         C.8 Is state control of money the cause of the business cycle?

   As explained in the [1]last section, capitalism will suffer from a
   boom-and-bust cycle due to objective pressures on profit production
   even if we ignore the subjective revolt against authority by working
   class people. It is this two-way pressure on profit rates, the
   subjective and objective, which causes the business cycle and such
   economic problems as "stagflation." However, for supporters of the free
   market, this conclusion is unacceptable and so they usually try to
   explain the business cycle in terms of external influences rather than
   those generated by the way capitalism works. Most pro-"free market"
   capitalists blame government intervention in the market, particularly
   state control over money, as the source of the business cycle. This
   analysis is defective, as will be shown below.

   First it should be noted that many supporters of capitalism ignore the
   "subjective" pressures on capitalism that we discussed in [2]section
   C.7.1. In addition, the problems associated with rising capital
   investment (as highlighted in [3]section C.7.3) are also usually
   ignored, because they usually consider capital to be "productive" and
   so cannot see how its use could result in crises. This leaves them with
   the problems associated with the price mechanism, as discussed in
   [4]section C.7.2. It is here, in the market for credit and money, that
   the role of the state comes into play, distorting the natural workings
   of the market and causing the ups and downs of business.

   In pre-Keynesian bourgeois economics, the reason why Say's Law is
   applicable in a money economy is the interest rate. As we discussed in
   [5]section C.2.6, this is claimed to reflect the "time preference" of
   individuals. While it is possible for sales not to be turned into
   purchases in the market, the money involved is not withdrawn from the
   economy. Rather, it is saved and made available to investors. The
   interest rate is the means by which savings and investment come into
   line. This means that Say's Law is maintained as savings are used to
   purchase capital goods and so demand and supply match. As long as
   interest rates are working as they should, the possibility of a general
   crisis is impossible. The problem is that the credit system does not
   work exactly as it claimed and this lies with the banks who introduce
   fractional reserve banking. This allows them to loan out more money
   than they have in savings in order to increase their profits. This
   lowers the rate of interest below its "natural" (or equilibrium) rate
   and thus firms get price signals which do not reflect the wishes of
   consumers for future goods rather than current ones. This causes
   over-investment and, ultimately, a crisis. This is because, eventually,
   interest rates must rise and projects which were profitable at the
   lower rate of interest will no longer be so. The moral of the theory is
   that if the actual rate of interest equalled the "natural" rate then a
   situation of "neutral" money would be achieved and so misdirections of
   production would be avoided, so ending the business cycle.

   As far as capitalist economics had a theory of the business cycle, this
   was it and it was the dominant ideological position within the
   profession until publication of Keynes' The General Theory of
   Employment, Interest and Money in 1936. Politically, it was very useful
   as it recommended that the state should do nothing during the crisis
   and this was the preferred position of right-wing governments in
   America and Britain. It was forcefully argued by "Austrian" economist
   Frederick von Hayek during the early 1930s, who was repeating the
   earlier arguments of his mentor Ludwig von Mises and has been repeated
   by their followers ever since. Yet, for some strange reason, they
   almost always fail to mention that Hayek was roundly defeated in the
   theoretical battles of the time by Keynesians. In fact, his former
   students (including John Hicks and Nicholas Kaldor) showed how Hayek's
   theory was flawed and he gave up business cycle research in the early
   1940s for other work. Kaldor's first critique ("Capital Intensity and
   the Trade Cycle"), for example, resulted in Hayek completed rewriting
   his theory while Kaldor's second article ("Professor Hayek and the
   Concertina-effect") showed that Hayek's Ricardo Effect was only
   possible under some very special circumstances and so highly unlikely.
   [Kaldor, Essays on Economic Stability and Growth, pp. 120-147 and pp.
   148-176]

   Kaldor's critique was combined with an earlier critique by Piero Sraffa
   who noted that Hayek's desire for "neutral" money was simply impossible
   in any real capitalist economy for "a state of things in which money is
   'neutral' is identical with a state in which there is no money at all."
   Hayek "completely ignored" the fact that "money is not only the medium
   of exchange, but also a store of value" which "amounts to assuming away
   the very object of the inquiry." Sraffa also noted that the starting
   point of Hayek's theory was flawed: "An essential confusion . . . is
   the belief that the divergence of rates is a characteristic of a money
   economy . . . If money did not exist, and loans were made in terms of
   all sorts of commodities, there would be a single rate which satisfies
   the conditions of equilibrium, but there might be at any moment as many
   'natural' rates of interest as there are commodities, though they would
   not be 'equilibrium' rates. The 'arbitrary' action of the banks is by
   no means a necessary condition for the divergence; if loans were made
   in wheat and farmers (or for that matter the weather) 'arbitrarily
   changed' the quantity of wheat produced, the actual rate of interes on
   loans in terms of wheat would diverge from the rate on other
   commodities and there would be no single equilibrium rate." ["Dr. Hayek
   on Money and Capital," pp. 42-53, The Economic Journal, vol. 42, no.
   165, p. 42, pp. 43-4 and p. 49] Hayek admitted that this was a
   possibility, to which Sraffa replied:

     "only under conditions of equilibrium would there be a single rate,
     and that when saving was in progress there would be at any one
     moment be many 'natural' rates, possibly as many as there are
     commodities; so that it would be not merely difficult in practice,
     but altogether inconceivable, that the money rate would be equal to
     'the' natural rate . . . Dr. Hayek now acknowledges the multiplicity
     of the 'natural' rates, but he has nothing more to say on this
     specific point than that they 'all would be equilibrium rates.' The
     only meaning (if it be a meaning) I can attach to this is that his
     maxim of policy now requires that the money rate should be equal to
     all these divergent natural rates." ["A Rejoinder," pp. 249-251, Op.
     Cit. Vol. 42, No. 166, p. 251]

   Then there was the practical suggestions that flowed from the analysis,
   namely do nothing. It also implied that the best thing to do in a
   recession or depression is not to spend, but rather to save as this
   will bring the savings and loans back into the equilibrium position.
   Economist R. F. Kahn recounted when Hayek presented his theory at a
   seminar in Cambridge University. His presentation was followed by
   silence. Then Kahn asked the obvious question: "Is it your view that if
   I went out tomorrow and bought a new overcoat, that would increase
   unemployment?" All that Hayek could offer in reply was the unconvincing
   claim that to show why would require a complicated mathematical
   argument. The notion that reducing consumption in a depression was the
   best thing to do convinced few people and the impact of such saving
   should be obvious, namely a collapse in demand for goods and services.
   Any savings would, in the circumstances of a recession, be unlikely to
   be used for investing. After all, which company would start increasing
   its capital stock facing a fall in demand and which capitalist would
   venture to create a new company during a depression? Unsurprisingly,
   few economists thought that advocating a deflationary policy in the
   midst of the most severe economic crisis in history made much sense. It
   may have been economic orthodoxy but making the depression worse in
   order to make things better would have ensured either the victory of
   fascism or some-sort of socialist revolution.

   Given these practical considerations and the devastating critiques
   inflicted upon it, Keynesian theory became the dominant theme in
   economics (particularly once it had been lobotomised of any ideas which
   threatened neo-classical supremacy -- see [6]section C.8.1). This has
   not, as noted, stopped Hayek's followers repeating his theory to this
   day (nor has its roots in equilibrium theory bothered them -- see
   [7]section C.1.6). Bearing this in mind, it is useful to discuss this
   theory because it reflects the pre-Keynesian orthodoxy although we must
   stress that our discussion of "Austrian" economics here should not be
   taken as suggesting that they are a significant school of thought or
   that their influence is large. Far from it -- they still remain on the
   sidelines of economics where they were pushed after von Hayek's defeat
   in the 1930s. We use them simply because they are the only school of
   thought which still subscribes fully to the pre-Keynesian position.
   Most modern neo-classical economists pay at least lip-service to
   Keynes.

   Take, for example, "Austrian" economist W. Duncan Reekie's argument
   that the business cycle "is generated by monetary expansion and
   contraction . . . When new money is printed it appears as if the supply
   of savings has increased. Interest rates fall and businessmen are
   misled into borrowing additional funds to finance extra investment
   activity." This would be of "no consequence" if it had been the outcome
   of genuine saving "but the change was government induced . . . Capital
   goods industries will find their expansion has been in error and
   malinvestments have been incurred" and so there has been "wasteful
   mis-investment due to government interference with the market."
   [Markets, Entrepreneurs and Liberty, pp. 68-9]

   Yet the government does not force banks to make excessive loans and
   this is the first, and most obvious, fallacy of argument. After all,
   what Reekie is actually complaining about when he argues that "state
   action" creates the business cycle by creating excess money is that the
   state allows bankers to meet the demand for credit by creating it. This
   makes sense, for how could the state force bankers to expand credit by
   loaning more money than they have savings? This is implicitly admitted
   when Reekie argues that "[o]nce fractional reserve banking is
   introduced, however, the supply of money substitutes will include
   fiduciary media. The ingenuity of bankers, other financial
   intermediaries and the endorsement and guaranteeing of their activities
   by governments and central banks has ensured that the quantity of fiat
   money is immense." [Op. Cit., p. 73] As we will discuss in detail below
   what is termed "credit money" (created by banks) is an essential part
   of capitalism and would exist without a system of central banks. This
   is because money is created from within the system, in response to the
   needs of capitalists. In a word, the money supply is endogenous.

   The second fallacy of this theory of the business cycle lies with the
   assumption that the information provided by the interest rate itself is
   sufficient in itself to ensure rational investment decisions, it that
   provides companies and individuals with accurate information about how
   price changes will affect future trends in production. Specifically,
   the claim is that changes in interest rates (i.e. changes in the demand
   and supply of credit) indirectly inform companies of the responses of
   their competitors. As John O'Neill argues, the argument assumes "that
   information about the panned responses of producers in competition is
   indirectly distributed by changes in interest rates: the planned
   increase in production by separate producers is reflected in an
   increased demand for credit, and hence a rise in interest rates." [The
   Market, p. 135]

   For example, if the price of tin rises, this will lead to an expansion
   in investment in the tin industry to reap the higher profits this
   implies. This would lead to a rise in interest rates as more credit is
   demanded. This rise in interest rates lowers anticipated profits and
   dampens the expansion. The expansion of credit stops this process by
   distorting the interest rate and so stops it performing its economic
   function. This results in overproduction as interest rates do not
   reflect real savings and so capitalists over-invest in new capital,
   capital which appears profitable only because the interest rate is
   artificially low. When the rate inevitably adjusts upwards towards its
   "natural" value, the invested capital becomes unprofitable and so
   over-investment appears. Hence, according to the argument, by
   eliminating state control of money these negative effects of capitalism
   would disappear as the credit system, if working correctly, will
   communicate all the relevant information required by capitalists.

   "However," argues O'Neil, "this argument is flawed. It is not clear
   that the relevant information is communicated by changes in interest
   rates." This is because interest rates reflect the general aggregate
   demand for credit in an economy. However, the information which a
   specific company requires "if the over-expansion in the production of
   some good is to be avoided is not the general level of demand for
   credit, but the level of demand amongst competitors." It does not
   provide the relative demands in different industries (the parallels
   with Sraffa's critique should be obvious). "An increase in the planned
   production of some good by a group of competitors will be reflected in
   a proportional change in interest rates only if it is assumed that the
   change in demand for credit by that group is identical with that found
   in the economy as a whole, i.e. if rates of change in the demand for
   credit are even throughout an economy. However, there is no reason to
   suppose such an assumption is true, given the different production
   cycles of different industries." This will produce differing needs for
   credit (in both terms of amount and of intensity). "Assuming uneven
   changes in the demand for credit" between industries reflecting uneven
   changes in their requirements it is quite possible for over-investment
   (and so over-production) to occur "even if the credit system is working
   'satisfactorily'" (i.e., as it should in theory. The credit system,
   therefore, "does not communicate the relevant information" and for this
   reason "it is not the case that we must look to a departure from an
   ideal credit system to explain the business cycle." [Op. Cit., pp.
   135-6]

   Another underlying assumption in this argument is that the economy is
   close to equilibrium (a concept which "Austrian" economists claim to
   reject). After all, rising interest rates will cause debt-servicing to
   become harder even if it reflects the "natural" rate. Equally, it also
   suggests that both banks and firms are capable of seeing into the
   future. For even if the credit market is working as postulated in the
   theory it does not mean that firms and banks do not make mistakes nor
   experience unexpected market situations. In such circumstances, firms
   may find it impossible to repay loans, credit chains may start to break
   as more and more firms find themselves in economic difficulties. Just
   because actual interest rates somehow equal the natural rate does not
   make the future any more certain nor does it ensure that credit is
   invested wisely. Crucially, it does not ensure that credit is not used
   to inflate a bubble or add to over-investment in a specific sector of
   the economy. To assume otherwise suggests the firms and banks rarely
   make mistakes and that the accumulative impact of all decisions move an
   economy always towards, and never away from, equilibrium. As
   Post-Keynesian Paul Davidson dryly noted, "Austrian subjectivists
   cannot have it both ways -- they cannot argue for the importance of
   time, uncertainty, and money, and simultaneously presume that plan or
   pattern co-ordination must exist and is waiting to be discovered."
   ["The economics of ignorance or the ignorance of economics?", pp.
   467-87, Critical Review, vol. 3, no. 3-4, p. 468]

   In other words, the notion that if the actual interest rate somehow
   equalled the "natural" one is not only rooted in equilibrium but also
   the neo-classical notion of perfect knowledge of current and future
   events -- all of which "Austrian" economists are meant to reject. This
   can be seen when Murray Rothbard states that entrepreneurs "are trained
   to forecast the market correctly; they only make mass errors when
   governmental or bank intervention distorts the 'signals' of the
   market." He even attacks Joseph Schumpeter's crisis theory because, in
   effect, Schumpeter does not show how entrepreneurs cannot predict the
   future ("There is no explanation offered on the lack of accurate
   forecasting . . . why were not the difficulties expected and
   discounted?"). [America's Great Depression, p. 48 and p. 70] Rothbard
   does not ponder why bankers, who are surely entrepreneurs as well, make
   their errors nor why the foresight of business people in an uncertain
   and complex economy seems to fail them in the face of repeated actions
   of banks (which they could, surely, have "expected and discounted").
   This means that the argument concerning distortions of the interest
   rate does not, as such, explain the occurrence of over-investment (and
   so the business cycle). Therefore, it cannot be claimed that removing
   state interference in the market for money will also remove the
   business-cycle.

   However, these arguments do have an element of truth in them. Expansion
   of credit above the "natural" level which equates it with savings can
   and does allow capital to expand further than it otherwise would and so
   encourages over-investment (i.e. it builds upon trends already present
   rather than creating them). While we have ignored the role of credit
   expansion in our comments above to stress that credit is not
   fundamental to the business cycle, it is useful to discuss this as it
   is an essential factor in real capitalist economies. Indeed, without it
   capitalist economies would not have grown as fast as they have. Credit
   is fundamental to capitalism and this is the last fallacy in the
   pre-Keynesian argument. In a real economy, it is the most important.
   Even assuming that the actual rate of interest could always equal the
   equilibrium rate and that it reflected the natural rate of all
   commodities and all industries, it would not matter as banks would
   always seek to make profits by extending credit and so artificially
   lower the actual interest rate during booms. To understand why, we need
   to explain the flaws in the main laissez-faire approaches to money.

   There are three main approaches to the question of eliminating state
   control of money in "free market" capitalist economics -- Monetarism,
   the 100% gold reserve limit for banks and what is often called "free
   banking." All three are associated with the right and all three are
   wrong. The first two are easy to dismiss. Monetarism has been tried and
   has failed spectacularly in the early 1980s. As it was a key aspect of
   the neo-liberal war on working class people at this time we will
   discuss its limitations as part of our account of this period in
   [8]section C.8.3.

   The second option, namely imposing a 100% gold reserve limit for banks
   is highly interventionist and so not remotely laissez-faire (why should
   the banking industry be subject to state regulation unlike the rest?).
   Its logic is simple, namely to ensure that banks do not make loans
   unless they have sufficient savings to cover them all. In other words,
   it seeks to abolish the credit cycle by abolishing credit by making
   banks keep 100% gold reserves against notes. This, in effect, abolishes
   banking as an industry. Simply put (and it seems strange to have to
   point this out to supporters of capitalism) banks seek to make a profit
   and do so by providing credit. This means that any capitalist system
   will be, fundamentally, one with credit money as banks will always seek
   to make a profit on the spread between loan and deposit rates. It is a
   necessity for the banking system and so non-fractional banking is
   simply not possible. The requirement that banks have enough cash on
   hand to meet all depositors demand amounts to the assertion that banks
   do not lend any money. A 100% reserve system is not a reformed or true
   banking system. It is the abolition of the banking system. Without
   fractional reserves, banks cannot make any loans of any kind as they
   would not be in a position to give their clients their savings if they
   have made loans. Only someone completely ignorant of a real capitalist
   economy could make such a suggestion and, unsurprisingly, this position
   is held by members of the "Austrian" school (particularly its minimum
   state wing).

   This leaves "free banking." This school of thought is, again,
   associated with the "Austrian" school of economics and right-wing
   "libertarians" in general. It is advocated by those who seek to
   eliminate fractional reserve banking but balk by the regulations
   required by a 100% gold standard (Rothbard gets round this by arguing
   this standard "would be part and parcel of the general libertarian
   legal prohibition against fraud." [Op. Cit., p. 32]). It is based on
   totally privatising the banking system and creating a system in which
   banks and other private companies compete on the market to get their
   coins and notes accepted by the general population. This position, it
   must be stressed, is not the same as anarchist mutual banking as it is
   seen not as a way of reducing usury to zero but rather as a means of
   ensuring that interest rates work as they are claimed to do in
   capitalist theory.

   The "free banking" school argues that under competitive pressures,
   banks would maintain a 100% ratio between the credit they provide and
   the money they issue with the reserves they actually have. They argue
   that under the present system, banks can create more credit than they
   have funds/reserves available as the state exists as lender of last
   resort and so banks will count on it to bail them out in bad times.
   Market forces would ensure the end of fractional reserve banking and
   stop them pushing the rate of interest below its "natural rate." So if
   banks were subject to market forces, it is argued, then they would not
   generate credit money, interest rates would reflect the real rate and
   so over-investment, and so crisis, would be a thing of the past.
   Knowing that the state would not step in to save them will also force
   banks to be prudent in their activities.

   This analysis, however, is flawed. We have noted one flaw above, namely
   the problem that interest rates do not provide sufficient or correct
   information for investment decisions. Thus relative over-investment
   could still occur. Another problem is the endogenous nature of money
   and credit and the pressures this puts on banks. As Steve Keen notes,
   Austrian economists think that "the current system of State money means
   that the money supply is entirely exogenous and under the control of
   the State authorities. They then attribute much of the cyclical
   behaviour of the economy to government meddling with the money supply
   and the rate of interest." In contrast, Post-Keynesian economists argue
   that "though it may appear that the State controls the money supply,
   the complex chain of causation in the finance sector actually works
   backwards" with "private banks and other credit-generating institutions
   largely forc[ing] the State's hand. Thus the money supply is largely
   endogenously determined by the market economy, rather than imposed upon
   it exogenously by the State." He notes that the "empirical record
   certainly supports Post-Keynesians rather than Austrians on this point.
   Statistical evidence about the leads and lags between the
   State-determined component of money supply and broad credit show that
   the latter 'leads' the former." [Debunking Economics, p. 303] Moreover,
   as our discussion of the failure of Monetarism will show, central banks
   could not control the money supply when they tried.

   To understand why, we need to turn to the ideas of the noted
   Post-Keynesian economist Hyman Minsky. He created an analysis of the
   finance and credit markets which gives an insight into why it is
   doubtful that even a "free banking" system would resist the temptation
   to create credit money (i.e. loaning more money than available
   savings). This model is usually called "The Financial Instability
   Hypothesis."

   Let us assume that the economy is going into the recovery period after
   a crash. Initially firms would be conservative in their investment
   while banks would lend within their savings limit and to low-risk
   investments. In this way the banks do ensure that the interest rate
   reflects the "natural" rate. However, this combination of a growing
   economy and conservatively financed investment means that most projects
   succeed and this gradually becomes clear to managers/capitalists and
   bankers. As a result, both managers and bankers come to regard the
   present risk premium as excessive. New investment projects are
   evaluated using less conservative estimates of future cash flows. This
   is the foundation of the new boom and its eventual bust. In Minsky's
   words, "stability is destabilising."

   As the economy starts to grow, companies increasingly turn to external
   finance and these funds are forthcoming because the banking sector
   shares the increased optimism of investors. Let us not forget that
   banks are private companies too and so seek profits as well. As Minsky
   argues, "bankers live in the same expectational climate as businessmen"
   and so "profit-seeking bankers will find ways of accommodating their
   customers . . . Banks and bankers are not passive managers of money to
   lend or to invest; they are in business to maximise profits." [quoted
   by L. Randall Wray, Money and Credit in Capitalist Economies, p. 85]
   Providing credit is the key way of doing this and so credit expansion
   occurs. If they did not, the boom would soon turn into slump as
   investors would have no funds available for them and interest rates
   would increase, thus forcing firms to pay more in debt repayment, an
   increase which many firms may not be able to do or find difficult. This
   in turn would suppress investment and so production, generating
   unemployment (as companies cannot "fire" investments as easily as they
   can fire workers), so reducing consumption demand along with investment
   demand, so deepening the slump.

   To avoid this and to take advantage of the rising economy, bankers
   accommodate their customers and generate credit rather than rise
   interest rates. In this way they accept liability structures both for
   themselves and for their customers "that, in a more sober expectational
   climate, they would have rejected." [Minsky, Inflation, Recession and
   Economic Policy, p. 123] The banks innovate their financial products,
   in other words, in line with demand. Firms increase their indebtedness
   and banks are more than willing to allow this due to the few signs of
   financial strain in the economy. The individual firms and banks
   increase their financial liability, and so the whole economy moves up
   the liability structure. Like other businesses, banks operate in an
   uncertain environment and have no way of knowing whether their actions
   will increase the fragility within the economy or push it into crisis.

   The central banks, meanwhile, accommodate the banks activity. They do
   not and cannot force them to create credit. Alan Holmes, a senior vice
   president at the New York Federal Reserve, put the process this way:

     "In the real world, banks extend credit, creating deposits in the
     process, and look for the reserves later. The question then becomes
     one of whether and how the Federal Reserve will accommodate the
     demand for reserves. In the very short run, the Federal Reserve has
     little or no choice about accommodating that demand, over time, its
     influence can obviously be felt." [quoted by Doug Henwood, Wall
     Street, p. 220]

   As long as profits exceed debt servicing requirements, the system will
   continue to work. Eventually, though, interest rates rise as the
   existing extension of credit appears too high to the banks or the
   central bank. This affects all firms, from the most conservatively
   financed to the most speculative, and "pushes" them up even higher up
   the liability structure. Refinancing existing debts is made at the
   higher rate of interest, increasing cash outflows and reducing demand
   for investment as the debt burden increases. Conservatively financed
   firms can no longer can repay their debts easily, less conservative
   ones fail to pay them and so on. The margin of error narrows and firms
   and banks become more vulnerable to unexpected developments, such a new
   competitors, strikes, investments which do not generate the expected
   rate of return, credit becoming hard to get, interest rates increase
   and so on. In the end, the boom turns to slump and firms and banks
   fail. The state then intervenes to try and stop the slump getting worse
   (with varying degrees of success and failure).

   Thus the generation of credit is a spontaneous process rooted in the
   nature of capitalism and is fundamentally endogenous in nature. This
   means that the business cycle is an inherent part of capitalism even if
   we assume that it is caused purely by disequilibrium in the credit
   market. In other words, it is more than likely that the credit market
   will be in disequilibrium like every other market in any real
   capitalist economy -- and for the same reasons. As such, the natural
   rate of interest relies on concepts of equilibrium that are not only
   inconsistent with reality but also with the broader principles of
   "Austrian" economic ideology.

   The "free banking" school reject this claim and argue that private
   banks in competition would not do this as this would make them appear
   less competitive on the market and so customers would frequent other
   banks (this is the same process by which inflation would be solved).
   However, it is because the banks are competing that they innovate -- if
   they do not, another bank or company would in order to get more
   profits. Keynesian economist Charles P. Kindleburger comments:

     "As a historical generalisation, it can be said that every time the
     authorities stabilise or control some quantity of money. . . in
     moments of euphoria more will be produced. Or if the definition of
     money is fixed in terms of particular assets, and the euphoria
     happens to 'monetise' credit in new ways that are excluded from the
     definition, the amount of money defined in the old way will not
     grow, but its velocity will increase . . . fix any [definition of
     money] and the market will create new forms of money in periods of
     boom to get round the limit." [Manias, Panics and Crashes, p. 48]

   This can be seen from the fact that "[b]ank notes . . . and bills of
   exchange . . . were initially developed because of an inelastic supply
   of coin." Thus monetary expansion "is systematic and endogenous rather
   than random and exogenous." [Kindleburger, Op. Cit., p. 51 and p. 150]
   This means that "any shortage of commonly-used types [of money] is
   bound to lead to the emergence of new types; indeed, this is how,
   historically, first bank notes and the chequing account emerged." If
   the state tries to regulate one form of money, "lending and borrowing
   is diverted to other sources." [Nicholas Kaldor, "The New Monetarism",
   The Essential Kaldor, p. 481 and p. 482] This means that the notion
   that abolishing central banking will result in the use of gold and 100%
   reverses and so eliminate the business cycle is misplaced:

     "This view overlooks the fact that the emergence of
     money-substitutes -- whether in the form of bank notes, bank
     accounts, or credit cards -- was a spontaneous process, not planned
     or regulated 'from above' by some central authority, and for that
     reason alone it is impossible to treat some arbitrary definition of
     money (which included specific forms of such money-substitutes in
     the definition of money) as an exogenous variable. The emergence of
     surrogate money was a spontaneous process resulting from the
     development of the banking system; this development brought a steady
     increase in the ratio of money substitutes of 'real' money."
     [Nicholas Kaldor, The Scourge of Monetarism, p. 44f]

   This process can be seen at work in Adam Smith's time. Then Scotland
   was based on a competitive banking system in which baking firms issued
   their own money and maintained their own reverse of gold. Yet, as Smith
   notes, they issued more money than was available in the banks coffers:

     "Though some of those notes [the banks issued] are continually
     coming back for payment, part of them continue to circulate for
     months and years together. Though he [the banker] has generally in
     circulation, therefore, notes to the extent of a hundred thousand
     pounds, twenty thousand pounds in gold and silver may frequently be
     a sufficient provision for answering occasional demands." [The
     Wealth of Nations, pp. 257-8]

   In other words, the competitive banking system did not, in fact,
   eliminate fractional reserve banking. Ironically enough, Smith noted
   that "the Bank of England paid very dearly, not only for its own
   imprudence, but for the much greater imprudence of almost all of the
   Scotch [sic!] banks." Thus the central bank was more conservative in
   its money and credit generation than the banks under competitive
   pressures! Indeed, Smith argues that the banking companies did not, in
   fact, act in line with their interests as assumed by the "free banking"
   school for "had every particular banking company always understood and
   attended to its own particular interest, the circulation never could
   have been overstocked with paper money. But every particular baking
   company has not always understood and attended to its own particular
   interest, and the circulation has frequently been overstocked with
   paper money." Thus we have reserve banking plus bankers acting in ways
   opposed to their "particular interest" (i.e. what economists consider
   to be their actual self-interest rather than what the bankers actually
   thought was their self-interest!) in a system of competitive banking.
   Why could this be the case? Smith mentions, in passing, a possible
   reason. He notes that "the high profits of trade afforded a great
   temptation to over-trading" and that while a "multiplication of banking
   companies . . . increases the security of the public" by forcing them
   "to be more circumspect in their conduct" it also "obliges all bankers
   to be more liberal in their dealings with their customers, lest their
   rivals should carry them away." [Op. Cit., p. 269, p. 267, p. 274 and
   p. 294]

   Thus the banks were pulled in two directions at once, to accommodate
   their loan customers and make more profits while being circumspect in
   their activities to maintain sufficient reserves for the demands of
   their savers. Which factor prevails would depend on the state of the
   economy, with up-swings provoking liberal lending (as described by
   Minsky). Moreover, given that credit generation is meant to produce the
   business cycle, it is clear from the case of Scotland that competitive
   banking would not, in fact, stop either. This also was the case with
   19th century America, which did not have a central bank for most of
   that period and that "left the volatile US financial system without any
   kind of lender of last resort, but in booms all kinds of funny money
   passed." This lead to "thousands of decentralised banks . . . hoarding
   reserves" and so "starving the system of liquidity precisely at the
   moment it was most badly needed" while "the up cycles were also
   extraordinary, powered by loose credit and kinky currencies (like
   privately issued banknotes)." [Doug Henwood, Op. Cit., p. 93 and p. 94]

   As Nicholas Kaldor argued, "the essential function of banks in the
   creation of 'finance' (or credit) was well understood by Adam Smith,
   who . . . regarded branch-banking as a most important invention for the
   enrichment of society. He described how, as a result of the finance
   banks were able to place at the disposal of producers, the real income
   of Scotland doubled or trebled in a remarkably short time. Expressed in
   Keynesian terms, the 'finance' provided by banks made it possible to
   increase investments ahead of income or savings, and to provide the
   savings counterpart of the investment out of the additional income
   generated through a multiplier process by the additional spending."
   This process, however, was unstable which naturally lead to the rise of
   central banks. "Since the notes issued by some banks were found more
   acceptable than those of others, giving rise to periodic payments
   crises and uncertainty, it was sooner or later everywhere found
   necessary to concentrate the right of issuing bank notes in the hands
   of a single institution." ["How Monetarism Failed," Further Essays on
   Economic Theory and Policy, p. 181] In addition, from an anarchist
   perspective, no ruling class wants economic instability to undermine
   its wealth and income generating ability (Doug Henwood provides a
   useful summary of this process, and the arguments used to justify it
   within the American ruling class, for the creation of the US Federal
   Reserve at the start of the 20th century. [Wall Street, pp. 92-5]). Nor
   would any ruling class want too easy credit undermining its power over
   the working class by holding down unemployment too long (or allowing
   working class people to create their own financial institutions).

   Thus the over supply of credit, rather than being the cause of the
   crisis is actually a symptom. Competitive investment drives the
   business cycle expansion, which is allowed and encouraged by the
   competition among banks in supplying credit. Such expansion complements
   -- and thus amplifies -- other objective tendencies towards crisis,
   such as over-investment and disportionalities. In other words, a pure
   "free market" capitalism would still have a business cycle as this
   cycle is caused by the nature of capitalism, not by state intervention.
   In reality (i.e. in "actually existing" capitalism), state manipulation
   of money (via interest rates) is essential for the capitalist class as
   it allows indirect profit-generating activity, such as ensuring a
   "natural" level of unemployment to keep profits up, an acceptable level
   of inflation to ensure increased profits, and so forth, as well as
   providing a means of tempering the business cycle, organising bailouts
   and injecting money into the economy during panics. Ultimately, if
   state manipulation of money caused the problems of capitalism, we would
   not have seen the economic successes of the post-war Keynesian
   experiment or the business cycle in pre-Keynesian days and in countries
   which had a more free banking system (for example, nearly half of the
   late 19th century in the US was spent in periods of recession and
   depression, compared to a fifth since the end of World War II).

   It is true that all crises have been preceded by a
   speculatively-enhanced expansion of production and credit. This does
   not mean, however, that crisis results from speculation and the
   expansion of credit. The connection is not causal in free market
   capitalism. The expansion and contraction of credit is a mere symptom
   of the periodic changes in the business cycle, as the decline of
   profitability contracts credit just as an increase enlarges it. So
   while there are some similarities in the pre-Keynesian/"Austrian"
   theory and the radical one outlined here, the key differences are
   two-fold. Firstly, the pro-capitalist theory argues that it is possible
   for capitalist banks not to act, well, like capitalists if subject to
   competition (or regulated enough). This seems highly unlikely and fits
   as badly into their general theories as the notion that disequilibrium
   in the credit market is the root of the business cycle. Secondly, the
   radical position stresses that the role of credit reflect deeper
   causes. Paul Mattick gives the correct analysis:

     "[M]oney and credit policies can themselves change nothing with
     regard to profitability or insufficient profits. Profits come only
     from production, from the surplus value produced by workers . . .
     The expansion of credit has always been taken as a sign of a coming
     crisis, in the sense that it reflected the attempt of individual
     capital entities to expand despite sharpening competition, and hence
     survive the crisis. . . Although the expansion of credit has staved
     off crisis for a short time, it has never prevented it, since
     ultimately it is the real relationship between total profits and the
     needs of social capital to expand in value which is the decisive
     factor, and that cannot be altered by credit." [Economics, Politics
     and the Age of Inflation, pp. 17-18]

   In short, the apologists of capitalism confuse the symptoms for the
   disease.

   The cyclical movements on the real side of the economy will be enhanced
   (both upwards and downwards) by events in its financial side and this
   may result in greater amplitudes in the cycle but the latter does not
   create the former. Where there "is no profit to be had, credit will not
   be sought." While extension of the credit system "can be a factor
   deferring crisis, the actual outbreak of crisis makes it into an
   aggravating factor because of the larger amount of capital that must be
   devalued." [Paul Mattick, Economic Crisis and Crisis Theory, p. 138]
   But this is also a problem facing competing private companies using the
   gold standard. The money supply reflects the economic activity within a
   country and if that supply cannot adjust, interest rates rise and
   provoke a crisis. Thus the need for a flexible money supply (as
   desired, for example, by Mutualists and the US Individualist
   Anarchists).

   It must always be remembered that a loan is not like other commodities.
   Its exchange value is set by its use value. As its use value lies in
   investing and so generating a stream of income, the market rate of
   interest is governed by the average expectations of profits for the
   capitalist class. Thus credit is driven by its perceived use-value
   rather than its cost of production or the amount of money a bank has.
   Its possible use value reflects the prospective exchange-values (prices
   and profits) it can help produce. This means that uncertainty and
   expectations play a key role in the credit and financial markets and
   these impact on the real economy. This means that money can never be
   neutral and so capitalism will be subject to the business cycle and so
   unemployment will remain a constant threat over the heads of working
   class people. In such circumstances, the notion that capitalism results
   in a level playing field for classes is simply not possible and so,
   except in boom times, working class will be at a disadvantage on the
   labour market.

   To sum up, "[i]t is not credit but only the increase in production made
   possible by it that increases surplus value. It is then the rate of
   exploitation which determines credit expansion." [Paul Mattick,
   Economics, Politics and the Age of Inflation, p. 18] Hence credit money
   would increase and decrease in line with capitalist profitability, as
   predicted in capitalist economic theory. But this could not affect the
   business cycle, which has its roots in production for capital (i.e.
   profit) and capitalist authority relations, to which the credit supply
   would obviously reflect, and not vice versa.

C.8.1 Does this mean that Keynesianism works?

   If state interference in credit generation does not cause the business
   cycle, does that mean Keynesianism capitalism can work? Keynesian
   economics, as opposed to free market capitalism, maintains that the
   state can and should intervene in the economy in order to stop economic
   crises from occurring. Can it work? To begin to answer that question,
   we must first quickly define what is meant by Keynesianism as there are
   different kinds of Keynesianist policies and economics.

   As far as economics goes, Keynes' co-worker Joan Robinson coined the
   phrase "Bastard Keynesianism" to describe the vulgarisation of his
   economics and its stripping of all aspects which were incompatible with
   the assumptions of neo-classical economics. Thus the key notion of
   uncertainty was eliminated and his analysis of the labour market
   reduced to the position he explicitly rejected, namely that
   unemployment was caused by price rigidities. This process was aided by
   the fact that Keynes retained significant parts of the neo-classical
   position in his analysis and argued that the role of the state was
   limited to creating the overall conditions necessary to allow the
   neo-classical system to come "into its own again" and allow capitalism
   "to realise the full potentialities of production." [The General
   Theory, pp. 378-9] Unlike many of his more radical followers, Keynes
   was blind to real nature of capitalism as a class based system and so
   failed to understand the functional role that unemployment plays within
   it (see [9]section C.1.5).

   However, the context in which Keynes worked explains much. Faced with
   the dire situation capitalism faced during the 1930s, he presented a
   new theoretical analysis of capitalism that both explained the crisis
   and suggested policies that would, without interfering with its general
   principles, end it. Keynes' work was aided both by the practical
   failure of traditional solutions and growing fear of revolution and so
   even the most died-in-the-wool neo-classical economists could not keep
   his theory from being tried. When it appeared to work that, on one
   level, ended the argument. However, at a deeper level, at the level of
   theory, the struggle was just beginning. As the neo-classical (and
   Austrian) tradition is axiom-led rather than empirically-led (otherwise
   their axioms would have been abandoned long ago), the mere fact that
   capitalism was in crisis and that Keynes had presented a theory more in
   line with the reality was not enough to change mainstream economics.
   From the start, neo-classical economists began their counter-attack.
   Led by Paul Samuelson in the US and John Hicks in the UK, they set
   about making Keynes' theories safe for neo-classical economics. They
   did this by using mathematics on a part of his theory, leaving out all
   those bits that were inconsistent with neo-classical axioms. This
   bowdlerised version of Keynes soon became the standard in undergraduate
   courses.

   The fate of Keynes reinforces the comment of French revolutionary Louis
   de Saint-Just that "those who make revolution half way only dig their
   own graves." Keynes ideas were only a partial break with the
   neo-classical orthodoxy and, as such, allowed the basis for the
   neo-classical-Keynesian synthesis which dominated post-war economics
   until the mid-1970s as well as giving the Monetarist counter-revolution
   space to grow. Perhaps this partial break is understandable, given the
   dominance of neo-classical ideas in the economics profession it may
   have been too much to expect them to renounce all their dogmas yet it
   ensured that any developments towards an economics based on science
   rather than ideology would be resigned to the sidelines.

   It is important to stress that Keynes was, first and foremost, a
   supporter of capitalism. He aimed to save it, not to end it. As he put
   it the "class war will find me on the side of the educated
   bourgeoisie." [quoted by Henwood, Wall Street, p. 212] That he
   presented a more accurate picture of capitalism and exposed some of the
   contradictions within neo-classical economics is part of the reason he
   was and is so hated by many on the right, although his argument that
   the state should limit some of the power of individual firms and
   capitalists and redistribute some income and wealth was a far more
   important source of that hatred. That he helped save capitalism from
   itself (and secure their fortunes) did not seem to concern his wealthy
   detractors. They failed to understand Keynes often sounded more radical
   than he actually was. Doug Henwood gives a good overview of Keynes'
   ideas (and limitations) in chapter 5 of his book Wall Street.

   What of Keynesian policies? The "Bastard Keynesianism" of the post-war
   period (for all its limitations) did seem to have some impact on
   capitalism. This can be seen from comparing Keynesianism with what came
   before. The more laissez-faire period was nowhere near as stable as
   modern day supporters of free(r) market capitalists like to suggest.
   There were continual economic booms and slumps. The last third of the
   19th century (often considered as the heyday of private enterprise) was
   a period of profound instability and anxiety as it "was characterised
   by violent booms and busts, in nearly equal measure, since almost half
   the period was one of panic and depression." American spent nearly half
   of the late 19th century in periods of recession and depression. By way
   of comparison, since the end of world war II, only about a fifth of the
   time has been. [Doug Henwood, Wall Street, p. 94 and p. 54] Between
   1867 and 1900 there were 8 complete business cycles. Over these 396
   months, the economy expanded during 199 months and contracted during
   197. Hardly a sign of great stability. Overall, the economy went into a
   slump, panic or crisis in 1807, 1817, 1828, 1834, 1837, 1854, 1857,
   1873, 1882, and 1893 (in addition, 1903 and 1907 were also crisis
   years).

   Then there is what is often called the "Golden Age of Capitalism," the
   boom years of (approximately) 1945 to 1975. This post-war boom presents
   compelling evidence that Keynesianism can effect the business cycle for
   the better by reducing its tendency to develop into a full depression.
   By intervening in the economy, the state would reduce uncertainty for
   capitalists by maintaining overall demand which will, in turn, ensure
   conditions where they will invest their money rather than holding onto
   it (what Keynes termed "liquidity-preference"). In other words, to
   create conditions where capitalists will desire to invest and ensure
   the willingness on the part of capitalists to act as capitalists.

   This period of social Keynesianism after the war was marked by reduced
   inequality, increased rights for working class people, less
   unemployment, a welfare state you could actually use and so on.
   Compared to present-day capitalism, it had much going for it. However,
   Keynesian capitalism is still capitalism and so is still based upon
   oppression and exploitation. It was, in fact, a more refined form of
   capitalism, within which the state intervention was used to protect
   capitalism from itself while trying to ensure that working class
   struggle against it was directed, via productivity deals, into keeping
   the system going. For the population at large, the general idea was
   that the welfare state (especially in Europe) was a way for society to
   get a grip on capitalism by putting some humanity into it. In a
   confused way, the welfare state was promoted as an attempt to create a
   society in which the economy existed for people, not people for the
   economy.

   While the state has always had a share in the total surplus value
   produced by the working class, only under Keynesianism is this share
   increased and used actively to manage the economy. Traditionally,
   placing checks on state appropriation of surplus value had been one of
   the aims of classical capitalist thought (simply put, cheap government
   means more surplus value available for capitalists to compete for). But
   as capital has accumulated, so has the state increased and its share in
   social surplus (for control over the domestic enemy has to be expanded
   and society protected from the destruction caused by free market
   capitalism). It must be stressed that state intervention was not
   totally new for "[f]rom its origins, the United States had relied
   heavily on state intervention and protection for the development of
   industry and agriculture, from the textile industry in the early
   nineteenth century, through the steel industry at the end of the
   century, to computers, electronics, and biotechnology today.
   Furthermore, the same has been true of every other successful
   industrial society." [Noam Chomsky, World Orders, Old and New, p. 101]
   The difference was that such state action was directed to social goals
   as well as bolstering capitalist profits (much to the hatred of the
   right).

   The roots of the new policy of higher levels and different forms of
   state intervention lie in two related factors. The Great Depression of
   the 1930s had lead to the realisation that attempts to enforce
   widespread reductions in money wages and costs (the traditional means
   to overcome depression) simply did not work. As Keynes stressed,
   cutting wages reduced prices and so left real wages unaffected. Worse,
   it reduced aggregate demand and lead to a deepening of the slump (see
   [10]section C.9.1 for details). This meant that leaving the market to
   solve its own problems would make things a lot worse before they became
   better. Such a policy would, moreover, be impossible because the social
   and economic costs would have been too expensive. Working class people
   simply would not tolerate more austerity imposed on them and
   increasingly took direct action to solve their problems. For example,
   America saw a militant strike wave involving a half million workers in
   1934, with factory occupations and other forms of militant direct
   action commonplace. It was only a matter of time before capitalism was
   either ended by revolution or saved by fascism, with neither prospect
   appealing to large sections of the ruling class.

   So instead of attempting the usual class war (which may have had
   revolutionary results), sections of the capitalist class thought a new
   approach was required. This involved using the state to manipulate
   demand in order to increase the funds available for capital. By means
   of demand bolstered by state borrowing and investment, aggregate demand
   could be increased and the slump ended. In effect, the state acts to
   encourage capitalists to act like capitalists by creating an
   environment when they think it is wise to invest again. As Paul Mattick
   points out, the "additional production made possible by deficit
   financing does appear as additional demand, but as demand unaccompanied
   by a corresponding increase in total profits. . . [this] functions
   immediately as an increase in demand that stimulates the economy as a
   whole and can become the point for a new prosperity" if objective
   conditions allow it. [Economic Crisis and Crisis Theory, p. 143]

   State intervention can, in the short term, postpone crises by
   stimulating production. This can be seen from the in 1930s New Deal
   period under Roosevelt when the economy grew five years out of seven
   compared to it shrinking every year under the pro-laissez-faire
   Republican President Herbert Hoover (under Hoover, the GNP shrank an
   average of -8.4 percent a year, under Roosevelt it grew by 6.4
   percent). The 1938 slump after 3 years of growth under Roosevelt was
   due to a decrease in state intervention:

     "The forces of recovery operating within the depression, as well as
     the decrease in unemployment via public expenditures, increased
     production up to the output level of 1929. This was sufficient for
     the Roosevelt administration to drastically reduce public works . .
     . in a new effort to balance the budget in response to the demands
     of the business world. . . The recovery proved to be short-lived. At
     the end of 1937 the Business Index fell from 110 to 85, bringing the
     economy back to the state in which it had found itself in 1935 . . .
     Millions of workers lost their jobs once again." [Paul Mattick,
     Economics, Politics and the Age of Inflation, p. 138]

   The rush to war made Keynesian policies permanent. With the success of
   state intervention during the second world war, Keynesianism was seen
   as a way of ensuring capitalist survival. The resulting boom is well
   known, with state intervention being seen as the way of ensuring
   prosperity for all sections of society. It had not fully recovered from
   the Great Depression and the boom economy during the war had obviously
   contrasted deeply with the stagnation of the 1930s. Plus, of course, a
   militant working class, which had put up with years of denial in the
   struggle against fascist-capitalism would not have taken lightly to a
   return to mass unemployment and poverty. Capitalism had to turn to
   continued state intervention as it is not a viable system. So,
   politically and economically a change was required. This change was
   provided by the ideas of Keynes, a change which occurred under working
   class pressure but in the interests of the ruling class.

   So there is no denying that for a considerable time, capitalism has
   been able to prevent the rise of depressions which so plagued the
   pre-war world and that this was accomplished by government
   interventions. This is because Keynesianism can serve to initiate a new
   prosperity and postpone crisis by state intervention to bolster demand
   and encourage profit investment. This can mitigate the conditions of
   crisis, since one of its short-term effects is that it offers private
   capital a wider range of action and an improved basis for its own
   efforts to escape the shortage of profits for accumulation. In
   addition, Keynesianism can fund Research and Development in new
   technologies and working methods (such as automation) which can
   increase profits, guarantee markets for goods as well as transferring
   wealth from the working class to capital via indirect taxation and
   inflation. In the long run, however, Keynesian "management of the
   economy by means of monetary and credit policies and by means of
   state-induced production must eventually find its end in the
   contradictions of the accumulation process." [Paul Mattick, Op. Cit.,
   p. 18] This is because it cannot stop the tendency to (relative)
   over-investment, disproportionalities and profits squeeze we outlined
   in [11]section C.7. In fact, due to its maintenance of full employment
   it increases the possibility of a crisis arising due to increased
   workers' power at the point of production.

   So, these interventions did not actually set aside the underlying
   causes of economic and social crisis. The modifications of the
   capitalist system could not totally countermand the subjective and
   objective limitations of a system based upon wage slavery and social
   hierarchy. This can be seen when the rosy picture of post-war
   prosperity changed drastically in the 1970s when economic crisis
   returned with a vengeance, with high unemployment occurring along with
   high inflation. This soon lead to a return to a more "free market"
   capitalism with, in Chomsky's words, "state protection and public
   subsidy for the rich, market discipline for the poor." This process and
   its aftermath are discussed in the [12]next section.

C.8.2 What happened to Keynesianism in the 1970s?

   Basically, the subjective and objective limitations to Keynesianism we
   highlighted in the [13]last section were finally reached in the early
   1970s. It, in effect, came into conflict with the reality of capitalism
   as a class and hierarchical system. It faced either revolution to
   increase popular participation in social, political and economic life
   (and so eliminate capitalist power), an increase in social democratic
   tendencies (and so become some kind of democratic state capitalist
   regime) or a return to free(r) market capitalist principles by
   increasing unemployment and so placing a rebellious people in its
   place. Under the name of fighting inflation, the ruling class
   unsurprisingly picked the latter option.

   The 1970s are a key time in modern capitalism. In comparison to the two
   previous decades, it suffered from high unemployment and high inflation
   rates (the term stagflation is usually used to describe this). This
   crisis was reflected in mass strikes and protests across the world.
   Economic crisis returned, with the state interventions that for so long
   kept capitalism healthy either being ineffective or making the crisis
   worse. In other words, a combination of social struggle and a lack of
   surplus value available to capital resulted in the breakdown of the
   successful post-war consensus. Both subjected the "Bastard
   Keynesianism" of the post-war period to serious political and
   ideological challenges. This lead to a rise in neo-classical economic
   ideology and the advocating of free(r) market capitalism as the
   solution to capitalism's problems. This challenge took, in the main,
   the form of Milton Friedman's Monetarism.

   The roots and legacy of this breakdown in Keynesianism are informative
   and worth analysing. The post-war period marked a distinct change for
   capitalism, with new, higher levels of state intervention. The mix of
   intervention obviously differed from country to country, based upon the
   needs and ideologies of the ruling parties and social elites as well as
   the impact of social movements and protests. In Europe, nationalisation
   was widespread as inefficient capital was taken over by the state and
   reinvigorated by state funding while social spending was more important
   as Social Democratic parties attempted to introduce reforms. Chomsky
   describes the process in the USA:

     "Business leaders recognised that social spending could stimulate
     the economy, but much preferred the military Keynesian alternative
     -- for reasons having to do with privilege and power, not 'economic
     rationality.' This approach was adopted at once, the Cold War
     serving as the justification. . . . The Pentagon system was
     considered ideal for these purposes. It extends well beyond the
     military establishment, incorporating also the Department of Energy.
     . . and the space agency NASA, converted by the Kennedy
     administration to a significant component of the state-directed
     public subsidy to advanced industry. These arrangements impose on
     the public a large burden of the costs of industry (research and
     development, R&D) and provide a guaranteed market for excess
     production, a useful cushion for management decisions. Furthermore,
     this form of industrial policy does not have the undesirable
     side-effects of social spending directed to human needs. Apart from
     unwelcome redistributive effects, the latter policies tend to
     interfere with managerial prerogatives; useful production may
     undercut private gain, while state-subsidised waste production. . .
     is a gift to the owner and manager, to whom any marketable spin-offs
     will be promptly delivered. Social spending may also arouse public
     interest and participation, thus enhancing the threat of democracy.
     . . The defects of social spending do not taint the military
     Keynesian alternative. For such reasons, Business Week explained,
     'there's a tremendous social and economic difference between welfare
     pump-priming and military pump-priming,' the latter being far
     preferable." [World Orders, Old and New, pp. 100-1]

   Over time, social Keynesianism took increasing hold even in the USA,
   partly in response to working class struggle, partly due to the need
   for popular support at elections and partly due to "[p]opular
   opposition to the Vietnam war [which] prevented Washington from
   carrying out a national mobilisation . . . which might have made it
   possible to complete the conquest without harm to the domestic economy.
   Washington was forced to fight a 'guns-and-butter' war to placate the
   population, at considerable economic cost." [Chomsky, Op. Cit., pp.
   157-8]

   Social Keynesianism directs part of the total surplus value to workers
   and unemployed while military Keynesianism transfers surplus value from
   the general population to capital and from capital to capital. This
   allows R&D and capital to be publicly subsidised, as well as essential
   but unprofitable capital to survive. As long as real wages did not
   exceed a rise in productivity, Keynesianism would continue. However,
   both functions have objective limits as the transfer of profits from
   successful capital to essential, but less successful, or long term
   investment can cause a crisis is there is not enough profit available
   to the system as a whole. The surplus value producing capital, in this
   case, would be handicapped due to the transfers and cannot respond to
   economic problems as freely as before. This was compounded by the world
   becoming economically "tripolar," with a revitalised Europe and a
   Japan-based Asian region emerging as major economic forces. This placed
   the USA under increased pressure, as did the Vietnam War. Increased
   international competition meant the firms were limited in how they
   could adjust to the increased pressures they faced in the class
   struggle.

   This factor, class struggle, cannot be underestimated. In fact, the
   main reason for the 1970s breakdown was social struggle by working
   people. The only limit to the rate of growth required by Keynesianism
   to function is the degree to which final output consists of consumption
   goods for the presently employed population instead of investment. As
   long as wages rise in line with productivity, capitalism does well and
   firms invest (indeed, investment is the most basic means by which work,
   i.e. capitalist domination, is imposed). However, faced with a
   workforce which is able to increase its wages and resist the
   introduction of new technologies then capitalism will face a crisis.
   The net effect of full employment was the increased rebellious of the
   working class (both inside and outside the workplace). This struggle
   was directed against hierarchy in general, with workers, students,
   women, ethnic groups, anti-war protesters and the unemployed all
   organising successful struggles against authority. This struggle
   attacked the hierarchical core of capitalism as well as increasing the
   amount of income going to labour, resulting in a profit squeeze (see
   [14]section C.7). By the 1970s, capitalism and the state could no
   longer ensure that working class struggles could be contained within
   the system.

   This profits squeeze reflected the rise in inflation. While it has
   become commonplace to argue that Keynesianism did not predict the
   possibility of exploding inflation, this is not entirely true. While
   Keynes and the mainstream Keynesians failed to take into account the
   impact of full employment on class relations and power, his left-wing
   followers did not. Influenced by Michal Kalecki, the argued that full
   employment would impact on power at the point of production and,
   consequently, prices. To quote Joan Robinson from 1943:

     "The first function of unemployment (which has always existed in
     open or disguised forms) is that it maintains the authority of
     master over man. The master has normally been in a position to say:
     'If you don't want the job, there are plenty of others who do.' When
     the man can say: 'If you don't want to employ me, there are plenty
     of others who will', the situation is radically altered. One effect
     of such a change might be to remove a number of abuses to which the
     workers have been compelled to submit in the past . . . [Another is
     that] the absence of fear of unemployment might go further and have
     a disruptive effect upon factory discipline . . . [He may] us[e] his
     newly-found freedom from fear to snatch every advantage that he can
     . . .

     "The change in the workers' bargaining position which would follow
     from the abolition of unemployment would show itself in another and
     more subtle way. Unemployment . . . has not only the function of
     preserving discipline in industry, but also indirectly the function
     of preserving the value of money . . . there would be a constant
     upward pressure upon money wage-rates . . . the vicious spiral of
     wages and prices might become chronic . . . if it moved too fast, it
     might precipitate a violent inflation."
     [Collected Economic Papers, vol. 1, pp. 84-5]

   Thus left-wing Keynesians (who later founded the Post-Keynesian school
   of economics) recognised that capitalists "could recoup themselves for
   rising costs by raising prices." [Op. Cit., p. 85] This perspective was
   reflected in a watered-down fashion in mainstream economics by means of
   the Philips Curve. When first suggested in the 1958, this was taken to
   indicate a stable relationship between unemployment and inflation. As
   unemployment fell, inflation rose. This relationship fell apart in the
   1970s, as inflation rose as unemployment rose.

   Neo-classical (and other pro-"free market" capitalist) economics
   usually argues that inflation is purely a monetary phenomenon, the
   result of there being more money in circulation than is needed for the
   sale of the various commodities on the market. This was the position of
   Milton Friedman and his Monetarist school during the 1960s and 1970s.
   However, this is not true. In general, there is no relationship between
   the money supply and inflation. The amount of money can increase while
   the rate of inflation falls, for example (as we will discuss in the
   [15]next section, Monetarism itself ironically proved there is no
   relationship). Inflation has other roots, namely it is "an expression
   of inadequate profits that must be offset by price and money policies .
   . . Under any circumstances, inflation spells the need for higher
   profits." [Paul Mattick, Economics, Politics and the Age of Inflation,
   p. 19] Inflation leads to higher profits by making labour cheaper. That
   is, it reduces "the real wages of workers. . . [which] directly
   benefits employers. . . [as] prices rise faster than wages, income that
   would have gone to workers goes to business instead." [J. Brecher and
   T. Costello, Common Sense for Hard Times, p. 120]

   Inflation, in other words, is a symptom of an on-going struggle over
   income distribution between classes. It is caused when capitalist
   profit margins are reduced (for whatever reason, subjective or
   objective) and the bosses try to maintain them by increasing prices,
   i.e. by passing costs onto consumers. This means that it would be wrong
   to conclude that wage increases "cause" inflation as such. To do so
   ignores the fact that workers do not set prices, capitalists do. Any
   increase in costs could, after all, be absorbed by lowering profits.
   Instead working class people get denounced for being "greedy" and are
   subjected to calls for "restraint" -- in order for their bosses to make
   sufficient profits! As Joan Robinson put it, while capitalist economies
   denies it (unlike, significantly, Adam Smith) there is an "inflationary
   pressure that arises from an increase in the share of gross profits in
   gross income. How are workers to be asked to accept 'wage restraint'
   unless there is a restraint on profits? . . . unemployment is the
   problem. If it could be relived by tax cuts, generating purchasing
   power, would not a general cut in profit margins be still more
   effective? These are the questions that all the rigmarole about
   marginal productivity is designed to prevent us from discussing."
   [Collected Economic Papers, vol. 4, p. 134]

   Inflation and the response by the capitalist class to it, in their own
   ways, shows the hypocrisy of capitalism. After all, wages are
   increasing due to "natural" market forces of supply and demand. It is
   the capitalists who are trying to buck the market by refusing to accept
   lower profits caused by conditions on it. Obviously, to use Benjamin
   Tucker's expression, under capitalism market forces are good for the
   goose (labour) but bad for the gander (capital). The so-called "wages
   explosion" of the late 1960s was a symptom of this shift in class power
   away from capital and to labour which full employment had created. The
   growing expectations and aspirations of working class people led them
   not only to demand more of the goods they produced, it had start many
   questioning why social hierarchies were needed in the first place.
   Rather than accept this as a natural outcome of the eternal laws of
   supply and demand, the boss class used the state to create a more
   favourable labour market environment (as, it should be stressed, it has
   always done).

   This does not mean that inflation suits all capitalists equally (nor,
   obviously, does it suit those social layers who live on fixed incomes
   and who thus suffer when prices increase but such people are irrelevant
   in the eyes of capital). Far from it -- during periods of inflation,
   lenders tend to lose and borrowers tend to gain. The opposition to high
   levels of inflation by many supporters of capitalism is based upon this
   fact and the division within the capitalist class it indicates. There
   are two main groups of capitalists, finance capitalists and industrial
   capitalists. The latter can and do benefit from inflation (as indicated
   above) but the former sees high inflation as a threat. When inflation
   is accelerating it can push the real interest rate into negative
   territory and this is a horrifying prospect to those for whom interest
   income is fundamental (i.e. finance capital). In addition, high levels
   of inflation can also fuel social struggle, as workers and other
   sections of society try to keep their income at a steady level. As
   social struggle has a politicising effect on those involved, a
   condition of high inflation could have serious impacts on the political
   stability of capitalism and so cause problems for the ruling class.

   How inflation is viewed in the media and by governments is an
   expression of the relative strengths of the two sections of the
   capitalist class and of the level of class struggle within society. For
   example, in the 1970s, with the increased international mobility of
   capital, the balance of power came to rest with finance capital and
   inflation became the source of all evil. This shift of influence to
   finance capital can be seen from the rise of rentier income. The
   distribution of US manufacturing profits indicate this process --
   comparing the periods 1965-73 to 1990-96, we find that interest
   payments rose from 11% to 24%, dividend payments rose from 26% to 36%
   while retained earnings fell from 65% to 40%. Given that retained
   earnings are the most important source of investment funds, the rise of
   finance capital helps explain why, in contradiction to the claims of
   the right-wing, economic growth has become steadily worse as markets
   have been liberalised -- funds that could have been resulted in real
   investment have ended up in the finance machine. In addition, the waves
   of strikes and protests that inflation produced had worrying
   implications for the ruling class as they showed a working class able
   and willing to contest their power and, perhaps, start questioning why
   economic and social decisions were being made by a few rather than by
   those affected by them. However, as the underlying reasons for
   inflation remained (namely to increase profits) inflation itself was
   only reduced to acceptable levels, levels that ensured a positive real
   interest rate and acceptable profits.

   Thus, Keynesianism sowed the seeds of its own destruction. Full
   employment had altered the balance of power in the workplace and
   economy from capital to labour. The prediction of socialist economist
   Michal Kalecki that full employment would erode social discipline had
   become true (see [16]section B.4.4). Faced with rising direct and
   indirect costs due to this, firms passed them on to consumers. Yet
   consumers are also, usually, working class and this provoked more
   direct action to increase real wages in the face of inflation. Within
   the capitalist class, finance capital was increasing in strength at the
   expense of industrial capital. Facing the erosion of their loan income,
   states were subject to economic pressures to place fighting inflation
   above maintaining full employment. While Keynes had hoped that "the
   rentier aspect of capitalism [was] a transitional phase" and his ideas
   would lead to "the euthanasia of the rentier," finance capital was not
   so willing to see this happen. [The General Theory, p. 376] The 1970s
   saw the influence of an increasingly assertive finance capital rise at
   a time when significant numbers within ranks of industrial capitalists
   were sick of full employment and wanted compliant workers again. The
   resulting recessions may have harmed individual capitalists
   (particularly smaller ones) but the capitalist class as a whole did
   very well of them (and, as we noted in [17]section B.2, one of the
   roles of the state is to manage the system in the interests of the
   capitalist class as a whole and this can lead it into conflict with
   some members of that class). Thus the maintenance of sufficiently high
   unemployment under the mantra of fighting inflation as the de facto
   state policy from the 1980s onwards (see [18]section C.9). While
   industrial capital might want a slightly stronger economy and a
   slightly lower rate of unemployment than finance capital, the
   differences are not significant enough to inspire major conflict. After
   all, bosses in any industry "like slack in the labour market" as it
   "makes for a pliant workforce" and, of course, "many non-financial
   corporations have heavy financial interests." [Doug Henwood, Wall
   Street, pp. 123-4 and p. 135]

   It was these processes and pressures which came to a head in the 1970s.
   In other words, post-war Keynesianism failed simply because it could
   not, in the long term, stop the subjective and objective pressures
   which capitalism always faces. In the 1970s, it was the subjective
   pressure which played the key role, namely social struggle was the
   fundamental factor in economic developments. The system could not
   handle the struggle of human beings against the oppression,
   exploitation, hierarchy and alienation they are subject to under
   capitalism.

C.8.3 How did capitalism adjust to the crisis in Keynesianism?

   Basically by using, and then managing, the 1970s crisis to discipline
   the working class in order to reap increased profits and secure and
   extend the ruling classes' power. It did this using a combination of
   crisis, free(r) markets and adjusted Keynesianism as part of a ruling
   elite lead class war against labour.

   In the face of crisis in the 1970s, Keynesianist redirection of profits
   between capitals and classes had become a burden to capital as a whole
   and had increased the expectations and militancy of working people to
   dangerous levels. The crisis of the 1970s and early 1980s helped
   control working class power and unemployment was utilised as a means of
   saving capitalism and imposing the costs of free(r) markets onto
   society as whole. The policies implemented were ostensibly to combat
   high inflation. However, as left-wing economist Nicholas Kaldor
   summarised, inflation may have dropped but this lay "in their success
   in transforming the labour market from a twentieth-century sellers'
   market to a nineteenth-century buyers' market, with wholesome effects
   on factory discipline, wage claims, and proneness to strike." [The
   Scourge of Monetarism, p. xxiii] Another British economist described
   this policy memorably as "deliberately setting out to base the
   viability of the capitalist system on the maintenance of a large
   'industrial reserve army' [of the unemployed] . . . [it is] the incomes
   policy of Karl Marx." [Thomas Balogh, The Irrelevance of Conventional
   Economics, pp. 177-8] The aim, in summary, was to swing the balance of
   social, economic and political power back to capital and ensure the
   road to (private) serfdom was followed. The rationale was fighting
   inflation.

   Initially the crisis was used to justify attacks on working class
   people in the name of the free market. And, indeed, capitalism was made
   more market based, although with a "safety net" and "welfare state" for
   the wealthy. We have seen a partial return to "what economists have
   called freedom of industry and commerce, but which really meant the
   relieving of industry from the harassing and repressive supervision of
   the State, and the giving to it full liberty to exploit the worker,
   whom was still to be deprived of his freedom." The "crisis of
   democracy" which so haunted the ruling class in the 1960s and 1970s was
   overcome and replaced with, to use Kropotkin's words, the "liberty to
   exploit human labour without any safeguard for the victims of such
   exploitation and the political power organised as to assure freedom of
   exploitation to the middle-class." [Kropotkin, The Great French
   Revolution, vol.1, p. 28 and p. 30]

   Fighting inflation, in other words, was simply code used by the ruling
   class for fighting the class war and putting the working class back in
   its place in the social hierarchy. "Behind the economic concept of
   inflation was a fear among elites that they were losing control" as the
   "sting of unemployment was lessened and workers became progressively
   less docile." [Doug Henwood, After the New Economy, p. 204] Milton
   Friedman's Monetarism was the means by which this was achieved. While
   (deservedly) mostly forgotten now, Monetarism was very popular in the
   1970s and was the economic ideology of choice of both Reagan and
   Thatcher. This was the economic justification for the restructuring of
   capitalism and the end of social Keynesianism. Its legacy remains to
   some degree in the overriding concern over inflation which haunts the
   world's central banks and other financial institutions, but its
   specific policy recommendations have been dropped in practice after
   failing spectacularly when applied (a fact which, strangely, was not
   mentioned in the eulogies from the right that marked Friedman's death).

   According to Monetarism, the problem with capitalism was money related,
   namely that the state and its central bank printed too much money and,
   therefore, its issue should be controlled. Friedman stressed, like most
   capitalist economists, that monetary factors are the most important
   feature in explaining such problems of capitalism as the business
   cycle, inflation and so on. This is unsurprising, as it has the useful
   ideological effect of acquitting the inner-workings of capitalism of
   any involvement in such developments. Slumps, for example, may occur,
   but they are the fault of the state interfering in the economy.
   Inflation was a purely monetary phenomenon caused by the state printing
   more money than required by the growth of economic activity (for
   example, if the economy grew by 2% but the money supply increased by
   5%, inflation would rise by 3%). This analysis of inflation is deeply
   flawed, as we will see. This was how Friedman explained the Great
   Depression of the 1930s in the USA, for example (see, for example, his
   "The Role of Monetary Policy" [American Economic Review, Vol. 68, No.
   1, pp. 1-17]).

   Thus Monetarists argued for controlling the money supply, of placing
   the state under a "monetary constitution" which ensured that the
   central banks be required by law to increase the quantity of money at a
   constant rate of 3-5% a year. This would ensure that inflation would be
   banished, the economy would adjust to its natural equilibrium, the
   business cycle would become mild (if not disappear) and capitalism
   would finally work as predicted in the economics textbooks. With the
   "monetary constitution" money would become "depoliticised" and state
   influence and control over money would be eliminated. Money would go
   back to being what it is in neo-classical theory, essentially neutral,
   a link between production and consumption and capable of no mischief on
   its own. Hence the need for a "legislated rule" which would control
   "the behaviour of the stock of money" by "instructing the monetary
   authority to achieve a specified rate of growth in the stock of money."
   [Capitalism and Freedom, p. 54]

   Unfortunately for Monetarism, its analysis was simply wrong. It cannot
   be stressed enough how deeply flawed and ideological Friedman's
   arguments were. As one critique noted, his assumptions have "been shown
   to be fallacious and the empirical evidence questionable if not totally
   misinterpreted." Moreover, "none of the assumptions which Friedman made
   to reach his extraordinary conclusions bears any relation to reality.
   They were chosen precisely because they led to the desired conclusion,
   that inflation is a purely monetary phenomenon, originating solely in
   excess monetary demand." [Thomas Balogh, Op. Cit., p. 165 and p. 167]
   For Kaldor, Friedman's claims that empirical evidence supported his
   ideology were false. "Friedman's assertions lack[ed] any factual
   foundation whatsoever." He stressed, "They ha[d] no basis in fact, and
   he seems to me have invented them on the spur of the moment." [Op.
   Cit., p. 26] There was no relationship between the money supply and
   inflation.

   Even more unfortunately for both the theory and (far more importantly)
   vast numbers of working class people, it was proven wrong not only
   theoretically but also empirically. Monetarism was imposed on both the
   USA and the UK in the early 1980s, with disastrous results. As the
   Thatcher government in 1979 applied Monetarist dogma the most
   whole-heartedly we will concentrate on that regime (the same basic
   things occurred under Reagan as well but he embraced military
   Keynesianism sooner and so mitigated its worse effects. [Michael
   Stewart, Keynes and After, p. 181] This did not stop the right
   proclaiming the Reagan boom as validation of "free market" economics!).

   Firstly, the attempt to control the money supply failed, as predicted
   by Nicholas Kaldor (see his 1970 essay "The New Monetarism"). This is
   because the money supply, rather than being set by the central bank or
   the state (as Friedman claimed), is a function of the demand for
   credit, which is itself a function of economic activity. To use
   economic terminology, Friedman had assumed that the money supply was
   "exogenous" and so determined outside the economy by the state when, in
   fact, it is "endogenous" in nature (i.e. comes from within the
   economy). [The Essential Kaldor, p. 483] This means that any attempt by
   the central bank to control the money supply, as desired by Friedman,
   will fail.

   The experience of the Thatcher and Reagan regimes indicates this well.
   The Thatcher government could not meet the money controls it set. It
   took until 1986 before the Tory government stopped announcing monetary
   targets, persuaded no doubt by the embarrassment caused by its
   inability to hit them. In addition, the variations in the money supply
   showed that Friedman's argument on what caused inflation was also
   wrong. According to his theory, inflation was caused by the money
   supply increasing faster than the economy, yet inflation fell as the
   money supply increased. Between 1979 and 1981-2, its growth rose and
   was still higher in 1982-3 than it had been in 1978-9 yet inflation was
   down to 4.6% in 1983. As the moderate conservative MP Ian Gilmore
   pointed out, "[h]ad Friedmanite monetarism. . . been right, inflation
   would have been about 16 per cent in 1982-3, 11 per cent in 1983-4, and
   8 per cent in 1984-5. In fact . . . in the relevant years it never
   approached the levels infallibly predicted by monetarist doctrine."
   [Ian Gilmore, Dancing With Dogma, p. 57 and pp. 62-3] So, as Henwood
   summarises, "even the periods of recession and recovery disprove
   monetarist dogma." [Wall Street, p. 202]

   However, the failed attempt to control the money supply had other, more
   important effects, namely exploding interest and unemployment rates.
   Being unable to control the supply of money, the government did the
   next best thing: it tried to control the demand for money by rising
   interest rates. Unfortunately for the Tories their preferred measure
   for the money supply included interest-bearing bank deposits. This
   meant, as the government raised interest rates in its attempts to
   control the money supply, it was profitable for people to put more
   money on deposit. Thus the rise in interest rates promoted people to
   put money in the bank, so increasing the particular measure of the
   money supply the government sought to control which, in turn, lead them
   to increase interest rates. [Michael Stewart, Keynes in the 1990s, p.
   50]

   The exploding interest rates used in a vain attempt to control the
   money supply was the last thing Britain needed in the early 1980s. The
   economy was already sliding into recession and government attempts to
   control the money supply deepened it. While Milton Friedman predicted
   "only a modest reduction in output and employment" as a "side effect of
   reducing inflation to single figures by 1982," in fact Britain
   experienced its deepest recession since the 1930s. [quoted by Michael
   Stewart, Keynes and After, p. 179] As Michael Stewart dryly notes, it
   "would be difficult to find an economic prediction that that proved
   more comprehensively inaccurate." Unemployment rose from around 5% in
   1979 to 13% in the middle of 1985 (and would have been even higher but
   for a change in the method used for measuring it, a change implemented
   to knock numbers off of this disgraceful figure). In 1984 manufacturing
   output was still 10% lower than it had been in 1979. [Op. Cit., p. 180]
   Little wonder Kaldor stated that Monetarism was "a terrible curse, a
   visitation of evil spirits, with particularly unfortunate, one could
   almost say devastating, effects on" Britain. ["The Origins of the New
   Monetarism," pp. 160-177, Further Essays on Economic Theory and Policy,
   p. 160]

   Eventually, inflation did fall. From an anarchist perspective, however,
   this fall in inflation was the result of the high unemployment of this
   period as it weakened labour, so allowing profits to be made in
   production rather than in circulation (see [19]last section for this
   aspect of inflation). With no need for capitalists to maintain their
   profits via price increases, inflation would naturally decrease as
   labour's bargaining position was weakened by the fear mass unemployment
   produced in the workforce. Rather than being a purely monetary
   phenomena as Friedman claimed, inflation was a product of the profit
   needs of capital and the state of the class struggle. The net effect of
   the deep recession of the early 1980s and mass unemployment during the
   1980s (and 1990s) was to control working class people by putting the
   fear of being fired back. The money supply had nothing to do with it
   and attempts to control it would, of necessity, fail and the only tool
   available to governments would be raising interest rates. This would
   reduce inflation only by depressing investment, generating
   unemployment, and so (eventually) slowing the growth in wages as
   workers bear the brunt of the recessions by lowering their real income
   (i.e., paying higher prices on the same wages). Which is what happened
   in the 1980s.

   It is also of interest to note that even in Friedman's own test case of
   his basic contention, the Great Depression of 1929-33, he got it wrong.
   For Friedman, the "fact is that the Great Depression, like most other
   periods of severe unemployment, was produced by government
   mismanagement rather than by any inherent instability of the private
   economy." [Op. Cit., p. 54] Kaldor pointed out that "[a]ccording to
   Friedman's own figures, the amount of 'high-powered money'. . . in the
   US increased, not decreased, throughout the Great Contraction: in July
   1932, it was more than 10 per cent higher than in July, 1929 . . . The
   Great Contraction of the money supply . . . occurred despite this
   increase in the monetary base." ["The New Monetarism", The Essential
   Kaldor, pp. 487-8] Other economists also investigated Friedman's
   claims, with similar result. Peter Temin, for example, critiqued them
   from a Keynesian point of view, asking whether the decline in spending
   resulted from a decline in the money supply or the other way round. He
   noted that while the Monetarist "narrative is long and complex" it
   "offers far less support for [its] assertions than appears at first. In
   fact, it assumes the conclusion and describes the Depression in terms
   of it; it does not test or prove it at all." He examined the changes in
   the real money balances and found that they increased between 1929 and
   1931 from between 1 and 18% (depending on choice of money aggregate
   used and how it was deflated). Overall, the money supply not only did
   not decline but actually increased 5% between August 1929 and August
   1931. Temin concluded that there is no evidence that money caused the
   depression after the stock market crash. [Did Monetary Forces Cause the
   Great Depression?, pp. 15-6 and p. 141]

   There is, of course, a slight irony about Friedman's account of the
   Great Depression. Friedman suggested that the Federal Reserve actually
   caused the Great Depression, that it was in some sense a demonstration
   of the evils of government intervention. In his view, the US monetary
   authorities followed highly deflationary policies and so the money
   supply fell because they forced or permitted a sharp reduction in the
   monetary base. In other words, because they failed to exercise the
   responsibilities assigned to them. This is the core of his argument.
   Yet it is important to stress that by this he did not, in fact, mean
   that it happened because the government had intervened in the market.
   Ironically, Friedman argued it happened because the government did not
   intervene fast or far enough thus making a bad situation much worse. In
   other words, it was not interventionist enough!

   This self-contradictory argument arises because Friedman was an
   ideologue for capitalism and so sought to show that it was a stable
   system, to exempt capitalism from any systemic responsibility for
   recessions. That he ended up arguing that the state caused the Great
   Depression by doing nothing (which, ironically, was what Friedman
   usually argued it should do) just shows the power of ideology over
   logic or facts. Its fleeting popularity was due to its utility in the
   class war for the ruling class at that time. Given the absolute failure
   of Monetarism, in both theory and practice, it is little talked about
   now. That in the 1970s it was the leading economic dogma of the right
   explains why this is the case. Given that the right usually likes to
   portray itself as being strong on the economy it is useful to indicate
   that this is not the case -- unless you think causing the deepest
   recessions since the 1930s in order to create conditions where working
   class people are put in their place so the rich get richer is your
   definition of sound economic policy. As Doug Henwood summarises, there
   "can be no doubt that monetarism . . . throughout the world from the
   Chilean coup onward, has been an important part of a conscious policy
   to crush labour and redistribute income and power toward capital."
   [Wall Street, pp. 201-2]

   For more on Monetarism, the work of its greatest critic, Nicholas
   Kaldor, is essential reading (see for example, "Origins of the new
   Monetarism" and "How Monetarism Failed" in Further Essays on Economic
   Theory and Policy, "The New Monetarism" in The Essential Kaldor and The
   Scourge of Monetarism).

   So under the rhetoric of "free market" capitalism, Keynesianism was
   used to manage the crisis as it had previously managed the prosperity.
   "Supply Side" economics (combined with neo-classical dogma) was used to
   undercut working class power and consumption and so allow capital to
   reap more profits off working class people by a combination of reduced
   regulation for the capitalist class and state intervention to control
   the working class. Unemployment was used to discipline a militant
   workforce and as a means of getting workers to struggle for work
   instead of against wage labour. With the fear of job loss hanging over
   their heads, workers put up with speedups, longer hours, worse
   conditions and lower wages and this increased the profits that could be
   extracted directly from workers as well as reducing business costs by
   allowing employers to reduce on-job safety and protection and so on.
   The labour "market" was fragmented to a large degree into powerless,
   atomised units with unions fighting a losing battle in the face of a
   recession made much worse by government policy (and justified by
   economic ideology). In this way capitalism could successfully change
   the composition of demand from the working class to capital.

   Needless to say, we still living under the legacy of this process. As
   we indicated in [20]section C.3, there has been a significant shift in
   income from labour to capital in the USA. The same holds true in the
   UK, as does rising inequality and higher rates of poverty. While the
   economy is doing well for the few, the many are finding it harder to
   make ends meet and, as a result, are working harder for longer and
   getting into debt to maintain their income levels (in a sense, it could
   be argued that aggregate demand management has been partially
   privatised as so many working class people are in debt). Unsurprisingly
   70% of the recent gain in per capita income in the Reagan-Bush years
   went to the top 1% of income earners (while the bottom lost
   absolutely). Income inequality increased, with the income of the bottom
   fifth of the US population falling by 18% while that of the richest
   fifth rose by 8%. [Noam Chomsky, World Orders, Old and New, p. 141]
   Combined with bubbles in stocks and housing, the illusion of a good
   economy is maintained while only those at the top are doing well (see
   [21]section B.7 on rising inequality). This disciplining of the working
   class has been successful, resulting in the benefits of rising
   productivity and growth going to the elite. Unemployment and
   underemployment are still widespread, with most newly created jobs
   being part-time and insecure.

   Indirect means of increasing capital's share in the social income were
   also used, such as reducing environment regulations, so externalising
   pollution costs onto current and future generations. In Britain, state
   owned monopolies were privatised at knock-down prices allowing private
   capital to increase its resources at a fraction of the real cost.
   Indeed, some nationalised industries were privatised as monopolies for
   a period allowing monopoly profits to be extracted from consumers
   before the state allowed competition in those markets. Indirect
   taxation also increased, reducing working class consumption by getting
   us to foot the bill for capitalist restructuring as well as
   military-style Keynesianism. Internationally, the exploitation of
   under-developed nations increased with $418 billion being transferred
   to the developed world between 1982 and 1990 [Chomsky, Op. Cit., p.
   130] Capital also became increasingly international in scope, as it
   used advances in technology to move capital to third world countries
   where state repression ensured a less militant working class. This
   transfer had the advantage of increasing unemployment in the developed
   world, so placing more pressures upon working class resistance.

   This policy of capital-led class war, a response to the successful
   working class struggles of the 1960s and 1970s, obviously reaped the
   benefits it was intended to for capital. Income going to capital has
   increased and that going to labour has declined and the "labour market"
   has been disciplined to a large degree (but not totally we must add).
   Working people have been turned, to a large degree, from participants
   into spectators, as required for any hierarchical system. The human
   impact of these policies cannot be calculated. Little wonder, then, the
   utility of neo-classical dogma to the elite -- it could be used by
   rich, powerful people to justify the fact that they are pursuing social
   policies that create poverty and force children to die. As Chomsky
   argues, "one aspect of the internationalisation of the economy is the
   extension of the two-tiered Third World mode to the core countries.
   Market doctrine thus becomes an essential ideological weapon at home as
   well, its highly selective application safely obscured by the doctrinal
   system. Wealth and power are increasingly concentrated. Service for the
   general public - education, health, transportation, libraries, etc. --
   become as superfluous as those they serve, and can therefore be limited
   or dispensed with entirely." [Year 501, p. 109]

   The state managed recession has had its successes. Company profits are
   up as the "competitive cost" of workers is reduced due to fear of job
   losses. The Wall Street Journal's review of economic performance for
   the last quarter of 1995 is headlined "Companies' Profits Surged 61% on
   Higher Prices, Cost Cuts." After-tax profits rose 62% from 1993, up
   from 34% for the third quarter. While working America faces stagnant
   wages, Corporate America posted record profits in 1994. Business Week
   estimated 1994 profits to be up "an enormous 41% over [1993]," despite
   a bare 9% increase in sales, a "colossal success," resulting in large
   part from a "sharp" drop in the "share going to labour," though
   "economists say labour will benefit -- eventually." [quoted by Noam
   Chomsky, "Rollback III", Z Magazine, April 1995] Labour was still
   waiting over a decade later.

   Moreover, for capital, Keynesianism is still goes on as before,
   combined (as usual) with praises to market miracles. For example,
   Michael Borrus, co-director of the Berkeley Roundtable on the
   International Economy (a corporate-funded trade and technology research
   institute), cites a 1988 Department of Commerce study that states that
   "five of the top six fastest growing U.S. industries from 1972 to 1988
   were sponsored or sustained, directly or indirectly, by federal
   investment." He goes on to state that the "winners [in earlier years
   were] computers, biotechnology, jet engines, and airframes" all "the
   by-product of public spending." [quoted by Chomsky, World Orders, Old
   and New, p. 109] As James Midgley points out, "the aggregate size of
   the public sector did not decrease during the 1980s and instead,
   budgetary policy resulted in a significant shift in existing
   allocations from social to military and law enforcement." ["The radical
   right, politics and society", The Radical Right and the Welfare State,
   Howard Glennerster and James Midgley (eds.), p. 11] Indeed, the US
   state funds one third of all civil R&D projects, and the UK state
   provides a similar subsidy. [Chomsky, Op. Cit., p. 107] And, of course,
   the state remains waiting to save the elite from their own market
   follies (for example, after the widespread collapse of Savings and
   Loans Associations in deregulated corruption and speculation, the 1980s
   pro-"free market" Republican administration happily bailed them out,
   showing that market forces were only for one class).

   The corporate owned media attacks social Keynesianism, while remaining
   silent or justifying pro-business state intervention. Combined with
   extensive corporate funding of right-wing "think-tanks" which explain
   why (the wrong sort of) social programmes are counter-productive, the
   corporate state system tries to fool the population into thinking that
   there is no alternative to the rule by the market while the elite
   enrich themselves at the public's expense. This means that state
   intervention has not ended as such. We are still in the age of Keynes,
   but social Keynesianism has been replaced by military Keynesianism
   cloaked beneath the rhetoric of "free market" dogma. This is a mix of
   free(r) markets (for the many) and varying degrees of state
   intervention (for the select few), while the state has become stronger
   and more centralised ("prisons also offer a Keynesian stimulus to the
   economy, both to the construction business and white collar employment;
   the fastest growing profession is reported to be security personnel."
   [Chomsky, Year 501, p. 110]). In other words, pretty much the same
   situation that has existed since the dawn of capitalism (see
   [22]section D.1) -- free(r) markets supported by ready use of state
   power as and when required.

   The continued role of the state means that it is unlikely that a repeat
   of the Great Depression is possible. The large size of state
   consumption means that it stabilises aggregate demand to a degree
   unknown in 1929 or in the 19th century period of free(r) market
   capitalism. This is not to suggest that deep recessions will not happen
   (they have and will). It is simply to suggest that they will not turn
   into a deep depression. Unless, of course, ideologues who believe the
   "just-so" stories of economic textbooks and the gurus of capitalism
   gain political office and start to dismantle too much of the modern
   state. As Thatcher showed in 1979, it is possible to deepen recessions
   considerably if you subscribe to flawed economic theory (ideology would
   be a better word) and do not care about the impact it is having on the
   general public -- and, more importantly, if the general public cannot
   stop you).

   However, as we discuss in [23]section C.10 the net effect of this
   one-sided class war has not been as good as has been suggested by the
   ideologues of capitalism and the media. Faced with the re-imposition of
   hierarchy, the quality of life for the majority has fallen
   (consumption, i.e. the quantity of life, may not but that is due to a
   combination of debt, increased hours at work and more family members
   taking jobs to make ends meet). This, in turn, has lead to a fetish
   over economic growth. As Joan Robinson put it in the 1970s when this
   process started the "economists have relapsed into the slogans of
   laisser faire -- what is profitable promotes growth; what is most
   profitable is best. But people have began to notice that the growth of
   statistical GNP is not the same thing as an increase in welfare."
   [Collected Economic Papers, vol. 4, p. 128] Yet even here, the
   post-1970s experience is not great. A quarter century of top heavy
   growth in which the vast majority of economic gains have gone to the
   richest 10% of the population has not produced the rate of GDP growth
   promised for it. In fact, the key stimulus for growth in the 1990s and
   2000s was bubbles, first in the stock market and then in the housing
   market. Moreover, rising personal debt has bolstered the economy in a
   manner which are as unsustainable as the stock and housing bubbles
   which, in part, supported it. How long the system will stagger on
   depends, ultimately, on how long working class people will put up with
   it and having to pay the costs inflicted onto society and the
   environment in the pursuit of increasing the wealth of the few.

   While working class resistance continues, it is largely defensive, but,
   as in the past, this can and will change. Even the darkest night ends
   with the dawn and the lights of working class resistance can be seen
   across the globe. For example, the anti-Poll Tax struggle in Britain
   against the Thatcher Government was successful as have been many
   anti-cuts struggles across the USA and Western Europe, the Zapatista
   uprising in Mexico was inspiring as was the Argentine revolt against
   neo-liberalism and its wave of popular assemblies and occupied
   workplaces. In France, the anti-CPE protests showed a new generation of
   working class people know not only how to protest but also nonsense
   when they hear it. In general, there has been continual strikes and
   protests across the world. Even in the face of state repression and
   managed economic recession, working class people are still fighting
   back. The job for anarchists to is encourage these sparks of liberty
   and help them win.

References

   1. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC7.html
   2. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC7.html#secc71
   3. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC7.html#secc73
   4. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC7.html#secc72
   5. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC2.html#secc26
   6. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC8.html#secc81
   7. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC1.html#secc16
   8. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC8.html#secc83
   9. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC5.html#secc15
  10. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC9.html#secc91
  11. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC7.html
  12. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC8.html#secc82
  13. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC8.html#secc81
  14. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC7.html
  15. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC8.html#secc83
  16. file://localhost/home/mauro/baku/debianize/maint/anarchy/secB4.html#secb44
  17. file://localhost/home/mauro/baku/debianize/maint/anarchy/secB2.html
  18. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC9.html
  19. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC8.html#secc82
  20. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC3.html
  21. file://localhost/home/mauro/baku/debianize/maint/anarchy/secB7.html
  22. file://localhost/home/mauro/baku/debianize/maint/anarchy/secD1.html
  23. file://localhost/home/mauro/baku/debianize/maint/anarchy/secC10.html
