Gold Continues To Point The Way

The price of Gold has hit another new high today reaching $1057 an ounce. Two years ago I explained in my blog Gold – Why Its Price Is Soaring the background to the rise in the Gold Price that has been occurring since 1999. The statement there,

“When the price of gold moves up sharply like this, it is an indication tht deep within the bowels of the capitalist economy something is stirring, and its usually not something good”,

was rather prescient as this was the time we know now that the Credit Crunch actually began, which resulted in the collapse of Northern Rock, and which a year later broke out in the worst financial crisis in history!

There is a fundamental reason for the rise in the Gold price rooted in Marxist Economic Theory, and explained by Long Wave Theory. Marx explains the way Exchange Value develops, theoretically and historically. The Exchange Value of commodities, in economies before the domination of Capitalism proper – so called Generalised Commodity Production – is determined by the amount of socially necessary labour for their production.

See: Historical Proofs and Origins of Value.

As a result of what Marx calls Commodity Fetishisation, the real economic relationship, the relationship between human beings, and their expenditure of Labour Power, is hidden behind a façade of the relationship between things, so that we actually view the value of a commodity in terms of how much a exchanges for b. In reality there are a multitude of commodities in an economy each exchanging with each other, but in reality all hiding the relationship of different amounts of socially necessary labour-time continually being equated and measured through the process of exchange on the market.

If we think of just a small number of commodities then we might see something like.

10 yds of linen = 100 tons of cotton.
100 tons of cotton = 1 suit
1 suit = 1 ton of potatoes.

Seeing these relationships, and understanding that they are not just accidental, but reflect and objective measurement of value – that is the amount of necessary social labour-time each requires for its production, we can in fact make further statements. We can say,

10 yds of linen = 100 tons of cotton
10 yds of linen = 1 suit
10 yds of linen = 1 ton of potatoes.

One of the first subjectivist economists Samuel Bailey did not believe that it was possible to make such statements. He believed that there was no objective basis of the relationship of one commodity to another, and that the amount of one that exchanged for another was purely a subjective matter of how much at any one time those exchanging them were prepared to accept. There could then be no standard of value, because value was continually fluctuating with each exchange.

Marx showed what was wrong with this idea. He said that all this theory did was to push the vital question one step back. If A was prepared to exchange 10 units of X, for 20 units of Y, then even if we believe that this is a purely subjective value judgement, a scientist has to ask what the basis of this judgement are. What factors does A take into consideration in arriving at this valuation?

But, it is precisely because each commodity does have an Exchange Value determined by the amount of socially necessary labour-time it contains that allows each commodity to be brought into a quantitative relationship with every other commodity. This is what Marx terms the Value Form. The Exchange Value of one commodity is always expressed in terms of a certain quantity of some other Use Value. The first term in the equation is always the Exchange Value, and the second term is always the measure of that exchange Value in terms of another Use Value. This has significant importance.

“If all commodities except one increase in value because they cost more labour-time than they did before, smaller amounts of these commodities will be exchanged for the single commodity whose labour-time remains unchanged. Its exchange-value, insofar as it is realised in other commodities—that is, its exchange-value expressed in the use-values of all other commodities—has been reduced. “Would you then say that the value of that one is unaltered?” This is merely a formulation of the point at issue, and it calls neither for a positive nor for a negative reply. The same result would occur if the labour-time required for the production of the one commodity were reduced and that of all the others remained unchanged. A given quantity of this particular commodity would exchange for a reduced quantity of all the other commodities. The same phenomenon occurs in both cases although from directly opposite causes. Conversely, if the labour-time required for the production of commodity A remained unchanged, while that of all others were reduced, then it would exchange for larger amounts of all the other commodities. The same would happen for the opposite reason, if the labour-time required for the production of commodity A increased and that required for all other commodities remained unchanged. Thus, sometimes commodity A exchanges for smaller quantities of all the other commodities, and this for either of two different and opposite reasons. At other times it exchanges for larger quantities of all the other commodities, again for two different and opposite reasons. But it should be noted that it is assumed that it always exchanges at its value, consequently for an equivalent. It always realises its value in the quantity of use-values of the other commodities for which it exchanges, no matter how much the quantity of these use-values varies.”
See: Theories of Surplus Value .

An important result now flows because if we reverse the Value form set out above we will have.

100 tons of cotton = 10 yds of linen
1 suit = 10 yds of linen
1 ton of potatoes. = 10 yds of linen

We have now expressed the Exchange Values of the three commodities Cotton, Suits and Potatoes, in a certain quantity of a single Use Value Linen. If this Use Value we no longer take to be linen, but Gold, we have the genesis of a Money Commodity. We can say the price of 100 tons of cotton is 1 ounce of Gold, as is the price of 1 suit, or 1 ton of potatoes. Exchange Value has been transformed into price through the introduction of a Money Commodity, a Commodity, which through social intercourse as been agreed upon as one which is accepted in exchange for any other commodity.

But, if we then take Marx’s comments above we can see the basis for the fluctuations in prices. Prices of commodities could rise of fall either because the Labour-time required for their production increased or decreased, or conversely the same thing could result from an increase or decrease in the labour-time required for the production of the money commodity itself. And, in fact, history shows that where Gold formed the Money Commodity, prices certainly did move in accordance with such a principle. When Spain plundered the Gold of South America, and brought its hoard back to Spain, the effect was quickly to see a rise in Spanish prices. A similar pattern occurred when new Goldfields were opened up in California, which required much less expenditure of labour-time to produce a given quantity of Gold.

But, in his “A Contribution to the Critique of Political Economy”, Marx further explains the relationship. Where Gold is Money, that is prior to the introduction of paper fiat currencies how is the amount of money required determined?

This depends upon the amount of commodities being traded, their prices, and the relation of these prices to the value of the medium of circulation. The Economist July 10th 1858 gives the output of the mint as 1855 £9,245,000; 1856 £6,476,000; 1857 £5,298,858, and says that during 1858 the mint had scarcely anything to do. The different figures were due to the varying quantities of commodities in circulation in each year,

“Much will be manufactured when it is wanted; and little when little is wanted.”
(A Contribution to the Critique of Political Economy, Karl Marx p106.)

And in Holland, after the discovery of gold in California, its gold currency was replaced with silver currency which meant that 15 times more silver was required than gold. Although, the velocity of circulation of the medium of exchange will affect how much needs to be put into circulation, and different denominations circulating in different spheres will have different velocities – an increase in velocity reducing the amount and vice versa – changes in the velocity are determined by technical considerations, which mean that this does not have a marked effect in the short term. In short the quantity of gold or silver coins put into circulation is determined by the quantity of commodities to be circulated, and the relative values of those commodities. So, for example, after the discovery of new gold mines, the relative value of gold fell and consequently more had to be put into circulation.
Once in circulation coins made from precious metals soon begin to deteriorate either as a result of normal wear and tear or from clipping. This has caused some considerable problem and debate because it means that a contradiction arises between the coin as unit of account, and as medium of exchange. As unit of account a 1 oz. gold coin has a relative value as against other commodities based upon its weight. This value, as has been demonstrated, is based upon the labour time required to produce an ounce of gold, and the labour time required to produce the commodity against which it is being exchanged, say a bushel of wheat. But if the nominal value of this coin is set at 1 bushel of wheat, but as a result of clipping or wear and tear its weight is reduced to .8 ounces then clearly the actual value of the coin in gold is less and should in terms of its actual gold value only buy .8 bushels of wheat rather than 1. If the coin continues to purchase goods at its nominal value rather than the value of the gold it now contains then in effect the coin has become nothing more than a token for the nominal value of the gold it is supposed to represent. But despite the fact that these coins had become mere tokens whose actual value was much less than their nominal value they continued to circulate, which then provided the basis for replacing coins made from gold, and silver first with coins made from copper and other metals, and subsequently with paper. As Benjamin Franklin put it again,

“At this very time, even the silver money in England is obliged to the legal tender for part of its value; that part which is the difference between its real weight and its denomination. Great part of the shillings and sixpences now current are by wearing become 5,10, 20 and some sixpences even 50% too light. For this difference between the real and the nominal you have no intrinsic value; you have not so much as paper, you have nothing. It is legal tender with the knowledge that it can easily be repassed for the same value, that makes three pennyworth of silver pass for a sixpence.”

(Remarks and Facts Relative to the American Paper Money, 1764 p348)

The determining factor was not the actual metal value of the coin vis a vis its nominal value, but the quantity of coins put into circulation. Provided no increase in the coins, put into circulation, occurred the debased coins would continue to operate as tokens of the full value. The important point here is that it was not the coin, which constituted money, but the gold, which the token represented. The value of money i.e. gold (or silver if silver was the money commodity) remained the same provided its price of production did not vary, and consequently provided the coins issued as tokens representing this gold were not increased the value of the tokens would remain the same. If however the number of tokens (even gold tokens of less weight than their nominal value) was increased then the value of these tokens would be decreased proportionately. The Bank of England took action to ensure that coins of inadequate weight were withdrawn. By law a sovereign, which had lost more than 0.747 grains of weight ceased to be legal tender.

“When the decline of the metal content has affected a sufficient number of sovereigns to cause a permanent rise of the market price of gold over the mint price, the coins retain the same names of account but these henceforth stand for a smaller quantity of gold. In other words, the standard of money will be changed, and henceforth gold will be minted in accordance with this new standard. Thus, in consequence of its idealisation as a medium of circulation, gold in its turn will have changed the legally established relation in which it functioned as the standard of price. A similar revolution would be repeated after a certain period of time: gold both as the standard of price and the medium of circulation in this way being subject to continuous changes so that a change in the one aspect would cause a change in the other and vice versa.”

(A Contribution to the Critique of Political Economy, Karl Marx p110.)

"Thus the English pound sterling denotes less than one-third of its original weight, the pound Scots before the Union only 1/36, the French Livre 1/74, the Spanish Maravedi less than 1,000th, and the Portuguese Rei an even smaller proportion. Historical development thus led to a separation of the money names of certain weights of metals from the common names of these weights.” (ibid p72)

The inflation of prices does not arise as a result of an increase in the supply of money, but from an increase in the number of tokens circulating which represent money. A confusion exists because of the nature of theories concerning the determination of value, and because of a concentration on the role of money merely as a means of circulation. Suppose the value of gold remains constant i.e. its price of production does not change. More gold coins are put into circulation than are required to circulate the given amount of commodities in the economy at their given values. This increased money supply does not result in an inflation of prices because if it did the value of gold as a commodity would itself rise above the value of gold as medium of exchange – 1 ounce of gold would trade for more than a 1 ounce gold coin. This is because the value of gold both as commodity and as money is determined not by demand and supply (though its price may be in the short term) as the neo-classical school maintain, but by the labour time required for its production. A surplus of gold coins would consequently not result in an increase in the prices of other commodities, but in the surplus of those coins being withdrawn from circulation and hoarded as stores of value either in the form of coins, or by being melted down and sold as bullion. Ricardo who began by correctly defining the value of money in terms of its cost of production fell into this trap because he equated the total amount of gold with the total issue of currency forgetting that gold has a separate life as a commodity to that as coin. It is this separate life, which makes it different to paper.

Unfortunately, on the basis of Ricardo’s incorrect analysis and evidence to Parliament the 1844 Bank Acts were passed which exacerbated the crisis of 1858, and the crisis in its turn led to these Acts being suspended. The analysis of paper currency has been read back on to gold currency incorrectly so that the correct concept that an increase in tokens causes inflation has been interpreted as an increase in real money causes inflation. As Marx put it,

“It is thus evident that a person who restricts his studies of monetary circulation to an analysis of the circulation of paper money with a legal rate of exchange must misunderstand the inherent laws of monetary circulation. These laws indeed appear not only to be turned upside down in the circulation of tokens of value but even annulled; for the movements of paper money, when it is issued in the appropriate amount, are not characteristic of it as token of value, whereas its specific movements are due to infringements of its correct proportion to gold, and do not directly arise from the metamorphosis of commodities.”

(ibid p122)

Marx demonstrates what really happens with the issue of coins as opposed to paper money.

“Thus for example in England copper is legal tender for sums up to 6d. and silver for sums up to 40s. The issue of silver and copper tokens in quantities exceeding the requirements of their spheres of circulation would not lead to a rise in commodity prices but to the accumulation of these tokens in the hands of retail traders, who would in the end be forced to sell them as metal. In 1798, for instance, English copper coins to the amounts of £20, £30 and £50, spent by private people, had accumulated in the tills of shopkeepers and since their attempts to put the coins again into circulation failed, they finally had to sell them as metal on the copper market.”

(A Contribution to a Critique of Political Economy, Karl Marx p113)

“The circulation of commodities can absorb only a certain amount of gold currency, the alternating contraction and expansion of the volume of money in circulation manifesting itself accordingly as an inevitable law, whereas any amount of paper seems to be absorbed by circulation.”

(ibid p122)

“Gold circulates because it has value, whereas paper has value because it circulates. If the exchange value of commodities is given, the quantity of gold in circulation depends on its value, whereas the value of paper tokens depends on the number of tokens in circulation. The amount of gold in circulation increases or decreases with the rise or fall of commodity prices, whereas commodity prices seem to rise or fall with the changing amount of paper in circulation.” (ibid p121-2)

This latter point is the key. Now with Money in the form of paper and metal tokens, and indeed in the form of credit, the natural mechanisms that controlled the amount of money in circulation to what was required to circulate commodities do not exist. Whereas an excess of Gold coins would result in them being hoarded or exported or converted into bullion, because their Gold Value exceeded their mint value, no such thing exists with paper money tokens, because the paper is itself effectively worthless.

Whereas, an inadequate supply of money will result in the kind of crisis Marx describes above, and which we have just seen with the Credit Crunch, an over-supply of money will not necessarily result immediately in a rise in prices. A shortage of Money Supply will cause all the things we have just seen, people hoard cash, which forces up interest rates, payments cannot be made so economic activity grinds to a halt. Theoretically, if all prices fell in proportion then the amount of money tokens would be adequate, but it simply does not work that way precisely because of the dislocation caused. If the money supply remains constricted then before prices adjust downwards the immediate consequence is an economic crisis in which prices remain the same, but the number of commodities circulated declines.

And, as the current crisis has shown under such conditions, if the Money Supply is increased this does not necessarily result in a rise in prices immediately, or even in an increase in economic activity.

Just as Marx pointed out that the amount of real money put into circulation reflected the amount required, so the level of economic activity immediately determines the quantity of money tokens required. If more money than that is printed, the immediate consequence is that the velocity of circulation – the number of transactions that any particular piece of money performs – declines, as these money tokens simply sit as deposits in banks. This is the phenomena described by Keynes as being like pushing on a string. It is for this reason that under such circumstances, Government’s cannot rely simply on Monetary Policy, but require the additional use of Fiscal Policy – spending by the Government – to create a demand for this money, putting it to work in the economy, thereby creating additional aggregate demand that feeds through into demands for goods and services, and kickstarts the demand for money and credit from businesses and individuals.

But, as I pointed out in that original blog back in 2007, at that point, 8 years into a new Long Wave Boom, there was, in fact, plenty of economic activity, plenty of aggregate demand requiring this money. China was producing masses of consumer goods that were finding there way into western markets, asset price bubbles had lifted the prices of houses and shares etc. Economic activity in China and elsewhere had created an insatiable demand for food and primary products, which had already led to food shortages and record food price rises. In China itself wages were rising very rapidly, and the rising living standard was being reflected in a rising value of the RMB, in turn raising the prices of Chinese exports, and beginning to feed through into Western consumer prices. Even into 2008, prior to the onset of the financial crisis, Central Banks were raising interest rates to counteract rapidly rising inflation.

Gold had pointed the way to the underlying realities of the economy. This is fully consistent with Long Wave Theory. During the Long Wave decline a number of factors are at play. The price of primary products – foodstuffs, raw materials – declines. The reason is simple. In the Spring Phase of the cycle, demand rises quickly. Prices of these products rises as Supply is unable to match demand. There is a scrabble for exploration to find new sources of materials such as iron and copper and so on. But, it takes several years to conduct such exploration, and when new sources have been identified in areas where it is profitable to extract them, it then takes around 7 years to bring say a copper mine on stream. By the time production has fully got underway, around 12 years have elapsed from the beginning of the upswing. This reflects the peak for prices of primary products. But, the investment required for such production is vast. Producers have to continue production at fairly high levels even as demand begins to wane. The consequence is that prices fall, and production only declines slowly as producers simply cut back investment, and cease new developments – the reason that production cannot be quickly increased when the new Long Wave begins.

Gold is affected in two ways. Firstly, as the historic Money Commodity, demand for Gold declines as economic activity itself declines. But, as itself a primary product, its price of production is affected in the same way as any other mineral – the period since 1999 has seen massive exploration and development of new gold mines in Kazakhstan and central Asia alongside the development of new Copper mines for example. Both factors act to push the price of Gold down during the Long Wave downturn. Similarly, from 1999 the price of Gold has risen from a low of $250 an ounce to its current level of $1057 an ounce. But, Gold has other peculiarities. Unlike iron or copper, Gold cannot be destroyed. Every ounce of gold mined by Man sicne he first appeared on the planet remains in existence. That means that this huge store of Gold has a large affect on the current market price of Gold through the interplay of Supply and Demand. It is no surprise that there are now lots of firms advertising on TV for people to send them their Gold Jewellery in return for cash. The firms then make big profits by turning the Gold into bullion. The price is also susceptible to intervention by the authorities through sales of their huge reserves. In fact, some years ago there was considerable speculation that Governments were selling Gold to keep the price down as it began to rise rapidly, because a number of large financial institutions were dangerously exposed to a large rise in the price.

I made that rumour a part of the plot for my novel Revolution .

There are essentially two peaks in the Gold Price within the context of the Long Wave. The first Peak is a peak in the price of Gold in real terms, that is its price relative to all other commodities. In the last Long Wave the peak was reached in 1960 – 11 years after the Long Wave began in 1949. On that basis the corresponding peak should be reached next year. I anticipate that in today’s dollars Gold will reach $3,000 an ounce by the end of 2010.

But, there is a second peak, and that is a peak that arises due to the devaluation of paper currencies as against Gold. In a period of less than a decade the price of Gold rose from $30 an ounce to a high of $800 an ounce in 1980 – an almost 30 fold increase in price. That rise in price reflected the depreciation of the dollar and other paper currencies during that period, and the reassertion of the role of Gold as the true Money Commodity. It also led the US Government to make it illegal for US citizens to own Gold bullion! Were this Long Wave to follow the pattern of the previous one then this would mean Gold rising to around $7,500 an ounce by 2030.

However, this cycle is different. The 1950’s and 60’s did not see a huge expansion of money supply and credit in the same way that the last decade or so has seen a massive injection of liquidity. During that period it was not necessary. The US as the economic hegemon was growing strongly, and where it was injecting liquidity it was being immediately soaked up in investment in new productive capacity in the rebuilding of Europe under the Marshall Plan. In contrast, it has been the economic weakness of US Capitalism from the 1970’s onwards that has required constant injections of liquidity, not to finance investment and new productive capacity, but to finance US Consumption of foreign products! The same has been true of the UK, though less so for Western Europe. Japan has printed vast amounts of money, not finance its own consumption, but in order to keep the value of the Yen low in order to be able to continue to export its manufactures, without which its economy would have been in an even more dire condition than it has been for the last twenty years.

The combination is a heady mix. It means that as economic activity resumes, as the data show it is, the velocity of circulation, for this vast lake of liquidity swilling around the global economy will rise. Prices will begin to rise rapidly along with it.

That is what the rise in the price of Gold is telling us now. The latest data has shown that despite already raising interests rates, Australian employment has soared in the last period. It looks as though, this month will be the low point for UK inflation, and in fact, economists believe that UK inflation could rise so quickly that Mervyn King might have to write to the Chancellor as early as January to explain why inflation is above target. We might not suffer the kind of hyper inflation that was witnessed by the Weimar Republic, or by Argentina, and more recently by Zimbabwe that was similarly caused by an excessive printing of paper money, but a period of very high inflation is the inevitable consequence of increasing the Money Supply, and of the current practice of Quantitative Easing.

As I have pointed out before this is also the means by which every Government in history has cleared its debts to its creditors. It’s the reason the Tories are proposing a Pay Freeze, and the reason they have now said they will link Pensions to Earnings not prices. Workers have to be ready to respond by demanding that wages, pensions and benefits be linked via a sliding scale to a workers cost of living index calculated by committees of workers.