn’t Happen Here”. In this 2002 speech, Bernanke is directly addressing the real time threat of deflation produced by the 2001 onset of the present depression. So we get to compare it with the argument made by Robert Kurz in his 1995 essay, “The Apotheosis of Money”.
In part three, the source will be Bernanke’s recent speech before the International Monetary Fund meeting in Tokyo, Japan earlier this month, “U.S. Monetary Policy and International Implications”, in which Bernanke looks back on several years of managing global capitalism through the period beginning with the financial crisis, and tries to explain his results.
To provide historical context for my examination, I am assuming Bernanke’s discussion generally coincides with the period beginning with capitalist breakdown in the 1930s until its final collapse (hopefully) in the not too distant future. We are, therefore, looking at the period of capitalism decline and collapse through the ideas of an academic. Which is to say we get the chance to see how deflation appears in the eyes of someone who sees capitalist relations of production, “in a purely economic way — i.e., from the bourgeois point of view, within the limitations of capitalist understanding, from the standpoint of capitalist production itself…”
This perspective is necessary, because the analysis Bernanke brings to this discussion exhibits all the signs of fundamental misapprehension of the way capitalism works — a quite astonishing conclusion given that he is tasked presently with managing the monetary policy of a global empire.
The monetarist argument on capitalist crisis
In the 1991 essay, Bernanke takes as his starting point Friedman’s diagnosis of the Great Depression as a monetary phenomenon. Frieidman asserts the depression was brought on by a contraction in the money supply between 1929 and 1933. Wikipedia presents this synopsis of Friedman’s argument:
“…the Great Depression was mainly caused by monetary contraction, the consequence of poor policy-making by the American Federal Reserve System and continued crisis in the banking system. In this view, the Federal Reserve, by not acting, allowed the money supply as measured by the M2 to shrink by one-third from 1929–1933, thereby transforming a normal recession into the Great Depression. Friedman argued that the downward turn in the economy, starting with the stock market crash, would have been just another recession.
I am astonished by how silly this argument is — truly astonished. I cannot believe the Chairman of the Federal Reserve in 2012, is fighting the worst crisis in capitalism’s history armed only with this nonsense. Clearly this is a case of a man with only a hammer trying to repair a computer operating system. The silliness of Friedman’s argument is demonstrated by the task Bernanke sets forth in the essay. Bernanke admits:
“If the argument as it has been made so far has a weak link, however, it is probably the explanation of how the deflation induced by the malfunctioning gold standard caused depression; that is, what was the source of this massive monetary non-neutrality?”
In other words, the Friedman hypothesis that the Great Depression was caused by deflation, or a contraction of the money supply in 1929, has everything going for it but a credible argument for how this could happen. To make the monetarist argument credible, Bernanke has to account for the fact that money, which is only a reflex of the circulation of commodities suddenly becomes the determining factor in this circulation. However, Bernanke’s argument has a subtle twist on the monetarist argument: While Friedman’s original argument suggests that even if a depression resulted from causes other than a contraction of the money supply, it could be fixed by an expansion of the money supply; with Bernanke the monetarist argument had subtly evolved in another direction:
“The goal of our paper is to try to understand better the mechanisms by which deflation may have induced depression in the 1930s.”
So we have gone from an argument that states: “Whatever the cause of a depression, easy money can fix it”; to one that states “Tight money causes depressions”. The shift here is subtle because between the Great Depression and 1991, bourgeois economics is now dealing with a completely different problem. As we shall see, the problem posed in 1991 by Bernanke is better stated as “What causes a recession?”
Most people tend to equate a recession and a depression as characteristically identical, differing only in the severity of the event. As in the case of the monetarists, the popular definition of a recession is a mild depression — which is to say, a depression can be distinguished from a recession by its unusual duration and depth. If a recession lasts long enough, and is of sufficient intensity, it will qualify as a depression.
In this regard, it is notable that the National Bureau of Economic Research (NBER), who funded Bernanke’s research, and who are responsible for determining when a recession has occurred, actually has no definition for a depression. It is not that NBER defines a depression as a recession of some specific length and intensity with given indicators, they have no definition for a depression at all. In this essay, which is published by the NBER, therefore, Bernanke is trying to explain the cause of something NBER doesn’t acknowledge even exists.
Recession versus Depression
Bernanke is not discussing depressions, although he probably believed he was in this paper; he is only discussing the effects of deflation — which may or may not be accompanied by a depression. Bernanke expressly states this, when he says:
“The length and depth of the deflation during the late 1920s and early 1930s strongly suggest a monetary origin, and the close correspondence (across both space and time) between deflation and nations’ adherence to the gold standard shows the power of that system to transmit contractionary monetary shocks. There is also a high correlation in the data between deflation (falling prices) and depression (falling output), as the previous authors have noted and as we will demonstrate again below.”
The condition where falling prices lead to falling output is not a characteristic not of depressions; it is a characteristic expression of a recession, which is essentially a monetary phenomenon — i.e., contraction created by the contraction of credit. Historically, deflations have actually been accompanied by periods of robust expansion of output; they have nothing whatsoever to do with depressions.
Most of the latter half of the 19th Century and the period leading to the Great Depression was marked by robust expansion of output and falling prices of commodities. If anything, rapidly rising prices, cyclical inflation, generally characterized the period before the onset of economic contractions up to the Great Depression. The argument for a “a high correlation in the data between deflation (falling prices) and depression (falling output)” makes no sense at all, unless Bernanke is talking about recessions.
However, it is not enough to state that Bernanke’s argument of a high correlation between deflation and depressions makes no sense, we also have to explain the condition under which it appears to make sense. The capitalist mode of production is self-contradictory; and this self-contradictory character makes nonsense appear perfectly rational. So a statement that is absurd on its face, “falling prices lead to falling output”, must appear to be rational from the standpoint of the capitalist mode of production. And not simply rational as a statement in a textbook, it has to be the way the real world actually operates — supported by empirical data.
So if before the Great Depression empirical evidence suggests rising output accompanies falling prices; after the Great Depression the opposite must now hold empirically: a rise in output requires a rise in the prices of commodities. The question raised by Bernanke (1991) is what causes this inversion of the relation between prices and output? In other words, why, after the Great Depression, does an increase in output require an increase in prices of commodities?
How Bernanke attempted to hide the collapse of his argument
Bernanke argues the depression is a confluence of three separate forces: “high real wages”, “high real interest rates” and a credit system “constrained” by the gold standard. Why “high” real wages and “high” interest rates and the constraints of the gold standard did not result in a great depression prior to the Great Depression is unclear. And it is a question Bernanke makes no attempt to investigate. Instead, Bernanke neatly side-steps the need to offer analysis for why the Great Depression saw such a change in the behavior of capitalism by redirecting our attention from a comparison of how the economy worked in the periods before and after the Great Depression to a comparison between various countries after the onset of the depression. We are supposed to accept the comparison of the policies of the various countries in a single time-frame as a substitute for how the policies of each (or any) of the countries studied evolved over time.
This is a magnificent sleight of hand performed by the Chairman back in his days as a worthless academic. In fact, even when Bernanke looks for evidence to support his hypothesis that a credit contraction produced the Great Depression he admits his hypothesis cannot account for the empirical data, but he does this by again redirecting our attention away from the evidence:
“Because of data problems, we do not provide direct evidence of the debt-deflation mechanism; however, we do find that much of the apparent impact of deflation on output is unaccounted for by the mechanisms we explicitly consider, leaving open the possibility that debt deflation was important.”
Which is to say, Bernanke admits his thesis of a monetary cause for the Great Depression is not supported by the empirical data, hence he must posit debt deflation as accounting for the unexplained impact of deflation on output. If Bernanke had stated “Our hypothesis does not account for much of the impact of falling prices on falling output”, he would have been honest; but, in that case, he probably would not be the Chairman of the Federal Reserve at this juncture in the history of capitalism.
Instead, Bernanke tries to account for “much of the apparent impact of deflation on output” by introducing something for which he found no evidence: Irving Fisher’s silly debt deflation thesis. A synopsis of Fisher’s thesis, which was all the rage after the outbreak of the financial crisis, can be found on Wikipedia:
“Debt deflation is a theory of economic cycles, which holds that recessions and depressions are due to the overall level of debt shrinking (deflating): the credit cycle is the cause of the economic cycle.”
You really have to mark what is happening here: Bernanke cannot find any evidence in the historical record prior to the Great Depression that credit cycles cause economic cycles, but, as an academic in good standing, he attributes the failure of his own hypothesis to account for the empirical data to the impact of another hypothesis he also cannot demonstrate even exists. This is economics, folks, where treating the patient with blood-letting has never disappeared as a “science”
How gold became “massively non-neutral”
Bernanke assumes the coincidence of falling prices and falling output can be best explained by a gold standard that somehow “malfunctioned” during that period prior to the depression. In earlier studies, writers pointed to the effects on production of real wages and interest rates. It should be understood here that the term “real wages” is not neutral; it presupposes that the money wages paid to the worker has no definite relation to a fixed quantity of subsistence. There is a “money wage” — some amount of dollars — and a “real wage” — what this money can actually purchase in commodities.
The relation of the gold standard to the “real wage” is that with gold serving as money in the economy the real wage would always be equal to the money wages denominated in dollars. Aside from deviations that more or less cancel each other out, a commodity based money, will always represent in money some definite quantity of subsistence. The argument against the gold standard, therefore, is nothing more than an argument for being able to reduce the “real wage”, while leaving the money wage unchanged. It is based on the assumption that the worker is too dumb to notice her wages no longer buys a given amount of goods in the grocery store, or is unable to combat it effectively if she does.
When Bernanke speaks of the “massive monetary non-neutrality” of gold, he is essentially stating that beginning with the Great Depression a commodity money like gold no longer was compatible with capitalist relations of production. In order for money relations to remain compatible with capitalist relations of production, gold had to be removed from circulation and replaced with inconvertible state issued tokens.
This argument by Bernanke is confirmed by the empirical data, which shows expansion did not begin until FDR issued Executive Order 6102 in 1933 making it illegal for private citizens to possess gold, and requiring them to hand their gold into the Treasury Department. This confiscation was followed up in 1934 by Gold Reserve Act that devalued the dollar (and, therefore, wages) by seventy percent. Bernanke’s argument is also confirmed by the recovery in numerous countries, where expansion of the economy in those countries commenced only with similar measures. In order, as each country abandoned the gold standard and devalued the wages of their working classes, the empirical data show their economies began to rebound.
Once a worker’s money wages bought a decreasing quantity of commodities — that is, once the purchasing power of money wages could be inflated away by the state — capitalism began to expand again.
The “massive monetary non-neutrality” of gold standard money simply meant that if capitalism were to survive, the worker’s labor power had to sell below its value. What has to be understood, however, is that it was not at all unusual in a depression for wages to fall below the value of labor power — workers were always tossed in the streets, unemployment rose, wages collapsed and capitalism recovered. What was different about the Great Depression, and why it represented a watershed moment in the history of capitalism, is that, unlike previous depression, capitalist expansion required both the abolition of the gold standard and the imposition of a permanent regime of continuous wage devaluation through inflation.
Inflation, or the permanent regime of wages reductions
The argument that this would be necessary had been made four years earlier not by a bourgeois economist — not by Keynes, not by Irving Fisher or any of that sorry bunch of vultures — it had been predicted by a Marxist, Henryk Grossman as the necessary outcome of the impending depression. Grossman’s research had led him to believe that capitalism was approaching a point of breakdown and would not be able to continue unless labor power sold below its value permanently — essentially subsidizing profits by continuously devaluing wages. He wrote:
“In my description the process is totally different. I have shown that even if all conditions of proportionality are maintained and accumulation occurs within the limits imposed by population, the further preservation of these limits is objectively impossible. The system of production described in Bauer’s own scheme has to breakdown or the conditions specified for the system have to be violated. Beyond a definite point of time the system cannot survive at the postulated rate of surplus value of 100 per cent. There is a growing shortage of surplus value and, under the given conditions, a continuous overaccumulation. the only alternative is to violate the conditions postulated. Wages have to be cut in order to push the rate of surplus value even higher. This cut in wages would not be a purely temporary phenomenon that vanishes once equilibrium is re-established; it will have to be continuous. After year 36 either wages have to be cut continually and periodically or a reserve army must come into being. This would not be one of those periodic crises within the system that Bauer refers to, for a crisis of this sort could always be surmounted by adjusting the scale of the productive apparatus to the available population. Here there is no more room for adjustments.”
Grossman wrote this passage in 1929, just as the world market entered a financial crisis and depression from which it did not begin to escape until the gold standard was abolished and wages were cuts through devaluation of the currency. Bernanke’s argument and the arguments of the neoclassical school in effect confirm Grossman’s prediction that the depression would not be ended until capitalism found some method to continuously push the worker’s wages below its value.
Gold had become “massively non-neutral”.
Absolute overproduction and breakdown
While Bernanke gives no explanation for the sudden appearance of this “massive monetary non-neutrality” — even in hindsight — Grossman had predicted it based on a careful reconstruction of Marx’s labor theory of value. Grossman gives as the reason for the breakdown of capitalism in the Great Depression, not monetary causes, but absolute over-accumulation of capital. In volume three of Capital, Marx makes the argument that eventually capitalism must reach a point where no addition of newly created capital to the production process will result in additional profits — indeed new capital investment will actually lead to a fall in profits.
“Over-production of capital, not of individual commodities — although over-production of capital always includes over-production of commodities — is therefore simply over-accumulation of capital. To appreciate what this over-accumulation is (its closer analysis follows later), one need only assume it to be absolute. When would over-production of capital be absolute? Overproduction which would affect not just one or another, or a few important spheres of production, but would be absolute in its full scope, hence would extend to all fields of production?
There would be absolute over-production of capital as soon as additional capital for purposes of capitalist production = 0. The purpose of capitalist production, however, is self-expansion of capital, i.e., appropriation of surplus-labour, production of surplus-value, of profit. As soon as capital would, therefore, have grown in such a ratio to the labouring population that neither the absolute working-time supplied by this population, nor the relative surplus working-time, could be expanded any further (this last would not be feasible at any rate in the case when the demand for labour were so strong that there were a tendency for wages to rise); at a point, therefore, when the increased capital produced just as much, or even less, surplus-value than it did before its increase, there would be absolute over-production of capital; i.e., the increased capital C + ΔC would produce no more, or even less, profit than capital C before its expansion by ΔC. In both cases there would be a steep and sudden fall in the general rate of profit, but this time due to a change in the composition of capital not caused by the development of the productive forces, but rather by a rise in the money-value of the variable capital (because of increased wages) and the corresponding reduction in the proportion of surplus-labour to necessary labour.”
This point of absolute overproduction had been reached in the Great Depression and resulted in what Bernanke defines as a “massive monetary non-neutrality” of gold standard money. The concept Bernanke is trying to formulate into words with his phrase in a completely silly bourgeois fashion is simple: at a certain point in the development of capitalism, a commodity money like gold cannot become money capital. Which is to say, capitalists, seeing no opportunities for further profitable investment, become mere hoarders of money, hoping investment opportunities will open up later. Only those investment opportunities did not open up. They never opened up until a world war devastated the Eurasian continent and plunged the planet into holocaust. At that point the opportunity for investment was opened up for the lone surviving industrial power — the United States.
Bernanke hints at my interpretation with these words:
“Some writers (notably Charles Kindleberger) have also pointed to the fact that the prewar gold standards was a hegemonic system, with Great Britain the unquestioned center. In contrast, in the interwar period the relative decline of Britain, the inexperience and insularity of the new potential hegemon (the United States), and ineffective cooperation among central banks left no one able to take responsibility for the system as a whole.”
After the war the US “took responsibility” for managing the capitalist production process as a whole.
The gradual acceptance of inflation as a subsidy for profits
There is a view, prevalent in this crisis, that simply cutting the wages of the working class through austerity will boost capitalist profits. Bernanke shows in the empirical data from the Great Depression why this argument is not just silly, but entirely wrong. He notes,
“…in Germany, the government actually tried to depress wages early in the Depression. Why then do we see these large real wage increases in the data?”
Obviously the answer is that Germany was not trying to depress “the real wage”, but wages in general. During the Great Depression, the idea of a distinction between nominal wages and real wages was not yet fully formed. And this is also true of the distinction between nominal and real rates of interest. Both of these concepts assume inflation as a given, since the difference between real and nominal wages is simply the rate of inflation.
Inflation, however, was seen as a scourge, and for good reason given the Weimar Republic experience and World War I. The idea that inflation could actually be a subsidy for capital and devalue wages only took hold gradually until it emerged full blown in Keynes’s work. Even today, 99.99999% of Marxists, anarchists and libertarians do not grasp this idea.
So, in his paper, Bernanke is discussing a concept in hindsight, that had no established expression during the period he is discussing. Germany thought that if it could just reduce money wages, it could restore the rate of profit. What Germany overlooked was that the wages of the working class was the market for capitalist production — a cut of money wages only resulted in a further weakening of the market for capitalist output. For a reduction of wages to be effective in this situation, the money wages of the working class had remain to intact while the real equivalent of the wages were depressed.
To put this another way, the capitalist process of production required the total number of employed workers constantly increase; but it also required the total real wage of this increased number of workers be the same as before the increase. These two conditions could be fulfilled only on the assumption that money wages and real wage were not identical. And the only way this condition could be enforced was by removing commodity money.
Bernanke had to explain how deflation — previously a spur to production — became a curb or hindrance to production, beginning with the Great Depression. Falling prices resulting from improvements in the productivity of labor that had previously constantly expanded the market for the output of capital, now served as a obstacle to production. The contradiction can only be explained by the fact that capital is not just a system for producing commodities, but a system for producing surplus values in the form of commodities; which is to say, the aim of capital is profit, not production of commodities. The very methods undertaken to improve the productivity of labor power also results in a diminishing quantity of labor expended directly in the production of commodities. Although bourgeois economics denies labor is the source of surplus value, they cannot account for the sudden shift by 1929 that falling prices, instead of expanding production as before, now hindered production — causing an intractable depression.
The Bernanke price-output paradox revealed
Nevertheless, it is true that by 1929, as Bernanke argues, there is “a high correlation in the data between deflation (falling prices) and depression (falling output)”. This truth, however, is only a conditional truth: it only applies to conditions imposed by the capitalist mode of production. Capitalism continuously reduces the quantity of labor expended in the production of the individual commodity, reducing its price; but does this only on condition the quantity of labor power expended on production of commodities as a whole constantly grows. If both of these conditions are not fulfilled, capitalism suffers crises and ultimately collapses altogether.
This law, which operates over the life of capitalism and gives it its dynamic, explosively productive, character, is true in the case of all commodities produced capitalistically, but it is particularly true for the essential capitalist commodity — labor power. Labor power is the essential capitalist commodity because it is the one commodity capable of making real capital out of capital.
This explains why the present austerity in Europe must run into a brick wall as attempts to reduce the total wage bill, no matter how much this appears “necessary” to the bourgeois economist, violates the fundamental conditions for continuation of capitalism itself. And it is the whole meaning of the phrase “fiscal cliff” in the American budget deficit debate.
As we will see, this explains why the underconsumptionist school is wrong — capitalism cannot be fixed (or offset) by simply raising wages. The dynamic of capitalist production is to continuously reduces individual wages, no matter the consequences.
And it also explains why the Austrian school is wrong to believe capitalism can be fixed by ending “malinvestment”, since “malinvestment” is nothing more than the expenditure of superfluous labor, which growth is now essential to the survival of capitalism.
To conclude the examination of Bernanke’s 1991 paper, anyone reading it should understand Bernanke is not talking about the relation between deflation and depressions, but the relation between deflation and recessions. The difference between the two is to be found in the fact that a recession is indeed a monetary phenomenon, and is determined by a credit cycle that is being managed by the fascist state.
The difference here is meaningful, because most of the post-war recessions that have occurred were deliberately induced by the Federal Reserve and have a pronounced, clearly identifiable vee-like structure. This vee-like structure is the result of Fed “tightening” — raising interest rates — to choke off debt-fueled economic activity. Once, interest rates are relaxed, the trajectory of debt expansion and employment resumes. If you look at recessions prior to 1991, you will find just this unmistakeable signature of Fed monetary policy. After 1991, however, we find recessions do not exhibit this vee-like structure, which signaled monetary policy was beginning to break down. The evidence can be seen in this chart showing the rebound of employment in various recessions going back to 1948:
From 1990 onward, the change in employment no longer shows the characteristic vee-like structure; as the effectiveness of monetary policy begins to breaks down. It is this change Bernanke is trying to understand in his 1991 paper. And it is the mystery he again addresses in his 2002 speech.
I will examine that paper next.