Gold - Why Its Price is Soaring
You may have noticed in the press or on TV that the price of gold has been rocketing up, and now stands at prices last seen 25 years ago. When the price of gold moves up sharply like this, it is an indication tht deep within the bowels of the capitalist economy something is stirring, and its usually not something good. The last time gold rocketed like this, for example, coincided with the high inflation of the 1970's, and the onset of the worst crisis since the end of the second world war, the slump of 1974-5. That slump and inflation continued until the beginning of the 1980's when the crisis of capitalism was resolved in the interest of capital and at the expense of labour by the class war politics of Thatcher and Reagan, which smashed labour organisation in order to drive down wages and conditions in order to push up profits. From 1982 until 2000 Stock Markets entered a long secular bull market on the back of that victory for Capital. At the same time Gold went into a steady decline, having reached a peak of over $800 an ounce it fell to a low point of $250 an ounce in 1999. From that point it has more than doubled, whilst Stock Markets have crashed and then stagnated. Gold's rise is most marked in terms of its dollar price, and as I will try to explain this is largely the explanation behind what is going on, but in the last year or so the price of gold has risen in sterling and euro terms too, by around 30%. What then is going on.
In order to explain it you need to understand something about the nature of what money is, and gold's specific role. I am giving a more detailed account of Marx's Theory of Money in a separate post below, but for now let me try to give the very short version.
Marx explains that the exchange value of commodities is determined by the amount of labour required on average for their production. On this basis you can work out that if a pair of shoes contains 10 hours of labour, whereeas a coat contains 20 hours of labour then 1 coat will exchange for 2 pairs of shoes. In a society where people barter this is fine. If you have a coat to exchange and want shoes you find someone who has shoes and wants a coat. But this is cumbersome. The more people trade the more a better solution is needed. Hence money. If you can find a commodity that everybody wants, which everyone will accept because they can use it to buy other things they want then you can price all commodities in this one commodity. For example, at one point when salt was very valuable salt acted as money. But most societies have used precious metals because, using Marx's method of determining value they tend to be very valuable because it takes a lot of labour to find them, establishing mines, get them out of the ground, smelt them etc. They are also durable, and capable of being divided up into various weights that can be used to denominate different amounts of value. Hence, gold, copper and silver have tended to be the most commonly used metals - copper for lower denominations, silver for more intermediate values, and gold for the most expensive purchases. Of these gold as the most valuable became predominant, and the values of silver and copper coins became functions of the value of gold.
For a long time actual coins made from these metals were used as money. This had many drawbacks. Gold smiths and usurers werre the most common possessors of gold hoards, and they would charge a premium over the value of their gold in order to release it to be minted into coins. Moreover, gold coins could be "clipped" in other words people would snip bits of the coin in order to accumulate gold whilst using the coin at its full value to buy things. Government's too in issuing coins could issue coins which had a face value equivalent say to a quarter of an ounce of gold (for a sovereign), but which actually contained less than that. In addition as trade increased rapidly during the 19th century using physical money was cumbersome. Capitalsist began to use instead Bills of exchange in their internal dealing with one another. For example if A sells £1,000 worth of cotton to B then rather than requiring B to give him £1,000 of gold currency straight away a Bill of exchange is raised. This is like an IOU which states that B owes A £1,000. A can use this Bill to purchase goods from C, by simply passing it to C so that B now owes the money to C not A. Quickly, Discount Houses arose that would accept these Bills and pay the owner of them money up front, in return for a discount. These became Merchant Banks. It is a small step from there to replace the actual mettalic currency in its higher denominations with the logical extensions of these Bills, paper money. All that this paper money does is to promise to pay the bearer a sum of gold. If this paper money is then issued by someone whose authority guarantees that this gold can be handed over - for example - the State - then this paper money becomes as good as gold.
However, between nations gold continued to reign supreme. There was little point in a French farmer being paid in English pound notes. So, if England bought £10 million pounds worth of goods from France, and rance bought £15 million of goods from England, then France owed England £5 million pounds, which would be settled by a transfer of gold from France to Engalnd.
But, then things moved on from there. Because, Britain became the biggest industrial country in the world during the 19th century, and its Empire stretched around the globe, many things that were bought and sold internationally were priced in pounds. Nations could and needed to accumulate pound notes in order to buy things. As long as the value of the pound remained fixed to the value of other currencies by them all being fixed to the price of gold then pound notes could act internationally as well as within Britain as money that was as good as gold. That was what happened, currencies were fixed to the value of gold according to the Gold Standard, and the pound became an international currency alongside gold - it became the so called reserve currency.
That continued until WWII. In the First World War Britain almost bankrupted itself by diverting a large proportion of its production into war production rather than wealth producing production. In order to pay for its production it suspended the gold standard and printed pound notes to cover its expenses. The pound notes continued to be accepted because of sterling's role as reserve currency, but the effect was to increase the number of these notes in circulation in relation to gold, and therefore to reduce the value of each note. At the same time the US was becoming the world's premier industrial power. The introduction of mass production techniques, combined with the introduction of electric power in place of steam led to huge increases in US production. Moreover, because the US stayed out of the war at the beginning it could use this production potential to meet the needs of European countriesw including Britain, whose production capacity was being wasted on military expenditure. As one of the jokes on Dad's Army went - the only thing Americans charged in the First World War was the interest on the money they lent to buy their goods.
Typical of the way capitalism operates in a contradictory manner, even the huge icnrease in US productive power at this time, which you would think should have provided increasing wealth led to disaster. The US began to export more and more goods abroad, compared to what it imported. In order to pay for these goods, therefore, other countries had to send gold to the US. Now the Gold Standard was supposed to provide a self-regulating mechanism to prevent these imbalances from getting seriously out of whack. Countries that sent gold out of the country had to increase their interest rates which cut their money supply reigned back consumption and activity, which reduced the amount they imported. Countries like the US which received gold did the opposite. But the US was already booming, and lower interest rates caused the boom to expand even more. BUt the more the expansion took place the fewer opportunities for profit there were. The rate of profit began to fall, so just as they had done during the 19th century capitalists began to look for places to invest their money where they could get higher returns - they began to speculate. On the back of that came the Stock Market boom of the 1920's. But, just as such speculation in the Railway Mania had resulted in catastrophe in the 19th century, so it did in 1929 with the Stock Market crash, and the massive poverty and unemployment, and waste of resources that followed with the Depression of the 1930's.
An almost identical thing happened with the crash of 2000. Massive increase in production brought about by new technology. Large increase in money supply, low iinterest rates brought in on aoccasion to offset potential panics - the Asian currency crisis, latin American currency crisis, Russian rouble crisis, Millennium Bug fears etc., and ridiculous speculation in Internet companies whose share pricres rocketed despite most of them never having a chance of making any money.
From the edn of WW2 the US occupied the role Britain had done. The dollar became the world reserve currency. In the 1970's France said it wanted to be paid in gold not dollar's because they resented the fact that the US could pay for its imports by simply prinitng dollars, which it did to pay for its expenses in the Vietnam war. Nixon abolished the dollar's link to gold, made it illegal for US citizens to hold gold, and thereby set the basis for the US to use its position to basically buy goods with increasingly devalued currency. The US since then has gone from being the world's largest creditor to the world's largest debtor. US citizens spend kmore than they save, the US government has a budghet deficit bigger than any the world has ever seen, and it pays for all this by pruinting more dollars. From what I have said before it can be seen that the only way for the dollar to go then is down. But in fact although the dollar has fallen against gold, and against sterling and the euro its value has not fallen that much. Why? Because of its continued role. To buy oil you must acquire dollars because oil is priced and sold in dollars, though Iraq changed that just before it was invaded and Iran is promising the same now. Moreovr, other countries such as China which sell a lot to the US buy US securities such as shares and Government bonds so that the US has money to buy Chinese goods and keep Chinese factories epanding.
In addition worried about potential recession and with their economies pretty stagnant already other countries like Britain, Europe and Japan have kept interest rates low and printed money in order to try to keep consumers spending and factories working (though increasingly that spending keeps Chinese factries rather than European factories working. So with the value of all currencies being devalued as governments print more of them, the only money that can go up in value is real money - gold. If the crisis gets worse, and more money is printed - gold will go much higher. To get to its previous high in real terms it will have to go to $3,000, and some gold investors think it could go as high as $5,000 or even $7,000 an ounce - the latter would match its perentage icnrease in the late 70's early 80's.
Have to go for now, but more later.
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Gold - Continued
Globalisation provides tremendous opportunities for Capital. Bringin huge new areas of the world fully into the capitalist world economy, that is bringing them within the framework of a set of property rules which guarantee the ability for capital to operate and make profits, establishes vast new markets for the sale of commodities, and more importantly for Capital whole new workfoces that can be subjected to Capital and produce profit.
But at the same time it creates some significant problems. Despite the fact that it now operates on a global scale, and searches out the most profitable locations in which to establish production, Capital remains significantly tied to the nation state (though in Europe and to some extent in Asia this is becoming more tied to an economic bloc as for example the EU takes on more of the functions of a nation state). Partly this is because for very large companies a large part of their operations remains in their homeland, and the connections they have built up over generations to guarantee their ability to continue making profits are connections most closely held with their domestic state. This poses some problems.
Take a large British company like BP. Its operations are spread across the globe, but its ties are most closely with the British State. Indeed some would argue that largely behind the decision to invade Iraq was cocnern on the part of Britain to ensure the interests of companies like BP were protected - not just in Iraq but within the region. Anything that weakens the British State, let alone which might challenge the existence of that state, or might see a change of regime threatens BP. Capital as a whole has an interest in preventing instability in the main economic centres, Capital most closely associeated with those centres has an even greater interest.
But the emergence of new dynamic centres of production in Asia, and Eastern Europe has the potential for creating such instability. Capital is forced by its very nature to seek out these more profitable locations, but in doing so it de-industrialises its own heartlands. The argument has always been that this would not be a problem because as more mature products became products made in developing countries, so labour and capital would move into new higher value production at home. But, countries like China and India with huge highly educated workforces are able not to just to become the centres for production of mature products, but are increasingly the centres for high value added production too.
The effect is most pronounced in the US, but Britain has similar characteristics. Increasingly, the US has moved out of factory production. It continues to be a major source of food because of its huge, fertile areas, and large capital intensive farms. It is probably the world's premier producer of high value products, through companies such as Microsoft, Intel etc. But the employment opportunities in these industries are very limited, partly because they are high value added industries that rely on a relatively small number of very highly trained and specialised people. The rest of its production it has in great swathes moved to low wage countries, or worse still for the US has been foced out of by new companies based in these countries that have simply undercut it and driven it out of business.
Yet unemployment is relatively low in the US - this has to be considered carefully, however, besides the fact that US unemployment statistics hide a large amount of unemployment because huge numbers of workers that no longer receive benefit, and have given up the hope of a job no longer register, the way the US collates the data is fraudulent. It assumes that large numbers of people are self employed, and it is not infrequent that this figure has to be periodically adjusted by around half-million or so people. One of the reasons that unemployment is low is that large numbers of people have been employed in both retailing, and in service industries.
But this is not self sustaining. In order to pay for the goods you import you have to export other goods. Some "goods" produced in service industries can be exported and be very profitable such as those related to the Financial Services industry. But many of the people employed in service industries are not of this type, they are people employed at McDonalds, or hotels, etc. These are things which are very difficult to export or to earn foreign currency income from. The biggest retailer in the US is Wal-Mart, and it demonstrates the problem America has. 70% of everything sold in Wal-Mart comes from China.
So a large number of US workers are employed selling things to other US workers, but the things they sell are made outside the US. The US does not produce the goods to sell as exports to pay for these goods so it has to borrow the money, or print the money. As I said above it does both. The US has effectively been robbing the world blind for more than 30 years by using the role of the dollar as reserve world currency. It buys things, and prints more dollars to pay for them. The effect is that countries selling to he US get paid back in money that is continually being depreciated as more of it is printed.
The Chinese were wise to this, and prevented it by pegging the renminbi to the dollar. So as more dollars are printed and the dollar falls so the RMB falls too. This has caused great consternation in the US. The US has the gall to accuse the Chinese of currency manipulation because they refuse to accept devalued US currency in exchange for their goods. This has caused a problem for the US because its largest trade deficit is with China. So the US has to borrow money. The Chinese are happy to oblige because China is icnreasingly buying up the US by the backdoor, and at the same time by lending to the US the US keeps buying Chinese goods, keeping Chinese workers employed, and making profits for Chinese companies.
But those workers still employed in manufacturing in the US have been finding over the last 20 years that their wages have been falling in real terms. Their companies cannot compete with companies based in China paying workers a 30th of what US workers receive, and are forced to cut or hold down prices, and wages, and increasingly to lay workers off, cut health insurance, pension contributions etc. GM which until recently was the world's biggest car marker is in this position as I have detailed in previous posts. It looks almost certain to go bust. Ford is slashing jobs and will probably follow suit.
But US workers have made up for stagnant and falling wages by other means, which have in turn been caused by the vast sums of money printed by the government. After the Stock Market crash of 2000, the money sloshing around in the economy had to go somewhere. Much as in Britain it found its way into property. House prices began to rise sharply. Seeing their house increase in price US workers thought they had become better off, and were like their UK counterparts encouraged to borrow against their house to finance their consumption. They have done so with vigour, running up huge debts which have enabled them to keep consuming even while their wages were falling - hence as I said above they now spend more than they earn.
The US government rather like the British government and European governments have every reason to encourage such behaviour. The last thing they want is for the whole thing to come tumbling down even as it did in 1974, let alone as it did in the 1930's. In fact given the larger scale of production, and the enlarged sphere of activity for Capital worldwide a major crisis now, would probably be worse than the 1930's. That would cause huge problems for Capital. It relies on the ideological superstructure in which continually rising living standards are a central plank. Large scale mass unemployment lasting for a prolonged period would undermine the ideology of consumer driven capitalism, leading inevitably to large scale civil unrest.
In Europe things are slightly different because governments have maintained higher levels of social welfare than in Britain or the US, and so higher levels of unemployment for example in France and Germany have not caused unrest - though the riots last year in France show how easily that could change if economic crisis erupted.
For some time now financial markets have been worried that at some point the Chinese, Japanese, the OPEC states etc. that finance US consumption will decide enough is enough, will fear a sharp drop in the dollar which would seriously devalue the worth of their US assets, and that they will begin at least to slow down their lending to the US, or worse might begin to withdraw some of it - which they have so far avoided because to do so would cause the very collapse they fear. But a number of these countries as well as Russia which is piling up large foreign earnings with the rise in oil prices, have announced they will begin to diversify their reserves, buying amongst other things gold. Iran is creating an oil market based in Tehran which will price oil in Euros, and will challenge the New York Mercantile Exchange (NYMEX) as a centre for the trading of oil. China is buying gold and euros, and is using some of its dollar reserves to buy commodities such as coffee, copper, zinc, iron, etc. on the commodities exchanges as well as doing deals with countries in Latin America and Asia for long term contracts for these goods.
None of this is good for the US in particular, but on a lesser scale nor is it good for Britain or Europe. If the US and Britain (which also has a huge Trade Deficit, and massive private indebtedness) find that people no longer wish to lend them money then either they will be forced to print large amounts of paper curency which will trash the value of their currency and lead to massive inflation, or they will be forced to send their economies into a large retrenchment, with skyrocketing interest rates to deter spending and increase saving, in the hope that they can export the surplus production to pay off their debts. Europe in general which runs a trade surplus is in a less serious position, but if the US let alone the US and Britain, went down the latter course Europe would find not only that its exports fell catastrophically, but that it was competing with a flood of British and US exports too. In short either scenario leads to a huge world crisis. Within that context and the risk of each country trying to rescue itself by printing more and more money (the new US Fed Chief, Ben Bernanke, famously said that in order to stave off depression and deflation in the US they could crank up the printing presses and throw dollar bills out of helicopters) the risk would be not just of the kind of 20% plus inflation of the 1970's, but of the kind of hyperinflation of Germany in the 1920's.
Under those circumstances, the value of real money - gold - shoots to astronomic levels. Savvy investors such as Warren Buffet and George Soros are already banking on the dollar falling severely. Just over a year ago some of the so called Gold Bugs - the super rich who made billions in the late 70's when Gold went up from $30 to $800 dollars an ounce decided that they saw all the same circumstances now as then, and began to buy gold in large quantities.
In the 1920's the Roaring 20's seemed to convey the message that everyone could be rich. Capitalism seemed to be producing never ending wealth. Overnight it turned into the opposite. Capitalism is cock a hoop at the moment after he fall of Stalinism, but a look beneath the surface shows that all of the contradictions that Marx analysed 150 years ago continue to mount and become heightened. The capitalists might not share that analysis, but significant sections of their more far sighted members iknow that all is not well. That is why gold is going up, and is likely to continue to go up, and up, and up.....
Arthur Bough
Marx's Theory of Money
The Division of Labour is the precondition for exchange. In primitive co-operative communities the Division of Labour arises (firstly between men and women) and production is increased accordingly, but without trade occurring. The male hunters do not trade their products with those of the females, but the whole produce is a collective produce to be shared out equally. Trade only begins as a peripheral activity between tribes rather than within them. However, once trade between tribes commences, then, together with the establishment of classes within society, trade begins to take place within the society too. A precondition for trade within the society is the establishment of private property as a replacement for communal or collective property.
With trade of goods being peripheral, often it amounts to little more than bridal gifts, there is no need to consider in depth the question of exchange values of the goods exchanged. At best all that is required is a rudimentary system of barter. However, when trade begins to develop within each society rather than between different societies, and when the goods exchanged begin to be produced for the purpose of exchange rather than simply being surplus production i.e. they become commodities, the question of how much of one commodity should exchange for another becomes an issue. All historical record, from societies all over the world, demonstrates that the basis of this calculation was the amount of time required to produce each commodity.
This basis of calculating the rate of exchange also provides the basis for setting aside one commodity, which can act as a universal equivalent. If I take the sequence A = 2B, B = 3C, C = 2D I can replace these individual rates of exchange with the single A = 2B, 6C, 12D. The underlying relationship of each commodity based on the labour-time required for its production can now be subsumed under the relationship of each commodity to the universal equivalent A. The exchange value of each commodity can now be expressed as so much A. A does not have to be physically present for this calculation to occur it is merely an abstraction – it has become a unit of account. This is the first stage in the development of money.
Benjamin Franklin described the situation,
“By labour may the value of silver be measured as well as other things. As, suppose one man is employed to raise corn, while another is digging and refining silver; at the year’s end, or at any other period of time, the complete produce of corn, and that of silver, are the natural price of each other; and if one be twenty bushels, and the other be twenty ounces, then an ounce of that silver is worth the labour of raising a bushel of that corn. Now if by the discovery of some nearer, more easy or more plentiful mines, a man may get forty ounces of silver as easily as formerly he did twenty, and the same labour is still required to raise twenty bushels of corn, then two ounces of silver will be worth no more than the same labour of raising one bushel of corn, and that bushel of corn will be as cheap at two ounces, as it was before at one ceteris paribus. Thus the riches of a country are to be valued by the quantity of labour its inhabitants are able to purchase.”
And “trade in general being nothing else but the exchange of labour for labour, the value of all things is, as I have said before, most justly measured by labour.”
Ben Franklin “A Modest Inquiry into the Nature and Necessity of a Paper Currency” pp 265 and 267.
Franklin should have pointed out that of course the particular labour of the silver miner and the grain farmer are as different as the silver and the grain they each produce. It is not this particular labour that is the measure, but generalised social labour in the abstract. And what determines the average amount of this labour that is socially necessary – competition.
Once commodity A is accepted as the unit of account it is a simple step forward for this unit to become universally accepted in exchange for any other commodity, in other words, for it to become the medium of exchange. The process does not require the intervention of the State or government to bring this about it arises naturally in the course of development of exchange. This did not always happen e.g. using gold as the standard of value, but silver as the medium of exchange. Only when the standard of value, and the medium of exchange are the same can it truly be considered money. The introduction of a medium of exchange abolishes all the limitations on trade imposed by barter, and in its turn provides a great stimulus to the development of trade.
The question then arises how much of this medium of exchange is required. This depends upon the amount of commodities being traded, their prices, and the relation of these prices to the value of the medium of circulation. The Economist July 10th 1858 gives the output of the mint as 1855 £9,245,000; 1856 £6,476,000; 1857 £5,298,858, and says that during 1858 the mint had scarcely anything to do. The different figures were due to the varying quantities of commodities in circulation in each year “Much will be manufactured when it is wanted; and little when little is wanted.” it said. (A Contribution to the Critique of Political Economy, Karl Marx p106.) And in Holland, after the discovery of gold in California, its gold currency was replaced with silver currency which meant that 15 times more silver was required than gold. Although, the velocity of circulation of the medium of exchange will affect how much needs to be put into circulation, and different denominations circulating in different spheres will have different velocities – an increase in velocity reducing the amount and vice versa – changes in the velocity are determined by technical considerations, which mean that this does not have a marked effect in the short term. In short the quantity of gold or silver coins put into circulation is determined by the quantity of commodities to be circulated, and the relative values of those commodities. So, for example, after the discovery of new gold mines, the relative value of gold fell and consequently more had to be put into circulation.
Once in circulation coins made from precious metals soon begin to deteriorate either as a result of normal wear and tear or from clipping. This has caused some considerable problem and debate because it means that a contradiction arises between the coin as unit of account, and as medium of exchange. As unit of account a 1 oz. gold coin has a relative value as against other commodities based upon its weight. This value, as has been demonstrated, is based upon the labour time required to produce an ounce of gold, and the labour time required to produce the commodity against which it is being exchanged, say a bushel of wheat. But if the nominal value of this coin is set at 1 bushel of wheat, but as a result of clipping or wear and tear its weight is reduced to .8 ounces then clearly the actual value of the coin in gold is less and should in terms of its actual gold value only buy .8 bushels of wheat rather than 1. If the coin continues to purchase goods at its nominal value rather than the value of the gold it now contains then in effect the coin has become nothing more than a token for the nominal value of the gold it is supposed to represent. But despite the fact that these coins had become mere tokens whose actual value was much less than their nominal value they continued to circulate, which then provided the basis for replacing coins made from gold, and silver first with coins made from copper and other metals, and subsequently with paper. As Benjamin Franklin put it again,
“At this very time, even the silver money in England is obliged to the legal tender for part of its value; that part which is the difference between its real weight and its denomination. Great part of the shillings and sixpences now current are by wearing become 5,10, 20 and some sixpences even 50% too light. For this difference between the real and the nominal you have no intrinsic value; you have not so much as paper, you have nothing. It is legal tender with the knowledge that it can easily be repassed for the same value, that makes three pennyworth of silver pass for a sixpence.” (Remarks and Facts Relative to the American Paper Money, 1764 p348)
The determining factor was not the actual metal value of the coin vis a vis its nominal value, but the quantity of coins put into circulation. Provided no increase in the coins put into circulation occurred the debased coins would continue to operate as tokens of the full value. The important point here is that it was not the coin, which constituted money, but the gold, which the token represented. The value of money i.e. gold (or silver if silver was the money commodity) remained the same provided its cost of production did not vary, and consequently provided the coins issued as tokens representing this gold were not increased the value of the tokens would remain the same. If however the number of tokens (even gold tokens of less weight than their nominal value) was increased then the value of these tokens would be decreased proportionately. The Bank of England took action to ensure that coins of inadequate weight were withdrawn. By law a sovereign, which had lost more than 0.747 grains of weight ceased to be legal tender.
“When the decline of the metal content has affected a sufficient number of sovereigns to cause a permanent rise of the market price of gold over the mint price, the coins retain the same names of account but these henceforth stand for a smaller quantity of gold. In other words, the standard of money will be changed, and henceforth gold will be minted in accordance with this new standard. Thus, in consequence of its idealisation as a medium of circulation, gold in its turn will have changed the legally established relation in which it functioned as the standard of price. A similar revolution would be repeated after a certain period of time: gold both as the standard of price and the medium of circulation in this way being subject to continuous changes so that a change in the one aspect would cause a change in the other and vice versa.”
(A Contribution to the Critique of Political Economy, Karl Marx p110.)
“Thus the English pound sterling denotes less than one-third of its original weight, the pound Scots before the Union only 1/36, the French Livre 1/74, the Spanish Maravedi less than 1,000th, and the Portuguese Rei an even smaller proportion. Historical development thus led to a separation of the money names of certain weights of metals from the common names of these weights.” (ibid p72)
The inflation of prices does not arise as a result of an increase in the supply of money, but from an increase in the number of tokens circulating which represent money. A confusion exists because of the nature of theories concerning the determination of value, and because of a concentration on the role of money merely as a means of circulation. Suppose the value of gold remains constant i.e. its cost of production does not change. More gold coins are put into circulation than are required to circulate the given amount of commodities in the economy at their given values. This increased money supply does not result in an inflation of prices because if it did the value of gold as a commodity would itself rise above the value of gold as medium of exchange – 1 ounce of gold would trade for more than a 1 ounce gold coin. This is because the value of gold both as commodity and as money is determined not by demand and supply (though its price may be in the short term) as the neo-classical school maintain, but by the labour time required for its production. A surplus of gold coins would consequently not result in an increase in the prices of other commodities, but in the surplus of those coins being withdrawn from circulation and hoarded as stores of value either in the form of coins, or by being melted down and sold as bullion. Ricardo who began by correctly defining the value of money in terms of its cost of production fell into this trap because he equated the total amount of gold with the total issue of currency forgetting that gold has a separate life as a commodity to that as coin. It is this separate life, which makes it different to paper. Unfortunately, on the basis of Ricardo’s incorrect analysis and evidence to Parliament the 1844 Bank Acts were passed which exacerbated the crisis of 1858, and the crisis in its turn led to these Acts being suspended. The analysis of paper currency has been read back on to gold currency incorrectly so that the correct concept that an increase in tokens causes inflation has been interpreted as an increase in real money causes inflation. As Marx put it,
“It is thus evident that a person who restricts his studies of monetary circulation to an analysis of the circulation of paper money with a legal rate of exchange must misunderstand the inherent laws of monetary circulation. These laws indeed appear not only to be turned upside down in the circulation of tokens of value but even annulled; for the movements of paper money, when it is issued in the appropriate amount, are not characteristic of it as token of value, whereas its specific movements are due to infringements of its correct proportion to gold, and do not directly arise from the metamorphosis of commodities.”
(ibid p122)
Marx demonstrates what really happens with the issue of coins as opposed to paper money.
“Thus for example in England copper is legal tender for sums up to 6d. and silver for sums up to 40s. The issue of silver and copper tokens in quantities exceeding the requirements of their spheres of circulation would not lead to a rise in commodity prices but to the accumulation of these tokens in the hands of retail traders, who would in the end be forced to sell them as metal. In 1798, for instance, English copper coins to the amounts of £20, £30 and £50, spent by private people, had accumulated in the tills of shopkeepers and since their attempts to put the coins again into circulation failed, they finally had to sell them as metal on the copper market.” (A Contribution to a Critique of Political Economy, Karl Marx p113)
“The circulation of commodities can absorb only a certain amount of gold currency, the alternating contraction and expansion of the volume of money in circulation manifesting itself accordingly as an inevitable law, whereas any amount of paper seems to be absorbed by circulation.” (ibid p122)
“Gold circulates because it has value, whereas paper has value because it circulates. If the exchange value of commodities is given, the quantity of gold in circulation depends on its value, whereas the value of paper tokens depends on the number of tokens in circulation. The amount of gold in circulation increases or decreases with the rise or fall of commodity prices, whereas commodity prices seem to rise or fall with the changing amount of paper in circulation.” (ibid p121-2)
Arthur Bough
Theory of value
I have enjoyed reading these posts as they have provided some of the answers to questions I haver wanted answering for some time. I would appreciate it if you could clarify for me; is the labour power theory of value complimenary or conradictory to the law of supply and demand?
If the labour power required for two hats is the same as for one coat then one coat is worth two hats. Hat production improves and ten hats can be made with the labour power of one coat. However, hats go out of fashion unlike coats which are on everyones wish list. Consequently, you can hardly exchange 100 hats for one coat. In this hypothosis what is the value of one hat or one coat?
Short Answer
Marx like all the Classical Economists was aware of the laws of supply and demand. But what these economists pointed out was that supply and demand affect only short run prices, what supply and demand does not explain is why at the equilibrium point where supply equals demand the price should be X rather than Y. The theory of supply and demand can describe the fact that if demand is greater than supply then prices will rise, but it does not adequately explain why supply was at the level it was, or why demand was at the level it was.
To come to your question relating to the coat and hats. If as a result of improvements ten times more hats can be produced than before so that we now have 20 hats being produced, but only the same number of coats can be produced then the exchange value of hats measured in coats will now be 20 hats to 1 coat rather than 2 hats to 1 coat. Now you say but what happens if the demand for hats falls, won't this according to supply and demand mean that the price of hats to coats falls even further?
Let me explain this by a different example. Suppose a peasant farmer produces potatoes and carrots. With 6 months labour he can produce 1 ton of carrots and 2 tons of potatoes. Put another way for a day's labour he can produce twice as many potatoes as carrots. Now assume that our farmer has a preference for carrots over potatoes (an orthodox economist would say his marginal utility was higher for carrots than potatoes). He therefore decides to allocate his available labour so that he produces more carrots than potatoes. So he spends 9 months producing carrots and 3 months potatoes. This results in him producing 1.5 tons of carrots and .5 tons of potatoes. Suppose now that his taste for carrots diminishes for some reason so that he decides he would like fewer carrots and more potatoes. Does this change of taste change how many carrots he has to forgo in order to acquire potatoes? No. The exchange relation between carrots and potatoes remains the same he has to give up twice the weight of potatoes for the same weight of carrots, or put another way if he forgos 1 cwt. of carrots he gets 2 cwts of potatoes. Why is that relation unaltered despite his changed tastes - his changed demand for carrots? Because the relationship is not determined by his tastes, by his demand for potatoes or carrots but is determined by the production relation of how much labour has to be given up to produce one or the other.
In other words the change in taste resulting in a reduction in demand for carrots, or hats does not change that underlying relationship of the cost of production of the two exchangeable commodities. What it does determine ultimately is how much of each will be produced. The way that works itself out appears to be the law of supply and demand acting as the self regulating mechanism that orthodox economics describes, but in fact that merely disguises a more complex mechanism going on behind the scenes.
Suppose Capitalist A produces hats. The cost of producing 100 hats is £80, and he makes £20 profit. The total selling price is then £100 or £1 per hat.
Capitalist B produces Coats. He produces 10 coats at a cost of £80, with £20 profit so that each coat sells for £10.
Both capitalists make 25% profit, and both sell all their goods. Now demand for hats falls by 50%. Capitalist A cannot sell half his hats. In order to sell the hats he is forced to cut their individual price (in fact there would be many capitalists and competition between them would force the price down). Let us say for the sake of simplicity that he has to cut the price in half to 50p. But the result is now that at this price he makes a 30p loss on each hat. As capitalists do not go into business for the fun of it, but in order to make profits Capitalist A slashes his production (in practice some capitalists would go bankrupt or just move out of hat production). But if everything else remains equal cutting back production to 50 hats will mean that his costs are now £40, and he will make £10 profit, once again selling each hat at £1. He will once again make 25% profit on his capital, and the price of a hat will once again be £1 whilst the price of coats remain £10, and the former relation of coats to hats will remain the same. All that has happened is that the change in demand for hats has resulted in a lower supply of hats, and a reduction in the amount of resources going into hat production.
In reality the capital no longer used in hat production would seek out some other area in which it could be invested profitably. If say the demand for hats had been accompanied by an increase in demand for scarfs then the higher price of scarfs would have encouraged capital to move into that area where the higher prices would have resulted in higher profits.
In short what determines the movement of capital - whcih in turn determines the level of supply - is the search for profit. If profit is low in one sector and high in another then capital will move to the area where higher profits can be made. But what is the determining factor in how much profit can be made? It is in the long term the cost of production. If the cost of production of coats is £8 and the average rate of profit that can be made in the economy is 25% then capital will only move to coat production if it can make that rate of profit, ie. if coats can be sold for £10.
But what in the end does the cost of production boil down to? All of the costs of production (apart from rent, interest and taxes) come down to the purchase of other things made by labour. The costs of these things then divide down ultimately into wages and profit, but profit is only unpaid labour time. Therefore, the value of everything produced comes down in the end to the amount of labour required for production. For reasons I can't go into here for the sake of simplicity, this does not equate for each commodity to its value equalling its price, but if you take the total prices of everything produced that total will equal the total of the exchange values of those goods as determined by the labour time required for their production.
I hope that has clarified rather than complicated the situation, but I am more than happy to give further clarification if you wish, or you can look up some of the explanation given elsewhere on the site in the educational notes for understanding Marx's Capital.
Arthur Bough
A further question
How long does it take for this to average out?
I'm Not Sure What You Mean
I'm not sure I understand your question. I don't know what you mean by "this". If you mean, as I think you probably do how long does it take for the rate of profit to average out, the answer is it never does. What you have is a dynamic process. At any one time it will be possible to make a higher rate of profit in one activity than in another. Capital will tend to move to the places it can make a higher rate of profit just like you look for the best rate of interest for where to put your savings. But the process is not automatic or mechanical.
Suppose you are a small business say a small engineering firm. You set up in business because you trained as an engineer, you understand engineering. Now if your profits fall, and you look around and see that if you sold up you could invest your capital in a flower arranging business so as to make more profit you might still decide to stick with engineering because you know bugger all about flower arranging. So there will be some friction that prevents capital moving to other areas for various reasons.
The more capital develops and becomes employed on much larger scales however this effect diminishes. For example, take Nokia. Originally they produced all kinds of things including wellies, and toilet paper. Noticing a new profitable line of business, mobile phones, they kicked all theother stuff into touch and concnetrated on phones. A large capitalist enterprise isn't bothered what it makes as long as it maximises profits. Obviously, if you have buoilt a reputation in some particulalry line of business and have a lot of fixed investment - say in car manufacture - you won't give it up overnight and replace the machines with say machines for making carpets. But even big companies like GM, or General Electric have done something similar. Noticing that large profits could be made by lending money both the above companies sunk large amounts of capital into becoming finance companies. GM makes huigle losses as a car producer, but makes large profits as a Finance company issuing mortgages and loans etc.
If you were to measure profit rates at any one time you could get an average rate of profit. Some will be above it some below it. As a tendency capital will move away from the lower and towards the higher. As that happens the supply of goods in those areas with lower profit rates will fall and prices will rise, and supply of goods in those areas where capital moves to will increase and prices will fall. Correspondingly, falling prices will reduce profits and rising prices will increase them so that they begin to converge on the average, but the average is moving all the time.
I think this answers your question if you meant how long does it take for prices to average out too, because the prices are moved by the changes in supply.
Arthur Bough
I mean by 'this'
You say supply and demand "affect only short run prices".
To further quote you; "For reasons I can't go into here for the sake of simplicity, this does not equate for each commodity to its value equalling its price, but if you take the total prices of everything produced that total will equal the total of the exchange values of those goods as determined by the labour time required for their production."
If an economist was to demonstrate this mathematically he or she would have to select a period of time to work with. What would be a reasonable length of time for them to use? Would a year be long enough, or is it more like a generation?
Sorry, Now I Understand
Okay, gotcha. Basically, you could take any period of time you like. If you take the total number of commodities produced in a day, week, month, or year then the total Exchange Values of those commodities will equal their total prices. I'm sure that someone actually did this some time ago, and proved that it was true, but I haven't a clue who did it, or where to find the information. When I say they match I don't mean down to the last penny because with the vast amount of calculations to do you would never get that accuracy. When the Government calculates Gross Domestic Product they calculate it in basically two different ways Income and Expenditure. By defintion the two should be the same because one person's (organisations) expenditure is another's income. But even on this basis the figures are never the same.
The reason the Exchange Values and prices do not match is for two basically different reasons. Firstly, there is the issue we've discussed. If all commodities sold at their Exchange Values (and I'll explain why they don't) then in the short term the price of commodity A might rise above its Exchange Value as a result of demand being higher than supply. As I've said this is only a short term effect because the higher price will create above average profits, this will encourage new capital into that area, supply will rise and so prices will fall again. How long short term is depends on how long it takes for this extra capital to move and to increase supply. Another example is, seasonal or peak pricing. The Swimming Baths have peak and off-peak prices reflecting the times of the day when they are busy or not, airlines have higher seasonal prices during the Summer when more people want to travel. But really you have to take an average of these prices. A new swimming pool won't open just to cater for the higher demand at peak times, nor will a new airline begin business just to cater for the Summer.
So an imbalance of demand and supply would cause prices to rise above Exchange Values. However, think about this. If all commodities were in equilibrium i.e. demand and supply were balanced, prior to the imbalance of this one commodity, then its imbalance must cause an imbalance in at least one other commodity in the other direction. If demand has increased for Commodity A, and people increase their purchases of it, or spend more money on it than they previously did, then (assuming no savings for simplicty) they must reduce their spending on something else. So demand for commodity B falls, supply exceeds demand for commodity B and consequently its price falls. The opposite process occurs as for commodity A. The rate of profit for capitalists producing B now falls below the average, seeing profits in A above the average they will tend to move their capital into producing A. As capital moves out of B its supply falls bringing it back into balance with supply and its price rises to the equilibrium price, in this case the Exchange Value. As capital moves to A supply rises bringing it into balance with demand, and price falls also to the equilibrium price equal to Exchange Value. The change of preference by consumers away from B to A has resulted in no long term effect on prices or profits, but has increased the amount of society's resources now used to produce A, and less to produce B. But even before this readjustment total prices would equal total Exchange Values because the extra money spent on A would be equally matched by a reduction in the money spent on B.
Now let me try to explain why Exchange Values do not equal prices. This is a controversial area, and I intend to write a full article on it. I've been working on it for some time along with a number of other economic articles.
When trade was only small scale a peasant say exchanging some food for his horse to be shod it was quite easy to calculate how much time a given amount of wheat took to produce, and how long it took to shoe a horse. There are lots of examples of how the peasant would work in the blacksmiths fields while the blacksmith shod the horse so that an equal amount of labour was exchanged. In addition the amount of capital in hte form of tools and equipment etc. was very small compared to the amount of labour performed. So exchanging goods purely on the basis of the labour content is straightforward.
However, with capitalism this changes. The reason is profit. The peasant or blacksmith who performs a certain amount of labour does not think in terms of profit, the capitalist thinks in terms only of profit. What Marx explains, and this had confused all the previous Classical Economists, is that because different types of business use different amounts of capital and labour the rate of profit that these businesses make would always be different if prices were equal to Exchange Values. But as I've said Marx shows that capital will always move to where it can make the highest rate of profit, and out of areas where the rate of profit is lower than the average, so that it is always trying to converge on the average figure. By definition this means that prices and exchange Values can nevre be equal other than for those business whose proprtion of capital to labour represents the average for all businesses. In short if the prices of commodities in sectors where the rate of profit is below average was equal to exchange value this would soon change because capital would leave this sector and move to a sector with a higher rate of profit. Supply would fall, the balnce of demand and supply would be disturbed, and prices would rise. The opposite would happen in those sectors where the rate of profit was above average, capital would move in, supply would increase and prices would fall.
That is the very short answer. In order to understand it fully you have to understand how Marx shows that profit (surplus value) is only produced by labour i.e. surplus value is unpaid labour. Consequently, industries which have a lot of what Marx calls Constant Capital (machines, raw materials etc.) in proportion to labour will make a lower than average rate of profit if calculated on the basis of Exchange Value. Industries which have a lot of Labour-Power (which Marx calls Variable Capital) will make a higher than average rate of profit calculated on Exchange Value.
So take two industries both have the same total amount of capital but one has a lot of constant capital the other a lot of variable capital. In both cases it is assumed that labour is exploited at the same rate of 100% i.e. if the workers employed can reproduce their wages in 6 hours, and they work for 12 then they produce 6 hours surplus labour for the capitalist, they are exploited at a rate of 100%.
A C = 80 V = 20 S (Surplus Value) = 20 Total Value of production 120.
B C = 20 V = 80 S = 80 Total Value of production 180.
Now you can see that although both industries have the same capital employed of 100 because the first industr has little labour compared to capital the extra value produced, the amount of surplus value is low. The second industry which employs a lot of the value creaing substance - labour power - produces a lot more new value, and so the total value of its output is higher.
If you now look at the effect this has on the rate of profit, you see that the first industry makes a rate of profit of 20/80 whereas the second industry makes a rate of profit of 80/100 - 25% compared with 80%. So for the reasons I have outlined capital would definitely move, and prices would be adjusted.
Marx gave a simplified solution to the problem. He said, think about the economy as being one industry with each individual industry being just a department of it. Now taken as a whole you can calculate the total Constant Capital, the Total Variable Capital, and the Total Surplus Value. If you then take the Surplus Value as a proprtion of this total Capital you will get an average rate of profit. In this case
C = 100 V = 100 S = 100. Total Value produced 300. Rate of profit 100/200 = 50%.
So now if you adjust the prices of A upwards to give a surplus value of = to 50, and reduce the prices of B to give again a surplus of 50 you have solved the problem. Both firms get the average rate of profit, the total of prices equals 300, which is equal to the total of Exchange Values.
In fact Marx knew that this was not quite right. Some of the prices are not end prices (output prices) but input prices. In other words the price of a machine, or raw materials is an output for one indsutry, but an input for another. To be absolutely correct you would have to adjust these input prices, which would affect the proportions of Constant to Variable Capital. In addition some of the outputs are wage goods, and if the price of wage goods fell, then this affects the value of labour power so a further adjustment is required.
A number of economists have produced various schema to resolve this problem including some who are not Marxist economists. The solution is also used by mainstream economists as the basis of input-output matrices for models of resource allocation, and equilibrium market prices. However, the main thing is that at the end of the day it is that underlying Exchange Value - a value which is objective as opposed to the Subjective Value that orthodox economists base their theories on - which explains the basis of prices and price movements. Without that theory of Exchange Value it is impossible to explain the origin of profit i.e. that it is surplus labour, labour provided free to the capitalist over and above what is paid as wages. That is why orthodox economics avoids this question, and tries to explain profit as a return for risk taking, or reward for abstaining from consumption etc. But all these answers are not answers at all. Its like saying Death is the wages of sin. It may be but it doesn't actually tell you what the cause of death was.
In fact if you look at any standard orthodox Micro-economics textbook such as David Laidler's "Microeconomis", you will find that according to orthodox theory profit should not exist, because it should be competed away. Despite a 100 years, and vast amounts of money and research by the ideologists of capitalism only Marx has the explanation of how capitalism really works.
Arthur Bough
Thanks for taking the time to
Thanks for taking the time to explain this, you have added much to my understanding of the world.
Sean Some Further Discussion
Sean,
I thought you might be interested in the discussion at the following link. The thread begins with me outlining the misrepresentation of Marx's ideas by Von Mises one of the leading figures in Austrian economics whose ideas are at the root of Liberalism. The discussion goes on as one of the advocates of Libertarianism puts forward the idea that wages and profits are the same thing, that there is no difference between workers and capitalists. After I demosntare that he has proved the opposite he makes an exit but returns under an alias and tries a different tack trying to explain the source of profit. He fares no better under this alias.
A number of the things discussed above are addressed within the context of a polemic which might or might not be illuminating. The ideas of Mises and Hayek on whichthe Libertarians base their ideas were fundamental to Maggie Thatcher's guru Keith Joseph, and the Mises Institute is funded by some pretty rich and powerful people. I find it useful arguing against them in order to sharpemn my position, and there Libertarian positions also criticise a lot of the neo-con politics inthe US, though of course from an even more irght-wing position.
Mises and Misrepresentation
Arthur Bough
I have red it all, pretty hea
I have red it all, pretty heavy going to be honest. I managed to digest most of it and now have a much more coherant understanding of the source of value, wages and profits. I do have one question; in the example of the man who buys the broken cart and fixes it up for a profit the broken cart has a market price of £10 but what is the value of the broken cart. The same quantity of labour power has gone into the cart regardless of its condition. When the cart is broken then repaired labour power, and consequently value, is added to it. Now I understand that value and price are different but does the repaired cart have a greater value than the new cart?
Of Carts and Value
Sean,
The broken cart has a value of £10 (assuming for simplicity price and value are equal). You make a good point that the cart would have contained a greater quantity of labour than this. So why then would its value now be less than the value of the labour it contains? For the simple reason that the exchange value of commodities is not determined on an individual basis but on the basis of how much labour power is required on average to produce them. If a new cart has a value of £20 comprised of £12 of materials plus £8 of labour, then I will not pay that amount for a broken cart, because in order to make the broken cart the same as a new cart more labour will need to be expended upon it. In fact then you could work back to how much the broken cart's value is by taking the value of a new cart and deducting the value of labour and material that will need to be added to the broken cart. This is what business effectively do with machinery. They reduce each year the value of the machinery they use by deducting an amount of depreciation which they show in their profit and loss account, with a corresponding reduction in the book value of the asset/machine in their Balance Sheet.
What Finster was trying to show was that given three different scenarios where a broken cart is repaired and sold the value added could be described as wages or as profit depending upon whether the person doing the work was a worker working for someone else (wages) or was an entrepreneur working for himself (profit - or as he tried to make out later wages and profit).
In order to make each situation the same he had to set it up such that structurally each example was the same - that is only fair, but having done so it undermined his argument.
So in each case we have a broken cart whose market value is £10. We have necessary materials to mend the cart with a market value of £2. When labour is performed on the cart to repair it it has a market value of £20. Clearly then the value added to the cart by this labour is £8, and Finster agreed that this was indeed the market rate of wages for the work done. But therein lies his problem. On this basis if the worker is employed by someone else, then this someone else cannot make profit. The costs are £10 + £2 + £8 = £20. The income from the sale of the repaired cart is also £20, so nothing is left over for profit.
But if as is required each example is structurally identical i.e. we have the same costs, and the same amount of labour required etc. then the same is true if the worker is an entrepreneur and repairs the cart using his own labour. He still pays £10 for the broken cart, he still pays £2 for the materials to repair it, and he still has to spend the same amount and same type of labour power to repair it. Finster wanted to say that the £8 was now profit not wages, but this is nonsense in terms of economics even from his own Austrian Economics standpoint. The work done (screwing and banging as I described it) is work done by the entrepreneur as a worker just as it is if it is done by a worker working for soemone else, the payment for this work is therefore wages. The entrepreneur could call it profit if he wanted to, but he would just be deluding himself, and as far as economcs is cocnerned its wages, and its wages for a very good reason. The entrepreneur here acting as his own worker has to live. The money he receives - the £8 - has to go to buy food, shelter, clothing etc. In other words it is used up in consumption. Consequently it cannot fulfil the very purpose of profit - to increase Capital. Only if profit is made can investment take place such that the business grows, and no business under capitalism can stand still, it has to grow or it is overtaken by others and forced out of business.
However, you cut it the £8 is wages. In every scenario the broken cart has a value of £10, and the materials a value of £2. This is a good example of the point made by Marx that these values can only pass into the final product. If either the worker or the entrepreneur bought either the broken cart or the materials and came to sell them again without doing anything to them, they could only expect to get back the same value as they paid for them. It is only by labour acting upon them that the final product has greater value. If the amount of value added by this labour is the same as the payment of wages then no profit can be made.
Finster was then stuck his argument failed so he tried to get round it by claiming that some of the labour performed in the scenario where the worker was self employed was not manual labour but entrepreneurial labour, and therefore, attracted profit. But he could not do that because that meant he had broken the constraint that each scenario was identical. If no entrepreneurial labour was undertaken when the worker was employed and he specified none, then you cannot then introduce entrepreneurial labour in this second scenario because straight away you are adding a quantity of labour that was not present in the previous example.
Only the example I gave whereby the market rate for wages falls to £6 do you get the possibility of profit. But then what you have is the same situation as before £10 for the broken cart, £2 for materials, £8 added by labour giving a total of £20 equal to the selling price, but now the £8 of value added by labour is divided into £6 wages and £2 profit. In other words what he demonstrated was not what he started out by arguing i.e. that workers and capitalists are really the same and that there is no basis for class struggle, but the complete opposite - he showed the fundamental corectness of Marx's theory - profits/surplus value are created by labour.
There are some more very interesting discussions on that Board, in particular the threads discussing Liberty in which a number of Proudhonists joined in the debate. Amongst other things raised that the Libertarians didn't really want to discuss was the idea put forward by one of their leading theorists Murray Rothbard, that there should in a Libertarian society be a free market in babies!! Another one was there belief that owners of property in the means of production should be free to discriminate against say Jews in deciding who they will employ or sell to.
A longer discussion going to about 400 exchanges on whether value is objective or subjective was deleted when the board was changed, but I think I have a copy of it sent to me by Finster if you are interested.
Arthur Bough
objective/subjective values
I am interested in this debate but I would not be able to give such a lengthy discussion a serious read before the summer. I have so much uni work now (first priority) + paid work minicabbing (important though soul destroying) + some semblance of family life (girlfriend and stepdaughter). In fact unless it has bearing on my dissertation I probably couldn't even touch it in the summer, my reading schedule is pretty packed.
I Understand
Sean,
It is very long and in parts tedious, though also quite amusing in others. For example I gave a "Diary of a Subjective Valuer" which mocked the idea - if I can find that bit I'll post it. I do intend to write a piece on Theories of Value which will cover it in a more accessible form.
Arthur Bough
What does Marx Mean?
Mr. Bough, I found your post interesting, but one of the quotations from Marx I couldn't - and still can't after reading his article - make sense of. It is:
“The circulation of commodities can absorb only a certain amount of gold currency, the alternating contraction and expansion of the volume of money in circulation manifesting itself accordingly as an inevitable law, whereas any amount of paper seems to be absorbed by circulation.” (ibid p122)
Do you think you could explain this? I would appreciate it.
Tom.
I'll Do My Best
Tom, thanks for the question. It is actually what is at the heart of the confusion of modern theories of money such as those of Milton Friedman, and you will even hear some Marxists say that inflation is caused by printing too much money. I'll try to explain what Marx meant by the statement you quote and in doing so explain why this last statement "inflation is caused by printing too much money" is wrong - actually on several counts.
I don't want to explain Marx's labour Theory of Value again as its contained in the post above, so I am going to take it you udnerstand that bit of his theory. What flows from that is that - if we adopt the simplified version where all commodities exchange at their exchange values rather than their modified prices - gold as a commodity will exchange with every other commodity in accordance with its value determined by the quantity of labour required for its production.
As the quote from Benjamin Franklin quoted by Marx puts it if it takes 1 day to produce an ounce of gold (or silver) and one day to produce a bushel of wheat (using average labour in each case) then 1 ounce of gold (or silver) will exchange for 1 bushel of wheat. If the technology improves and in 1 day 2 bushels of wheat can be produced then 1 ounce of gold (or silver) will exchange for 2 bushels of wheat. Simple observation shows this to be the case that where improvements in production for a particular commodity take place then its price falls relative to other commodities. Competition to average out the rate of profit ensures that the price of the commodity is reduced in line with the reduction in its cost of production.
The fact that gold or silver are adopted as money i.e. as commodities which perform the function of being a general equivalent representing all other commodities, does not change this nature they have of being commodities. So their value relative to other commodities continues to be determined in the same way. If the reverse of the case above occurs, for example a new source of gold such as occurred when gold was discovered in California, then the labour required on average for the production of gold falls and its exchange value falls you need more of it than you did before to purchase your bushel of corn. Again this can be proved by simple observation. When Spain began robbing gold from South America, and when the gold discoveries in California, and Australia occurred the value og gold fell, more gold needed to be put into circulation to buy the same quantity of commodities.
That is the first part of what Marx is saying - with real money gold, silver or any other precious metal - it is the fall in its value caused by a reduction in the average amount of labour required for its production which means that more of it has to be put into circulation. Its value falls so the total quantity of money must rise to compensate. For example, if 1 ounce of gold previously exchanged for 1 bushel of wheat, but now 2 ounces of gold can be mined in 1 day its value falls in half. Now 2 ounces of gold are equal to 1 bushel of wheat, and so in order to buy the wheat 2 ounces of gold must be put into circulation. For the simple reason why would wheat producers give up 1 days labour contained in their wheat in return for just 1/2 day's labour contained in the gold?
As Marx points out during the 19th century the Bank of England used this to determine how much gold money needed to be put into circulation. The basic calculation is this. Take all the commodities thrown on to the market, multiply these by their prices and you will have the total amount of value against which money must be exchanged. Now because one piece of money, say a gold sovereign, will undertake many different transactions, you have to divide this total by the average number of transactions each piece of money will perform (the velocity of circulation). Having done this you have the value of money that needs to be put into circulation in order that all commodities can circulate freely. So as the quote from Marx sets out, in years where the economy was growing strongly and more commodities were being bought and sold the Bank needed to mint more gold, silver and copper coins. In years when there was a retrenchment then less money was required, and as the quote says it might mint no coins at all.
This brings us to the second point that answers your question. What happens to those gold or other coins that are in excess of what is required for circulation when such a retrenchment takes place? Again Marx gives the answer in relation to copper coins with an example from real life. Let me, however, relate it to gold. If the value of gold is set relative to other commodities as previously outlined then the value of 1 ounce of gold, and the value of a 1 ounce gold coin must be the same - otherwise you would have what is now known as arbitrage. The difference in value would give the opportunity for someone to make money out of the difference. If more gold coins are in circulation than are required by the above formula then either some of them must sit around not being circulated because they can find no equivalent, or the value of each coin must fall. But if the value of a 1 ounce coin falls below the value of 1 ounce of gold then I have every reason to melt down the coin and sell the ounce of gold, or as usually happened to export the gold as bullion. In either case the surplus quantity of gold coins is automatically reduced to what is required for circulation.
The same argument applies to silver or copper which circulated as means of payment for commodities of different values.
So that I hope answers your question about "the circulation of commodities can only absorb a certain amount of gold". In other words the Labour Theory of Value sets the value of gold relative to all other commodities. The quantity and value of commodities put into circulation then determines how much gold must be used as money, if more gold than this is put into circulation as gold coin then it will by the operation of the law of value be thrown back out again, stored as a hoard of gold coins, or minted down as bullion. If on the other hand not enough gold is minted then commodities will not be able to circulate freely, there will be a shortage of liquidity, and again examples of this were to be found in the 19th century, and they tended to create panic and crises. A shortage of gold coins meant that businesses could not pay for their inputs, so they tended to hold on to any money they had if they could, in addition where they might previously have given their customers credit they would insist on cash payment further exacerbating the shortage of money in circulation. In effect the value of gold coins would rise above the value of their gold content, the demand for money would rise as against the supply of money from the money capitalists holding capital in money form so interest rates would rise. There would be an arbitrage opportunity to melt down gold and have it minted, so an automatic adjustment would occur increasing the amount of gold coin in circulation.
Now to try to answer the second part of your question relating to paper. Marx points out that over a long period the actual gold content of gold coins became less than it should be. So coins whose names denoted the original weight of gold or silver contained in them over time became worth a reduced amount reflecting their actual average weight, although they kept their original names. Despite the fact that all these coins were debased through clipping etc., and despite the fact that everyone knew they were debased they continued to circulate as though they contained the value that their face value denoted. They did so on one condition that the quantity of them put into circulation was maintained at the quantity that their face value determined was required. In other words these coins had become tokens merely representing the actual money. In other words suppose that using the formula outlined above 1 million 1 ounce gold coins need to be put into circulation. Suppose now that the gold coins in circulation have been debased by clipping so that they contain 10% less gold than they should. Provided that 1 million coins remain in circulation then these 1 million coins would act in just the same way as 1 million gold coins of the full weight. Why because the gold tokens were backed by the state their value was determined by the state, and if any possessor of one of these coins wished they could go to the bank and exchange the coin for gold or silver of the face value of the coin. However, if the state took advantage of the 10% debasement of the coins and minted 10% more coins with the gold clipped from them, then the value of each gold token would fall by 10% correspondingly, for the simple reason that the tokens could not now all be redeemed at their face value.
But the recognition of this fact meant that coins made from precious metals could be repalced, first by coins of lower value metals such as copper and zinc, and finally by paper tokens. This then is the answer to the second part of your question. Provided these tokens were only minted or printed in the same quantity as the quantity of gold money that would previously have been put into circualtion then their value remained equal to the value of the gold money they represented. But as soon as these tokens are issued in greater quantity than that then their value must fall. However, where a surplus of gold or silver or copper coins was automatically dealt with by these coins being melted down in order to obtain their actual commodity value as gold, silver or copper this is not possible with paper money because it has virtually no intrinsic value of its own - a quarter of an ounce of gold (a sovereign) is worth at todays price around £80, the piece of paper on which a £50 note is printed is worth less than a penny. Consequently, where surplus real money was withdrawn, surplus paper tokens are not. The consequence is that these paper tokens must fall in value against the real money they are supposed to represent, and consequently fall in value against all other commodities.
The reason that the theories of the monetarists are wrong therefore is that it is not an icnrease in money that causes inflation, it is an increase in the tokens which represent money that causes inflation.
I hope that answers your question, but feel free to come back if it doesn't.
Arthur Bough
Addenda
I said that current monetarist theories were wrong for more than one reason, but basically only gave one reason why they wee wrong i.e. that they confuse money (i.e. the actual money commodity for which during the last 100 years or so has been gold, hence its rise in price as countries around the world print more paper, or issue more credit which is a whole other article) with the paper token representing money.
It would take too long to go into the different varieties of theories of money adopted by different schools of modern orthodox economics. I did, however, want to refer to an example I came across recently which was completely wrong. The writer of the article was an adherent of the so called Austrian School of Mises and Hayek. They put forward the proposition that inflation is equal to an increase in the supply of money (by which they mean paper and credit), and defined deflation in the equivalent terms i.e. a reduction in the quantity of paper money and credit put into circulation. Hence a 10% increase in "money" supply means 10% inflation (even if that inflation is not manifest in an actual increase in money prices of commodities.
This clearly is nonsense for the reasons I have given above. If a greater volume of commodities is thrown on to the market because of an expansion in the economy (this is different than just an increase in the volume of commodities produced as a result of an improvement of technique/productivity, it is real economic growth meaning more people employed, more machines employed, more raw materials used etc.)then in accordance with the law of value elaborated above this greater volume of commodities thrown on to the market resulting from the increase in economic activity requires more money in order that these commodities can circulate.
If we do away with paper curency and credit and envisage circulation via just gold currency then more gold would have to be minted in order to circulate these commodities. What would happen if this extra gold money was not minted? Exactly as elaborated in my previous post. There would be a relative shortage of gold money in circulation, interest rates would rise economic activity would be curtailed. In short economic growth would become impossible. Alternatively, owners of gold bullion would have an incentive to mint it because the value of a 1 ounce gold coin would rise above the value of an ounce of bullion (assuming that only coins and not bullion could circulate as money).
Provided that the quantity of extra gold coinage put into circulation was only equal to the amount required for the circulation of the greater volume of commodities then the relative exchange value of gold to other commodities is mainatined and there is no inflation, even though money supply has increased. But the same is true of paper money. If the volume of paper money added to circualtion in such circumstances is likewise limited to the quantity of gold that would have been added to circulation then the value of this paper currency relative to the gold it represents remains the same, and therefore its relationship to all other commodities remains the same. It is when the issue of paer money tokens is in excess of this limit that inflation results (though in reality it is more complex than this because you need to take into consideration the extent to which resources are under utilised, and the possibility that an increase in "money" supply might promote economic growth such that the increased currency issue is absorbed by the increased economic activity. This is part of the so called Chicago School Theory of Money.
This situation is different than an increase in commodities thrown on to the market as a result of an increase in productivity/improvement in technique as mentioned above. Where no real increase in economic activity occurs, but productivity rises then we have the same situation as that we began with in Ben Franklin's quote. The increase in productivity simply means that a commodity/group of/all/commodities now requires less labour to produce than it did before, or put another way more of this/these commodities can be produced with the same amount of labour as previously. If the labour required for the production of gold as the money commodity remains the same then the prices of this/these commodities will fall relative to gold. The same quantity of gold in circulation will then be able to circulate this increased volume of commodities at lower prices.
One theory put forward by some Marxists is that because productivity is constantly increasing for the majority of commodities then prices should fall. However, businesses do not like falling prices because it is difficult to get workers to take nominal wage cuts. Falling prices without falling wages means falling profits. That is effectively what is happening now (though it has been happening for all the last century) as globalisation means that prices are set in accordance with a global market (whereas in the past businesses were to some extent protected within their own national economy) and on that global market low wage economies like China set the standard. Because economies are dominated by large oligopolistic firms with considerable political muscle they apply pressure on governments to avoid severe reductions in prices on their domestic markets by printing more "money" so that the falling prices of commodities is disguised by increasing nominal prices. The problem with this is that in market economies there is no way to control where the paper goes to when it is printed. Consequently, many prices of commodities produced in China etc. have still fallen considerably, whilst the excess paper has gone into purchasing other things such as technology shares in the 90's, property over the last 5 years, etc. creating asset price bubbles of the type described by Marx in relation to the Railway Mania or John Law's scheme, or the South Sea Bubble.
I hope that has helped to further clarify things.
Arthur Bough
Further Clarification
A Further Clarification for Tom on Gold Circulation
Having read my responses above I thought it might still not be absolutely clear why Marx says that only a certain amount of gold money can be circulated given a certain quantity and value of commodities being circulated. Let me try to give some simplified examples to better explain it.
Let’s start with perhaps the simplest situation there could be two people, two commodities one of which is the money commodity gold. I am assuming throughout that the labour employed producing the money commodity, and the second commodity are equal to average social labour. This is merely a simplification. You could just as easily say that the labour that produces the gold is more skilled than the labour used to produce the other commodity – that it is, as Marx puts it, complex labour. This merely makes calculation more difficult rather than changing anything substantive. It would mean for example just counting one hour of a gold miner’s labour as equal to two hour’s labour of the worker producing the other commodity.
Thomas Sowell (“Marx’s Capital after 100 Years” in ‘The Economics of Marx’, M.C. Howard and J.E. King ed.) claims that Marx never said he had a Labour Theory of Value. He claims Marx refused to justify such a theory as Bohm-Bawerk had claimed. He says that Marx only has a “definition” of value based on labour-time. Such a definition is no different from Keynes use of labour units as a means of measurement – it is a numeraire the same as a metre or kilogram, it does not have to imply that labour is the only source of value, merely its chosen unit of measurement. I think Sowell is wrong, Marx does have a Labour Theory of Value just as did Adam Smith, Ferguson, Ricardo, and all the other Classical economists, but the point that you do not have to accept the Labour Theory of Value to accept Labour-time as a numeraire for value I think is clearly true.
Suppose then that in this two person, two commodity economy A produces wheat and B produces Gold. B also mints gold into 1 ounce coins which we will call sovereigns. It requires 1 days labour to produce a bushel of wheat, and 1 day’s labour to produce an ounce of gold. A bushel of wheat then has the same exchange value as 1 ounce of gold. If A and B decide that they wish to exchange (and we can accept the orthodox economists explanation that they trade because they both get something they want from this trade) then the rate of exchange will be 1 bushel of wheat to 1 ounce of gold. If we wanted to make this more realistic we could say that A represents 1 million wheat producers and B 1 million gold producers so that competition between all the A’s would force the price of wheat down to its exchange value, and competition between all the B’s would force down the price of gold to its exchange value.
Let us make the assumption that trades are made using gold coins, and make the simplifying assumption that the cost of minting the coins is zero. After a 6 day week A has produced 6 bushels of wheat and B 6 ounces of gold. A needs to feed his family and so consumes half the wheat he has produced. He therefore wishes to sell the other half of his wheat. B needs to buy wheat to feed his family. The exchange value tells us that he will need to give up coins equal in value to 3 ounces of gold to buy 3 bushels of wheat. So he mints 3 sovereigns, and uses these to buy the wheat he requires. Suppose he had minted all six ounces of the gold he has mined. Then 3 of these coins would simply have sat unused. They may just as well have not been minted. Indeed if we consider an economy where another producer C might exist who is a jeweller then it would have been advantageous for B not to have minted the other 3 coins, but to have sold some of the unminted gold to C for him to use in making jewellery. This is the simplest example I can think of for explaining what Marx means by saying that given a certain value of commodities to be circulated there is a maximum of gold coin that can be absorbed, the rest sits unused as a hoard or is melted down for use as bullion, or to be used as a commodity in the production of other things.
Converesely, if B had only minted 2 gold coins then he would only have been able to have bought 2 bushels of wheat from B. If he did not mint another coin he would find his own consumption fell short of his requirements, and A would be unable to sell his other bushel of wheat. A might then consume this bushel himself, or save this bushel for the next week, so that he only needed to work 5 days, alternatively if he believed that the coins coming from B the following week would again only be sufficient to buy 2 bushels, then he might work just 4 days producing his own requirements in 3, half the requirements for sale to B in 1, and using the other bushel in hand for the other. In other words the shortage of coin here leads to a curtailment of economic activity below what it otherwise would have been.
We can expand this example to illustrate further points. Suppose we introduce a third producer C. C produces potatoes. In 1 day he produces 1 cwt of potatoes, 6 cwt in a week, of which he consumes half. A likes potatoes B does not. The exchange value of potatoes to wheat is 1cwt to 1 bushel, both are equal to 1 ounce of gold or 1 sovereign. A sells his wheat to B who gives him three sovereigns freshly minted. B now buys 3 cwt of potatoes from C using the 3 gold sovereigns from B, and which is equal to their value. We now have 9 sovereigns of value having been produced and circulated (3, sovereigns worth of gold, 3 sovereigns worth of wheat, and 3 sovereigns worth of potatoes.) The same 3 sovereigns have performed several transactions so that less value of gold money was required than the actual value of commodities circulated. This is the velocity of circulation. The more transactions that a given currency can perform in a given time the less of it that is required. But this velocity of circulation tends to be technically determined by factors such as methods of payment. If we know the velocity of circulation, and we know the value of commodities to be circulated then we can calculate the value of money that is required in order for this circulation to take place. Less than that of real money will curtail economic activity, more than that will result in the money commodity being hoarded as coin or bullion, and thereby excluded from circulation.
As I said in previous posts none of this applies to tokens representing money. The amount of real money required continues to be defined as above, if the number of tokens representing this money i.e. more pound coins, or five pound notes are issued than the gold they are supposed to represent, then the value of these tokens falls as compared money, gold and therefore other commodities. It is the massive expansion of the production of these tokens by central banks and financial institutions, together with the colossal expansion of credit which also acts as a means of circulation which has reduced the value of these money tokens against gold and other commodities, or in most cases other assets such as shares, property, bonds, etc.
Arthur Bough
Understood
Arthur,
Thanks for your detailed response. I think I understand what Marx meant. Simplistically, gold coins are not just symbols - the gold in them always retains its value as a commodity. It would be impossible for a gold coin to rise or fall below its value as gold: the value of 1oz. of gold must equal the value of 1oz. of gold in a coin. Any excess gold coins in circulation would be turned back into gold and too few would result in the minting of more coins. However, paper money is just a symbol. Since it is not a commodity it can be nothing other than what it is. If there is too much in circulation, it cannot be turned into anything else so it cannot be withdrawn. Therefore the value of the paper money falls in relation to the commodity: more paper would be needed to buy 1oz. of gold because the amount of paper representing 1oz. of gold had increased.
And I have some questions connected to this; they concern basic ideas (I'm an absolute beginner). They are:
1. Using gold coins, inflation is not ultimately possible because the value will equal the gold. But is it possible for there to be a disparity for a short amount of time, before gold coins are melted down or gold minted? Or is this merely hypothetical because the equality of 1oz. of gold with a 1oz. gold coin is fully understood, never tested?
2.a. Inflation means the commodity price increases, so deflation means that the commodity price decreases?
b. Deflation is never a problem, because paper money can easily be printed?
c. If so, that would give the state (printing the notes) the ability to set the minimum price for commodities. More printed money would send the commodity price up. But it would need to be done gradually or the sudden influx of paper would just create inflation - in other words, not affect the price of the commodity?
3. Why can't paper money be withdrawn from circulation by the state?
Thank you again for answering in such detail. It's helping me a lot.
Tom.
Hope This Answers Your Questions
Tom, in broad outline you have it right. Gold coins if they are the full weight are not symbols they are real money, but you are correct because the weight of a gold coin always gets reduced either by wear and tear or by deliberate action they in practice become tokens for real money even though they are made from the substance of the money commodity. This was Ben Franklin’s point about silver sixpences, some of them had only half the weight they should have, but continued to function as though they were full weight because their value was backed by the state. It is also why the Bank of England tried to prevent coins falling substantially below weight by taking them out of circulation. But as Marx relates from history over long periods of time the weights of coins did fall people realised the had fallen, and that more had been put in circulation. At this point the currency is re-issued with its official weight being reduced. So a pound sterling (originally a pound of sterling silver) gets reduced and reduced in weight, and correspondingly more produced to compensate, but it keeps its original name – a pound sterling.
This brings me to your first point that with coins made from precious metals inflation is not possible. Yes it is. There are several ways this can happen. The first I have outlined above. If the currency is progressively debased over a period then in order to maintain faith in it the authorities are forced to re-issue with its official weight reduced to something like the average weight of the actual coins in issue. This reduction in weight, and therefore, the value of the coins means that more of them must be put into circulation to counteract their fall in value. So a pound sterling that is reissued at half its weight to take an exaggerated example would require that twice as many “pounds” are issued. Each of these pounds is worth only half what the previous pound was worth, and on that basis twice as many of them would have to be given up to buy any other commodity. In other words there is inflation, but the inflation arises not from issuing more coins as such, but from the fact that the value of each coin fell in half, causing more of them to be issued.
The second cause is that the value of gold falls. As I have previously quoted the Spanish brought back masses of gold from South America that they had stolen. It was on such a scale that it affected the value of gold. Obviously, if you steal a vast amount of gold it costs you a lot less than if you have to find it, mine it and purify it. Similarly, when the Gold Rush occurred in California the average amount of labour required to produce gold fell dramatically because large quantities of it suddenly became available in mines that were more productive than the worked out mines that had previously been the main sources. This reduction in the value of gold again meant that more coins needed to be issued such that if previously a cwt of wheat could be had for 1 gold sovereign, now it cost 2 gold sovereigns. In other words inflation. In fact this latter example, was one of the reasons that industrial capitalism got started in Britain. The fall in the value of gold created inflation of prices of agricultural and other products. However, most rents were on long leases with a fixed rent. The capitalist farmers that were beginning to emerge obtained higher nominal prices for their products, but their rents remained the same in nominal terms, which meant in reality they were falling. The landlords found that their rents remained the same, but the prices they had to pay for the goods they bought were rising. It caused financial ruin for some of the landlords, and led them to sell their land at knock down prices to capitalist farmers. It was one of the factors contributing to the primary accumulation of capital in Britain. Thirdly, the converse of the fall in the value of gold is an increase in the value of other commodities. This tends not to happen in modern capitalism because the majority of production is industrial production and there is continual technical innovation. However, consider a largely agricultural economy. A poor harvest means that less is produced with the same or more amounts of labour than usual. The value of agricultural products goes up, and prices rise.
The second part of your question is very good. The problem of too many gold coins does not tend to be a problem. They do not have to be melted down in order to be removed from circulation. If they merely sit in a strong box as a hoard of gold they are equally well out of circulation, remaining simply a store of value for their owner, but not currency. Shortage of coin is a bigger problem, and again it is interesting to see how capitalism as Marx says really was a revolutionary and dynamic force. I have given a fuller response to this elsewhere, but let me try to summarise. Capital divides down into 3 types Productive Capital, Money Capital, Commercial Capital. Although, there have always been capitalists of each of these types at the beginning of the Industrial Revolution, or at least of the beginning of industrial capital which begins around 1800 all three were often bound up in the single figure of the industrial capitalist. He had a sum of money capital, he used it as productive capital to buy labour, machines and raw material, and eventually he tied some of it up in selling his products. However, it becomes more efficient for specialised capitalists to become Money Capitalists people who own Capital in the form of loanable money, others to be industrial capitalists, and others to specialise in selling the products of the industrial capitalist. In short specialisation makes savings possible.
Now the industrial capitalist borrows from the money capitalist to pay his wages, and for his materials and reimburses him with interest from the proceeds of selling his goods. For this the money capitalist gets paid interest as a deduction from the industrial capitalists profit (the merchant capitalist likewise buys goods from the industrial capitalist below their value, and sells them at their value to make